Trying to learn from my mistakes

Mmmm, where do I begin? I've not been blogging for a while, so getting this out is a little more difficult than what I remember.

I'm sure we all remember the recent market correction? The one that we, technically, haven't yet come out of? Yes, that 12.3% pullback on the Allshare Index that undoubtedly rattled the cages of the over-geared and under-prepared. How many casualties that correction claimed, I do not know. What I do know though it that the way I played it, was completely wrong.

To be honest, I saw it coming. A mile away. Although I did nothing and watched the slow-motion train wreck with pain filled eyes and a very frayed feeling soul. I was stressed. I saw the daily ALSI chart close below the medium term trend line. The channel that the ALSI had been trading in since the bottoming out of the previous crash, had just been broken. I knew I had to short it. I knew I had to hedge my longs. I knew there was a unique opportunity to make money. I did nothing.

Fair enough, for the long term equity investor, staying long is exactly what you do, always. But for the short term trader/weird-trading-portfolio-builder-and-trader-hybrid-whatever-I-am-thingy, staying long is not always the best option. Granted, the strategy that I use to trade (not as much a strategy as a conceptual framework within which I trade) is one that favours being long over short, but that does not mean that I can justify not taking the short when it was so obviously clear. So why didn't I take the short?

This is where the tricky part comes in. I didn't take the short because I was already long, too long. My rules are simple, DO NOT GEAR AT THE TOP OF THE MARKET. Simple.

I had geared at the top of the market. Not much, mind you, but enough. I was geared 1.6x when the trend line broke. Why was I geared 1.6x times when I was, according to my rules, not supposed to be? Simply put; I was on a winning streak, overconfident and greedy. So there I was, looking at the clearest short in years and my internal bias refuses to let me acknowledge what I am looking at. Mistake number 1.

The next phase I did rather well, I think, to stick to the game plan. Buy into weakness, allow the market to fall, gear into the correction. Don't get scared. The market fell and I stuck to the plan, calm as calm as calm can be. Soon enough though, the gearing gauge clocked 3x (if you remember I was over-geared to start off with) and the market hadn't come down enough to warrant 3x. My colleagues had pale faces, their stress heightened mine (because saying that I wasn't stressed would be not just a lie, but a bad one too), we worked each other up... thoughts turned to the worst case scenario. The idea of cutting it all, taking the punch on the chin and going to cash was toyed with, discussed, considered. I banked my first losing trade at the very bottom. Mistake number 2.

Now at this point you should notice that if it weren't for mistake number 1, mistake number 2 would have been more easily avoided. Alas, it was for mistake number 2.

Eventually, as indicated by the height of my panic, the market had started to bounce, and by this time, seeing as I had now taken the view that I need to get out, I refused to believe that it was actually going to bounce all the way up. I saw the bounce as a bear trap, a fools rally, I sold into it. Some trades I banked at losses, some I broke even on, some I actually made a profit on. The accounts recovered to the High Watermarks, a little above in fact, and I took the opportunity to get out of, in hindsight, all the winners. I went to cash, wiped my brow and felt grateful that I got out without losing a cent. 

Had I stuck to my rules, I'd still be in the likes of WHL, CML, SHF and PSG... and more. The accounts would have been much, much higher above their High Watermarks. 

I think the real lesson here for me is that; all the mistakes I have made over the last 2 months stemmed from just one, lack of discipline. I got cocky and thought that this was easy. It cost me. Now though, I need to be careful to not be too hard on myself and keep reeling in the pain of leaving money on the table due to poor trading. The market moves on, and I must move with it. Except now I need to stick to my rules. A difficult as they can be to adhere to, I need to stick to my rules.

Tulips, Bitcoins and Naspers

Well alright, they have nothing in common at all. Except one thing... parabolic charts. Now this is not meant to scare anyone, or predict the future, or to poorly attempt to look like a guru. This is purely an observation and some thoughts that have been rattling around my head.

First, lets look at the past. We start with Tulips. I am sure everyone knows the story of Tulip Mania, so I will not go into detail regarding what happened.

This chart shows what happened to the price of Tulips between 1634 and 1637. That a long, long time ago, although it forms the basis of my observation. It can be seen a a prime example of human nature perhaps, the tendency for people to go a little crazy at times when greed and fear start taking over. Clearly this was a bubble that formed from the euphoria that reigned at the time, and inevitably popped when people realised 'hey, these are just flowers..'. 

The next example of a bubble is the South Sea Company bubble that formed and popped between 1719 and 1722. Again euphoria took hold and again it ended badly.

These are more recent examples that show the Nikkei, the Nasdaq and the DOW during the .com bubble. Again people became euphoric about something and later realised 'hey, these are just websites...', which inevitably lead to the popping of the bubble.

Alright so now we have a few historic examples of how these things have played out in the past. Let's look at the psychology behind these bubbles. 

This chart does well to indicate the different states that people are in when these bubbles form and inevitably pop. It is important for us, here, to take note of the Blow off Phase and the Bull Trap and Return to 'normal' stages. 

Now let's look at Bitcoin's chart. 

The first chart looks are Bitcoins versus the .com bubble. The similarity in the charts should be evident.

These two charts compare the typical bubble chart to the Bitcoin chart. Once again, the correlation here should be clear.

This chart shows the most recent picture we have of Bitcoin. It looks to me as if we are re-entering the Awareness Phase. We know these patterns of human behavior repeat themselves and thus can assume that Bitcoin will in due course push for another high. Time will tell how long it takes to go parabolic again, if at all. 

I say 'patterns of human behavior', because that's all the stock market really is, isn't it? A place where humans interact with each other and allow their primal emotions to rule their actions. There is no such thing as a rational investor and ultimately sentiment drives markets. Anyway, I digress.

Now let's look at the Naspers chart.

Look familiar? Sure it does. To me anyway. This chart is from 2011 to 27 June 2014, roughly the same period of time as the examples from 1634 and 1719. It also looks like we are in the 'Return to normal' stage doesn't it?

There are no shortage of Naspers bears, or bulls for that matter. I am not saying that this is the beginning of the end either. I am just saying that it all looks terribly similar. 

Opinions, thoughts and comments are welcomed! Please leave a comment below if you would like to add anything.

>Peace and love

Massive Returns or Stable Growth?

I've spent a bit of time thinking about taking risks and reaping rewards. I'll bet the first things that pops into the minds of most when those two words are mentioned are things like; the 2% rule, at least a 1:2 risk:reward ratio, and so on. I have a few issues with those rules. It'll take some explaining, but here goes.

Starting with the 2% rule. 

Simply stated, the 2% rule is: Do not risk more than 2% of your capital in one trade. This is supposed to ensure that if you get it wrong and you are forced to stop out, you don't do too much damage to your account. What this rule does not mention is how many trades you can have open at any give time or how many times you are allowed to gear yourself (your portfolio).

So let's imagine that, like most new traders (not saying you're a new trader, just saying that there are a lot of newbie traders out there and hopefully this will help them - now the flow of this sentence is all wrong, so start it again and skip this part), you subscribe to the 2% rule and and you put on a few trades. Sticking to the 1:2 risk:reward ratio, it goes pretty well. You're risking 2% and banking 4%. Eventually you're sitting with 11 trades open, each risking 2%. Now, if all 11 trades go against you (let's say that you are only long) and the market has a week like it did last week, odds are that (in the worst case scenario) all your trades are now at their stop loss levels. Which means that you have just taken a 22% smack in a market that is down 5% or so. I have watched this happen in the past so I know it is possible, or rather, probable that it can and will happen to anyone. But that's not all... because what most people don't realise is that there are brokerage costs to include in your calculations, so what should be a 22% loss is closer to a 30% due to brokerage and slippage.

What the 2% rule does not account for is gearing. Mostly, the position size is calculated based on the entry price, stop loss level and amount (2%) that will be lost if the stop loss is hit. This leads the trader to believe that he/she is safe because they have predefined the risk and have a stop loss. What they don't realise is that they are not managing their exposure efficiently. And that is where I believe the problem lies.

1:2 risk:reward ratio

In theory there is nothing with this. The only problem I see here is that it will sometimes get you out of your trades too soon. Sometimes there is a 150% run for the year, as was the case with Coronation Fund Managers (CML) last year. Letting go of that big winner too soon is one of my biggest weaknesses and I am working on learning to hold onto winners longer.

Another note worthy of being mentioned is that, depending on the strategy, trades with risk reward ratios of 15:1 can be very profitable. It sounds crazy.. risk 15% to make 1%!? Well not exactly, but take for example the strategy I have been trading for a little while now. It allows me to hold a share and survive a 24% drawdown in the share price (or index). And by survive I mean that if the share or index falls 24%, the strategy will only be 12% in the down. This does exclude brokerage, so with that included the final 'risk' that it takes is 15% - 16% per share/index that the strategy is deployed on. The weakness of the strategy is that if the market trends really strongly, it could (and probably) will underperform. Although in a volatile market the strategy performs really very well, and it ensures that you are hardly ever geared, and that you catch the big move (albeit only with a small position). 

I guess I have no criticism on the 1:2 risk:reward rule at all. It is a good rule and should be incorporated in some way or another into any trading strategy. I guess I just haven't figured out how to put it in mine yet. Another piece of the puzzle I need to work on.

We should be thinking in terms of exposure

The way I see it, and I could be wrong here of course, is that in order to survive the crashes and sustainably make profit, we need to think in terms of exposure. If you have R100k in your account, for fuck sakes don't go out and buy R700k worth of stock. It's stupid. Also, being long R300k and short R300k does not nett off to zero exposure... it's a R600k position and for a R100k account, it's too big.

I know that trading in derivative instruments, be it CFD's or SSF's, allows you to gear. It leads to thinking like; "well, I can take a bigger position because I have the margin for it, besides it's not that much risk anyway" and, "I'm long and short at the same time, I'm safe". Remember that you are paying interest on that position for every day you hold it. The only real bonus with trading derivatives is that the brokerage rates are lower. Remember that. I'm not talking about index futures or options here.

As a general rule of thumb, remember this: The lower the market goes, the higher you can gear. As long as you can afford to ride it down 50% from the high. And don't add to a loser!

So what about stability?

Well I guess that this is what it all comes down to: designing a system, or developing a method that you know will be able to survive a 50% market correction. Not only that, but a system that will leave you with enough free cash to be 'long the rocker' when the market is down there. 

In a sense, you need to find a way of trading that will keep your account stable. It needs to enjoy the upside when the market rallies and not fall as hard when the market comes down. Stability is more important than massive returns in my book. The trick to surviving in the market is to accumulate profit. Booming and Busting is not how fortunes are made. Slow steady growth is the key. It might not always beat the market, but keep the volatility of your portfolio low and the equity curve pointing up and in a few years you will have grown your capital in a relatively stress free way. Look at Berkshire Hathaway. It didn't beat the S&P500 last year, but it is stable and on the up, and also one of the greatest portfolios in the world.

If you have questions or comments, please feel free to ask in the comments section below and I will be sure to get back to you.

>Peace and Love!

Planning, talking, negotiating

Sho, I can hardly believe how busy I've been over the last 2 days. It feels as if divine favour shines upon me. I have options, and all of them are good :)

I am a little frustrated that I'm not watching the market, but from what I hear and see from the corner of my eye, it's a good time to be sitting in a holiday chalet in Kommetjie and furiously planning the future - which I am :P

Yellen talks tonight at 20:00 and Futures Close Out tomorrow. Interesting times lay ahead.

>Peace and love!

Taking big steps

After over a week of talking, thinking, considering, weighing up options and more talking, I am sad to say that my relationship with Rock Capital has come to an end.

It is the beginning of a new journey for me. My quest to be the absolute best trader that I can be now leads me down a new and unexplored path.

Trading is a part of me. It is in my DNA. It is entwined with the very fabric of my being. My current focus is to align myself with a firm where trading, and the constant learning that comes with it, will be my primary care (more on this in due time).

Trade well out there.

Guess it's time to wipe the dust off this thing

Alrighty, it's been a long time since I posted anything here. So long, in fact, that I have deleted all the old stuff and decided to start fresh.