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Tradecraft – Out With the Old

On December 11, 2009, In Good Articles, by ElfLord

I MUST ADMIT to being a bit of a pack rat. Even if I can’t remember why I owned it in the first place, I’m loath to part with any prized possession, from concert T-shirts to stacks of Clinton-era copies of Wired magazine.

These days, however, I’m giving some spring cleaning a try. And with your portfolio, just as with your closets, you should always start with the old and broken junk that you never use. In short, let your winners run, but cut your losses.

It’s a common misconception that the best traders always pick winning stocks. Every portfolio will have a healthy share of losing trades. And while nothing satisfies the ego like cashing in some chips, the correct way to cleanse your portfolio means starting with the losers.

Buying a stock is easy the real skill comes in having the ability to get out. Tell yourself it’s a tax loss if you must, but the real reason to “toss the loss” is that losing trades tend to stay losing trades, and usually for much longer than anyone ever expects. The best move isn’t to keep the faith with long-term losers, but discard them altogether. (more…)

Tradecraft – Bending With the Wind

On December 9, 2009, In Good Articles, by ElfLord

WHAT MAKES THE Sears Tower able to withstand 60-mile-an-hour winds isn’t its strength, but its flexibility. Although the building soars 1,700 feet into the sky and weighs almost half-a-billion pounds, it’s designed to sway gracefully in high winds — by up to a foot at times.

And so it is with trading. Most often it isn’t the market that hurts us the worst, but our own stubbornness and pride. Nobody is bigger than the market, and when an irresistible force meets an immovable object, trust me: The force will win every time. The best traders aren’t the ones who can throw punches, but the ones who can roll with them.

Probably the most important yet deceptively simple aspect of trading flexibly is maintaining the ability to keep an open mind about the market. Just as the girl you had a crush on in high school looks different 10 years later, stocks are like living, breathing animals that change over time. Yesterday’s leaders are often tomorrow’s losers, and while I’m no raging bear, it’s amazing to see how many people believe that they should hold onto losing stocks for the long term in the belief that they have to come back. As WorldCom (WCOM) demonstrates they don’t have to do anything of the sort. (more…)

Tradecraft – Let the Winners Run

On December 7, 2009, In Good Articles, by ElfLord

ODDSMAKERS WILL ALWAYS handicap the favorites. But at the start of every baseball season, all teams — even longtime losers — are contenders.

The same early-season optimism can be found in the stock market, where a new quarter brings opportunity in both new names and old favorites.

As the wheeling-dealing gets underway, investors should approach every trade with the confidence of Warren Buffett and the wisdom of a blackjack dealer, who knows that even the best players have plenty of losing hands. Although most people want to slap a “time horizon” on their trades, the truth is that the market should decide your holding period, not emotions or research. Every long-term investment starts out the same way — as a short-term trade.

In my view, an appropriately sized initial position is no more than 5% of your overall portfolio. Once you get your trade confirmation, all the analyst reports and newsletter recommendations become moot. As we’ve pointed out in the past, after the first trade is made, it’s all in the follow through. Your job isn’t to research, but react. (more…)

Tradecraft – Playing It Safe

On December 4, 2009, In Good Articles, by ElfLord

WHETHER YOU’RE RUNNING a trust account worth billions or a bank account worth considerably less, there are times when you just want to play it safe. Maybe you’ve grown less tolerant of risk. Maybe you’ve got a major expense coming up or are just sick of seeing your account balance drop.

Whatever the reason, it’s okay to downshift your risk from time to time — as long as you do it right. For most people, “playing it safe” means selling their entire portfolio and stuffing their assets into a seemingly risk-free investment — most likely a CD or money-market or savings account. But even leaving aside the tax bite that comes with selling long-term positions, stuffing your money in the proverbial mattress is a losing move.

There’s no such thing as a free ride. Savings accounts and CDs are insured, but you’re paying for every bit of that safety in the form of mediocre returns. Even uninsured money-market funds are paying a record low 1.35% interest. The return becomes even more depressing after taxes. (more…)

Tradecraft – Beyond Uncle Sam

On December 2, 2009, In Good Articles, by ElfLord

AT ANY GIVEN MOMENT, my first inclination isn’t to take a risk, but to reduce it. And for those readers who earn and spend U.S. dollars, one of the most important and least considered risks is that of a relative decline in the value of U.S. assets, from bonds to greenbacks.

So at a time in which most people are just starting to think about diversification away from the big domestic stocks, my sights are focused on a few more exotic locales, since it’s quite likely that the next big bull market will occur somewhere outside the U.S.

I’m not the only one making the call. In recent days, both Credit Suisse First Boston and Merrill Lynch have upped their allocations of non-U.S. equities, and although the pundits have a habitual knack for inaccuracy, I do believe this is one of the few macro calls worth heeding. A few weeks back we discussed some general opportunities in foreign and emerging markets. This time around, we’ll focus primarily on fixed income.

Because they are backed by the “full faith and credit” of the U.S. government, U.S. bonds are considered the world standard. Because they’re the most liquid and actively traded bonds in the world, U.S. Treasurys are the most often quoted barometer of interest rates. When most people refer to the bond market, they’re referring to the U.S. 30-year bond and, more recently, the 10-year note. (more…)

Tradecraft – Stereotypes and Stockpicking

On November 30, 2009, In Good Articles, by ElfLord

CONVENTIONAL THINKING SUGGESTS that the best decisions are the unbiased ones. But the fact is that we’re genetically rigged to make assumptions. We didn’t come out of the womb ready to operate as adults. Knowledge is learned, and our opinions on everything from sex to Cisco (CSCO) are simply the sum of our experiences. If you’re alive, conscious and have a brain you’ve got a bias.

And so it goes in trading. Some people are biased toward playing stocks from the long side. Others seem to be perennially short. Should I buy or sell Oracle (ORCL)? Or perhaps do nothing at all? Even nondecision is an active choice governed by your personal market biases.

What distinguishes the successful trader is that he understands his biases and knows how to overcome the ones that harm the bottom line. To help you do the same, here’s a look at the three biggest sources of trading bias.

The most common way biases are formed is through *previous experiences*. As a kid, it only took one serious burn for me to realize that touching fire wasn’t a very pleasant thing. More recently, we all learned that companies with a dot-com suffix have a strange tendency to deflate, decline or just disappear altogether. (more…)

Tradecraft – The Money Tree

On November 27, 2009, In Good Articles, by ElfLord

A TRADE, like every other perishable thing, operates on a distinct and established cycle. Each one is a living entity with an identity all its own.

Life springs up in the strangest of places, and a trading idea is no different. It might come from a fully formed and well-researched hypothesis or on a completely impulsive whim. A trade can be inspired by a personal experience or an emotionless stock screen. It might add to your portfolio’s volatility, or reduce it.

Remember, though, that an oak tree drops thousands of acorns, but only a tiny fraction will ever sprout. And so it goes with building a portfolio. Because nobody can be right all the time, you must scatter your seed far and wide. So find a standard trading unit — somewhere between 2% and 5% of your portfolio, and stick with it. Get used to putting on trades that grow into oak trees, not starting with oaks that may shrivel back into acorns.

When a trade is young and foundering and looking for direction there’s not much we can do for it. And just as every toddler could one day grow up to be president, so does every trade carry the possibility of being the next big thing. (more…)

ZF Capital

Tradecraft – Out With the Old

Tradecraft – Bending With the Wind

Tradecraft – Let the Winners Run

Tradecraft – Playing It Safe

Tradecraft – Beyond Uncle Sam

Tradecraft – Stereotypes and Stockpicking

Tradecraft – The Money Tree

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