The Problem with Rules One and Two

Everyone who has done any reading on trading or investing has heard Buffett's Rules One and Two:

Rule Number One - Don't Lose Money;
Rule Number Two - See Rule Number One.

(these rules are most often attributed to Bufffett, but I've no idea whether he coined them or not). While the idea that one should not lose money when investing is a good notion, it is very impractical, impossible even. The very existence of the market implies risk. From the farmer who borrows money from the bank to buy a tractor so he can increase his acreage in production to the speculator who is betting that the dollar is going to fall against the yen (two ends of the investing/trading spectrum), risk is playing its part. The "Don't Lose Money" prohibition is a good guideline, but like all guidelines, it comes with a wide margin of error. You will never make any money if you are not willing to incur at least a small risk. Even putting money in a low yield savings account has risk (opportunity costs, inflation, bank insolvency). And you will never make serious money without being willing to take on the risk that leverage imposes. Suffice it to say that risk is our enemy, but in order to win, we must seek it out, and master it.

The issue becomes then, how best to manage risk? Volumes have been written on the subject of money management, and most of what has been written by successful investors and traders (Buffett, Booker, Ponsi, Elder) is useful. The bottom line is, however, that you've got to find your own comfort level when it comes to risk. You've got to be willing to embrace it, but how much will depend on your risk tolerance. Your analysis of how much risk you can and should accept will be a function of your financial position, your trading goals and your psychological make up. It is a question that only you can answer. Most broker sites (at least stock/options broker sites) will have some tool to help you decide what your risk tolerance is, but don't rely too much on what those results are. The answer is inside you and you know, or should know, what it is. It is important to find out what your acceptable level of risk is, because if you trade outside of it you will lose. Too much risk engenders fear and fearful you makes bad decisions. So find out what your level of risk should be, stay with it and periodically revisit the issue to see if the parameters have changed. Remember, no risk, no reward. Too much risk, busted account.

Good Trading!

Forex Thoughts

This is likely to be a volatile week in the currency markets as a basket full of reports which tend to move the market are coming out, not the least of which is the FOMC's Tuesday/Wednesday meeting. The smart money is on a Fed Rate cut of 25 basis points (but such a cut is by no means a certainty). I've been watching three currency pairs for the last several days and it seems like there is a good bit of waiting going on in the market. The USD/CAD pair has been trading in a 2 cent range for the better part of a month now and will eventually break out. Which way? I've got no idea, but a buy order at the top of the range and a sell order at the bottom seems like it might be a good idea. Markets move and it would be unusual for this market to stay range bound for too much longer.

The other break out play is the USD/CHF. Since its run up on the 23rd, its been trading in a tight range. The same type of buy at the high end and sell at the low end might be appropriate.

My third thought is on the EUR/USD. The Euro has been doing very well against the dollar for the last, well long time. It has fallen off just a bit in the last week as it bounced off of the resistance at 1.60. If the Fed lowers interest rates again, it could push this pair back toward its resistance level. Might be an opportunity to make a few pips if the Fed does lower rates.

Just my few scattered musings on the Forex market. Let us see how it plays out.

Good Trading!

What to Trade?

I was having a conversation with a colleague interested in trading today and he posed me a question which I’m asked fairly often. In answer to the question “what should I trade?” I often find myself responding that it just does not matter. Since the advent of electronic trading the opportunities in the markets are tremendous. One can trade stocks, bonds, mutual funds, ETFs, stock futures, commodities futures, index futures, options on stock, commodities futures, or ETFs, currencies, options on currencies, or any other of a thousand tradeable derivatives. But the truth of the matter is that it doesn’t matter what you trade. What matters is that you manage your trade correctly, that you limit your risk, that you know when you will exit (which is so much more important than knowing when you’ll enter), that you don’t overtrade, and that you understand what the thing is that you are trading (meaning don’t trade currency swaps if you don’t understand what makes them move). Markets are markets and the people who are trading these markets (whatever markets they are) have the same hopes and fears that are reflected in every chart of every market throughout the history of recorded trading. A price chart for historic milk prices will look a lot like pork bellies, which will look a lot like IBM, which will look a lot like the EUR/USD. If you understand what motivates people, if you understand the psychology of trading, you can trade any market successfully.

It does not matter what you trade. What matters is that you trade intelligently.

Good Trading!

The Lawyers are the Problem

Here is my gripe of the day. I decided to open up a new trading account with Interactive Brokers (my gripe is not about them - the concept of the Universal Account is fabulous). During the process I had to fill out 15 forms and read and accept 13 disclosures (other than those within the forms which account for another 8 disclosures). In total, 15 forms electronically signed, and 21 disclosures accepted. Now, I'm not complaining about the forms. Your broker needs the information in order to correctly track, organize and administer your account, and that's not something you want them to mess up. Rather, my gripe is with the disclosure forms. I mean, does anyone actually read all of that legaleze? Ok, I did, and it took me 3 hours to get through it all. Most of the information in these disclosure forms is redundant. You make many of the same promises in the Data Feed Disclosure as you do in the Risk of Trading or the Risk of Leverage or the System Failure Disclosure. I suggest that the fault lies with the lawyers that represent the various vendors to our brokers as well as the lawyers that represent our brokers. Couldn't we streamline the system to be something along the line of "You agree that unless we do something on purpose, or that is so stupid that no one would reasonably do it, that makes you lose money, you won't sue us?" All I'm asking for is a little common sense. The problem with how we handle legal issues in this country (and I've been a practicing commercial transactions lawyer for 15 years) is that we use patches. Someone drafts a decent agreement or form and it gets used. Down the road a problem crops up that no one foresaw and something is added to the form to cover that. Then we use the form for a slightly different purpose so we add something to cover the different thing. Then someone sues over something the form allegedly does not cover, so we add a provision or twelve to cover that. After a while you've got some monster of an agreement or disclosure that is so cumbersome that no one even remembers what it looked like in its simple and elegant beginning. I can't tell you how many times I've read deal documents that make no sense because lazy attorneys are cutting and pasting information about a new deal into an old deal's documents. And that old deal had the same problem so the issue compounds until one day an unsuspecting trader is opening an account and he has to read and sign 21 disclosure forms. It irks me, can you tell?

Have a good weekend and Good Trading!

BTW - nothing in this post is in anyway to be construed against Interactive Brokers. They are just covering their assets, as they were advised to do by their attorneys (the bastards!).

Trading = Freedom

Why do we trade? I'm sure there are many answers to that question, but it is worth asking. In my opinion (and since this is my blog, mine is the one that counts) is that the only reason to trade is to make money. If you are in it for the thrill of the action, or because you think you should be, or for any other reason other than to make money, then you should stop reading, liquidate your positions, and give some serious consideration to the issue of what trading is all about. Trading is about making money, period. There is no other answer. Making money. That's it.

Trading, when pursued for the right reasons, is freedom. The freedom to do what you want, when you want. The freedom not to have to deal with unpleasant people in order to make a living. The freedom to buy what you need and sometimes what you just want. To go where you want, when you want without anyone holding anything over your head. Trading is Freedom. (But trading is not happiness, and don't fool yourself that it is. That is an issue for an entirely different issue for a different post.)

Why do I trade? Is that a trick question? To make money of course. To pay the mortgage, to buy cars to take trips to pay my daughter's private school tuition. Trading is a business and I do it only to make money. It does interest me and I do enjoy it (so its a bonus for me that it makes money). I have always been interested in the markets. When I was a boy I would pour over the stock market listings in our local paper and follow companies I knew about. General Motors, IBM, 3M (where my father worked) were all companies which had a place in my world. I did not understand the significance of the stock market, but I did understand that shares rose and fell in price and that they represented ownership in the company. I bought my first mutual fund (IDS Income Fund) when I was 12 with some money I had earned from my paper routes and some my parents contributed. That investment was forgotten over the course of about 10 years and when it was rediscovered it had tripled in value. My curiosity was engaged. Curiosity led to reading. Reading led to interest, followed by the temporary diversion of law school. Interest led to study. Study led to my first attempt, which led to losses. Losses led the review and my second attempt, which was mildly profitable. And over the next 10 years or so, a trading style, trading plan, trading business was formed.

Read, learn, practice and when you are ready, trade. Trading to make money = Freedom.

Good Trading!

The Inverse Relationship between Time and Time Frames

When to trade and what time frames to trade are two questions you must answer before you can execute your trading plan. From personal experience I know that if you don’t have a set time you work on your trading then you will not consistently get to it, and consistency is an absolute requirement when it comes to successful trading. You must set your work hours and get your significant other, family and friends to respect that time. If you are like me and use the early mornings before anyone else is up (during the week at least) it is not too much trouble. Weekends are another matter. Whatever the hurdles, you absolutely have to have sacrosanct time to work on your trading business. How much and when will be, in part, determined by what time frames you trade.

When I say “time frame” in relation to trading I mean whether you will be trading from daily charts, weekly, hourly, 15 minutes, by the tick or some other time frame. It is important because each time frame has its own style, its own personality, whatever your trading vehicle is. Trading from the hourly charts is not the same as trading from the weeklies, and the amount of time it takes to trade hourly charts is greater than daily or weekly charts. Hence, you need to devote more time during the trading day to the shorter time frames. This should be intuitive, but you’d be surprised how many people believe that a one minute chart and a monthly chart are fundamentally the same. I grant that, from a distance, they look similar (for a liquid equity, future or currency pair), but they are not the same. And the amount of time you need to devote to your trading will be inversely proportional to your time frame.

So, first, know what time frame you’ll be trading, then plan to spend the time you need to do what needs to be done for trading it. Get buy-in from your family and friends and commit to a specific work schedule. If you’ll do this, you stand a much better chance of success than if you don’t.

Good Trading!

Focus, part II

Focusing on a particular market and particular trading vehicles, be they stocks, futures, options or forex is a good way to start to build trading expertise. But it is only half the picture, or perhaps better put, the picture is only half in focus. One must also limit oneself to the types of situations where trades are initiated. By this I mean, you don’t want to use every available system or indicator to signal trades even on only those markets you are following closely. As important as limiting your markets is limiting your trading signals. Find the systems that work well for your mental frame of mind and learn the ins and outs of those systems. Don’t worry about adding to the number of systems you trade or signals you watch for until you are thoroughly comfortable with what you are using now. For example, when I trade the Forex I restrict myself to six non-correlated currency pairs (a correlated currency pair would be a pair that moves in tandem most of the time like EUR/JPY and GBP/JPY, or inversely like EUR/USD and USD/CHF – its not wise to trade correlated pairs because it basically doubles your position in the same basic trade), and I use only support and resistance lines, trend trading and flags/pennants as my trading signal/indicators. There are literally hundreds of different trading indicators and systems available for every market. Some work, some don’t and some work better than others. But the important thing is to limit yourself to what works for you and master those before adding anything to your bag of tricks.

Good Trading!

Focus

When I first started trading through an online brokerage I went through a phase of "information overload". I was using E*Trade (which I still do for some of my trading) and using Worden's TeleChart for charting (when I moved to commodities I started using MetaStock for charting and backtesting). I had the world of information at my fingertips. There is a danger to being able to examine information on any equity or futures contract traded in the market, you can easily lose focus. Let's face it, we just don't have the capacity to follow every market for every traded stock, option, future, or currency pair.

When I realized that part of the reason I was losing money was that I was trying to do too much, that I was falling into the trap of feeling that there was an opportunity out there somewhere if I just searched hard enough, that I had to be in the market all the time, then, and only then, did I begin to consistently win. So how do we deal with all of this information? We discriminate (in the good way, not the bad). We carefully choose the markets we are going to trade. We start small and slowly increase our capacity. If you are trading equities, start with stocks you already know. Pick no more than ten to follow and follow them in whatever timeframe you are trading until following these ten is no problem. Once you can follow these ten without missing anything then add another interesting stock to your stable. In this way you limit your trades to only those you've actually studied. You develop an understanding of how certain stocks move and you can learn to exploit that understanding. You are not in the market all the time, rather only when you have the best of it.

The same principle applies to currency pairs, futures contracts and options. If you slowly stretch your knowledge and understanding instead of just jumping into the deep end of the pool, you are much more likely to swim than to sink.

Good Trading!

The Difference Between Gambling, Trading and Investing

Anyone who has been in the market long enough, especially if they do any short term trading or, god forbid, trade commodities or futures, know that there is alot of ignorance about trading. Who has not heard that short term trading is akin to gambling? That the only way to make a small fortune in commodities is to start with a big one? All of my life I've heard people, most of whom have either no experience in the markets or one painful losing experience, talk of traders this way. This type of attitude is grounded in ignorance of what the terms Trading, Investing and Gambling actually mean.

Let's define the terms and then discuss what they mean. These are my definitions and I'll differentiate them as necessary from Webster's. First Investing: Investing is the placing of value in an asset in order to derive a benefit from the long term appreciation of the asset. This definition does not differ appreciably from the dictionary definition, but I infer a long-term time frome on it in order to differentiate it from Trading. Investing means putting money into something like a stock or real estate an letting time pass in order to gain long term appreciation (which hopefully out paces inflation). Second Trading: Trading means looking for a short-term advantage in the marketplace. Looking to take advantage of the difference between the current price of an asset and its true value in the hopes that the market comes into line with the asset's value and the trader profits from the price movement. An example of Trading would be selling one currency to buy another in order to take advantage of an interest rate differential or because technical analysis indicates that one currency will move favorably relative to another in the short term. Any use of technical analysis in order to gain short-term advantage in the market is Trading. I use the capital gains time frame to differentiate between trading and investing. If you hold an asset long enough to have its increase taxed as a capial gain, then you've invested. If not, then you've traded. The difference is a bit arbitrary, but there is a border there somewhere that is hard to define. Third Gambling: Gambling is the risk of value upon pure chance. Gambling implies no advantage. If you threw a dart at the Investor's Business Daily's stock tables and put your money on the company you hit, that would be gambling. If you randomly walked through a casino and put money into a slot machine, that would be gambling. But there are betting opportunities that are not gambles. Poker, some video poker, sports betting, horse racing, blackjack, (and some would argue craps with dice control, and roulette with wheel clocking) are all casino based Gambling games where the player can have an advantage. Where you have an advantage, I would argue you are not Gambling. Having the "best of it" is, over time, not risking money on pure chance and hence, by my definition, not Gambling.

The whole point of this post is that putting your money where you have an advantage, whether that is investing (which everone should do), trading (which everyone should learn to do), or playing games with the best of it (which few should attempt, but is fun), is something we should all strive for. Don't gamble with your money. Be smart and have the best of it whatever you do.

Its all about Time

I work five to six days a week, 50 weeks a year. Monday through Friday are generally ten to twelve hours long. Saturday, three to five hours long. Add to this a family with whom I want to spend time and you've got a recipe for disaster when it comes to running a trading business. How to handle the time commitment has been an issue with me for several years (since the birth of my daughter - who is now five). I've found that, for me, trading in a longer term time frame works best because I don't have to monitor it during the work day. What do I mean? Well, with technology today you can trade just about every major market in the world (and some not so major markets) in real time and in time frames as short as a single tick. That sort of trading requires you to be tuned in to the market the entire time you are in it. Trading in time frames shorter than a day is, for me, too attention intensive. I needed to find a methodology which allows me to trade the markets in a way that does not require me to be watching it all the time. Hence, I trade in daily and weekly time frames. This means when I am looking for a trade, I examine the daily and weekly charts (sometimes the four-hour charts to help find entry points). I plan my entries and exits using these time frames and so I don't need to watch the markets until the new daily bar is generated. This minimizes my time spent planning and executing my trades and allows me to maximize my time in other areas of my life.

Of course, this does not mean that I do not spend significant amounts of time looking for opportunities and preparing for the next trade. I estimate that I spend ten to fifteen hours a week on my trading business. Sometimes a bit more, sometimes a bit less. I have found that having regular business hours helps. I know when I am working on my trading business and I can plan accordingly. For me, the first two hours of the morning (usually from 5 am to 7 am) are used for my trading business. On the weekends (especially Sunday as the Australian and Asian Forex markets open on late Sunday afternoon) I let my wife sleep in and I get a couple of hours of planning in.

There is no substitute for time. You've got to put the hours in if you want to be a successful trader. There is no other way. You can (and when you are ready, probably should) spend some time reading what other people believe the markets will do, but you can't rely on others to do your thinking for you. No one cares about your money as much as you do. If you remember that, you'll have a greater chance of getting out of the market with a profit.

Good luck, and good hunting.

Welcome to my Avocation

In time this will be where I discuss what it is like to be a professional in the working world, while trying to practice my avocation - Trading. I will discuss my 15 years of successes and failures in trading stocks, commodities, options and forex. It has been a ride and I look forward to sharing it with you. I look forward to sharing my opinions on time, the markets, capitalization, and more importantly, the money that can be made by a well executed trading plan. Because I do work 12 hours a day, it may take a while to get this up and running to the point I am satisfied with it, but I will endeavor to get it there.

In the mean time, I ask for your patience . . .