trading (iii): start with a paper portfolio

practice first

As I mentioned last week, your initial plan may be very simple, no more than “I intend to beat the S&P 500 index by selecting sectors with superior profit growth potential,” or “I intend to beat the S&P 500 by selecting individual stocks that are deeply undervalued as measured by the price/cash flow ratio.”

The next step is to create a paper portfolio to test out your ideas.

The paper portfolio is just what the name implies:  you create a portfolio on paper of the names you would want to buy (or sell, if that’s what you think you’ll be good at), watch what happens and keep score.

Based on the results, you refine your ideas.

using real money…

…in small amounts.  That’s the next step.

My experience is that if a paper portfolio is like going to the batting cages to practice your swing, using real money is like playing in a game with a live pitcher and fielders.  Your concentration is sharper, because the stakes are higher.  Sometimes, people who have no trouble performing with a paper portfolio encounter difficulties with a real-money portfolio.  That typically passes with time.

On the other hand, unless you’re convinced that you’re not taking your paper portfolio seriously enough, real-money trading won’t go well if your paper portfolio has consistently underperformed.

trading (ii)

have a game plan

In the beginning, when you’re feeling your way, a plan will likely be relatively simple.  Still, it should contain at least three elements:

–what you intend to do

–why what you’re doing will enable you to make money, and

–how you are going to measure your performance.

the process

In all likelihood, a trading process will include a healthy dose of technical analysis, which in its saner elements is an effort to read the short-term emotional mood of the market.

Take the case of Tesla (TSLA), where investors seem to alternate between bouts of severe depression and wild enthusiasm.  The plan may consist simply of buying TSLA at, say, $200-, when spirits are flagging, and selling at $250+, when owners are dancing in the streets.

Or it could be that you’ve held Amazon (AMZN) for years.  You observe that the stock is travelling in an upward-sloping channel that’s now bounded on the low side at, say, $750 and on the high side at $850.  You might decide you can trade around a core position by selling some of what you own above $850 and buying below $750.

the source of profits

Ultimately you have to believe that something you do gives you an edge over the average investor. Maybe you are very familiar with the price action of a certain stock because you’ve owned it for a long time.  Maybe your work gives you insight into the publicly traded companies in a given industry or geographical area.  Maybe you think that rising trading volume always precedes rising/falling price and you use screens to identify stocks where this is happening.

measuring performance

There’s a very strong tendency among even professional investors to remember successes vividly but brush losses under the rug.  Because of this, it’s essential to measure how you’re doing, both in absolute terms and relative to the performance of a benchmark index on at least a monthly basis.

This is also the best way to identify your strengths and, more importantly, the mistakes you are prone to.  Everyone has something in this second category.  Simply no longer doing stuff that you always lose money on can give a big boost to performance.  I know this sounds silly, but I can’t think of a single professional I’ve known over the years who hasn’t had to deal with eliminating a chronic bad investment habit.

More on Monday.

 

so you want to be a day trader

why trading?

As human beings, we’re all very complex.  Sometimes(often, in my case) we do things for reasons we don’t clearly understand.  We can be influenced in ways we’re not fully conscious of by our families, our friends, our neighbors, our heritage   …as well as by daily bombardment by media of all types.

Sounds silly, but:

–Early in my career as an analyst, I remember calling the CFO of an oil and gas exploration firm to ask him, in polite terms, why anyone would buy the tax shelter programs he was selling through investment advisers, since my reading of the prospectuses seemed to show that virtually all the benefits went to the promoter.  His reply was that buyers were not particularly sophisticated financially.  They typically bought the programs as a way to signal to others that they were wealthy enough to have a “tax problem.”

–Some people are attracted to the riskiest stocks simply because they’re risky rather than because they might offer superior returns.  Buying them is in effect a substitute for going on a thrill ride at the amusement park.

In my experience, successful investors and successful traders have one thing in common.  They are clear about their purpose   …which is to make money.  They’re not working to feed their egos, make friends, or enhance their standing in the minds of others, although these positive things might be nice as side effects.  It’s all about making a return.

This is not to say one shouldn’t have scruples.  As an active manager, I avoided tobacco stocks, for example, because I believe this is a morally bankrupt business.

There’s also no way to know whether you can make money buy buying and selling financial instruments–whatever your holding period–unless you try.

Nevertheless, if you are going to be successful, the bottom line must be that you intend to make a profit.

 

More tomorrow.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The case for day-trading: there isn’t much of one

A story about two day traders in California

The Sunday New York Times, which features human interest stories more than “hard” news, ran a story that recounts “a day in the life” of two day traders in California last weekend.  They support themselves by trading for their own accounts using technical indicators.

The more successful of the two says he has earned $100,000-$120,000 a year from his trading business over more than a decade.  He and his partner also give lessons to others, as well as trading for themselves.  They charge $199 a month and on the day the NYT followed them around they had at least 21 subscribers.  If those students all stuck around for a year, the trading “school” would generate income of about $50,000.  It’s not clear whether these fees are included in trading income.

When asked about how they operate, the two traders are “momentarily stumped” and “struggle to put a finger on what set-ups (i.e., favorable trading opportunities) are or how to spot them.”

Trading results on the day in question?  –60,000 shares traded, $300 in commissions, a loss of $135.

Academic studies:  active traders have worse results than their less active peers

in the US

The article then cites an academic study of US discount brokerage clients that seems to verify what professional investors in the US fervently believe, that the more you trade, the worse your results are.  Trading is emotionally satisfying but deadly to your bank account.

and in Taiwan

To me, however, the most interesting part of the article is its reference to an as-yet unpublished academic study of frequent traders in Taiwan (earlier versions of the paper can be found online ).   Why Taiwan?  — day trading data there are publicly available.  The research finds that a small core of individual day traders consistently makes money, but 99% of day traders make losses. Related research by the same authors shows that in Taiwan foreign institutions are the most profitable traders, followed by other institutions, ex corporations–which lose money after transaction costs.  Individuals as a class lose money, even before costs.

I don’t think Taiwan is a microcosm for the world as a whole.  My experience with this country is that individuals’ investment preferences and the universe of possible investments are far different from those in, say, the US.  Two things strike me, however.  The number of stocks available on the Taiwan Stock Exchange is relatively small vs. the US, suggesting that American day traders face a more daunting task than those in Taiwan.  Also, I wonder why corporations are consistent trading losers in Taiwan.  If their activity were relationship investing, one wouldn’t expect a lot of trading.  Since other trading in Taiwan seems to be symmetrical–foreigners win, locals lose; institutions win, individuals lose–could there be a symmetry between the small cadre of winning day traders and the loss-making behavior of corporations?  Hmm.  What would that mean?

Why I think day trading makes so little money Continue reading