Satuki @ Home

It has been a while since I updated my blog and my portfolio last time. Some people asked If I stopped trading. The answer is “No”.  For a housewife like me, I do not see anything else except day trading as a viable livelihood.  If you ask around, most people will perhaps tell you that they hate their day jobs, ,hate their co-workers ,hate their bosses, or the morning rush hour traffic.  I agree with them.

I was semi active in July. As you can see from the performance report generated by TradeStation below, I took a total of 19 trades and lost a bit over 300 dollars, which includes the commissions.  So I did not lose much per say.  A losing month is normal. Therefore, I will not analyze this and that.  Click the image below and a lot of the fields are self explanatory.

I do not post in my portfolio as much as I used to because I found it distracting.  But I will try my best to do it when possible.  However, I do post my sentiment(market directions and watch list)in the forum almost every day.

Alright everyone, good luck and have a better August!

Different trading styles dictate different stock picking methods. Today, I would like to share mine with you. 

If you have been with me for a while, you perhaps already know my trading style. If you are new, then my trading style is High Frequency Trading (HFT). Do not confuse scalping with HFT. They are totally different. I used to think HFT was scalping due to the sheer number of my trades.  After looking deep into my past trading, I found I did try my best to hold onto a winner.

I normally select a basket of 50 stocks every month and choose the strongest 5-7 and the weakest 5-7 among them every day for each direction (long and short). How do I select these 50 stocks every month? First, they should be liquid stocks, which include the mid cap and the large cap.  Small cap is fine once in a while.  But micro cap and mega cap are absolutely excluded. 

Second, it should have a high beta.  Beta is used to measure the volatility of a stock against S&P 500.  If it is less than 1, it means this stock is pretty flat or less volatile than average stocks. Hence, there are relatively few opportunities in either direction.  You can find the beta of your picks on Google Finance.

For exmaple, OSK (Oshkosh Corporation) has a beta of 2.77,which makes it a solid day trading stock. RIMM(Research In Motion Limited) has a beta of 1.88, which is very nice too.

On the other side, WMT(Wal-Mart Stores, Inc.) has a beta of 0.26, which means it moves like a 90 year old most of the time.

I recommend stocks with a beta > 1 at least.

Third is that the prices of my picks are normally more than 30 dollars.  Occasionally, I drift into stocks in 20s. I never touch anything in the teens or below.  It is just a personal taste though.

Fourth is that the basket should be broad enough to accommodate a lot of different sectors

It is easy to put all these criteria into a scanner. With a click of a button, it will spit out things you want.  There are a few free scanners you can use. There are also good commercial ones too. I will talk about them in the future.

Ok, now we have a basket of 50 candidates. Do we need to scan them constantly during our trading sessions? No. It is a common mistake that a lot of traders make. They are so busy scanning the market that they can not even focus on trading. A lot of them constantly chase hot stocks. By the time, they find a stock hot, it is already too late.  For example, the OSK trade I took last Friday.  See the timestamp I posted my entry. It just moved too fast for most people to jump in.

Before the market open, some stocks from my basket are already showing activity. So I normally choose 5-7 strongest and 5-7 weakest and then watch them closely throughout the day. Among these 10 or so stocks, one or 2 are bound to make a move every day. My objective is to catch them and keep my losers very small in the meantime. 

In addition, these 10 stocks should be from different sectors.  You can not have ABX, GG Or AEM at the same time since they are all gold related stocks.

As for how to trade them is a totally different story because there are so many different patterns. To have a pair of egales’ eyes to recognise these patterns requires that you work until your tail falls off.

Here is the trade I took in OSK last Friday. Click on the image to have a better view.

 
Here is the recap

Step 1: Select a basket of 50 stocks which should be 

1. Liquid
2. High beta
3. 30 dollar above(optional)
4. A diverisfied basket

You can just copy from my watch list. OSK is sitting right in the list.

Step 2:  Select 10-12 out of the 50 every day

1.  A few strong ones for the long side and a few weak ones for the shrot side
2.  Watch these guys only.
3. They should be diversified too.

It is my main method. I also trade news related stocks.

If you google High Frequency Trading (HFT), you will find a few definitions. One is that big traders use high powered computers to gain advantages that retail guys like you and me do not have. I have a 2 year old computer, which is 10 thousand miles away from being high powered.

Another definition is that HFT is a scam since it uses flash orders to have hidden bids or asks exposed. If this is true, then this is a huge loophole in our system.

HFT gained its notoriety in 2008 because it was wildly successful.  But for retail foxes like you and me (look at the stock market as a jungle. Mutual funds are elpehants or lions. You and I are foxes and there are a lot of other creatures between them and us.), we certainly do not have a super computer. But we are super nimble. Thus we can have our own version of HFT.

All traders are hunters including foxes.  We hunt things that are smaller than us. But we are being hunted at the same time. By employing HFT and our nimbleness, we could rapidly get out of harm’s way and yet still have a good chance to catch our prey.  Here are  the main characteristics of HFT.

1. Very high frequency of order executions
2. Pounce on every possible moving target you perceive as your prey.
3. Run for your life the first moment the prey smells like your predator.

HFT is a strategy.  To implement your strategy, you need to have some tactics that are suitable for HFT. I recommend tape reading. Your HFT tactics should be as simple as possible. If you are using more than 3 indictors at the same time, you will have a hard time implementing this strategy because they will confuse the living thing out of you.

 
One very important point to bear in mind is that you do not have time to think in HFT. Your thinking is done when you are not trading. After a lot of practice and zillions of trades (exaggerated), it becomes an instinct.

One shortcoming of HFT is that it will rack up your commission as we can see from my monthly report in Dec 2007 below.  The commssion for that month was about 1500. But again, $6986.11 was the net profit for that month. Some people are worried about commissions.  It is understandable if all the money you make goes to your broker.  However, if your system brings home a net monthly profit of 5000 and also generates 5001 in commission, you would not stop trading just because your broker is making so much by piggybacking your hard work, right?

Click on the image to have a better view

As we can see from the report above, I took a total of 424 round trip trades that month, 271 longs and 153 shorts. The profit for that month is $6986.11,  $3459.11 from the long side and $3527 from the short side. The profit factor was 1.41, meaning that for every dollar I lost, I made 1.41 dollars.

One reason that I adopted high frequency trading is to minimize draw-downs. The other is to make the best use of my money because I was running a tiny account of 50k and I never used leverage.

I had that kind of performance throughout 2007 until I hit a big snag in Jan, 2008 and lost my touch/mojo/instinct ever since. My trading is not fundamentally flawed. However there were a few small issues I needed to fix. That is why I reduced my trading to very small positions.

I had a flat year in 2008.  But looking at the performance of my 2009, I think I am on the right track to restore my instinct.  It is a lot of work, tenacity and time.  As you can see in my case, the gap would be 2 years if I could manage a come-back in 2010. Or maybe I will need another year.

Foxes might be tiny. But they can be mean too…

 I have taken about 1600 trades so far in 2009, which averages 160 or 80 round trip trades, per month.  Back in 2007, I averaged 40-50 round trip trades per day.  Yeah that is right because I was a scalper, whose average holding time was around 2-3 minutes.  For some super scalpers, 100 round trip trades per day is not considered over trading.  For others that like to milk every bit out of a position, 5 trades per day might be over trading.  Therefore, we perhaps can not use that as a criterion to see if one is over trading or under trading.  The number of trades a person takes might very well be just a matter of different trading styles. 

My current trading style is like a holder or a “day investor”, who intends to hold onto a winner for as long as humanly possible. This strategy has been working nicely so far this year.  However, I do under trade.  Here is why.   I have 75k sitting in my account.  And TradeStation gives me 4 times leverage for day trading, which is 300k daily purchasing power.  However, I have a hard time utilizing my 75k buying power to the fullest extent, not to mention the leverage. If you have been with me for a while, you know that I rarely have more than 30k worth positions open at one time.  For example, I took one long trade in AIG in the morning today, which was worth about 7000 dollars.  That was the only trade in the morning.  Then there was another long trade in PNC in the afternoon, which was worth only 10000 dollars.  After I closed my PNC trade, I took 2 shorts together, one SLG and one IOC, whose combined position size was slightly over 10000 dollars.  It looks as if I only needed 30000 trading capital. Ha-ha, talking about under trading. And this is it.

Some friends asked me if I could trade their accounts.  Now you see what problems I have with trading others money.  I can not even take full advantage of my own capital.  Anyway, here are 2 of the trades I took.  I will spare you the 2 shorts which were basically flat.

2 pictures are worth 2 thousands words.  I do not know what to explain.  After so many trades, trading has become a subconscious activity for me.  If you have questions, feel free to ask in the comment section.

Click on the image to have a better view

AIG

PNC

Here is the timeline of my entries

There is a lot of aspiring day traders out there.  I think that they would ditch their day jobs in a heart beat if they know they could day trade for a living. This statement is not exaggerated considering all the freedom that trading can bring you.

First of all, let’s define what a successful day trader is.  A successful day trader is not necessarily some one that makes millions a year.  It is someone who can consistently reproduce his income that he would otherwise make from his day job. There is no stress/dramas/draw-downs since trading has become a routine for him day in and day out.

This is the ultimate goal that an aspiring day trader needs to reach. We all know that the success rate of reaching that goal is quite low. Or everyone around us would be a day trader.  But there are extremely successful examples around us too.  These successful day traders worked their butts off and sacrificed a lot to get where they are today. Hard work is the only answer.  But here comes a dilemma for an aspiring day trader. 

This typical trader normally has a day job. He went to a four year college and got a job that is paying him 70k per year now in a small town.  That money is decent although he has to deal with a lot of BS at work.  He dreams about trading for a living one day. He clearly knows he has to put in a tremendous amount of hard work into it.  The question is “how could he find the time to put in the hard work?”

Have you ever heard of a successful part time day trader?  I have not.  “Part time” and ” successful day trader” are contradiction.  Simply put it this way. If he were successful, he would go full time.  Day trading requires one’s full attention.  He can not blatantly open a streamer at work unless he has a corner office.

One might think that he should quit his job so that he could devote all his energy and time practicing it.  This is not an easy decision to make.  He has all kinds of bills to pay and might have a few mouths to feed every month. How about health insurance? Health insurance is very expensive in the US. Canadians score 1 and Americans sore 0 here. If day trading does not work out for him after 3 years of dedicated practicing, his opportunity costs would be 210k. In addition, he might lose some money during these 3 years. All these factors will deter quite some aspiring day traders. For the most determined, a few of them will rise from the ashes eventually.

I hope I have scared you enough so that you would look at trading as a hobby, which includes swing trading while holding onto a full time day job.   If you are among those most determined and die hard aspiring day traders, I will talk about how to prepare for the first couple of years as a full time day trader.

A simple answer is the more, the better. Under capitalization is one of the major problems that traders have.  First of all,  trading is one of the most difficult professions on the earth due to its very high earning potentials.  If you have a few grand trying to make a living at it, then what I can tell you is that it is impossible.  You need at least 100k to even stand a chance to make a modest living if (a big if) you have the skills.

For example, your objective is to make 50k per year consistently, which is 50% of your 100k. A 50% annual return year over year WITHOUT compounding is very hard to achieve even for the most experienced traders.   With compounding, not even Warren Buffet could .  I believe Warren Buffet’s track record is perhaps around 15%-20% minus management fees with compounding.  Madoff’s “track record” was around 10% compounding. You know why I mentioned “Madoff” here.  Stay away from anyone who claims something like that.

As I always mentioned in the past, a few lucky shots or even a couple of years of lucky shots mean nothing to me. A trader must prove herself through at least one major crash like the dot come bust or the financial crisis that we just had, and a major bull market.  If you have gone through these cycles and still made some decent money, you are all set for the rest of your life since trading will never change.  It is this way today and was like that 100 years ago because it is all about human psychology.

A consistent 50% annual return without compounding is hard. But I believe a 30% without compounding is doable.  But 30% of 100K is only 30k. 30K is around the poverty line in the developed world such as the US, Canada or Japan.  But 30K packs a lot of purchasing power in a developing country like China.  The purchasing power of 30k US dollars in China is equivalent to 150k in the US and you do not have to pay taxes on capital gains. The beauty of trading is that you can do it wherever there is an Internet connection. I believe the income tax is around 17% in Hong Kong and 15% in Singapore. We will explore this option in another post.

So obviously 30k is not good in the US.  If you need to make 60k per year, you would need 200k trading capital. I am every bit against using leverage/margin.  So let’s not even go there.  If you have 1 million, you could make 300k theoretically provided you trade liquid stocks. That is one of reasons why I never trade those thin penny stocks.  The more liquid, the harder they are to trade such as GS, APPL, RIMM or GOOG because there are too many professionals in them. But you have to go compete with them head on.

Now you see why it is “the more, the better”.  But this does not mean people who are temporarily under capitalized should not even try.  You should.  But you should not focus on how much you can make in the first couple of years. Instead, you need to focus on your trading plan/system because all it matters in the end is your percentage.   If you could trade a 10k account well, you should do well with a 100k account.

In the stock market, you will want to invest in the sector leaders because you have a limited amount of capital and you would like to make the best use of it.  What characteristics does a sector leader possess?

1. A sector leader should have the best performance among its peers.
2. A sector leader should have liquidity so that it provides enough room for funds to buy in.
3. A sector leader is more resistant to doo-doo storms caused by the general market.
4. A sector leader should be good-looking, aka nice,clean and smooth charts (daily, weekly and monthly).
5. A sector leader almost always moves before its pack does.

A well known company’s stock does not necessarily become a sector leader becuase it might be alredy priced in.  Therefore, do not confuse companies with their stocks.  Here are a few real world examples from the solar sector and the coal sector. We will look at them one by one.

Solar Sector

As I mentioned on Twitter  last night.  If I should long the solar sector, I would pick TSL or STP instead of FSLR.  Their performance today manifested the importance of this rule.

Click on the images to have a better view
 

TSL

STP

FSLR

Coal Sector

The coal sector is kind of under pressure since China has slowed down stockpiling natural resources such as coal.  But it is not too hard to see that MEE and WLT are the sector leaders and PCX is a laggard.  I think WLT has the best potential since its uptrend is still intact.  MEE’s pull-back is a bit too deep, which requires some serious consolidation to drive out those trapped bulls. PCX has a very disgusting chart from a bull’s perspective.   Correct action should be shorting into the dead cat bounce when there is any weakness.   I will not go long until it breaks the dense congestion area(8-10) effectively.   On the flip side,  PCX has a very nice chart for the shorts.   I give them my due respect.

WLT

MEE

PCX

I can day trade anything that moves. I become somewhat picky when I look for swing trading targets. As a matter of fact, I do look at the fundamentals of a possible swing trading target albeit 75% of the decision making is still based on technical analysis.   When it comes to picking a stock for my retirement account, I become extremely picky. I can not or do not want to short the market (buy inverse ETFs) in my retirement account. Naturally, all my stocks are long.

What I look for in this type of investment grade stocks

1: Minimal Risk
2: Growth

To meet the 2 criteria above, I normally look at very large and well known companies such as Apple, Research In Motion, China Mobile and etc..  I will never buy small cap speculative growth stocks.  They are too volatile and risky.  I do not expect crazy returns from these stocks.  A 15-20% annual return with minimal draw-downs will make me very happy.

We had a bull run from 2003 to late 2007. That bull-run was propped by the housing bubble. And here we are at the 2002 level again today.  I believe it is worse than 2002 since we have added so many stocks since then.   Today’s 1800 is definitely not the same as the 1800 7 years ago.   The US market is too mature. There is no manufacturing left in the US thanks to outsourcing.  The banking industry has crumbled too.   There is nothing here left to grow.   Oh one thing that certainly grows fantastically is the money supply.  The Feds just prints it.  What I see in the US market for the next few years is that it is going to be a very boring market that chops around inside a big trading range.  It is actually fine for day trading and short term swing trading. But it will not be good for my retirement account for which I do use the buy and hold strategy.

Currently I am very interested in the Chinese stock market.  The whole country is growing. Their first stock market bubble has burst in 2007.  It crashed all the way from 6000 to 1700 within a year.  This reminds us of NASDAQ in 2001.  Although the crashes are similar I believe their recoveries will be different.  I think the SSEC (Shanghai Stock Exchange Composite) will reach 6000 again in the near future since they have real growth. Anyone who thinks that China is still communism is misinformed.  It is cutting-throat capitalism.  See the SSEC chart below.

 
The Chinese stock market is closed to the foreigners.  But we can still invest in the Chinese stocks listed here on the US market.

Here are the1st tier guys, which are monopolistic, massive, and still growing.  

China Mobile (CHL)
China Life Insurance (LFC)
Aluminum Corp of China (ACH)
China Petro and Chem Corp (SNP)
Baidu Inc(Bidu)

Here are the 2nd tier guys, who are smaller but with better growth.

Sohu.com (sohu)
Shanda Interactive Entertainment (SNDA)
Oriental Educ and Tech Group (EDU)
SunTech Power Holdings (STP)

STP is a little bit distressed now.  But it is the best solar company in China.

One of the readers asked me why I do not trade leveraged ETFs any more.  Did I fail at trading the ETFs?   The answer is Yes and No.   If you judge it by gains/losses, I did not since I made some money trading the EFTs.  If you judge it by my equity curve, I failed since I had so many draw-downs and spikes in the previous months when I focused exclusively on FAZ and SRS.

Draw downs and spikes mean that I am intrinsically taking too much risk.  Take a look at my trading in March, I had one big winner(FAZ) and that was all.  Without that trade, It would be a losing month.  if you have been following my blog, you know how lucky I was with that trade.   That big gain does not have much to do with my skills.

Keeping draw-downs to minimum is one of key characteristics of good money management.   Big draw downs mean poor risk management.   Let’s say if I was down 20% in March and up 30% in April, on the surface it seems Ok since I am still up 10%.   But if you look deep into it, it is horrible.  I let my risk control slip so that I ended up down a whooping total of 20%.  Yes, I was up 30% the next month.  Nevertheless If you examine it closely, it is still horrible. Here is perhaps what I did after losing 20% in March.  In order to get my money back, I increased my position size and took trades that probably did not have optimal set-ups.  And I was lucky and  pulled it off.  However, if I keep doing this, I am sure I would have two -20% months in a row sometime in the future.   Trust me.  It is very hard to come back when you are down 40%.  I would be just much better off with two consecutive positive months, 5% each.

If you can keep your draw-downs low, it does not matter what kind of vehicles you trade.  Some traders can be very good at trading boring bonds or T-Bills and bad with stocks.  Some traders can be good at trading E-mini and bad with Forex. It is all normal. For me, I really suck at trading penny stocks.  Yet some people are just good at it such as Tim Sykes.  It all comes down to choosing the right vehicles.

The primary goal to invest/trade in the stock markets is to make money.  However, we will never achieve this goal if we do not know why and how to manage risk.

Why risk management has top priority

In trading, risk management is far more important than anything else.  To make money, we need a trading stake.  How could we make  money if our trading accounts are wiped out or our capital is tied in some rotting positions?  It is absolutely  OK to have losers. But it is NOT OK to hold onto them once Mr. Market has warned us to get out.  Here is a post about how to treat losers and another about how to set stop loss orders.  

How to control your risk

So the first thing is to cut the losers.  Nevertheless. It is not enough to just cut the losers. If we have many losers to cut in a very short period of time, they can add up quickly.  We will have to set our overall loss cap and adjust our position size accordingly.  For day trading, our loss per trade should not exceed 0.5% of our total capital and our daily loss cap should be no more than 1.5% of our trading capital.  In other words, we stop trading after 3 losers in a row. A daily loss cap is not enough; we need to set a weekly cap too. My weekly cap is 5%.  If I have lost 5% by Wednesday, I will stop trading for the rest of the week.  And my monthly cap is 10%.

We will also have to pay attention to our position size. Position size should be reduced to a level where we can feel comfortable without looking at it or thinking about it constantly. If we are constantly worried about our positions, then they are too big and our judgment will be impaired.

In order to control position size, we will have to pay attention to what sectors our positions are in. If we have MOS and POT at the same time, then they are considered one position since they move together most of the time. We should only have one of them or at least split our capital between them.  For example, after careful studies, you feel comfortable with 10k per trade.  You normally choose whatever is the strongest in a sector. Let’s say MOS. You put 10k into MOS and have nothing in POT. If you really like POT, then do a 50/50 or 60/40 split between MOS and POT.  You just can not have 10k in each since that would be equivalent to 20k on a fertilizer stock.

Another advantage about reducing the size of our positions is that we can use a wider stop loss and still stay within our risk threshold. If our risk for each trade is 200, then our stop loss would be 2% of a 10K position or 4% of a 5k position.  With the same amount of risk, a wider stop loss works better than a narrow one.  Of course, our profits will drop due to the reduced size.  But once again, I will put risk control before anything else in trading.

Here is the recap

1. Cut losers
2. Set a daily/weekly/monthly loss cap
3. Control position size
4. Pay attention to sectors

In trading, shorting stocks is referring to try to profit from falling stocks. From day one in school, you were taught all kind of wonderful investment strategies such as buy low and sell high or buy higher and sell higher (my strategy).   It sounds very unnatural to profit from falling stocks.   Nevertheless, Shorting is a genius idea.   If you ask me, nothing in the financial world comes close to allowing short selling.   It simply is a splendid idea for speculators like you and me. 

This will never happen in any places other than trading. When you buy a piece of real estate and hold onto it for a few years, you sell it for a profit if it has appreciated over the years.   It is all sound and good.   What if you go tell a housing developer to lend you a piece of real estate and sell it in 2007, buy it back in 2009, give him back the real estate and you keep the difference?     He would think you are just out of your mind.  He also must think you are one crook because you profit from his pains.   So in real life, you can not ask someone to lend you something and short sell it for a profit even if it is a technically sound idea.

However, you can enjoy shorting here in the stock market.  In order to short stocks, you will have to borrow stocks from your broker.  Your broker normally keeps a constant ratio between the number of shares shorted and the total number of shares in his inventory.   Let’s say that number is 40%.   Then it will be hard to borrow the stock to short once the number reaches that level.  That is why you can not short some stocks sometimes.  And you can short them again after a little while.  If a broker loans you any shares to short without any inventory, it is called “naked shorting”, which is illegal.

Here are a few unique characteristics about shorting

1. When a stock drops, it tends to move much faster than when it goes up. Here is why. In reality, the bulls far outnumber the bears since people are taught that shorts are unethical and you should be investing instead of speculating, blah, blah…  Therefore, when a stock goes down, there are a lot of panicked bulls that trample each other, thus cause a stock to drop very fast.
2. Stocks can drop on their own weight.  Have you seen stocks that drop a little bit every day without any volume for a long time?   Sellers (shorts and panicked bulls) just gradually pile on each other every day.   However, stocks seldom go up without any significant buying power and volume. Only cornered stocks would move withou any volume.
3. If you short a penny stock, it might gap up 500% tomorrow morning, which is very rare.  In addition, you should be fine if you keep your positions small   However, the most you can lose in a long position is 100%, which is also very rare.

Shorting is not for everyone.  As I said many times, you do not have to know how to short stocks to be a great trader.  You can be a great net long trader as long as you know when to stay out of the market when it is getting ugly.

Which one is suitable for you?  let’s first take a look at each style.  The following is based on the assumption that you follow the idiom “cut losers and ride winners”

Day Trading

Pros: 

• very little risk due to not holding postions overnight
• easy and quick entries and exits
• no need to worry about long term general trends
           

Cons: 

• much smaller profits than swing trading
• A very accurate system is required
• not good for people who have a day job.
            

Pros 1 and 2 are very easy to understand.   For pro 3, I believe we do not need to worry about the long term trend of a position that you are day trading because we try to capture small moves for a day position.  If a stock is in a long term up-trend, the probability that it will retrace at a certain point it is over 99%  since all stocks zig and zag. When it shows any signs of zagging, you can fade it intra-day. It is the same when a stock is in a downtrend.
 
 
 

Swing  Trading

Pros: 

1. bigger profits
2. no need for a very accurate system
3. suitable for everyone,  lawyers, doctors, policemen, you, me and Dupree
              

Cons: 

1. More risk due to holding positions overnight
2. A lot of your positions might die since they require much bigger moves     
              

Pro 1 is true since I always believe that your risk and reward is mathmatically proportional.  If you take a bigger risk, you MIGHT have  a bigger reward.
 
Pro 2. I explained in this post (Probability and Risk/Reward Ratio) that you will still make money even if the accuracy of your system is below 50%.

Let’s first take a look at each style. Investing means that you pore over a company’s financial statements, management, product lines, operational costs, barriers of entry, profit margin etc.. In other words, you look at a company’s fundamentals. If you think the market value of a company’s stock is below its intrinsic value, you buy it. Trading is on the other end of the spectrum.. Entry and exit of a position is made based on thorough technical analysis of a stock. Which one is better?

Most of financial articles and college econ. classes teach people how to be an investor at an early age. They will throw tons of econ. theories at you and cite Warren Buffet or Peter Lynch as living examples that investing is better than trading. What they do not tell you is that most of the investors lose money, let alone achieving anything remotely like 1/millionth of what Warren Buffet or Peter Lynch has achieved so far. I still remember that Benjamin Graham, teacher of Warren Buffet, said in his famous book Security Analysis “You are better off to buy a well diversified mutual fund in the long run than pick individual stocks on your own. If you are determined to do it yourself, read on.”

From my experience, trading is more suited than investing for average people like you and me. All the people I know, relatives, friends and next door neighbors who are/were investors suffered huge losses in 2008. The problem is that they did not have huge gains during the bull run from 2003 to early 2007 to offset those big losses. Cut the losers and let the winners run. You might have heard of this phrase from time to time. It sounds simple. Nevertheless, very few people can follow that idiom. Most investors do exactly the opposite thing, which is cut the winners and let the losers run. When he has a winner after a number of losses, he would ask himself 500 times a day if that winner would reverse. The more he asks himself, the more worried he is. He ends up prematurely exiting his otherwise a very profitable position. However, when he has a loser, every time that loser bounces back a little bit(sucker rally caused by shorts covering), he sees a light at the end of the tunnel. Yet the position edges even lower. He keeps asking himself “How is it possible? How is it possible since this stock has such a low PE ? Why? Why? ” The position continues to edge lower while he is still pondering why his investments are rotting. I have seen people hold onto gigantic losers that are over 50% under the water. 50% is an understatement in 2008. Before an average Joe like you and me know what went wrong with the company, the stock has been already crushed unrecognizable.

One reason that an investor can not cut losers is that he has a very strong conviction when he decides to buy a stock after spending so much time trying to understate the fundamentals of a company. In other words, he is very biased by the time he finishes studying the fundamentals of a company. If that stock goes against him, he will always fool him into something like “I am a long term investor and this company’s fundamentals are sound.” Before he realizes it, he has a pet. Here are a few classic losers in 2008. They all have sound fundamentals. But…

Click on the thumbnails to have a better view of these losers

MGM(MGM MIRAGE)

Drys(DryShips)

RIMM (Research In Motion Limited)

SIGM( Sigma Designs, Inc)

A stock moves because of the underlying psychology of many participating traders/investors. It reflects the mental states of all these participants. Technical analysis works like a heart rate monitor that you can use to see what others are thinking and then you make a trading decision based on what you can deduce from the readings. If you are a pure technician, you spend no time reading anything about the fundamentals of that stock. The stock is just an electronic symbol that may show you x,y,z symptoms of going lower/higher. You calculate/guesstimate/deduce the probability of the stock moving in your predicated direction. If your answer is 51%, you open a position.

 As we can see, one of the biggest mistakes an investor makes is keeping a pet. With a seasoned technician, it can not possibly happen since he might not even know what this company does. It is just a symbol to him. He can long a stock as easily as short the same stock. He uses solid risk management to avoid big losses, which is cutting the losers. There are good, bad and ugly technicians.

• Good technicians follow the idiom, cut the losers and let the winners run.

• Ugly technicians cut the winners as fast as the losers. These traders will always be around though. But they are not able to make consistent profits.

• Bad technicians slip into the investor mode, whom Mr. Market will send them packing as quickly as they entered the market.

When Dick Fuld, the CEO of now bankrupted investment bank, Lehman Brothers , testified on Capital Hill, he said “We acted like investors. We did not cut our losers quickly enough to avoid the steep losses.”  If you would like to invest in the stock market, buy a mutual fund or an index fund.  Most people simply can not beat those professional fund managers.  Most fund managers have a bunch of highly educated people working for them and they spend more than 8 hours a day researching stocks.  A lot people who I met actually believe they can beat those fund managers consistently even if they only spend 1 or 2 hours a day at most on researching stocks.

Of course, this is a perennial debate between investors and technicans. Choose one suitable for yourself. Happy Trading/Investing.