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!

Interpreting the August Employment Report

As I write this on Thursday night, very few people know what the August employment report will show. Only the President, Vice-President, and a few top economists get an advance look on Thursday afternoon. The BLS is in lockdown mode for eight days. Media sources get a look on Friday morning, but are cut off from communications until the embargo ends at 9:30 Eastern Time.

Second best is having the background and context for intelligent interpretation of the data.

What is job growth?

Many (most?) sources call the headline number of the report “job growth” or the number of jobs created. Not so. It is actually the net increase in jobs. A look at the actual data will make the significance clear.

Monthly gains in new jobs are nearly 2.5 million. Job losses are a bit less. The difference between the two is the widely reported net increase. Millions of jobs end and millions of others begin each month. The number of people affected by this is far greater than the net jobs story suggests.

Also dwarfing the net change number is the story behind the dynamic. Currently there are over 6 million open jobs. More than 2 million workers voluntarily quit their jobs in the last reported month. The net job change is small in comparison with both of these numbers.

Misleading Focus on the Net Change

Let us now consider the much smaller net change – the most widely cited number. The table below shows the average change in the establishment survey over the last year, about 180K. It also shows the 90% confidence interval, about 120K. The confidence interval is the result of sampling error, inherent in the survey process. It is not something that is “fixed” by revisions in later months.

The household survey counts workers rather than jobs. This means that someone who works several jobs is only counted once. Since the sample is smaller, the confidence interval is much larger, about 500K.

The key point? The typical monthly change is not great when compared to the confidence interval.

Here is a look at the confidence intervals for the overall payroll numbers, as well as some interesting subgroups.

And the BLS provides a helpful table comparing key characteristics of the two surveys.

While the confidence interval is very large on a monthly basis, it is proportionally smaller when we have a longer period and more data. Once again, this is a statistical result, not the consequence of revisions.

Conclusions

  • Those who focus on the net change — which is nearly everyone – are not looking at the more informative picture. Policy changes impact the gross numbers. The net numbers are a secondary consequence. A mere 5% increase in new jobs is more than 100K per month. This is the difference between a sluggish economy and a thriving one.
  • Too much is made of net changes in the absence of confidence intervals. Few understand the sampling process and the implications. Market observers get a fixation on the “headline” number, despite the known error band. It is not that some of the reports might differ significantly from the truth. We know that they will show these differences, both individually and in the aggregate.
  • The complex reports provide ample opportunity for those who want to make a misleading interpretation.
  • Most of the most frequently cited complaints – seasonal adjustments, the birth/death adjustment, etc. – are small in the overall picture. They have also been demonstrated to improve results.
  • Finally, keep each single report in perspective and context. The ADP private employment report provides another source of evidence with a different methodology.

Sources

Employment Situation Summary Table A. Household data, seasonally adjusted

Employment Situation Summary Table A. Household data, seasonally adjusted . (2017). Bls.gov. Retrieved 31 August 2017, from https://www.bls.gov/news.release/emp

  • Comparing employment from the BLS household and payroll surveys

    Comparing employment from the BLS household and payroll surveys. (2017). Bls.gov. Retrieved 31 August 2017, from https://www.bls.gov/web/empsit/ces_cps_trends.htm#concepts

  • Employment Situation Summary Table A. Household data, seasonally adjusted

    Employment Situation Summary Table A. Household data, seasonally adjusted . (2017). Bls.gov. Retrieved 31 August 2017, from https://www.bls.gov/news.release/empsit.a.htm

  • Employment by industry, monthly changes, with confidence intervals

    Employment by industry, monthly changes, with confidence intervals. (2017). Bls.gov. Retrieved 31 August 2017, from https://www.bls.gov/charts/employment-situation/otm-employment-change-by-industry-confidence-intervals.htm

A Few Questions for Dr. George Friedman

Dr. George Friedman is a true expert in international affairs. His Wikipedia entry describes him as “a U.S. geopolitical forecaster and strategist on international affairs”. He has a Cornell PhD and a long list of impressive public and private consulting roles. I read his reports with great interest.

He recently joined John Mauldin’s team of writers, probably increasing his reach and visibility quite significantly. Bravo.

But something has gone wrong?

As a subscriber to the regular Mauldin letters, I look forward to Dr. Friedman’s work. A few weeks ago, I was astonished at what I read. Last week I had a similar reaction.

His latest post carried the byline of Xander Snyder, but appeared over his signature. It had a strange linkage of two topics, as the title suggests: Skepticism of Experts and the End of Libor.

The article includes some reasonable facts about the LIBOR controversy, but seems to have a mission.

“Libor is essentially set by “expert judgment.” Each day, a panel of banks submits its estimated cost of lending to another bank for various time periods to ICE Benchmark Administration (formerly the British Bankers’ Association), the administrator of the rate. What this means in practice is that only some of the bank submissions are based on real underlying transactions, and the rest are left up to traders’ estimates. In 2015, for example, about 70% of the submissions were experts’ guesses”. 

The controversy did not come from a failure of experts, but from the biased reports of traders and banks with a stake in the game. What does this have to do with criticizing experts?

Here is another example of a false linkage:

The crisis abolished the idea that “experts” can manage the complex systems with which they have been entrusted. This is about more than the financial system. There is growing skepticism that experts of all kinds know what they’re doing. And if they don’t, will the public continue to tolerate the degree of complexity that has developed in public and financial institutions that justifies the experts’ existence?

The demise of Libor is just one example of the consequences stemming from this lack of faith.

 

This is a reasonable question, and I would welcome Dr. Friedman’s reasoned analysis. LIBOR was not created as something for “experts” to manage. The financial crisis showed that regulators often lacked the information to do their jobs properly. Do Dr. Friedman and John Mauldin advocate tightening those regulations? How should we deal with this alleged lack of experts?

The second example was even more disturbing. There was no other byline, but I seriously doubt whether Dr. Friedman wrote or even approved this post. For starters, he has no particular expertise in labor economics. (I do). The author combines a series of riffs on popular, but inaccurate themes. Mr. Mauldin’s introduction is about signal and noise, but this post has little of the former and amplifies the latter. Let’s see if we can help with that. I am trying to find a polite way to say that the entire post is replete with errors. I’ll stick to the big ones.

Major Errors

“Dr. Friedman:” The Bureau of Labor Statistics maintains a list of 60,000 households it calls monthly to determine who is employed, who isn’t, who has gotten a job that month, who had their hours cut or increased, and so on. Each month one quarter of this sample group is replaced, and after eight months, those who were dropped return to the rotation.

Jeff: Almost right.  The sampling frame is four months in, eight months out, four months back in, and then completely out.

Dr. F: I don’t mean to demonize the Bureau of Labor Statistics. It employs only about 2,500 people who must select a representative sample of the population, contact them directly, and develop and apply statistical analysis to get final numbers. It is a huge task for so few people. And even if they do their jobs perfectly, their findings still may not be all that reliable.

Jeff: Not right.  The BLS does the data analysis.  The Census Bureau conducts the survey, and has done so for the last 75 years. This is information that even a complete rookie would know.

Dr. F: Employment figures are never published with a margin of error. This is not because statisticians at the Bureau of Labor Statistics believe they are spot on but because they don’t know what the margin of error is.

Jeff: This is also completely wrong. The BLS reports a confidence interval on everything, using the same methods as other professional surveys. The author makes it seem like sample size effects are a matter of opinion, not scientific fact. Whoever wrote this knows nothing about statistics or the BLS.

Here is the process:

https://www.census.gov/programs-surveys/cps/technical-documentation/methodology.html

and the full list of technical notes and concepts

https://www.bls.gov/cps/documentation.htm

 

Importance – Why Should You Care?

The current trend to disparage experts is overdue for some careful examination. Does Dr. Friedman still claim status as an expert in International Strategy? Does Mr. Mauldin support that? I certainly think he is. If so, what is he doing opining about labor economics and statistics? One reason that people lose confidence in experts is that there are too many imposters!

There is a danger that the government will reduce the data collection on the employment situation. This would cripple one of the best and least partisan sources we have. True experts would suffer. Why is Dr. Friedman attacking the data that I need?

What Do I Hope?

I am hoping that Dr. Friedman (perhaps through John Mauldin) will respond, renouncing these views. He is offering paid newsletters and speaking appearances. If we are to regard him as authoritative, he needs to protect his reputation.

Since there is no way to comment on the post directly, I am struggling to find an effective way to respond. Mr. Mauldin has a million readers. I have 30,000 or so. It is an uphill battle.

If investors want accurate information, we all need a way for respectful and constructive engagement. This is my effort. As always, suggestions are welcome!!