Stock Exchange: Biggest Cause of Trading Failure

The Stock Exchange is all about trading. Each week we do the following:

  • Discuss an important issue for traders;
  • Highlight several technical trading methods, including current ideas;
  • Feature advice from top traders and writers; and,
  • Provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some ideas, please join in!

Review

Our previous Stock Exchange considered the importance of using discipline when entering and exiting trades. If you missed it, a glance at your news will show that the key points remain relevant.

This Week – What are the Biggest Causes of Trading Failure?

To frame this week’s discussion, we share a quote from Gustav Mejlvang at DayTraderLand. He does an excellent job of describing how “position sizing” can be a source for trading failure, particularly among new daytraders.

“Position Sizing is unfortunately very undervalued, especially for new daytraders who are often more interested in learning methods and setups.

The method constitutes only one third of a successful daytrader’s strategy, where the two other – and least equally important – are psychology/mindset and risk management. Method is definitely exciting, but in my opinion it’s far from the most important thing to focus on if you want to succeed with your daytrading.”

Gustav goes on to explain how position sizing can be used to control risk, and why limiting losses can prevent you from making psychological trading mistakes.

Sticking with the importance of trader psychology, Dr Steenbarger (the author of “The Psychology of Trading”) explains how pain and guilt are important parts of health in trading because they can tell us when we’re on the wrong path in this article: “The Power of Regret in Trading“.

However, in his next article titled “Turning Trading Anxiety Into Growth,” Dr. Steenbarger goes on to explain how your fears and anxieties may also be preventing you from taking enough risks. Both are worth the read.

And sticking with the “fear” theme, this recent DealBook article explains how trading in Wall Street’s Fear Gauge (The VIX) has been proliferating. Specifically, the article reviews how the volume of VIX related trades is growing, and how one day trader has made millions in recent years betting that market participants have been too fearful (i.e. this trader has been betting against The VIX). However, the article goes on to draw some similarities between the growing popularity of day traders trading The VIX now versus tech stocks during the tech bubble. And if anything else, this is a reminder of the importance of position sizing for day traders—one of the biggest causes of trading failure. I’ve certainly had many friends “blow out” including some with multiple such events.  Rarely is it a slow grind.

Expert Picks from the Models

This week’s Stock Exchange is being edited by our frequent guest: Blue Harbinger (also known as Mark D. Hines). Blue Harbinger is a source for independent investment ideas focused on value and income opportunities.

Holmes: This week I like Westinghouse Air Brake Technologies (WAB). This stock’s dip over the last month is the sort of set up I like to see. From the chart below you can see WAB is well below its 50-day and 200-day moving averages. This one has attractive upside potential.

Blue Harbinger: Interesting Holmes. Do you realize that the sharp price decline was because the company missed its second quarter earnings estimate and lowered guidance for the full-year 2017? According to the earnings call transcript, the CEO explained that the negative results were mainly the result of revised timing of sales and projects already in the backlog and to the market conditions which they’ve previously discussed as “rebounding slower than we anticipated.” Did you know all that, Holmes?

Holmes: As usual, Blue Harbinger, that’s a nice story, but my style is dip-buying and mean reversion. So no, I was not aware.

BH: Do you even know that Westinghouse provides technology-based equipment and services for the global freight and transit rail industries? How long do you plan to even hold this position, Holmes?

Holmes: My average holding period is about six weeks. I’ll exit when my price target is achieved, and I control risk with macro factors and stops.

BH: Well, that’s nice you have a process in place. I actually like this industry as long as the economy continues to grow. Any signs of a recession and this position could be in trouble.

H: Again, Six-weeks is my average holding period. I’ll be out of this trade long before the economy slows. Besides, Q2 GDP was just revised upwards this week from 2.6% to 3.0%. Doesn’t sound recessionary to me. How about you, Athena, what do you have this week?

Athena:

I like Take Two Interactive Software (TTWO). As you can see in the following chart, it has some attractive momentum on its side.

BH: Athena, RoadRunner would be honored you like TTWO because it was his pick three weeks ago, and so far he looks very smart considering the shares are up and he typically only holds a position for 4-weeks.

Athena: My process is totally different than his. I buy things based on momentum, and I exit when my specific price target is met. On average I hold my positions for about 1-month, and TTWO has more upside ahead.

BH: Well, as I mentioned to RoadRunner, Take Two seems fairly risky to me. I agree it appears to have some momentum on its side (video game sales continue to show strength), but the company is barely profitable (in fact, net income was negative in 2015 and 2016), and the entire franchise is heavily dependent on the success of one video game, Grand Theft Auto. Any missteps with the next release of that game could spell disaster for Take Two. Plus its price-to-sales and price-to-(forward)-earnings ratios are already very rich.

Athena: I have stops in place in case the trade moves against me.

RoadRunner: I am definitely honored that Athena likes my TTWO pick from three weeks ago, but this week Valeant Pharmaceuticals (VRX) is attractive.

BH: Interesting pick RoadRunner. I seem to recall a famous hedge fund manager that got burned badly on VRX. Any particular reason you like it?

RR: I like VRX because it’s at the bottom of a rising range as shown in the following chart.

BH: As I’m sure you are aware, Valeant is a pharmaceutical and medical device company. It has a lot of debt and basically no profits. Do you really think it can pull itself up by its bootstraps?

RR: My typical holding period is four weeks, so I’m not looking for VRX to become some sort of a long-term self-help story. I’m simply expecting its price to go higher over the next four weeks as it achieves a higher position in its rising channel. I get in and out at opportune times. How about you Oscar, what do you like?

Oscar: I like the Global X China Consumer ETF (CHIQ).

BH: Well I’ve got to hand it to you Oscar, you picked quite an ETF this week. This ETF provides exposure to a basket of Chinese Consumer stocks, and it’s up about 42.6% so far this year versus only about 10.7% for the S&P500 (SPY). Plus it holds some incredibly hot stocks right now like JD.com (the online direct sales company) and Alibaba (the online mobile commerce company). If you think Amazon has been hot this year (+30.8%) it is boring compared to JD.com (+65%) and Alibaba (+95%).

Oscar: I invest in momentum, my holding period is only 6-weeks on average, I rotate to something better when I’m ready to exit, and I use stops to control risks. And CHIQ is attractive right now.

BH: I respect your approach and your track record of success, but have you considered the potential volatility? When these types of stocks fall, they can fall hard.

Oscar: That’s why I’m invested in a basket of stocks through this ETF instead of individual names. CHIQ holds 39 stocks.

BH: Well- I like the idea of having some exposure to emerging markets, and this is certainly one way to do that. Are there any other ETFs you like right now, Oscar?

Oscar: For your reference, here is my list:

BH: Thanks for that list Oscar. How about you Felix, are you willing to share your list this week?

Felix: For your reference, here is the list (below). And just so you know, my average holding period of 66-weeks is quite a bit longer than the rest of the group.

Conclusion

There are many sources for trading failure, but a couple of the biggest are related to position sizing and psychology. For example, guilt and regret are psychological signs that we’re on the wrong path. Also, being able to overcome psychological anxiety can help us grow into a better trader. Further still, position sizing is critically important, often much more so than many new (and some veteran) traders realize.

Stock Exchange Character Guide

Background on the Stock Exchange

Each week, Felix and Oscar host a poker game for some of their friends. Since they are all traders, they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out http://dashofinsight.com/background-stock-exchange/  for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Stock Exchange: Disciplined Entry and Exit Points

The Stock Exchange is all about trading. Each week we do the following:

  • Discuss an important issue for traders;
  • Highlight several technical trading methods, including current ideas;
  • Feature advice from top traders and writers; an d,
  • Provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some earnings season ideas, please join in!

Review

Our previous Stock Exchange considered whether the bull market was slowing. If you missed it, a glance at your news will show that the key points remain relevant.

This Week – Using Discipline When Entering and Exiting Trades

To frame this week’s discussion, here is quote about using stops to exit your trades from a recent edition of Charles Kirk’s, The Kirk Report:

“I do not adjust my stops after they are set, especially not on the fly based on some outside risk event… I don’t like that kind of approach because it introduces a discretionary element into your risk management… At the end of the day, it isn’t up to me to decide whether the market is wrong or right. After all, the market is always right. The stop is there to protect my capital when the position is wrong.”

For some additional perspective on trading strategies, Valeriy Zakamulin adds a little order to the chaos in the field of market timing with moving averages in this article from Alpha Architect:

Trend-Following with Valeriy Zakamulin: Anatomy of Trading Rules

Further still, Alpha Architect provides more insightful information in this article:

Volatility Premium, Covered Call Selling, and Knowing What You Own

Specifically, the article defines the concept of “volatility premium” and then goes on to describe several ways to capture that premium when you enter your trades.

Expert Picks from the Models

This week’s Stock Exchange is being edited by our frequent guest: Blue Harbinger (also known as Mark D. Hines). Blue Harbinger is a source for independent investment ideas focused on value and income opportunities.

Homes: This week I like Franklin Resources (BEN). This stock’s dip over the last month is the sort of set up I like to see. From the chart below you can see BEN is below its 50-day moving average, and just above its 200-day moving average. It’s also received support at $42 twice now, and the price has moved up this week. With limited downside and plenty of upside potential, I hope I’ve brought the humans a solid pick.

Blue Harbinger: BEN is an interesting business Holmes. It’s largely an active asset manager targeting mainly retail investors, as well as some institutions. Asset managers make money based on the amount of assets under management (“AUM”) they have (i.e. their fees are often a percent of AUM). So when the market goes up, BEN’s revenues go up. The trouble with Franklin Resources is that there is this huge and continuing wave of assets moving away from active funds and into passive funds, this is NOT good for BEN.

Holmes: That a nice story about Franklin Resources, Blue Harbinger. But my style is dip-buying mean reversion, my average holding period is six weeks, I exit when my price target is achieved, and I control risks based on macro factors and stops.

BH: Well Franklin Resources delivered slightly disappointing earnings on July 28th, and that’s why the shares have sold off. The company’s AUM was up $2.8 billion during the quarter. Specifically, AUM was up $10.1 billion due to net market change, but then lost $7.3 billion in net outflows—you know, investors moving their money elsewhere. Holmes, have you considered a nice passive manager, like BlackRock (BLK)?… their assets under management will continue to benefit from investors moving to low-cost passive funds like the iShares they offer.

Holmes: I could counter your argument by pointing out active managers (including Franklin Resources) have been increasingly beating their benchmarks this year, and also that the retail mutual funds business has an enormous contingent of relationship-driven clients that will never go to the cold, bare bones, solutions offered by BlackRock. But instead, I’ll just remind you that my edge is based on quantifiable mean-reversion and dip-buying, and I’ll stick to that. How about you RoadRunner, what do you like this week?

RoadRunner: My most recent pick is RH (formerly Restoration Hardware) (RH). I look for stocks that are at the bottom of a rising trading channel, and if you look at the chart below you can see why I like RH. It’s been in a steady rising channel for months and may easily rise over $75 soon. I get in at opportune times, but only hold my position for so long—usually about four weeks.

Blue Harbinger: RoadRunner, might I remind you that you have picked RH in the past, on both July 28th and on May 19th. Is there any particular reason you keep bringing RH to our attention?

RR: Well aside from the reasons I just told you (it’s at the bottom of a rising channel, and it looks good for the next four weeks) my quantitative system has a profitable track record of getting in and out of these names at the right time.

BH: Ok RoadRunner, then I’m just going to remind you of some of the things I pointed out last time you recommended. First, I don’t like RH. It’s a luxury home furnishings company that just completed an extraordinarily aggressive share buyback program. Specifically, they bought back nearly 50% of the shares outstanding in less than six months, and that drove the price to more than double, and it caused the price-to-earnings ratio to also increase dramatically.

The company’s actions just seem very aggressive to me, especially considering they used some expensive debt to buy back the shares. And the market also believes there’s something odd going on here considering short interest is still over 50%! I just feel like this company could tank under even the slightest recession.

RR: Feelings are important, but not when it comes to my disciplined and repeatable process. RH is attractive. Anyway, how about you Felix—what have you got?

Felix: I like Yelp (YELP). This stock has some powerful momentum on its side.

BH: Interesting pick, Felix. It’s nice to see you finally bring an idea to the table after you had nothing for us last week.

Felix: Unlike you humans, I don’t get frustrated and try to force things when the opportunities simply aren’t there. On average, I hold my positions for 66 weeks. I’ll exit when my price target is achieved, and I use stops to manage risks.

BH: Yelp is interesting because revenues are growing rapidly, but so too are SG&A expenses. Your 66 week average holding period seems a little long compared to the rest of the gang, but I suppose that will give Yelp time to keep growing its business.

Yelp is basically an online platform to help people find highly regarded local businesses. It’s got a huge addressable market, so if it keeps growing revenues, and it finds a way to control costs (eventually it won’t have to spend so heavily on SG&A expenses), Yelp could turn into a highly profitable cash cow.

Felix: That’s an interesting story. However, I’m just here to pick winners.

BH: That’s why we like you Felix. Do you have an updated rankings list for us?

Felix: Yep. Here you go…

Conclusion

The trading process can often appear chaotic, especially if you are a newcomer to the field. However, there are methods behind the madness in determining when to enter and exit positions. For example, there are disciplined quantitative processes behind the selections of Felix, RoadRunner and Holmes (as well as Athena and Oscar). Further still, there are disciplined risk controls and exit methodologies in place. And having a disciplined process for entry and exit points is often what separates the most successful traders from the rest of the pack.

Stock Exchange Character Guide

Background on the Stock Exchange

Each week, Felix and Oscar host a poker game for some of their friends. Since they are all traders, they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out http://dashofinsight.com/background-stock-exchange/  for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Stock Exchange: Is The Bull Market Slowing?

The Stock Exchange is all about trading. Each week we do the following:

  • Discuss an important issue for traders;
  • Highlight several technical trading methods, including current ideas;
  • Feature advice from top traders and writers; and,
  • Provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some earnings season ideas, please join in!

Review

Our last Stock Exchange: “Buy the Dip or Abandon Ship?” took a closer look at market volatility and maintaining an opportunity-based mindset. If you missed it, a glance at your news will show that the key points remain relevant.

This Week – Is the 8+ Year Bull Market Rally Finally Slowing?

To frame this week’s discussion, here is a look at the percent gain and loss for the stock market volatility index (The VIX, also known as the “fear index”) and the S&P 500 (SPY) over the last two weeks.

Market volatility, as measured by the VIX, has gained over 63% during this period, an indication that fear has increased. However, for perspective, here is a look at the same chart since the depths of the financial crisis in March of 2009.

Market volatility has declined (-68.7%) and the S&P 500 has increased (+256.6%) during this impressive bull market rally. However, many investors are questioning how much longer the rally can continue considering the US Fed is less dovish (they’re expected to continue increasing interest rates) and market valuations are high. For example, the Shiller PE ratio sits at almost 30, far above the 1987 Black Monday level, and nearly as high as the 1929 Black Tuesday (but still far below the “Tech Bubble” level in 2000).

source

For some added perspective, Ben Carlson offers several interesting ideas about what could trigger an end to the ongoing bull market rally in this article: Prepare Now For The End of The Bull Market.

Also worth the read, Dr. Brett Steenbarger shares how he has learned to think in market cycles (both short, medium and longer term) in this article: What I’ve Learned From My Trading Setbacks. For example, Dr. Steenbarger writes:

“Think in Cycles – This has been one of the two greatest changes I’ve made in my trading.  I stopped thinking about trends and ranges entirely, I don’t focus on chart patterns, and I don’t pretend to know what the “big players” are doing apart from noting volume patterns.  Instead, I am identifying dominant cycles in the market at short, medium, and longer time frame and focusing on how those cycles interact with one another.  I am focusing on cycles of volatility in the market, as well as cyclical price action.  This has been a much more effective way to participate in directional market behavior, especially when implemented in event time.”

Further still, here is an interesting chart from Charlie Bilello that puts the recent VIX spikes into perspective.

Expert Picks from the Models

This week’s Stock Exchange is being edited by our frequent guest: Blue Harbinger (also known as Mark D. Hines). Blue Harbinger is a source for independent investment ideas focused on value and income opportunities.

Road Runner: My most recent pick is Align Technology (ALGN), and this is not the first time I have recommended it. I also found ALGN to be attractive during the weeks of 5/25 and 6/29. I look for stocks that are at the bottom of a rising trading channel and if you look at the chart below you can see why I like Align (again). It’s been in a steady rising channel for months and may easily rise over $180 soon. I get in at opportune times, but only hold my position for so long.

Blue Harbinger: I see what you’re doing here, Roadrunner, with these Align Technology trades, and I think you’re pretty clever. This is a company with a lot of upward momentum, and you keep recommending it every time the price pulls back within its upward channel. I imagine you really like it now after its big 5.1% decline yesterday.

RR: My system is disciplined and repeatable, and yes—it’s attractive.

BH: Both revenues and earnings are growing significantly for Algin, and the company posted even stronger numbers than expected last quarter. The numbers were driven by the company’s Invisalign case shipments in North America that were up almost 28%, and shipments in the teenage segment that were up almost 38%. Plus the company raised guidance for next quarter.

RR: I really don’t care about fundamentals like revenues and earnings, but it’s nice to know you appreciate my pick. How about you, Holmes, what have you got?

Homes: This week I like Boston Scientific (BSX). This stock’s dip over the last month is the sort of set up I like to see. From the chart below you can see BSX is below its 50-day moving average, and reasonably priced relative to its 200-day moving average. It’s also received support just below $27 in the past. The price moving above the 50-day average at $27.43 would be encouraging. With limited downside and plenty of upside potential, I hope I’ve brought the humans a solid pick.

BH: To be completely honest with you Holmes, I don’t have a strong opinion on Boston Scientific either way. I suppose it’s nice the company finally returned to profitability last year (and it has remained profitable for the first two quarters of this year) after posting negative net income in 2012 – 2015 and 2007 – 2010.

Another positive for BSX is its diversified and differentiated product portfolio. And further still, if you believe demographics will continue to drive healthcare needs higher, BSX is in a decent position to benefit.

Holmes: It’s nice you pay attention to historical earnings numbers and product portfolios, but my style is dip-buying mean reversion, my average holding period is six weeks, I exit when my price target is achieved, and I control risks based on macro factors and stops.

BH: Well have you also considered that BSX is sensitive to the medical device tax of the Affordable Care Act? It’s probably helpful for BSX management to have some clarity from Congress (for now anyway) that the tax won’t be eliminated considering the “Repeal and Replace” efforts seemed to have stalled out.

Holmes: That’s all great, but my edge is based on quantifiable mean-reversion and dip-buying, and I’ll stick to that. How about you Oscar, what do you like this week?

 Oscar: This week’s pick is the Video Game Tech ETF (GAMR). The pick feels appropriate considering the growing popularity of these games.

BH: That pick is a little concerning to me. It’s a small ETF with less than $30 million in assets. Such a small ETF size can create challenges. For example, there are days when the trading volume is only around 3,000 shares. You’re going to end up moving the market against yourself if you try to place any big trades.

O: That’s interesting, but I trade based on momentum, and my holding period is usually only about 6 weeks.

BH: Have you also considered the impact of the bid-ask spread on such a low volume ETF? Plus, I have to believe it’ll trade at a significant discount or premium to its NAV on a lot of days that may work against you too.

O: That doesn’t bother me. I’ve been able to successfully rotate in and out of sectors, and I control risk with stops. How about you Athena and Felix, any trades this week?

Athena: Felix and I have no new trades this week. We’ve learned not to reach when opportunities are not in our wheelhouse. Sometimes the wisest thing to do is nothing at all. We’ll certainly let you know when we’ve got something new and attractive.

Conclusion

Trading volatility spikes has special risks, but also special rewards. We continue to monitor the market for changing market cycle trends, and our models continue to indicate bullish market health in all time frames. Despite this being the second week in a row with a volatility spike (and another pullback in stock prices) we’re still finding attractive opportunities.

Stock Exchange Character Guide

Background on the Stock Exchange

Each week, Felix and Oscar host a poker game for some of their friends. Since they are all traders, they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out http://dashofinsight.com/background-stock-exchange/  for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!