Market Talk with Piranha is currently moving to its new home at The new site is up and running but many of the posts need editing as the images and stock charts did not transfer successfully (thanks blogger). I will post all new entries to both blogs – Thank you for your patience while I make this change!

Thursday, September 01, 2005

Lessons Learned after 25 Years of Trading

Read this article carefully because it echoes much of philosophy and trading rules that we employ at MSW. One of the biggest rules that we follow is: Buy Near the Yearly High. Any member of this community can tell you that we love to follow and buy stocks making new highs or stocks within 10% of a new high. My experience has proven that stocks that make new highs usually continue to trade higher. Another subject that Bulkowski speaks about is: "Half of all Trades Will Fail". This is so important because it is so true.

I struggled with my losses early in my trading career and I hated losing because it tore me apart. I felt so good when I was right even more so than making the actually money (that may be hard to believe). I now understand that trading has nothing to do with winning and losing, and it has everything to do with profits and losses (money management). Some of the world’s best traders have a 30% or 40% win-loss ratio but they make large sums of money year in and year out. They cut losses short and let the few big winners run. If you only hit one or two big winners each year, you can have 5 or 10 small losers; it will always work in your favor. Making a mistake while investing is 100% nayural as long as you recognize that it is a mistake and you sell the stock immediately, no questions asked!

Understand that investing is NOT about winning and losing, it’s always about the bottom line. Once an investor accepts this statement as truth, they will see their bottom line grow. It took me several years to finally believe this statement and train my emotions to also believe it. As humans, society trains us to win at everything and this hurts most novice investors.

Bulkowski refers to two charts in this article but I do not have the images to upload here. The original article was published in this month's edition of SFO Magazine, a publication about Stocks, Futures & Options.

Enjoy the article:

Lessons Learned after 25 Years of Trading
by: Thomas N. Bulkowski

Profits lost can be lessons learned. Eight simple lessons taught by the greatest teacher of all – experience.

Trading stocks doesn’t require a college degree. A trader’s education may begin at a bookstore or be handed down from relatives. Even before I earned my driver’s license, I became interested in stocks. After college, I contacted two dozen investment firms and reviewed their prospectuses for my first investment: a money market fund. I paper traded stocks for four years before I bought my first one, mostly because I didn’t have the bucks to invest, but also because the riskiest investment my parents ever made was in a U.S. savings bond. The result was worth the wait as I made 88 percent on that first stock. Over the years, I learned a number of lessons worth sharing, and although simply reading them cannot prepare a trader for the profits and losses and the stress of placing trades, it’s certainly a start.

Half of All Trades Will Fail
This surprises most beginning traders. My lifetime win/loss record is 49 percent, and it falls in the 40-percent to 60-percent range that many professional traders are rumored to maintain. How often a trader wins or loses is less important than how much they win. If a trader makes a million dollars in one trade and loses $10,000 in each of ten trades, he still has $900,000 to play with despite a win/loss percentage of just nine percent.

Use Stops to Limit Losses
If half of all trades fail, then a trader needs to know how to limit losses and maximize gains. One easy way to do that is to use a stop-loss order. . I bought 400 shares of Linens ‘N Things at 31.75 after the earnings announcement caused the price to gap up, forming what I call an earnings flag – a generic term for a price pause after an earnings announcement. I sold at 35.20 when price pierced an up-sloping trendline drawn beneath the valleys, confirmed by other technical indicators I follow and a downward turn in the general market. I made $1,350 in a month – more than ten percent on the trade.

As price climbed, I raised my stop from 28 to 30.84, to 32.13 and finally to 33.23. Notice how the numbers are oddball ones, not 31, 32 or 33.25. I don’t use round numbers, as they are common support or resistance zones. I place my stops below the support zones, trying to give price every opportunity to move higher.

When price climbed above the prior peak and made a new high, I raised the stop to a few cents below the nearby valley. Peaks and valleys are places where price is likely to find support, so they make handy stop-loss locations.

Notice how price formed a second peak at 36 and change – a double top – before sliding down to 24. Holding onto this stock and riding price lower would have been a costly mistake. That’s why stops are so important.

Scenario Trading: Ignore News
I read the business press daily but don’t pay much attention to trends they see forming. I remember a columnist in a weekly news publication touting that gold was a buy. Once a month, he’d quote a different expert who said the price of gold had bottomed and now was the time to buy. Gold continued down. A full two years later, his prognostication finally came true. Gold bottomed. Anyone buying gold stocks during his bullish buy signals would be choking on the metal.

Scenario trading is believing the sound bites and trading on them. The times I have invested in a scenario, I find myself so confident of the analysis that I invariably lose big, taking losses that are 15 percent or higher instead of the usual five to ten percent. As price drops, I average down (buy more at a lower price), compounding the loss. Averaging down is a wonderful technique for buy-and-hold investors willing to wait years for a stock to recover, but it leads to large losses for traders. Don’t average down, and don’t believe the scenarios spun by the news outlets. The purchase may be near the peak, or from a portfolio manager who is dumping his shares.

Let Profits Run
Want to make a bundle in the stock market? Don’t trade. If a trader uses the weekly scale for signals, he will make more money per trade than if he uses the daily scale. If a trader uses the daily scale, he’ll make more money per trade than if he trades intraday. As the trading frequency increases, the per-trade profit decreases. This makes intuitive sense. A stock can double in a year, but a trader would be hard pressed to double his money in one intraday trade.

Day trading allows a trader to make small amounts of money numerous times in one day. Position trading allows a trader to make a larger amount of money, but it may take days, weeks or even months to achieve the results.

I’m not knocking day trading. What I am suggesting is that a trader should let profits run. Don’t be so quick to sell. Whether day trading, position trading or buying and holding, there will come a time when it will be wise to sell. Wait for it. Follow a few stocks, and get a feel for how they move. Learn to predict significant price turns.

Buy Near the Yearly High
When I started investing, I didn’t have much money to spend, so I bottom fished. I picked stocks between $5 and $20 per share because that’s all I could afford. I bought them as they bottomed – or so I hoped. Invariably, the price dropped lower. If I held on for years, the rewards would be handsome, usually well over 100 percent. Sometimes, though, I would panic and sell at the bottom, which resulted in losses of 50 to 70 percent – the kind of hit that makes any trader’s mouth pop open and leaves him gasping for air.

It took years to discover what I was doing wrong because I was making money and wasn’t that concerned. First, I wasn’t using stops. Second, I was buying near the low and holding on until the stock rebounded. What would happen if I bought near the yearly high?

Now I select stocks with breakouts from chart patterns within a third of the yearly high because my statistical analysis of chart patterns says that’s where they perform best. I especially like it when the breakout makes a new high. There is little overhead resistance to stop a price run-up. Upward momentum allows a trader to place a stop and raise it as prices rise. If price doesn’t rise within a few days, that’s a good clue that the trade will result in a loss. Consider selling immediately.

When a trader buys near the yearly low, the tendency is for price to continue down. The trader doesn’t have a chance to raise the stop to breakeven. Like trying to catch a falling knife, trying to call the bottom in a stock is very difficult, even for the experts. Buying near the bottom is tempting, but do it sparingly.

Use Trendlines as Sell Signals
Trendlines are one of my favorite tools. By definition, if prices are trending up and then drop below a trendline, the trend isn’t up any longer. But just because price drops below an up-sloping trendline doesn’t mean that price will continue moving down.

Victor Sperandeo in his book, Trader Vic – Methods of a Wall Street Master (Wiley, 1991), says there are three ingredients to determining a trend change from up to down: (1) price pierces an up-sloping trendline; (2) price approaches the level of a prior peak but fails to attain it (or overshoots a bit before dropping); and (3) price closes below a prior valley. He also describes the method for down-sloping trends following similar guidelines.

Do I use his method? Sometimes. When a stock’s price goes almost vertical, I move my stop closer and draw an up-sloping trendline. I know it’s time to sell when price closes below the trendline. Even if I am wrong, it doesn’t matter because I don’t own the stock anymore.

Trade with the Trend
Anyone who has ventured into a river for a dip will say that swimming with the current is a lot easier than swimming against it. The same is true for stocks. For the best performance, select stocks that are moving with the general market and industry trends. I use the S&P 500 or Nasdaq Composite as the proxy for the markets. For the industry, my portfolio of 350 stocks contains more than 30 different industries. I look at each stock in the same industry as the one I’m interested in trading to see how they are doing.

Recently I sold a stock because others in the industry were rounding over and starting to decline. I lost 4.6 percent on the trade, but that’s a small loss, considering. Time will tell if the call was a good one, but it won’t matter because I’ll be trading something else.

Develop a Feel for the Market
Every day I eat an apple. Since I’ve been eating apples for a long time, I can tell a good one from a bad one. I check for firmness, dents and color before I buy, trying to sense what’s beneath the surface. Trading stocks is like eating apples. A trader develops a feel for how the markets and the stocks are behaving.

On October 11, 2004, I bought 1,000 shares of JLG that filled at 16.43. I bought primarily because of the Fibonacci retrace of the prior rise. In other words, prices dropped from the peak at point A, almost 62 percent of the distance of the prior rise, DA. With the stock declining for three days in a row, I felt the end was near. I was correct and bought just two days before price turned at B. The stock rounded up, forming an ascending scallop chart pattern. As price climbed, I raised my stop twice.

On November 18, I sold my position and received a fill at 19.85. Why sell? The stock was approaching 20, which is usually a resistance zone. On the monthly scale, the price at 21 also was nearing the top of a right-angled and descending, broadening pattern. The pattern resembles a megaphone tilted so that the top of it is horizontal and the bottom slopes downward. With price trending upward, I felt that the stock needed a rest and the scallop would form a handle. I wanted to get out before price retraced its gain by forming the handle, so I sold at the market open. I made almost $3,400 or more than 20 percent in about a month.

The Longer You Trade, The “Luckier” You Can Become
Other traders followed my lead as the stock closed down over a buck or five percent on the day I sold. The next day, an earnings announcement sent the stock gapping lower to 15.56 before closing at 17.30. This was an almost perfect swing trade. I was lucky, sure, but it still surprises me how “lucky” I’ve been as my trading knowledge has grown over 25 years. Or perhaps the result could be described more accurately as 25 years of preparation meeting a market opportunity.


At 1:30 AM, Blogger aa said...



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