Fickle Trader

Honorary veterinarian for a day

2006-10-16T00:54:00.000-05:00

My veterinarian-student girlfriend, Crystal, and I were walking up to my apartment this morning when we both heard a scratching sound coming from a pinched closed gutter pipe running down the side of a nearby building. At first I didn't think anything about it, but it came unmistakably from the gutter pipe a second time. Crystal said, "that sounds like a squirrel trapped in the gutter." It sounded that way to me too, so we quickly devised a plan to free it from certain doom in that diabolical pipe. It gives me claustrophobia just thinking about it. The poor animal may have been in there all night, or perhaps days.

I grabbed my toolbox while telling Crystal where to find a pair of gloves for protection in case the animal became aggressive while we tried to free it. Our plan was to pull the bottom of the gutter open with my biggest pair of plyers.

Unfortunately we were forced to change our plan on two accounts. First, opening the bottom of the gutter would drop the animal right into a second drainpipe that went straight down into the ground, and second, the plyers were bending the pipe in ways that could have crushed the trapped animal. We used tape from my toolbox and a nearby piece of plastic to cover the hole in the ground below the pipe, but our makeshift lid crowded around the gutter that we needed to somehow manipulate open.

Crystal observed that the gutter was old and flimsy, so I asked her if she thought tinsnips would cut it. She said yes, they probably would. It was slow going, I was standing next to the building holding the pipe while she made small clips out of the bottom of the pipe. It was very noisy and traumatic for the animal inside, which we found out when it crapped on my tinsnips! It was bird poo, which was a relief because birds don't bite like squirrels might.

After quite a bit of careful cutting, Crystal was able to see feathers, and then a dangling leg on the left side of the gutter. We could hear it shifting itself inside the gutter. At that time we thought it was a good idea to cut away on the right side of the pipe to make sure we didn't accidentally maim the bird. Minutes later we paused to re-evaluate the next place to cut when a big red head poked out of the pipe and started looking around! We backed away and the bird wiggled out of the pipe, which we had cut in such a way that there were no jagged edges.

That bird jumped around on the ground for a minute, and then flew up to a bush to join a few other birds, and they all flew off. I don't know if those other birds were watching us save their mate, or just hanging out on some branches, but I felt pretty amazing when I saw our rescued bird take flight.

Crystal and I have been together for almost 5 years, and the whole time she's had her focus on becoming a vet but I never really knew what gave her the drive. Today was the first time I got to feel the gratification that comes with making a life-saving intervention for an animal, and I feel like I know Crystal a little bit better because of it. She wants to have the knowledge and position to do this kind of thing every day. I will never have that knowledge, but today was my chance to do it in a small way. I was so proud of what we did that she agreed it would be okay that I could be an honorary veterinarian for a day!

Watch lists, ads, and vendors

2006-10-11T23:30:00.000-05:00

Jimmy, over at Trend Following with CANSLIM wrote a piece on trader watch lists that reflects my own opinion about bloggers posting stock watch lists. He says, "I sometimes find watch lists funny... Most people who post up lists will point out all the great stocks they posted up. 'If you bought X stock when I posted it, you would have a XXX% gain!' They don't mention the losses, 'If you bought X stock when I posted it, you would have had a margin call!'" Interestingly, a few people with ads on their sites are getting pretty defensive in the comments section of Jimmy's post.

There's nothing wrong with having ads, but realize that as soon as you put them on your site, you're more than just a trader, you're also vendor. Ads can make a site look more authentic, but they can also be a red flag. I know enough to filter out the good content from the bad, but there are a lot of impressionable people who visit our blogs and websites that don't.

I wonder if traders look at the ads on their own sites? Most of the ads I've seen on trading and finance related sites link to pyramid schemes or aggressive vendors that could be a mismatch for the reader, or worse, outright fraud. I would never dream of posting a link in the body of one of my blog posts to just about any ad destination I've ever seen based on the merit of its content. I don't believe in protecting people from themselves, but when they come to me to learn in good faith, I'm not going to point them in the wrong direction.

There's a relevant discussion going on over at Trader Mike's blog. Michelle says:
Other criticism directed at trading blogs is they do not say anything these critics do not already know, that you can get valuable information only if you are willing to pay, and if these bloggers were good at what they do, they wouldn’t be blogging. Apparently these critics have not considered perhaps the reason why a trading blogger writes is because he has something to write that has merit to someone, and he has a generous spirit, but nothing to sell — he is already making a good living.
I would disagree with the statement that blogs with ads aren't selling anything. Regardless of whether or not there are ads on a blog, I do feel that most highly read blogs add value because inevitably there will be readers who are being introduced to the content for the first time.

In the comments over at Jimmy's blog, No Doodahs points out a trader's cost of not being some kind of vendor:
If a "good trader" could make 40% annual and needs to take 10% off the top to pay for living expenses, or that same trader could make 40% annually and defray those expenses by having adverts and/or selling merchandise, which is smarter? Which will get that "good trader" retired faster? By the way, 10 years of 40% gives you equity that is twice as much as 10 years at 30%.
I guess my counterpoint is that if our hypothetical trader cares about the difference between having $7mil and $14mil at some fixed point in the far-away future, he would be better off managing accounts and collecting the fees and performance incentives over that time period.

About a year ago an old friend of mine had heard that I was knowledgable about trading. He called me up and started asking me very basic questions about options. I knew he was beating around the bush, and sure enough I found out what this was about. He asked if I would go with him to an Optionetics seminar, mentioning that he had 2 tickets. I told him not to even bother with it, that it was crap. He argued that he had went to the same seminar a few days ago and was interested. He wanted me to tag along and look for anything suspicious and share my general opinion about it. I agreed since it was only an hour long and I didn't have anything else planned that evening.

A few days later I arrived at the seminar. The hotel conference room was full of probably 30 people, with at least half looking like they had been invited in off the street to fill up seats. My friend warned me that the guy giving the seminar was a slick salesman, and as soon as I got a look at him I almost laughed at how slick he looked. As he pointed at slides and moved around on the stage, he kept rousing the audience and asking us rhetorical questions to invoke a peer pressure crowd response. It was obvious that many people in the crowd had practice with this sort of thing on Sunday mornings, and that slick guy worked it. He stopped looking at me when he would rally his audience because I wasn't joining the hype, and my friend was probably too embarassed to get into it like he probably would have if I wasn't there.

The worst part that sticks out in my mind was when this slick guy told everybody that people who bought stock were suckers. He claimed they had a 1 in 3 chance to make money because stocks could, A) go up, B) go down, or C) stay flat. These uninformed masses were just giving away their money because they only profited when stocks went up. If you took the optionetics course he was selling, you would learn how to make money no matter what stocks did.

This premise is completely false. I've won free lunches and all kinds of change from people by playing a similar game. It works like this: after buying in for a 3:1 jackpot payout, the buyer flips a coin and I flip a coin. The jackpot pays out if both coins land heads-up. There are 3 possible outcomes to this game, let's look at them for a $1 buyin:

Two heads land. I keep the buyin and give the $3 jackpot, so -$2 for me.
One lands heads and one lands tails. I keep the buyin, so +$1 for me.
Two tails land. I keep the buyin, so +$1 for me.

When negotiating the game, it should be pitched this way so as to represent a game of pure chance with 3:1 payout on 3 possible outcomes. However, the probability of the outcome with one coin landing heads and the other one tails is actually twice high as the probability of the other two outcomes, giving me an edge. People who buy US stocks usually have a similar edge: the market's natural upward drift. Unless, of course, they trade too frequently thus reducing portfolio correlation to market direction and large transaction costs to crowd out the edge, or fail to diversify enough for the edge to materialize.

So anyway, after the seminar, I spoke with my friend about all kinds of reasons I thought it was crap. But he still wanted to do it. Even after what I told him, he asked me to reduce the cost of the course by signing up with him and getting a two person discount! Unbelievable. I said, no way, and to watch me go verify these suspicions with the slick guy who gave the seminar.

I waited my turn to speak with him, and the first thing he asked me was, "So are you going to sign up today?" He was kind of smiling. As soon as I asked my first question, he stopped smiling. I asked him about the hedge fund he mentioned that was run by Optionetics founder, George Fontanillis. I pointed out that the hedge fund could potentially be on the other side of a lot of the trades recommended in the course, and how could I be sure that wasn't going to happen. You know what he told me? "I'm not even supposed to mention the hedge fund. That's all I'm saying." He was threatened, and my friend could see it by the way this slick guy was frowning at me. I wasn't going to let him off that easily though. I kept grilling him until he just stopped responding to my questions.

There's more to the story, but we'll leave it at that. The point of that story was to show that there are harmful vendors out there who are selling it as hard as they can to whoever they can. There are also curious and well-intentioned people like my friend, who didn't know enough to see that what was being sold at the seminar was just hopes and dreams. That kind of mistake can cost an aspiring trader years to make up for.

MNG chart

2006-08-21T03:01:00.000-05:00

I haven't posted a chart in a while and I thought this one looked good enough to post. Notating it is left as an exercise for the reader.

Winning entry to the writing contest

2006-08-08T21:39:00.000-05:00

This is the winning entry for the writing contest. As you can see, it is quite a production. Thanks to everybody who participated!

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Risk management

By Terry Zink

“You get paid for taking risks.” This one phrase is critically important to understand if we want to make money in the stock market.

What do we mean when we say we get paid for taking risks in the market? I believe we can understand it thusly: buy before you are certain and sell before you are sure. To put it another way, our returns our better if we act before all uncertainty has cleared.

Risk and uncertainty are two terms that are often used interchangeably. When we say that we are paid for taking risks we are usually referring to uncertainty. Uncertainty is the probability that an investment we make will work out positively for us. If we make an investment whose outcome is uncertain, we will typically expect a higher rate of return. If the outcome cannot be predicted with a high degree of certainty then it makes sense to look elsewhere where the outcome is more predictable. However, if the potential payout is higher, then some investors are willing to overlook that uncertainty in order to maximize return.

Logically, it makes sense that the more uncertain the outcome, the more potential return we ought to expect. If we have to pay a price for uncertainty then we should expect to get more if it works out. In the bond market, long-term bonds have (or should have) higher rates of return than shorter term bonds. The reason is that longer term bonds ties up a person’s money for a longer period of time, and a lot of stuff can happen in that longer time period. It becomes more and more difficult to predict what might happen as the passage of time progresses. Thus, the price of tying money up longer is a higher rate of return.

In real terms, how might we quantify uncertainty? It is unfortunate that risk and uncertainty are often used interchangeably, for while risk is measurable, uncertainty is not. So, how might we go about measuring risk? In practical terms, I believe we can define risk as the most amount of money we are likely to lose in the case that trades or investments do not proceed the way we planned. For example, if we were to invest in a stock, we might define the maximum amount of money we will allow ourselves to lose is $500 before closing our position. We would then call this our risk, or to put it another way, we risk $500. If we invest in real estate, we might say that the most we will be willing to lose on the property is $10,000 before we sell. In either case, the amount we risk is the most we would be willing to lose before closing our position and cutting our loss.

Risk is closely correlated to reward. In all investments we must always ask the question “What is the risk/reward ratio?” The risk/reward ratio, conceptually, is evaluating how much money we think we can make versus how much money we will allow ourselves to lose. If we believe that our potential reward is considerably greater than our potential risk then we have a favorable risk/reward ratio and the investment is probably a good one. How favorable the risk/reward ratio ought to be depends on the individual investor, but in any event, it had better be less than 1.

Using this concept of defining risk, the phrase “you get paid for taking risks” might be better stated as “your payouts are better when you act before all uncertainty has cleared.” We use various tools to guide us in our decision about whether or not to act, including fundamental or technical analysis, or a combination of the two.

The risk/reward ratio is one of the most important ideas in investing, because an analysis of the risk/reward ratio often answers the question of whether or not a potential investment ought to be made. It also can help eliminate the uneasiness associated with uncertainty. When it comes to uncertainty in the market, an investor will often want to predict whether or not the investment will work out. By analyzing the risk/reward ratio the investor need not predict whether or not an investment will work out, he (or she) can weigh the facts and a decision will naturally present itself.

Let me create an example. Suppose an investor is trying to decide whether or not to take a position in a stock. They really don’t know if the stock will go up or down. Let us assume that the stock has been trading in a range between $40 and $50 per share for two years. The stock is now at $48 per share. Should the investor buy the stock? We know the stock usually hits $50 and bounces down, that means it has $2 to go before it probably turns around and trends down. There is not a lot of room on the upside, but plenty of room on the down side. We could only let the stock go down to $46 for a risk/reward ratio of less than 1. That is not a lot of downside room. A tighter stop might be $47 for two-to-one odds, or $47.50 for four-to-one odds, but that is not a lot room as stocks can fluctuate that much in a single day. Indeed, this is not a great risk/reward ratio. If the stock were trading at $41 or $42, we now have a lot of upside room and we can still set a $1 or $2 stop that gets us out. Note that in this case, we didn’t need to worry if the stock will break out of its trading range, the risk/reward ratio ruled out the first case but left the door open for the second.

What are some real life examples of taking risks in the market? One is taking action in a potential head and shoulders top before the change in trend has been confirmed. Figure 1 is an example of a stock in an uptrend, bouncing up along the trend line along subsequent rallies and pullbacks. However, at point 1, it pulls back and breaches the trend line it had always successfully held. It makes a successive rally at point 2 but fails to attain the high of the previous rally. At point 3, it closes below the low point of the preceding pullback. This is a confirmed change in trend from up to down. At that point, traders might decide to close their existing positions or go short on the stock.

Figure 1 - Confirmed change in trend

Note that we must wait for the stock to close below the previous pullback low. Is this the optimal time to close the position? While the trend has confirmed a change from up to down, we have given up a good proportion of our potential gain. After trading costs, commissions and slippage, waiting for consummation of the down move can wipe out a significant portion of our potential profit.

Instead, we might decide to go short around the peak of a right-shoulder in a potential head and shoulders top. If we can see that an uptrend has been violated and the successive rally fails to clear the high from the previous one, we can act before we are sure that the trend has reversed. All uncertainty has not cleared, the previous pullback support level has not been violated but the return will be greater if we capture as much of the move as we can. This is illustrated in Figure 2. The up trend has been violated at point 1 and the subsequent rally at point 2 has failed to carry up to the high of the head. At point 2 we have a potential head and shoulders top and we can take action by closing an existing position or going short. We do not know if the trend will be confirmed but our return will certainly be greater by acting sooner rather than later. We then minimize our potential loss by clearly defining how much we are willing to lose before we conclude we are proven wrong. We might incorporate some technical analysis that will prove us wrong, or use a volatility reversal against our position, but in any case, we manage uncertainty by defining our risk.

Figure 2 - Possible head and shoulders top

Another example is at the end of bear markets, fear is rampant and investors are hesitant to go long in the market for fear of losing more money. This is a justifiable fear; nobody likes to lose money and the reason we buy stocks is because we expect them to go up. However, even bear markets come to an end. There are numerous systems that produce signals to get back into the market, and the earlier we get into them, the better our potential gains. The problem is that hesitation can come into play for fear of the market reversing again and shaking us out of our positions, netting us another loss. We can wait for the market to provide us a clearer signal but by the time that occurs our potential returns have been reduced. Again, adding in commissions and trading fees, not to mention slippage, our potential returns are shrinking the longer we wait. We must act before we are certain, and we manage our risk by clearly defining how much we are willing to lose.

In trending markets, we must keep in mind that the longer a trend has been in existence, the closer it is to its end. Thus, we need to have faith in our market analysis when it is telling us to get back into the market and we then manage our risk to keep us in the game in the event we are proven wrong.

This illustrates the concept of minimizing our risk vs. managing our risk. Minimizing our risk would certainly guarantee the probability of a positive outcome but that outcome would be quite small. By comparison, managing our risk is accepting that we don’t know for sure how an investment will turn out, we accept that fact, but we go ahead and do the investment anyways because we can potentially make a substantial positive return; we will close that position if we lose money according to a predefined condition.

There are several systems of managing our risk, one of which is diversification. Diversification is the practice of investing in numerous different industry groups; when one industry group goes down the losses are offset by the gains in another. Thus, a large loss in one can be counter-balanced by another. Diversification is not limited to investing in a broad number of industry groups, however. A smaller concentration of industry groups may be invested in with a specific amount of total capital risked for each trade, say 1%. A method that concentrates in high performing industry groups but limits itself to a few individual positions manages risk by avoiding overexposure to a major downturn in any one group and protecting total trading capital. Indeed, the protection of initial capital is crucial to managing risk; it takes a larger proportional gain to make back what you lost. For example, if your capital drops 10%, it requires an 11% gain to break even. If your capital drops 25%, it takes a 33% gain to break even. Thus, selecting strategies that protect trading capital is a method of risk management that is imperative for any speculator to make use of. Note that we have not necessarily dispelled any uncertainty but we have minimized our potential loss if conditions move against us.

Of course, no system of risk management is perfect. Acting before we are sure has its downsides, as markets can quickly reverse with little to no warning. Sometimes the moves that we anticipate would happen don’t happen after all. Fundamental news changes can drastically alter the decisions we would have made had we had access to that news. If we buy a position in a stock and plan to get out if we lose 5% of our original position, that assumes that we actually can get out before the 5% has elapsed. What if we buy the stock and the next day the company declares bankruptcy and the stock goes to zero overnight? What if we are short the stock market and the Federal Reserve decides to cut interest rates from 5% to 1%? What if we buy a California-based home builder and the next great earthquake hits and California breaks off from the continent and submerges into the sea? Indeed, all of these sudden changes in market conditions can hurt us much more than we planned. Our risk management system breaks down.

But even in these cases, it is not as bad as it sounds. While these sudden changes are possibilities, they are not probabilities (except for perhaps a sudden change in policy from the Federal Reserve or political decisions by government). It is a possibility every day that we may get into a car accident but most people still drive cars to go to work. We can get food poisoning from contaminated food but most of us rarely think about this in the food we buy from the supermarket. They are possibilities but not probabilities. We make decisions based on the most probable outcome and take the necessary steps to minimize our risk. In the case of a car accident, we can fasten our seatbelts and buy cars with airbags. With supermarket food, we can buy canned goods and wash our vegetables. In the market, we can allocate only a portion of our trading capital to any one position and define our exit criteria. None of these will protect against the absolute worst case but it manages risk and, in this case, reduces it. It is a matter of taking steps to minimize the damage in the event that we what we don’t expect to happen, happens.

Risk management, then, does not involve eliminating risk but instead managing it by accepting what might go wrong and how to prevent damage that can occur. It is a matter of making intelligent decisions on how to allocate capital and taking action before certainty becomes completely known. Any mediocre trader can become an excellent trader by incorporating risk management into his or her methods.

Watch list for week of 8-7-06

2006-08-07T01:16:00.000-05:00

If you look at the weekly charts of these stocks in addition to the daily charts it will become a lot more clear why I found them interesting. There appears to be long term bottoming patterns happening on a lot of them, but they aren't in the clear yet. I may enter small long positions in a few this week and add shares if they break out.

Also, it seems like the NYSE is getting all the action lately. Today it had far more new highs than the naz. Not really my kind of market, but it does show an underlying strength that gives me the incentive to place a few longs.

Breaking Off A Piece: Part 1

2006-08-01T02:59:00.000-05:00

Here's the blueprint for one of the more interesting basic pyramidding campaigns that you can do in a stock. This is nothing original, I'm just throwing it out there for discussion because it is useful and the numbers work out nicer than many of the other variations.

The strategy can be used when two conditions exist: a) the stock is strongly trending up, and b) you want to own shares. For your campaign, you must identify up front the amount of "risk capital" for your operation. If your campaign is successful, you will have a block of stock, and have converted all of your "risk capital" back to cash for use in the next campaign.

Say we want to break off a $5k block of stock. For this specific campaign you will need 3 times that amount in risk capital, so $15k. After carefully identifying a good risk:reward entry point using your favorite technical analysis or tape reading, 1/3 of the risk capital ($5k) is committed.

If the stock moves in your favor 10%, commit another 1/3 of the risk capital ($5k). You will have committed $10k of risk capital and are carrying $10,500 of stock.

After the position moves in your favor another 10%, commit the final 1/3 of your risk capital. You will have committed the full $15k of risk capital and are carrying $16,550 of stock.

A limit order is placed to sell 3/4 of your shares 21% higher than your final entry. After the stock has advanced 21% from your final entry point, your position will be worth $20,025.50. If your limit order fills completely, you will have reclaimed your entire $15k of risk capital, and have a $5k block of stock.

At no point are you excessively exposing your capital to great risk. As the position moves in your favor, you will gradually be enabled to reclaim most or all of your risk capital if you stop out. If the position moves against you from the start, you will only take a loss out of 1/3 of your risk capital. What you have done is taken shares from people who are not managing the risk as well as you are. By managing risk in ways similar to this, a trader can break off quite a lot of stock over the years.

Here's a spreadsheet recap of the strategy:

Risk capital Percentage multiplier Position size
5000 1 5000
5000 1.1 10500
5000 1.1 16550
0 1.21 20025.50

These numbers are just used as an example, there are all kinds of variations that can be used in different scenarios. A variation of this strategy can even be adapted for use by market makers to build inventory by adjusting the percentages way down.

Watch list for week of 7-24-06

2006-07-24T01:07:00.000-05:00

The stock charts I looked at were pretty dismal this weekend, but I've listed the best ones I saw above.

I expect to be able to announce the winner of the writing contest this week. Although only one entry can win, I would like to publish all of the articles on this blog because each writer had a unique and insightful perspective.

Mid-week reading material

2006-07-19T11:45:00.000-05:00

Brett Steenbarger has a nice summary of the two primary schools of thought in trading on his blog. The first is the visual / discretionary trader, and the second is the edge / statistical trader. The differences and similarities between the two are worth studying, especially their often different relationships with leverage. Which school of thought sounds the most appealing to you? Which sounds the most like your trading? If there is a divergence, you might have found an opportunity to improve your trading results by consciously shifting your efforts.

Chris "Piranha" posted his newsletter for the weekend to his blog. Usually only subscribers get his full report. Chris does excellent work, I have learned a lot from studying his market analysis over the past several years. If you like what you see, check out his website marketstockwatch.com.

Watch list for week of 7-17-06

2006-07-17T02:13:00.000-05:00

Today (Monday) is the last day for submitting an entry to the writing contest. I received a few more last week. If you submitted an entry last week and haven't heard back from me yet, I'll get back to you by email this week to confirm your entry.

This week my software only came up with 3 interesting candidates to watch, probably because downside volume is causing a lot of stocks to be filtered out. Here's the list:

I wonder if we'll see major indices go into freefall over the next few weeks. They look particularly vulnerable to crisis right now. The trend on nearly all time horizons is down.

Pirates and Probability

2006-07-14T11:41:00.000-05:00

Was anybody else figuring all kinds of probability during the dice game scene in the new Pirates of the Caribbean movie? They put a little something for everybody in there. That used up my annual vote for "movie of the year". If you haven't seen it, check it out this weekend :D

Idea for an improved GA

2006-07-11T23:19:00.000-05:00

I just had a slick idea for an improved genetic algorithm. I have not read about this anywhere, but I'm probably not the first to think of it:

Lay a lattice over the surface map you are working with and only solve for points on the lattice to get a good idea about which hills to climb at a finer precision. This should stomp the performance of a vanilla randomly seeded GA.

If you're curious about genetic algorithms or you just want to play with one, you can check out an old applet I made here. There is also good information available on the GA entry at wikipedia. GA applications in systems trading development are everywhere.

Watch list for week of 7-10-06

2006-07-10T02:34:00.000-05:00

Not much to say about nasdaq stocks this week. I have a short watch list from my market homework software, but I don't see any reason to weight long or short heavily right now based on recent charts.

There is one week left to submit an entry to the writing contest. Thanks to everybody who has submitted entries so far.

Watch list for week of 7-3-06

2006-07-03T00:50:00.000-05:00

The nasdaq summation index $NASI has turned positive over the last couple of days, so if I had to guess I'd say that short term bias is probably up, but volume will probably be light due to July 4.

I had a relaxing weekend sitting around coding the market modelling software with my cohort Brandon, and IM'ing Michael Taylor. Michael is moving to Missouri! I'm stoked about it.

Brandon and I spent most of Saturday looking at a problem that occurs when generating weekly bars in my model. The problem was manifesting when we were truncating remainders off of the date of the weekly bar when the week was split across two consecutive years. For example: the week of Sunday December 29, 2002 runs into 2003 and is actually the 53'rd week of 2002. I'll be damned if we didn't find a bug in the Java API. I spent Saturday night until about 2 am coding around it, but until Sun fixes this problem it could rear its head in other places down the road.

There's nothing like crafting science in Java and throwing back some Budweisers with a Morlack chill/goa set playing. I just forget all about time and life is never better.

I'm considering making my market homework software available for free. In the past year since I originally created it I've developed far more sophisticated tools for analysing markets, so it no longer feels "cutting edge" to me. I think making it available to everybody would resolve a lot of issues for me. I would feel like I've paid my dues to everybody who I've learned from over the years without the headaches of open-sourcing the project. It would also level the playing field just a tiny bit more for people who can't program things like that for themselves. I made the market homework software with these things in mind:

Keep an eye on the strongest stocks without me having to look at their charts each day.
To watch when the public isn't watching.
Identify breakout candidates before they break out and show me their charts in an accessible manner.
Avoid showing me charts whose price is extended up or down.
Avoid showing me charts that are plunging (no chance for an uptrend).

Before I make a decision on whether or not to make the market homework software available, I have to speak with Brandon about it. I've been using the report from the market homework software as an excuse to write to the blog regularly, but I don't really want to do that any more. I think the blog would be even better if I only posted when I had something really good to say, sort of like how Michael Taylor runs his blog. The only way I can figure to do this and keep everybody happy is to give to my readers the means to run the market homework software on their own master watch list whenever they want. That way we're all free to focus on what I really love about the markets: deconstructing how they work for the purposes of exploitation ;D

Anyway, here are the highlights from my market homework software this weekend:

Watch list for week of 6-26-06, writing contest extended

2006-06-26T01:06:00.000-05:00

A small list like this means not too many stocks are consolidating at support.

Due to several requests, I've decided to continue accepting entries for my writing contest for three weeks, so the deadline for submission is Monday, July 17. The prize is a copy of Victor Niederhoffer's latest book: "Practical Speculation" shipped from amazon.com to your house. For all the details, please see the link.

Reply to a reader regarding overnight risk during the 2003 bull

2006-06-22T22:18:00.000-05:00

"About your observation about there being a big premium that daytraders miss by not holding overnight risk. You should take a closer look at your data. Re-run the spreadsheet and this time start from about September 2002. You will see the relationship almost breaks down. Shorting overnight or going long over night yields more or less the same return. Before 2002, the point you made on your blog was quite valid. The interesting question then is why this relationship changed. Presumably, the answer is because most daytraders were eliminated by the bubble bursting." - sc

This is a great observation, but it only shows half of what is going on here. September 2002 was a major market bottom, so let's also look at the results for the person who carried risk through the entire period, September 2002 until present.

Buying the close and selling the open: $100,000 becomes $100,598.40
Buying and holding: $100,000 becomes $171,178.80

This tells us that the public was not willing to pay a premium for overnight liquidity. We might conclude that they were frequently getting out of positions and taking small gains because they were willing to pay premiums (higher prices) to people who for the most part bought and held and in doing so improved liquidity over a four year timespan. The people who did most of their buying near the market bottom bought when supply was relatively abundant and demand was relatively scarce...

Criticism of Daytrading Followup

2006-06-21T20:23:00.000-05:00

"To play devil's advocate...if your test shows the tide is against daytraders and against investors. Is the tide with those brave souls willing to hold overnight and dump their holdings the next day? Hold short-term? Long-term? What criteria are you using to determine the tide is with if you trade like yourself? Are you adjusting your exits depending on certain conditions? Scaling out? If so, possibly daytraders and investors can and most likely are doing the same. Plus, your test is only showing one instrument. What happens if you choose a different one? What happens if you diversify across several instruments. Or diversify across time? I could go on and on. There are so many ways to skin this cat...that it's very hard to discount one methodology over another." -- Michael Taylor

This is a great subject for writing about because it is hard to pin down all the angles. I can't resist ;-) Rather than process of elimination, let's discuss some of the important factors that all market participants must deal with because no matter what strategy you use, they are a factor. Off the top of my head some important ones are:

commission
bid-ask spread
margin interest
taxes
slippage
gaps
dividends
money market interest
interest on short positions
dividends paid out for short positions

Every trader should have a good understanding of how these factors affect each of their strategies and tactics. I bolded the two that I feel are immediately relevant to my previous post regarding daytrading and "investing". Before I tear into these strategies again, let me say that each has their place for a well rounded and properly capitalized trader.

Most people have probably given some thought to whether or not they feel that market prices have an infinite fractal dimensionality or not. In otherwords, if I show you a chart of continuous prices I grabbed at random that doesn't have labels on the time axis and price axis, could you make a good guess about what time horizon and price range you were looking at? Could you do it repeatedly with any accuracy? For me, the answer is no. So I assume that daytraders in general are in fact trading the same kinds of chart patterns and price trends that I am, just on a different scale. The daytrader could employ twice as much leverage as I could, but he would also be paying the same bid-ask spread as I would have to. Regardless of how much leverage he chose to use, he's paying the spread on the whole thing, and when expressed as a percentage of his average profits, the bid-ask spread takes a ridiculously larger chunk of his profits using the same chart trading techniques! The daytrader also has a higher turnover, which means more chances for commission and slippage to eat into the profits.

"Ah," you might say, "but the daytrader could avoid the spread by using limit orders." That is correct, you can choose the time of your trade or the price of your trade, but the two are mutually exclusive. So our limit ordering daytrader can't even be sure that he will get the positions that his strategy requires him to have. Also, the best trades have a funny way of not quite getting to your limit anyway. There is no shortcut around the bid-ask spread that doesn't penalize you in another equally sinister way.

Let's not forget gaps. There is a mutually exclusive relationship to explore here as well, and it is all about liquidity. It is a fact that people will pay a premium to reduce their risk. If you can provide liquidity for these people and are good at selectively managing the risks involved, you will be paid a premium. Carrying stock positions overnight is one way of providing liquidity to people in aggregate. Any trader who's thought deeply about it understands that when he is successful in his trading operations, it just so happens that he has improved the liquidity of the market. He has bought when both supply was abundant and demand was scarce. He has sold when supply was both relatively scarce and demand relatively abundant. Buy uncertainty and sell hope.

All these things are the tide that I'm talking about. It is quite convenient that you can see it on the price series of the QQQQ. I'm not saying that you can't be successful daytrading because there are zillions of people who are, but they are grinding it out in an uphill battle for reasons that are fundamental to the way markets work. On top of that, daytrading takes a LOT of time that could be spent on things equally as gratifying. I like the easy road.

Watch list for week of 6-19-06

2006-06-19T00:55:00.000-05:00

I'm convinced that the long-term market trend is down and that we're experiencing the first bear rally. The naz gained almost 3% on Thursday. That's the kind of stuff you see in bear markets. I'm out of almost all long positions, and will be closing the rest out over the next two to four weeks. I'll be shorting opportunistically, but not aggressively yet. Before I show my computer generated watch list, let me point out the two scariest charts and the two best charts I've seen all week:

Scary:
HANS
NTRI

Best:
LBIX
AERTA

Here's the highlights from my market homework software this weekend:

By the way, if you are a daytrader or an "investor", don't even bother to email me. Also, if you have some pay_for_stock_tips service, don't email me.

Somebody might ask, so I feel like I should explain why I'm not going to hawk daytraders' websites. There are two reasons. Daytraders fight the tide if they are going long, which can be seen on this very simple trading system that buys the QQQQ at the open and sells out at the close:

The starting balance was $100,000, and ending balance is $18,914. Where did all our daytrader's money go? Simple. It went to the traders who bought and sold to the daytraders, ie. the ones who took overnight risk and avoided intra-day movement. It might occur that the daytrader should be shorting and cover at the close, but that is also less than optimal due to the inability of a short position to compound as it moves in your favor.

Anybody who wants to reproduce the spreadsheet above can download the price data into excel from this link at yahoo finance, sort the price data in ascending order by date, and use this formula in column J: =J1*(E2/B2) . Put the starting balance in the header row of column J, and you're set.

I can't wail on the daytraders without wailing on the investors. So how did they do over the same period? By buying and holding over the entire period, the $100,000 account is worth $76,192.37. A lot better than the daytrader, but a sharp stick in the eye for seven years worth of "investing". The investor figures his money would have doubled in seven years. Every seven it doubles, right? It never works out that way.

The point is that you have to have an edge, and if you aren't looking for one then don't come here. If I haven't pissed you off yet, then I probably don't mind if you email me.

To tell the truth, I'm thinking of taking a break from this blog. There are so many reasons why, but to name a few:

1) The market has turned long-term bearish.
2) I got ZERO responses to my writing contest.
3) I keep getting more and more annoying emails from people starting investing or daytrading websites and less email from legitimate traders.
4) There's no point in trying to help people make good strategic choices. The public cannot ever "solve" the market. As I get closer and closer to it, I find I have less and less to say to the public about it.
5) It is tiring to keep up with an exponentially growing community when the quality will never get any better than it was.
6) Almost all the blogs I used to love reading are either posting 12 times a day instead of maybe once or twice, switched to daytrading, moved to a pay site, or they don't post anymore. Maybe I'm the one who's crazy, but either way I just don't feel like there's much left here for me.
7) The "evil scientist hibernation" instinct is starting to become overpowering. I have more clarity now than I've had in about three years. When I'm working on my software, the only conscious thoughts that interrupt my concentration is that none of my other work matters. I've got to start cutting out other things, and this blog is one of them.

I like formulating my discretionary trading plan on here each week, it keeps me organized and disciplined. I haven't missed a weekly strategy plan posted to the blog in well over a year and I think I'm at the point where I don't need the blog anymore to maintain it, sort of like when you're a kid and you're ready to take the training wheels off the bike. I might discontinue the "weekly watch list" postings because it will give me more time to focus on improving my strategy and computer programs, and doing some real writing about trading instead of just snippets to the blog.

Watch list for week of 6-12-06

2006-06-12T01:30:00.000-05:00

This correction has become more severe than I anticipated. It seems that a lot of bulls capitulated on Thursday, along with some margin call liquidation. If Friday had been an up day then I would have a little more confidence in long positions. I think this bull might be close to its last legs, but I cannot be certain yet so I am still net long. My watch list this week looks far better than it has for months. It has been a while since such high relative strength stocks have consolidated long enough to meet the criteria my market homework software looks for.

I'll probably be re-allocating some of my portfolio from the worse looking positions into better looking consolidations on the list below. I've had GIGM since I posted about it in March and added to it again this past Thursday morning. I'll add even more shares if it breaks out from its current consolidation.

NTRI
PWEI
RIV
AOB
FNET
GIGM (I'm long GIGM)
GROW
LBIX

Watch list for week of 6-5-06

2006-06-05T01:07:00.000-05:00

Everybody probably thought I was nuts last Monday morning when I said we were in a short-term rally and the naz closed down like 40 points. I didn't sell a thing that day. Like I've said before: most days your best move is to do nothing. It was for me, the naz ended the week up 9 points; its second consecutive up week. In fact, on Wednesday morning I bought some TZOO shares just above its 50-day SMA. TZOO hasn't broken out yet, and sure enough it made an appearance on my market homework software this weekend as a buy candidate. I'll be adding to that TZOO position if it does in fact break out.

I'll be watching the nasdaq very closely over the next month because it has made a significant lower low, taking out the low put in at the beginning of the year. I don't sell profitable long term trend trades when the naz is having a correction off of a fresh higher high, even if the pullback is extreme like this one in May, but I will be closing out those positions if the naz makes a consecutive lower high and lower low, completing a bearish head and shoulders chart pattern. This is the period of the short-term market cycle I love right now because you can make a bet either way on contracting stocks and you will win as long as you realize any losses quickly. Most of my bets over the next couple weeks will be on the long side, but after that, I suspect on the short side.

At the end of April I mentioned on the blog being up about 60% for 2006. In fact, I was up as high as 69% before the correction occured, but I was already unloading my weaker holdings. So how did I hold up through this recent correction? The gain in my discretionary stock trading account for 2006 has shrunken to 32%. Maybe I shouldn't be talking about this on here though because I don't want it to turn into a competition, but I do want to inspire people to learn about my style of discretionary trading and to strive for better emotional control and psychological discipline.

Well, the premier of Korgoth just came on cartoon network for the second time tonite and it actually looks kind of cool. I missed it earlier tonite but I'm going to watch it now, so I'm done talking ;)

Here are the highlights from my market homework software this weekend:

DCAI
TZOO (I own shares of TZOO)
AQNT
ANAD
CBIZ
FNET
FNSR
MICG
ESMC
MSO

Watch list for week of 5-30-06

2006-05-30T08:30:00.000-05:00

Sorry this post is about 10 hours later than normal, my internet went out last night so I could not finish my weekend market study until this morning. It looks like we are in the middle of the rally attempt I suspected we would be last week, so my analysis has not changed. If this rally stinks, I will begin shorting weak stocks. As for now, I am keeping only my outperforming stocks.

Here are the highlights from my market homework software this weekend:

Watch list for week of 5-22-06

2006-05-21T23:55:00.000-05:00

I don't have any new market commitments lined up for this coming week. The recent sell-off has been on huge volume, which is a big negative. Market breadth is terrible now, which you can clearly see on the Nasdaq summation index ($NASI at stockcharts.com). There are also more stocks making 52 week lows than are making 52 week highs. Still, I can't help but think that we're at a short-term market bottom. The most compelling evidence is found on the weekly chart of the nasdaq. 1) There is a decent wick on the bottom of last week's candle, 2) it sits very close to the long-term lower-channel line, and 3) it sits close to its 50 week moving average.

I'm net long right now, sitting in a little more than a half dozen outperforming stocks. All of my weaker holdings have been cut over the past three weeks. This means that I'm in a good position to watch how any rally behaves over the next month or two. If it craps out without my stocks moving to new highs, then I'll dump them, hopefully at an optimal time and probably start to pick up some short positions if the trend on the nasdaq weekly chart changes to down. Basically, I'm going to play this just like I played the market in Q1 2005 right after the naz cracked in the first couple weeks of January.

Here are the highlights from my market homework software this weekend:

Watch list for week of 5-15-06

2006-05-15T00:53:00.000-05:00

Over the past couple of weeks I've sold most of my underperforming positions. As a consequence, I'm sitting on more cash than I've had since late 2005 but I'm not probably not buying much next week based on what I've seen so far. All the stocks from my watch list last week have taken big hits except for PTMK. Thus, the breadth of stocks on my watch list has taken a turn for the worst. This is a big deal because it means that stocks that are trading near support prices are not being bought like they should be. The reason I track more stocks on my weekly watch list than I could possibly own is for this very reason.

A further warning sign that I consider to be particularly important is the $NASI (nasdaq summation index) breaking support on the daily and weekly chart.

So this week, I'll proceed with extreme caution. I'll settle only for the very best prices if I do decide to proceed with my campaign in PTMK, and I'll be quick to sell if support fails. I won't be shorting anything yet because the stocks I'm still long of are all still in aggressive uptrends, and the overall market trend on weekly charts is still up. If we do experience a rapid and extreme market crash in the next couple of weeks, my plan is to take profits on longs, and step aside so that I can be in a great position to be a buyer near the bottom. However, if the transition to a downtrend is slower and more obvious, then I will initiate some short positions. Regardless, the most likely event is that I will have to do nothing, sit in my long positions while the market continues its uptrend.

It goes without saying that the highlights from my market homework software this weekend is a very short list:

May 2006 Journal Musings

2006-05-10T23:26:00.000-05:00

I picked up Tool's new record "10,000 Days" this weekend and I've had it playing non-stop since. While there isn't as much philosophically interesting lyrical material to comtemplate as their previous record "Lateralus", there is an amazing track towards the end of the disc titled, "Right In Two." The chilling story that unfolds over almost a full nine minutes is told from the perspective of angels who are puzzled and amused as they watch the monkeys that they blessed with free will, logic, and opposable thumbs use these gifts to kill each other in a battle over resources, all while there is plenty to go around. "Monkey killing monkey, killing monkey, over pieces of the ground."

Not a lot has changed over all of history. Bloodshed over resources is still common to this day. Meanwhile, guys like me sit in our ivory towers while manuevering for more pieces of the pie. When is enough enough? Bud Fox posed this question to Gordon Gekko in the "Wallstreet" movie. Gekko is correct that it isn't a question of enough, it is a matter of monetizing the wastefulness and carelessness that inevitably results from humans being humans. Laws are levied, wars are fought, and lines are drawn for the rights to the spoils of any given group of people.

I too am puzzled and amused by this seemingly fundamental human character trait because it is both the holy grail and golden goose. Occasionaly I concieve some darwinian experiment that I can program into the computer and tweak, like Maynard's angels have done. What else can be their motivation? Are they not like me, selfishly curious? As for my more wasteful and not so curious fellow human beings, well... perhaps they might be interested in trying their luck at a game of chance. I'd be glad to arrange something ;)

I got caught in my first nasty gap down for 2006 this morning. On April 17 I bought a small "probe" position in AVII @ $6.73. AVII opened about 25% down this morning. I got out right at the open @ $5.22 for a 23% loss realized on a little more than 1/30'th of my buying power. Despite this loss in AVII and moderate pullbacks in a few of my other positions over the past few days, my account is up 61% overall for 2006 (no deposits or withdrawals). I've got 10 long positions on right now, some of them I've had for about 6 months. It's nice to think that a few of my big winners are half way to being long-term capital gains. Those who are quick to take a loss, but not so quick to take a profit are probably enjoying similar performance this year.

I had a really interesting conversation with my friend Jared earlier this week. I should begin by telling you that having Jared around is like having my own "market wizard" to talk to. The other day, he said that when a stock is late in an extreme move, most of the people who are getting into it are making a poor risk/reward decision and if you own that stock it is important to get some of your shares into their hands because their buying is incorrect. While this goes against pure "trend following," I believe Jared is absolutely on the money here. My response to his statement was something like this, "Well, most people aren't going to hold for more than one leg of a move either, so there is an exploitable niche managing that risk too." Pretty obvious I'm more in the trend-following camp than Jared is even though we came from a similar background. Regardless of the differences in our outlooks, we both agree that the psychological component of trading is the most important.

Watch list for week of 5-8-06

2006-05-08T02:18:00.000-05:00

Here are the interesting bases flagged by my market homework software for the upcoming week:

PTMK (see below for more details)
ECIL
FCN
BBD
BCON
CPSS

Dave Johnson asked in the comments last week how I use these weekly lists to trade. There are some good examples of how I look to trade these emerging bases in my blog archive from July 2005. The answer is that I use this list to make discretionary trades in a specific fashion. I've been buying longs exclusively since October of 2005 (no short positions since then) due to the slight up-trend on the nasdaq that began at that time.

I pyramid into each position a little differently than is convention. I start by trying to buy as closely to support in the base as I can. Sometimes this takes a few tries to get the best price. For example, I bought PTMK on Friday when an intraday surge of volume came into it making me think it was going to have a very short-term breakout. However, it did not follow through, so I may sell the shares I purchased at $10.58 and put a limit order to re-buy them around $9.85. The price may follow through on Monday though, so I may be good to sit and do nothing. The 50 week SMA line is $10.36, the 10 day SMA is $10.42, the 50 day SMA is $10.46, and the low on Friday is $10.30. If all of that support is broken, then I will stand aside while the shares get cheaper, and as long as they stay above the recent low near $9.60 I'll try to get long. I'll add more to my position if the stock breaks out past $11.50 on volume. This means I've already got a profit when activity comes into the stock. I like to play from a position of strength and this is the best way I've found to do it.

I buy in such a way that I don't need stops. There are three reasons for this. When I make my first purchase, I buy in such a way that a close below a clear support line is my que to abandon my campaign for that stock. This recently happened to me in NDAQ, which I sat in for 4 months before realizing the loss and abandoning my long NDAQ campaign. The second reason I don't use stops is that I've only got a fraction of my position on while I'm waiting for the stock to decide whether to break up or down. An upward breakout out of a base I've bought is my signal to add to that profitable position. The third reason I don't use stops is that I have the discipline to pull the trigger to unload each and every time my campaign doesn't work out as I expect and while my losses are small and managable.

Watch list for week of 5-1-06

2006-05-01T01:41:00.000-05:00

Once again, I'm sitting on a lot of large long positions in my trading account, some of them since last October. The nasdaq sits right at the support provided by its 50 day moving average and also the lower-channel line for the most recent rally. Not much interests me in the market right now because I feel that a lot of the low hanging fruit has been picked. I'm not chasing this up move because I got in position months ago and I have patience and the discipline to hold my winners. Still, this isn't a bad spot to add to consolidating longs. I added to TASR on Friday morning, but I have a limit order to sell some at the nearby resistance.

Here's my software generated list of consolidating and possibly bottoming stocks that I'll be keeping an eye on throughout the week:

Risk capital	Percentage multiplier	Position size
5000	1	5000
5000	1.1	10500
5000	1.1	16550
0	1.21	20025.50