I thought I would post here what I posted elsewhere. Enjoy.
In the interest of sharing with this august group, here are a few ideas about trading which will no doubt cause many of you to disagree. That's fine, since when you're disagreeing, you're thinking (one hopes) about why it is you believe what you believe, and how much you believe it. I restrict my concepts and ideas to trading, that is, the difficult attempt to buy and sell securities over a period of time and extract a profit. And of course these are not original ideas, just ideas which have stood certain tests of time and which, at this point in my trading career, strike me as true. As I continue to learn, my understanding of these ideas will probably change. If that change does not occur, I will be concerned.
1. Fundamentals do not work. This is the hardest concept since so many people take fundamental information and the analysis of it as a kind of security blanket. What can you believe if you can't believe the numbers? And so they would rather believe something that doesn't work (homo sapiens sapiens should really be called homo sapiens crediens, the believing man) than go through "life" without belief. Of course there are all kinds of fundamental information: company fundamentals (earnings reports, d/e ratios, turnover ratios, p/e, p/eg, product rollout, management changes, worldwide growth in demand for a company's products), there are macro fundamentals (FOMC meetings, interest rates, inflation reports, jobs numbers, world events, currency directions, metals prices, etc.) and every kind of fundamental information in between. Let's look at debt/equity ratios, or simply financial strength. Keeping in mind that we are traders (we want to make money), then if d/e ratios or big cash positions mattered, then those two money machines, CSCO and MSFT, should be making money for those who have bought their stocks during the last 2-3 years. But they haven't. And what about companies that haven't built up huge storehouses of cash, has the stock of many of them offered excellent profit making (and profit losing) opportunities? Of course, and the tickers are too many to mention. We can go through the same exercise for any piece of fundamental information out there. Not to mention that all company specific fundy information is, by definition, somewhere between 12 weeks and 64 weeks stale. Only one or two people in the world have a real grasp on a company's fundamentals, the CFO and his top underlings, and they shouldn't be able to trade on that information in any meaningful way.
Why do people cling to the hope that their understanding of whatever trace data they can retain from fundamentals will help them make money trading securities? Maybe the next parts can explain that.
2. Technical Analysis doesn't work. This is even sadder, since if FA doesn't work, the idea that TA doesn't work truly makes this seem a godless world. I mean, something's gotta work, or what the %$#@ are we doing here? Allow me to explain. TA in the traditional sense, doesn't work. As I noted when I described the absolutely perfect head 'n shoulders pattern in OIH that occurred in December where all the traditional TA stuff (resistance, perfect pattern, triple top, cyclical top) screamed out that it was going to break down and break down hard, it simply didn't. Oscillators, trend indicators, black box signal givers, all the traditional stuff of TA will fail over time. Patterns do not repeat, not with anything like predictability. Some wag said, patterns don't repeat perfectly, but they do "rhyme." Unfortunately, they don't rhyme with enough predictability to make safe money on. But patterns do repeat, of course, and you can predict them if only you don't have to go out beyond the right edge of the chart. You can go backwards over 5 years or 50 years or 500 years and do wonderful Elliot Wave pattern analysis, Gann fans, Fibonacci retracements and breakouts, you can skewer the markets with Andrews Pitchforks and make the market your absolute cup of tea with O'Neill's cups 'n handles (a perfect tea party) as long as you go backwards. Going forwards is like going to one of those Old World maps where they would describe what lies beyond the western sea (the Atlantic) as "Here be Devils." Yesterday does not predict tomorrow, and no amount of price, volume and time-derived indicators (which is all TA really is) will let you peer into the future and see it.
3. So, what does work, that is, what system will permit you as a trader to win in a volatile world? (Remember, it is the volitility itself which creates profit-making opportunities; those who wish to avoid volatility are saying they either want to squeeze out market maker's profits or they simply don't want to make any money.) The only system of trading that will work, over time, and subject to painful drawdowns from time to time, is a system that recognizes that you will never be able to call tops or bottoms, but you may be able to identify trends and hop along for the ride as long as the trend continues. You will make money by being along for the ride until the ride ends. In an uptrend you will not be able to get in at the bottom (no trend yet) so you will "give away" perhaps 15% of the move off the bottom. At the top you will not be able to call it, but with reasonable stops you will be out of the instrument in time to avoid the real damage, and probably give up something like the last 10% of your "profits". You will give up this last 10% of your profits because in exchange for this, you will have the opportunity to stay on the trend should it decide, in its chaos-driven motivation, to continue higher.
Same-o, same-o in a downtrend. You will not be able to call the top until it has been well broken, but you will be permitted to hitch a ride on the downtrend as far down as it goes, as long as you are willing to accept some blowback at the bottom where you will give up the last 10% or so of your profits in the true bottom discovery process.
So, it's really very simple. FA is either useless or false, take your pick. TA (traditional) predicts the past with stunning accuracy and a wonderful aura of mystery, but puts you in shark infested water beyond the right edge of the chart. But understanding the charts in light of chaos theory (think of the markets as a series of unpredictable, but often trending, explosions caused by human reaction and overreaction) can allow you to take the meat out of many trends across an investing career.
Final note. I believe it is possible, on short time frames, to trade successfully on "reversion to the mean" types of technical programs, as long as one absolutely controls the level of risk in terms of position management. If not, reversion to the mean programs will leave you in the company of many geniuses. Do it wisely and under strict control, and it can be an income producting activity. Go "all in" once too often and you can joing those in control of LTCM, the Barings debacle, Metalgesellschaft (sp?) and others who decided they were smart enough to model the investment universe.
Kb |
