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The newsletter other trading professionals demand
My friend is dying. She has cancer, and now it looks like her time is up. She will leave behind an adoring husband and two beautiful children who will feel an aching void for the rest of their lives. For the past few months I find myself thinking about her at the oddest moments. I flick back to the trips we've taken together, how she has laughed with my children, and how she has made me focus on what is really important in my life. I take comfort from the verse written by Joseph Epstein around 70 years ago. The same verse that was read at my own wedding: We do not choose to be born. And she did choose how to live. As a valued member of our Mentor Program before her health gave out, her care and concern for her fellow traders humbled us all. She became a full-time trader out of love. Love for her children. And maybe a sixth sense that her time on this earth would be cut short. She packed more life into her 46 years than most. Even as I write to you about my beautiful friend, tears are rolling down my face. So, I ask you - Have you chosen how you will live, or have the choices been made for you by external circumstances? Have you strived to achieve everything you want out of life? If today was all you had left on the earth, could you look back over your years and feel satisfied? It’s all too common to get caught up in being ‘busy’ – running around pretending we have time on our side, and not stopping to really think about what means the most to us in life. I challenge you to stop for a minute today and think of my friend. Tell the people in your life that you love them. Spare a minute away from the hustle of your life, shake off your shackles of worry about things that don’t really matter, and plan to achieve what’s really important to you. Don’t take for granted the opportunities you’ve been given. Grab life with both hands and pursue your goals with laser-like focus. Laugh a little louder than you should, and help a stranger today. Let us never forget what a precious gift we’ve been given in this life, and that this gift is temporary. We’ve only got one ‘today’, so let’s make the most of it. You're getting this newsletter because you know that it's important to spend some time thinking about these issues, as well as making the most out of trading the markets. You sense that you're in a safe place with us. And let me tell you...Chris Tate and I are honoured to spend some of our precious time with you, and join you on your journey towards achieving what you want - the way we've helped thousands of other traders.
In this month's newsletter: - Tate on Trading - Diversification, It's All the Same to Me
Traditionally, if you asked a broker or anyone else on the supply side of the financial markets to provide you with a diversified portfolio, you were given a list of stocks with different names and, if you were extremely sophisticated, you bought things with different names in different countries. However, this buying of things with different names in different countries was generally achieved by being told to buy Bobs Crap International Fund Number 31, which for years had never made any gains but still managed to rip 3% per annum off you. The argument for offering this advice was that international markets had very low correlation and what affected one might not necessarily affect another. I have always found this argument to be somewhat weak given the increasing effect of globalisation and increasing information flow on world markets. Fortunately for me someone has added some academic flesh to my version of 'ya reckon?' A recent paper titled Is the Potential for International Diversification Disappearing? by Peter Christofferson, Vihang Errunza, Kris Jacobs and Xisong Jin of McGill University has looked at this very question across a range of developed and developing markets and using a range of very robust analytical tools has come up with some surprising answers. Past studies, which looked at the correlation between developed markets between 1970 and 1988, found no evidence of increasing correlation between developed markets. That is, local forces were more of a driving force than a coupling between markets. The only exception to this rule was the 1987 crash, which was seen as a global phenomenon. However, later work using different tools had found an upward convergence in correlation between developed markets. This new paper puts a slightly different twist on this problem and their results can best be summarised by reference to the graphic below which shows the correlation between 16 developed markets and the clear trend towards convergence that has emerged over the past decade. Such a convergence is only logical when you factor in the forces of globalisation and increased information transfer. The buzz word of the past decade has been transnational and the effect of this is clearly evident not only in a rather academic sense but also in a social sense when you consider that words such as Google have entered the popular lexicon, not as company names, but as descriptive terms for activities. You can get a better sense of this convergence over time when you look at the graphic below. This shows the combined correlation between developed markets in a series of time grabs. From 1975 to 1995, correlations were reasonably stable – this tallies with the findings of previous work in this area. However, there is a clear acceleration in the correlation between markets in the past five years.
The question is, what does this ever increasing trend to one world market mean for investors? My quick answer would be 'not a lot' simply because diversification among sophisticated traders is more complicated than simply believing that shares with different names offer diversification. There is also a compelling argument questioning the merits of diversification. For example, if you are an expert at trading BHP options, why would you want to move away from what is your power play because of an academic notion that you should do so? Moreover - and this is the heart of the problem - there is a dislocation between what academia believes is an appropriate course of action and what will actually make you money. Making money is in part found by playing your own game and not someone else’s. Unfortunately, this is often a long drawn out process and there are no real short cuts in the evolution of a trader.
AIA National Investors Conference Investment strategies for changing markets Surfers Paradise Marriott Resort & Spa 25th to 28th July 2010 - Register now to receive early bird rate!
The Australian Investors Association (AIA) is a non-profit association providing independent, high quality, value for money education to all investors. Its annual conference caters to all investors, from beginner to the more experienced. The conference features 40 presentations on subjects such as technical analysis, risk management, ASX sectors, self managed super funds and more. Louise Bedford will be presenting two sessions as part of the Investing in the share market stream - Using technical analysis to find high probability trades and Dive brain-first into sharemarket profits. The first presentation will focus on technical analysis techniques to help you manage risk and the second will address our greatest enemy – ourselves. The $695.00 early bird registration expires 15th May. Non-members will need to join the AIA. One year membership costs $110.00 plus a once off $20.00 joining fee. To register, click here or visit http://www.tradinggame.com.au/countlink.php?emailID=7761&gotolink=http%3A%2F%2Fwww%2Einvestors%2Easn%2Eau%2Fevents/national-conference/ For information on the AIA, visit http://www.investors.asn.au/
April 20th, 2010 We're so excited to announce our first, exclusive CBS trading webinar. It's free to you, because you receive this newsletter, and it's being run by one of our favourite CBS brokers - Peter Camilieri. You'll need to book in fast though because numbers are strictly limited. Here's what you'll learn: 1. Who is CBS? 2. Why has Trading Game chosen CBS? 3. What is the Falcon Trader, and how you can get your free 30 day trial? 4. What are the common FAQ from Trading Game clients? Such as - What costs are involved in an account? What products are on offer? What risk management and support is available? You'll love it. Click here now to reserve your place on the webinar, which will be run on April 20th, for 1 hour. If you can't make it at that time, that's just fine. After the webinar, we'll email you details about how you can listen to it.
I was eaves dropping on two traders having a chat a few years ago. One turned to the other and said: "Trend trading just doesn't work any more. It worked years ago, but it doesn't work in today's market. We'd better start looking for an alternative." I was so shocked I just about vomited into my latte. If you truly believe trend trading no longer works - you are shooting yourself in the foot. You're going against one of the principles of great trading that requires you to “cut your losses and let your profits run”. Luckily, in 2007 I stumbled onto the Mentor Program with Chris Tate and Louise Bedford. I was taught how to turn sayings like 'the trend is your friend' into practice. With practice comes profits. At the end of the program, I not only knew what trend trading was, but I could also execute it in practice with success. Even at the end of the Mentor Program I was blissfully unaware that people thought trend trading was a “dead” trading strategy. Then I stumbled onto a book called “The Encyclopedia of Trading Strategies” by Katz and McCormaick. The book started out well enough, attempting to follow good scientific practice by holding the exit strategy static and testing various entry techniques. In my naivety, I assumed that they would also do the same by holding the entry strategy static, and vary the exit techniques. To carry out this testing they settled on an exit strategy that included a time stop as well as a profit stop. Ok, the 'spidey sense' was tingling a little with the profit stop, but I kept reading. As they progressed through various entry techniques including ones that the reader was told was a typical trend following strategy, against the standard exit - it became clear that the authors had completely missed the point about trend following. The authors concluded that because a trend trading entry system did not perform well with their standard exit strategy. Their summary was that trend trading did not work!! Well I nearly fell off my chair as this was the equivalent of saying that because a diesel engine didn’t work on petrol that diesel engines don’t work any more. So as you can imagine I wasn’t impressed with the book or the authors' approach and unsound reasoning. I started to look for subject matter that wrote about trend trading and in particular those that covered the subject about whether it worked or not. I was sorely disappointed. The interesting thing I found was those that said trend trading didn’t work any more, generally were testing the hypothesis with flawed logic in some way or another. For this reason I felt it appropriate to focus on the reasons why trend trading works. Ok, let's break it down to simple terms. We can see that markets trend. You only have to look at a chart of any market index, Australian dollar, or commodity such as gold to see this in effect. Not proof in its own right but it’s hard to disagree with the charts themselves. They trend up and down and do it for long periods of time. So one would think that if we had a mechanism to capture the majority of a trend's movement, we would be onto something. This is what trend trading attempts to do, that is, wait for a trend to start before getting in and then trail a stop up behind the action. When the trend ends (or is slowing in our trading time-frame) our stop kicks us out of the trade. So this means trend trading is not bottom fishing, nor is it anticipating the maximum price. Trend trading misses the absolute bottom and top but aims to capture the majority of the trend. Now, let us look at the basic tenant of trend trading – cutting losses short and letting winners run. Talk to anyone on this concept and the majority will agree with you it sounds like a good logical premise. Sounds good but what does it really mean? Well if we were to look at the profile of trades taken, we would expect that amongst them there would be some small winners and small losses. You'd also expect that there would be outliers in both directions i.e. some big winners and some big losers. This type of profile would look like the standard bell shaped or normal distribution curve - nothing surprising there except some muttering amongst the statisticians reading this about normal distribution curves and the market, but we will get to that a bit later.
So, what if the concept of cutting losses we were to move the left hand side of the normal distribution curve such that all of the losses were contained and small. We would still have the same number of losses (bugger). However we are now multiplying that same number of losses by only a small amount and what we have achieved is a mechanism that truncates the left hand side of the distribution curve while maintaining the right hand side.
Now for those of you that raise the valid point of stops being 'gapped through', which slightly distorts the perfect picture described above, you are correct and some trades can sneak past your stop values. However with some CFD providers you can purchase Guaranteed Stop Loss Orders, (or GSLOs) which can limit your graph very sharply on that left hand side. Now remember I mentioned the statisticians mumbling about the stock market and normal distribution curves? Well they are correct, the market does not react in a normally distributed fashion - in fact this is an added bonus for the trend trader - as the market throws up 'outliers' which tends to skew the normal distribution curve. Now remember we have cut off the left hand side of the graph so the only outliers available are to the right hand side of the chart.
So what does that mean? Well we get the added advantage that some stocks will keep going and going and going, just like the energiser bunny. And it only takes a few of these outlier trades to significantly skew the returns curve in the favour of the trend trader. So by about the blue line on the graph the trend trader has paid for all the losses in the red bar and the rest are profit. So in summary - We can still see trends emerging in today’s markets, so we know trends still exist. Trend trading does not attempt to get in at the bottom of a trend, it instead waits for the trend to get underway before entering. The trend has to prove to us it is established before we come out to play. We then use weight of evidence to plan our entries. Trend trading does not attempt to get out at the top of the trend, instead it waits for the market to tell us the trend has ended by falling back and hitting our trailing stop. Trend traders do not attempt to forecast an outcome, particularly in a bull market. We place the maths (note I did not say probability as this does not change) of a profitable outcome in our favour by setting and acting on our stops, thus reducing the amount lost overall on our combined losing trades. We then let the market skew the market returns in our favour by letting our profits run until they can’t run any more. Enjoy.
And the Winner is...
Here is what John has won:
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