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Author: shatterd Big red star, 1000 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 6326  
Subject: Lessons learned... Date: 7/30/2005 4:56 PM
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I have penned this post to reflect on some lessons I have learned since taking up trading a few years back. I thought if I p[osted it here that some new people would benefit from it.......


OK..I've been at this game now for 4-5 years(can't remember it's been so much fun). After trying real hard, reading a lot of books, asking alot of questions, and after having made some money and lost a good amount of money...I guess it's time to reflect on some of the important lessons I have learned along the way.

I believe that these lessons have made me a better trader. I am not at this point where ultimately I want to be...but yes I have come a long way. It has been an interesting journey to date.

OK..I hope that some of this stuff can help the new people. Maybe some of the other regulars here could add their insight.

Here goes.....

First off...technical analysis is every bit as valid as fundamental analysis. If you are going to trade in stocks...then I wouldn't even consider getting started without learning about technical analysis. Go to the recommended reading lists and pick out a few books on the subject. The concepts of support and resistance are essential. I would also recommend Dow Theory. Most people skip it and I don't know why. I highly recommend that a new person study the Dow Theory if you want to get into Technical Analysis. It is chapter three in 'Technical Analysis Of Stock Trends' by Edwards and Magee. Dow Theory helps build the basic foundation for everything else you will learn about technical analysis. Basic tenents of Dow Theory include.........

*The averages discount everything except acts of god.(and even they are quickly discounted once these calamities occur)

*There are three trend phases..primary, secondary, and minor.

*Market moves in waves...ebbs and flows much like the ocean tide. Tides, waves and ripples represent the three trends..primary(tide) secondary(waves) and ripples(minor trends).

*The averages must confirm another major average(Dow Jones Industrials and the Dow Transports for example)

*Volume goes with the trend. In uptrends...volume should expand when price moves up and decline on any pullbacks in the uptrend. In downtrends...volume should expand when prices fall and decline if price rises during the downtrend. This is volume 'confirming the trend'. Beware when you see price rising without volume confirmation. This divergence could be an early warning signal that a reversal is coming. This is exactly what happens during a head and shoulders top chart pattern.(low volume right shoulder).

*Closing prices are more important than intraday swings.

*A trend should be assumed in effect until such time as its reversal has been definitely signaled. For example..a trend of higher highs and higher lows has been broken by way of a lower high and a lower low..or when a trend of lower highs and lower lows has been broken by a sudden higher high and higher low.

Many of these Dow Theory concepts can be applied to the trends and actions of individual stocks. By knowing Dow Theory you will begin to see that patterns such as head and shoulders reversals are nothing more than Dow Theory reversal signals. Most chart patterns are built on Dow Theory. Dow Theory is simply the building blocks of technical analysis. I can remember after reading Dow Theory..when I was studying up on some chart patterns like head and shoulders tops and bottoms. I said to myself.."hey, that's just Dow Theory".

I believe that the most valuable concepts in technical analysis are the bare basic concepts in TA...Dow Theory, support, resistance, trendlines, price channels, moving averages, chart patterns, volume, etc. You don't necessarily need to know how to use an Aroon oscillator. Here's why I like Edwards and Magee..because their book was based on the basics...long before all these more fancy TA tools came about which really have not advanced the field of TA all that much. Technical analysis is something that you pick up and learn gradually. You can't become really good at it in a week or two. So I'd suggest a few books that will get you started off on a good technical foundation. O'Neil's 'How To Make Money In Stocks' and Weinstein's book 'Secrets For Profiting In Bull And Bear Markets' will provide a good relevant working foundation...plus you will read about many of these other concepts I am discussing. From there you might consider a book by Kamich 'How Technical Analysis Works' or Schwager's book 'Getting Started In Technical Analysis'. From there you can read John Murphy, Edwards and Magee, Bulkowski, Pring, Elder, etc. Read the quote in my signature. All the great traders I have read about used technical analysis in some capacity.

The good fundamentals in your stocks are most likely... in some way or another... already discounted in the price of the stock. Sometimes you will not have the advantage that you think you have by knowing the details of the stocks earnings, debt, sales, etc etc.) I'm not against fundamental research...just don't over estimate it's value to you. It is just one dynamic in the rainbow of dynamics that push stocks up and down. The market is a discounting machine. Fundamentals are 'known information'..and the market usually has all known information fully discounted. Again..I am not against fundamental research...as CANSLIM traders depend heavily on fundamentals and earnings momentum to evaluate their stocks. Just know that the market is always looking ahead..not behind. The market is a leading economic indicator...not a lagging one. Nicolas Darvas once said...."My only sound reason for buying a stock is that it is rising in price. If that is happening, no other reason is required. If that is not happening, no other reason is worth considering" What good are the stellar fundamentals if a stock is declining? also...a stock will often start rising before the public is fully aware of impoved earnings in the published reports. again..it was the market discounting future events and moving up the price to discount the imroved earnings well ahead of the expectations of the masses which are so often behind the curve. Usually when the masses are on the band wagon...it's a sign that the party is about to end badly.

C is for chart patterns. Chart patterns are a visual record of trading activity on a stock chart. Many patterns tend to recur over and over again throughout history because they represent the emotions of traders..such as hope, fear, and greed. As we know..basic human nature never changes. This is why these chart patterns never change..and why they keep recurring. If you study these patterns and can recognize them...they can offer you some somewhat dependable forecasting signals. Chart pattern analysis is an art and science...and is based on probabilities not certainties. Results using them will vary from trader to trader. Skill level will rise with study and practice. Patterns are often divided into reversal patterns(head and shoulders, double tops, double bottoms, etc) and continuation patterns(triangles, flags, pennants, rectangles, etc). Some of these patterns can serve as either conituation or reversal. The visual nature of this aspect of TA is what I find so attractive. I'd rather scan through 200 charts visually than sit down and read 2 or 3 financial statements. To each his own. If you want to learn more about chart patterns then I'd suggest Edwards and Magee's book 'Technical Analysis Of Stock Trends 8th edition, as well as any book by Thomas Bulkowski..such as his 'Encyclopedia Of Chart Patterns 2nd edition'

M is for Market!...so pay attention the the general market averages. don't buy stocks during a declining bear market...and don't sell stocks short in a strong rising market. Sounds like a simple basic concept...but its importance should in no way be minimized by its simplicity. Stay in synch and in tune with the market. Pay attention to the market as a whole...and not just your little individual pet stocks. Investor's Business Daily has a great column on its front page every day called The Big Picture.. Read this column every day unless you know how to track the averages youself. In the book 'How To Make Money In Stocks' by William O'Neil there is a great chapter in there dedicated to helping you interpret the action of the general markets. It's worth its weight in gold...and probably worth much much more.

Stocks can plunge after what appears to be a great earnings report...and shoot up after what appears to be a mediocre earnings report. Something you should know...if the game was as simple as buying a stock because it has put out a great earnings report then any retard could get rich in a hurry. The game is hard. The game is filled with smart and savvy people on the other end of the trades. They want to take your money..and if you think the game is that easy then they surely will take your money. The market is contrarian. It will often do the opposite of what you think it should do. When earnings are reported...be prepared fopr insane volatility. Some traders actually prefer to exit their positions when earnings are reported..and then possibly re-enter after the madness kools down.

Forest to the trees.......In his excellent book..Secrets For Profiting In Bull And Bear Markets, Stan Weinstein teaches a top down analysis approach where you first start with the market. How is the market doing. Is it an uptrending market or a down trending market? After you determine the trend then you move on to study the industry groups. What industry groups are leading the market and what industry groups are lagging? Stay away from the laggard groups and focusing on the leadng groups. Just look at how well you would have done in housing and energy stocks during the past year or two. So it is important to see which groups the market is favoring and moving up. After group analysis you can then look at the fundamentals and the charts of the stocks within those leading groups. As Jesse Livermore once said.."just because a bull market commences..it does not give you permission to spread out all over the place. Confine your operations to the leading groups and stocks of the day. If you cannot make money with them then you cannot make money anywher else". In Willaim O'Neil's fine book 'How To Make Money In Stocks' you will find alot of reading dedicated to the concepts of group action...and the importance of investing with a 'forest to the trees' approach.

Just because you have found(what you think) is a great stock doesn't mean you have found a good time to buy that great stock. Great stocks bought at the wrong time can produce staggering losses. Most new people don't consider the timing issues..but surely they will learn about it in the form of lost money. Repeat after me....I WILL BUY NO WINE(STOCKS)..BEFORE IT'S TIME! Here is where you will get alot of help from technical analysis.

Opinions will get you murdered in the market. By this I mean trading on what you think the stock will do. You look at a chart...and then you dig into the fundamentals a bit. After such an exercise, you form an opinion of what you think the stock should do. Then you act on that opinion and make a trade. I think this approach leads to steep losses on balance. As William O'Neil has said in his books.."Opinions are often wrong on Wall Street'. I have found this to be so true. Whenever I have traded on an opinion of mine..I have lost money. Now I would like to add...after years of trading I believe that your opinions will improve..but even then they will have limited forecasting value.
The lesson here is to trade based on what you are seeing and not what you are thinking. Listen closely.....this tip will save you a ton of money...if you form an opinion on what you think a stock is going to do..then simply wait for the stock to actually start to do what you thought it was going to do. Wait! Do not anticipate. Once you see it actually happening..then that is your signal. Sometimes the stock will actually do what you expected...but will never do it WHEN you thought it would. The timing issue is so hard..and usually is the reason for big losses.

Here is a simple rule that will save you a from deep and staggering losses. DO NOT TAKE TIPS! remember...you are the brain surgeon(or want to become one)...and you do not need anyone to tell you how to do brain surgery. Why would a brain surgeon ask a janitor how to do a brain surgery. Brain surgeons are few and far between. They are hard to recruit and difficult to replace. And so it is with good traders. If you want to learn about brain surgery...then make sure you seek the advice of another good brain surgeon. Just know up front that they are few and far between...very very rare indeed. The best way to learn this lesson is to go ask somebody..maybe a broker.."hey Joe..what looks good?" Joe will always have a a tip and he will tell you that stock XYZ is ready for a big rise. My advice is to go then right away and buy stock XYZ. The next day stock XYZ will most likely start trending down(at least in my experience this is what happens) and will show you a stinging loss. Once you are down about 10% sell the stock. Now you will never again take tips.

Beware...stock are pumped! That's right..stocks are actively promoted. This is not much different than the Coca Cola company putting on TV commercials to get you to buy Coke. Well so it is with stocks. They are constantly hyped and pumped. Never ever buy a stock because someone on CNBC said that it was going higher. Chances are that talking head owns the stock and is waiting for the masses to take the bait. The minute you are in he gets out. Suddenly he has a quick profit and you have a stinging loss. Stocks are also pumped by company insiders and even mutual fund managers. Insiders often own tons of their stock(given freely through options where as you had to buy your stock). Their personal wealth is usually tied more to their stock price..than to their slaraies. Generally these companies promote their stock to the masses as actively as they promote their products and services...although a bit more discreetly.. What is more...mutual funds need buying power to absorb their big positions when they want to sell. Never trust a fund manager when he is on TV pumping a certain stock. He may just be trying to stir up some buying power so he can sell. At the least he got in long ago and at a far better price. Never ever buy stocks because someone on CNBC or Bloomberg says its good. It might be good..but many times its a pump and dump. Whatever the case..they rarely have your best interest at heart. Don't be a sucker. Don't take tips. Do your own research. Buy your own ideas. Work 100% as an independant!

Don't ever sell a stock because you think it is overvalued or buy one because you think it is undervalued. See..there you go thinking again...forming opinions. What goes high can go much higher...and what goes low can go much lower. Here is where moving averages can be of great value. How far extended is the stock above the 200 day moving average? Is the 50 day moving average above the 200 day moving average? Are the moving averages sloping up? These questions are much better to ask than..what is the p/e of the stock? The price action and moving averages tell you what is happening. You take a p/e and use it to form an opinion. Again...opinions are going to cost you.

DO NOT TRADE AGAINST THE TREND! if a stock is rising...don't ever sell it short. If a stock is trending down..do not ever buy it as a long. I have done this before because I thought I was smart. I lost money. Now I do not ever do this. Never!

Remember these words.....THERE ARE NO QUICK AND EASY RICHES ON WALL STREET OR ANYWHERE ELSE. Just so you know.

Activity and profits are not directly proportional. Temper your trading activity. You won't make more money by keeping more active. Often your results will plummet as your trading activity increases. Try to become a disliplined trader. Control your emotions. Just know that it only takes a few very good trades to make big money over time. I do not care how much knowledge you obtain...if you don't master your temperament then you will always lose money. ALWAYS! Emotional control is vital! Pascal once said..."most of man's misfortunes can be drived from not being able to sit quietly alone in a room". Tape that quote to your computer screen. I believe that it will be infinitely helpful.

Buying right is the easiest part of the game. Selling right is the hardest. It is not how much profits you are showing...but how much profits you keep. You have to learn how to sell right and keep your profits. What good is a good offense without a good defense? Learn the sell side of the game. Stan Weinstein has a great book titled 'Secrets For Profiting In Bull And Bear Markets'. Stan has a few chapters in there that discuss the sell side of the game. He will teach you how to use stop loss orders...and how to raise them as your stocks rise so that you never give back your hard earned profits. Not everyone here believes in trailing your stops up and that's fine...but there is merit to this technique. Just read Nicolas Darvas book 'How I made $2,000,000 In The Stock Market'

Control your risk. The best traders control their risk at all times. This means trading only when the market climate is favorable to their style of trading. It also means selecting a trade where the risk versus reward is most in their favor. Risk control is also cutting losses short. You have to try to minimize your losses and maximize your profits. Do not cut your profits short! You need solid profits to pay for your losses...as well as your expenses and transaction costs. If you keep cutting your gains off by selling too soon then you are not going to make very much money in the markets. Cut the losses small. never let a stock run too far against you. I would say 8% is about the most I will ever let a trade go against me...and even that would sting like hell. Here is where knowing about support and resistance will help a bunch...because you can look at your stops in a technical sense. You can get a better sense of when you are wrong and then act by curtting off the trade because it has a technical failure of some sort(breaks support or what have you). CUT LOSSES SHORT. A string of losses at 10% or more will put you out of business. This is easier said than done. There is an art and science to cutting losses. Read and study. The rest will come with experience. You have a big advantage by knowing this at the start. One more thing...cutting losses will quickly get you out of what is not working...and into what is working...atleast in theory.

What about money management? Well I would say that position size is most important. No you do not have to diversify and own 20 stocks at once. I actually believe it is best to concentrate money into your best ideas. No one ever got rich off their 7th best idea. Diversification is an averaging of your errors and is not desireable for experienced traders. Warren Buffett once said that "once dumb money realizes its limitations it then ceases to be dumb". So diversifiation may be a good thing for someone whom doesn't want to take the time to study and learn to become more enterprising in his/her investment operations. It is going to be quite difficult to outperform the market with a 10 or more stocks...so don't expect to ever get outstanding returns with diversification. You cannot outperform the market if you are the market. Having said all this..if you are going to take the concentrated approach...it's vital that you do not have 100% of your account in one stock. Don't ever risk your entire account on one position. Remember.....if you cut a loss at 8% you want that loss to be 8% of that position..but not 8% of your account. If you had 100% of your funds in that one stock then an 8% loss on the position is an 8% loss on the entire account. NEVER LET THIS HAPPEN. It is much better if an 8% loss on one position is only a 1 or 2% loss on the entire account. That said...don't own 8-10 stocks at one time. keep working with only your very best ideas.

OK..go ahead and accept this fact now. You are going to lose some money. Be prepared for it. If you do not want to lose money then do not take up trading. The greatest trader of all time..Jesse Livermore once said..."a man has to have experience and he has to pay for it". Truer words have nevr been spoken. Maybe you have recently read Jon Tait mention that he has made a life long commitment to trading...and if he doesn't make it then he will simply die trying. Jon understands too that he will have losses..probably has had many losses early in his trading. My guess is that Jon gladlly paid those losses as a tuition fee for the experience and lessons he learned in exchange for those losses. My guess is that Jon would not give back these lessons and experience if the market would return his money. Jon knows that the lessons and experience are more valuable than the tuition he paid to obtain them. He knows that the experience and the lessons learned are priceless...and you cannot simply buy them. He knows that these experiences will win him back that money many many times over. It would be a great insult to Jon if you asked him 'Tell me a quick and easy way to make some fast money in Wall Street". That is like asking a brain surgeon to give you some quick and easy tips to perform brain surgery. Having said all this...no you are not getting into trading to ultimately lose money. But you should know up front that it is going to take losing money to learn how to make it. "The game teaches the game...and she does not spare the rod in her teaching"..as Jesse Livermore once said.

Hope this helps!
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