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Tradecraft – Dealing with Loss

On March 3, 2010, In Good Articles, by ElfLord

LIKE THE RING toss at the carnival and rollerblading at the beach, investing always seems easier than it really is. You can be correct on the sector but wrong on the stock. You can be correct on the timing but wrong on your position size. This is a game where there’s slim margin for error and plenty of opportunity to do the wrong thing.

When it comes to stock picking, I’m hit or miss. No matter how much research or analysis I do, many of my stock picks end up going exactly the wrong way. Although it’s tempting for investors to brag about gains, it’s how they deal with losses that really matters.

During the 1990s bull market, losses were a problem that nobody seemed to have. After three years of a bear market, however, most investors are now aware that not every investment goes according to plan. To that end, they’ve become more sophisticated: Hedging and stop-loss orders are a few of the strategies that have become part of many investors’ repertoires.

But dealing with emotions can be just as difficult as wrestling with the market itself. Perhaps even tougher. Trading, even when done right, can really mess with a person’s mind. (more…)

Tradecraft – The Brain Drain

On March 1, 2010, In Good Articles, by ElfLord

WHY AREN’T THE most highly educated money managers also the most profitable? Because in the market, it doesn’t matter what you know, but what you do. All of the degrees, training and letters after a name don’t add up to much unless they’re put to good use when it counts.

The problem with being overeducated is that, too often, knowing too much prompts us not to think, but rather to assume. And because a trader must always focus on a security’s current action, the challenge is often not to know your history, but to be able to forget it. From my perspective, the best indicator of the market is the market. When we know (or think) too much, we often slip into the habit of assuming relationships in the market that don’t always hold.

For instance, many people have come to assume that stocks and bonds are negatively correlated; that is, when equities rise, bonds fall. And historically, that has often been the case. But as we noted in last week’s column, over the past few months both stocks and bonds have been strong. Traders have benefited from owning not one or the other, but both. (more…)

Tradecraft – In Hedge Funds We Trust

On February 26, 2010, In Good Articles, by ElfLord

IT ISN’T THE purview of government to keep me from smoking cigarettes or eating fattening foods. Nor is it the responsibility of government to give me a job, an education or health care. While I’m confident that things could be “better” in this country, it can’t (and shouldn’t) be government controls that make it so.

Our society is founded on the principles of a government of laws, not of men. And although we’ve come to expect elected officials to push their agendas, the truth is that America isn’t clay to be molded by whoever is in office at the time. The Constitution is a document that limits the power of government. We all want the world to be a happier place, but the reality is that the government’s responsibility is rather narrow: to protect individual rights.

Yet over the decades, the role of government has gradually been shifted from protecting our rights to defining them. The law has now become the product of institutionalized mob rule. And because we’ve allowed some individual rights to be compromised, now they’re all up for grabs. Most people have come to expect that the government can do whatever it wants.

A prime example can be found in the way hedge funds are treated in this country. We last wrote about hedge funds a few years back. In recent weeks, the Securities and Exchange Commission has begun an investigation that’s almost sure to end in new regulatory constraints. And although as Americans our liberties aren’t to be limited by the government, but protected under them, even the existing hedge-fund regulation demonstrates how easily rights can be compromised by the whims of nonelected regulators who claim to serve the “public good.” (more…)

Tradecraft – A Rite of Spring

On February 24, 2010, In Good Articles, by ElfLord

FOR MANY PUNDITS, investment tips exist in a fantasy world with no capital constraints, margin limits or time horizons. Because pundits focus on stocks picks, and not portfolio management, most of their work centers on where to put new money rather than how to deal with existing positions.

So while in a perfect world we’d always have a clean slate to work with, in the real world most of us travel with baggage. And in your portfolio, that boils down to existing positions. As we’ve written before, that’s always the starting point for smart financial decisions. More than anything else, your existing positions should influence how you invest. Since it’s always preferable to maximize an existing position rather than open a new one, I suggest looking at what’s already happening within a portfolio instead of focusing on what might happen in the market.

The best way to begin evaluating a position is to determine whether you own it as a gain or a loss. But use caution: It’s at this initial step that many investors’ discipline goes horribly awry. Why? Because people tend to get rid of stocks that have made money, yet hold on to shares that have gone down the drain. (more…)

Tradecraft – God Sends Meat, the Devil Sends Cooks

On February 22, 2010, In Good Articles, by ElfLord

EVEN IMPORTED TRUFFLES and filet mignon can be ruined by a bad cook. Likewise, in investment portfolios, even the best trading ideas mean nothing without good technique. When you get right down to it, most people just want stock picks. But we’ve always tried to emphasize that it’s not what you trade, but how you trade that counts. No matter how skilled your stock-picking prowess, bad technique will prove ruinous every time.

As we wrote a few weeks back, investing is a game of speculation. No stocks come with guaranteed results. I’m from the school that says if you’re bullish on XYZ, buy it — mostly because the most influential decision isn’t necessarily which stock to buy, but how much of it to buy. Your position size shouldn’t be too big or too little, but just right.

The most obvious gaff investors make is betting too big. Even the best stocks fluctuate. Investors who put 10%, 15% or 20% of their assets in a single stock at a single price are just asking to get stopped out, most likely at a significant loss. There’s a difference between risk and recklessness; the point of trading is to grow big positions, not start out with them. (more…)

Tradecraft – How to Avoid Bear Traps

On February 19, 2010, In Good Articles, by ElfLord

BY DEFINITION, TRADING is about assuming risk. Like walking a tightrope or having unprotected sex, it only takes one trading misstep to wreck your life. This is a game that should be played carefully at all times.

Although the market is always unpredictable, trading technique can be controlled. To that end, I’ve observed (and, cough cough, committed) a number of common trading traps that will doom an account regardless of what the market does. In hindsight, I’ve learned that most of the frequent mistakes are also the easiest to avoid.

As Sun Tzu observed, the battle is won or lost before the fighting even begins. If you trade for money, let me assure you that the undercapitalized trader is trapped no, absolutely doomed, from the start. It’s not that the game is rigged against the little guy, but rather that there’s an inherent cost to trading. If you have no savings, hold high-interest debt or possess only a few hundred dollars to your name, my advice would be to invest nothing. If you can’t pay, you can’t play. No matter how good your stock-picking prowess, everybody needs to have a financial ark.

The most obvious cost in trading, of course, is the commission. Even at discount rates, this expense adds up quickly for active traders. A less-often considered cost is peace of mind. Plenty of people insist on trading with money they can’t afford to lose. Because the thought of a loss is so psychologically uncomfortable, they essentially hang themselves, ending up with big losses because they were too scared to take small ones. (more…)

Tradecraft – He Who Hesitates Is Lost

On February 17, 2010, In Good Articles, by ElfLord

IF SUCCESSFUL INVESTING was simply about doing your homework, then we’d all be rich. Truth be told, it’s not how skillfully you interpret information, but how you deal with the lack of it that really matters. To that end, I try to react to the market, not predict it’s every move. Regardless, if you’re buying or selling, I’m from the school that says trade first and ask questions later.

When it comes to making a trade, it’s human instinct to want certainty. I’m selling XYZ because it released poor earnings. I’m buying XYZ because its new product is in demand. The only problem: Markets anticipate news, rather than reflect it. By the time the “news” is out, the real move in the stock has likely already occurred.

So while we might crave certainty in our trades, we’re never going to get it. After all, that’s why it’s called speculation. Although it seems reckless, you’ve got to get comfortable with the idea of not always knowing why a particular stock is moving. If you’re always waiting for the headlines to confirm a market move, how can you ever expect to beat the herd? (more…)

ZF Capital

Tradecraft – Dealing with Loss

Tradecraft – The Brain Drain

Tradecraft – In Hedge Funds We Trust

Tradecraft – A Rite of Spring

Tradecraft – God Sends Meat, the Devil Sends Cooks

Tradecraft – How to Avoid Bear Traps

Tradecraft – He Who Hesitates Is Lost

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