"Water shapes its course according to the nature of the ground over which it flows; the soldier works out his victory in relation to the foe whom he is facing. Therefore, just as water retains no constant shape, so in warfare there are no constant conditions."
Sun Tzu

Wednesday, November 26, 2008

Very Interesting Trading Day Today

OK, it's Thanksgiving week, so we expect low volume and meaningless price moves. But: market action in the light of todays (probably negative) economic news announcements (housing starts, personal spending,...) will show, if the markets have already priced in a full blown recession. Today might determine, if I feel bullish or bearish for the rest of the year. Stay tuned.

Sunday, November 23, 2008

Trading and Discipline

A lot has been written about the need to be disciplined in trading, but the question remains: is discipline a skill that is given at birth or is it learnt during life.

A beauty of Covestor is that you have the ability to interact with other investors. A recent discussion with a fellow trader (thanks to Don Bartel for his questions) prompted me to write this post.

Let me just summarize, which tools I use in order to become a more consistent trader. I basically run two type of journals. One is just a summary of my trading performance, I register every trade in a Excel sheet (note that the quantity of shares is not my actual trading size):

Let me point out a couple of features that I feel have been important to improve my trading discipline:

- Initial stop: I know right from the beginning where to get out. I think this is something every succesful trader does
- Risk: I calculate my risk using my stop and ATR, based on some formula that I developed from my trading style. So my position size should always be smaller than 1% of my account size.
- Trade quality: this is maybe the most important feature. I grade every trade with either a "1" for
good, "2" for "minor mistakes" and "3" for "big trading mistake". Since I'm a visual guy, I color code
the grade for every entry and exit (green = good, red = bad). So I get a pretty good visual picture
of my trade quality. So for example, in the upper Excel sheet, you see that I had one bad entry and two bad exits. What defines a good or bad trade? I consider a entry/exit good when I followed my rules and didn't act emotional.

Using this trade grade system, I was able to find out some interesting characteristics about my trading:

- I tend to make more mistakes on the exit than the entry side
- I tend to make more mistakes on the entry side after a winning streak

So now I know what to work on in order to become a better trader. You might argue that I can also get information about my trade quality from just looking at my performance. Well, let's assume my performance wouldn't be that good. In that case I would need to answer the question: is it just strategy or just the execution of my strategy that is responsible for inferior results? Grading the trades helps you to find that out.

The second type of journal is straight forward: I maintain a Word document where I just write down market observations, my emotions and a weekly game plan. It helps to go over that game plan during the week to minimize the number of emotional trades.

Thursday, November 20, 2008

Covestor and my REAL Trading Performance

My performance on Covestor recently broke the 100% mark. To be honest: my actual performance is not that good. Reason is that Covestor doesn't track cash positions, which can make a big difference when you are a short term, high frequency trader. Since I like to be honest, here is a chart of my actual performance over the last one and a half years:

Don't get me wrong: I'm up 45%, which is not bad either. Please note that this performance number is after trading fees, which could be a significant portion. In fact, with over 500 trades in the last 18 month, I have to watch expenses very carefully. My platform, though, is Interactive Brokers, who offers very low fees.

According to "modern portfolio theory" and common wisdom, I shouldn't be able to outperform the market:

- I'm running very focused portfolios with 5 to 20 postions. Usually, this should mean a much higher volatility of my returns. In fact, the standard deviation of my performance is just slightly higher than of the S&P 500.

- I'm a high frequency trader. Common wisdom says: the more you trade, the more you loose.

- I am a amateur investor, so the odds of outperforming are against me. (90% of amateur investors underperform the markets on a risk adjusted basis.)

- I am competing with trading desks of big invesment banks with much more insight and accumulated brain power. So again the odds should be against me.

So: why do I obviously outperform?

Some potential explanations (and academics should study this in more depth)

- I am fast: I can move in/out of postions in way a (hedge) fund can't.
- I am NOT part of Wall Street, so I can see things that you cannot see as an 'Insider'.
- I developed a trading model (which I call the "HyperSwing model" :-) ), which probably gives me a statistical edge.

Friday, November 14, 2008

Sorros and the Super Bubble

The other day, I looked at a long term chart of the US stock market:

Granted, this is pretty long term: almost 30 years back, monthly bars.It's quite interesting to recognize a long term uptrend from the beginning of the eighties up until the end of the nineties. A chart analyst would call the "recent " formation a "double top" (if finalized through a break of the 800 level). Also note, that the '87 crash just looks like a minor correction on this chart (and I even plotted using a logarithmic scale).

Yesteray, I read piece of George Sorros about his latest book The New Paradigm of Financial Markets, where he argues that the burst of the housing bubble is just a "detonator of a much larger super-bubble that has been developing since the eighties". This "super-bubble" has been fueled by the ever increasing use of credit and leverage, according to Sorros.

Quite interesting when you look at the chart with his super-bubble thesis in mind. He might be right...

Wednesday, November 12, 2008

Due for a Little Oversold Rally

Despite the fact I'm Bearish these days, we're up for a little oversold rally. I will not sell all my shorts, but take some profits and balance with some LONG postions. In particular, I'm looking for stocks that showed some relative strength the last days: Mastercard, Apple, Allied Waste Management, Delta Airlines. Gotta run...

Tuesday, November 11, 2008

Some Thoughts...

I cannot believe how anybody can watch CNBC for reasons other than taking the contrarian point of view. The latest example: these guys were urging retail investors to get back into the market. What happened? The DOW lost 10% after that call, and we are probably not done yet. CNBC is just entertainment. Nothing more. Watch Bloomberg if you want informatiton.

I hope that the government will let them go bankcrupt (Chapter 11). It won't kill GM. It would give them the opportunity to renegotiate labor contracts, shut down car lines and have a much stronger position agains the unions. GM needs to reinvent themself if they really want to survive.

AIG, American Express, GM, Ford, Fannie May...
suddenly all these guys need more money from Paulson. Where's the bottom? I'm afraid we are in a "positive feedback loop": unemployment starts to rise, maybe above 10% (Headlines everyday now about companies laying off people) which puts more pressure on housing, which puts more pressure on the economy and so on. BTW: where is all that money coming from? What if the foreigners
stop buying the US dept?

Trading Theme
My #1 trading theme these days is the "collapse of the American consumer". We're playing this by shorting companies such as Dell (Product Positioning Problem), Men's Warehouse (Who the f*&$I is shopping at MW?), Target (getting squezzed by WalMart), Las Vegas Sands (didn't cut expansion plans in face of economic downturn), Lifetime Fitness (who's paying 100 bucks per month for workout when he just lost his job?), Whole Foods (expansion plans too agressive), Goodyear (instead of shorting GM, short a supplier)

Tuesday, November 4, 2008

Strong Open Today

Looks like the market is having some pre election rally and cheering W's end.
Seriously: the American President recently demonstraded almost no leadership in the face of ecomomic crises. The markets are taking even Obama's tax hikes as relief.

Market Thoughts

Let's collect some observations of recent market behaviour

  • The Dow is currently on top of its trading range between 8500 and 9500 (Bearish)
  • LIBOR is coming down since three weeks (Bullish)
  • Volatility has been coming down (Bullish)
  • Countries around the world lowering their interest rates, Europe, UK probably later this week (Bullish)
  • A lot of money is on the sidelines, money managers start bottom picking (Bullish)
  • No clear sector leadership in recent rally, high correlation between industries (Bearish)
  • Market seems to ignore horrible economic data of the last two weeks: Recession seems to be priced in (Bullish/Bearish)
  • Economic data inidicate possibility of a DEEP recession, which might not be factored in yet (Bearish)
  • Election results (Obama win) probably factored in (some "Obama friendly" sectors such as alternative energy, biotech have recently done well)
  • Whatever the solution for GM/Chrysler will be: we will see significant layoffs in the 10 of thousands (not really positive for the economy)

Bottom line: the surprise that pushes the Dow above 9500 this week could be the unemployment report on Friday. If we get a reading significantly below 200.000 we are
due for a rally. Unfortunatelly, I doubt we will see a good number.

Looking at the 60 min chart of the S&P SPDR reveals an interesting pattern: a decline followed
after prices rose on declining volume for two times in the last 20 days (Oct 15, Oct 22). We've seen volume drying up again for the last fours days. If that pattern holds, we're a in for significant pullback:

Current market action feels like "the calm before the storm". Maybe we"ll get a small pop after election results, interest rate cuts. By Thursday at latest I plan to load up some SHORT postions.