Technical Indicator Wisdom 16
Oscillators help identify overbought and oversold markets.
It is never easy to give a speech on day trading—but it is even more difficult to talk to people who want to be traders, but have become disillusioned by the extreme volatility of global markets.
In 2015 I was asked to give a lecture on trading in hostile markets. The lecture was interesting in that international exchanges were in a roaring bull market, yet many traders were disillusioned.
The lecture became one of my most interesting and interactive workshops on trading.
I stood for a minute before the +400 strong audience, being completely quite. After a mere 60 seconds, they started to get restless. Still I waited. Another 30 seconds went by and the group became truly uncomfortable. After two very long minutes, I walked right up to the seating area and said:
“How can you be traders, when simple silence unsettles you?”
The audience continued to shuffle in their seats. Now, not only were they restless, but I had insulted them. Indignation was rapidly taking over.
“And, how can you be global traders, if a single person can make you feel so uncomfortable, so quickly?”
I stopped. I waited. Then I said: “To succeed in the global arena, you need to throw away conventional ways of thinking. Grow a thick skin. Change your long-term perspective to a new and more …” I paused.
What came next really upset a number of people in the audience, especially some women.
“… hostile demeanour. To become really, really stinking wealthy in the global playground of day trading you must embrace all that is wrong with our world.”
“Love violence and embrace poverty.”
“Adore floods and terrorism. Take heart that there is famine in the world.”
Some of the people in the front row thought that this was funny; some left. But I really had their attention…
The aim was not to shock the audience, but to point out that, to be a day trader, you need to see opportunities in every situation. If you only think long term, you will usually equal the market average, but you won’t be truly successful as a trader? I am not suggesting that violence and floods are good or that terrorism is right. I am merely pointing out that these are the things that move markets. The aim of the day trader is to make money out of volatility. When markets don’t move, you don’t make money.
Take famine, for instance. Someone has to deliver food aid to such regions. Someone or some organization has to rebuild war-torn areas. I have followed war and disaster around the world with day traders and I can stress that these are the factors that make or break the day trader.
Therefore, this chapter looks at some of the more radical approaches to day trading. Not in the sense of trading techniques, but in insights that make up successful day traders. The word insight, after all, means the capacity to gain an accurate and deep understanding of someone or something.
I will keep this section short, as I know that you are more interested in the old-style techniques of trading. Nevertheless, they offer a good precursor to the more traditional mechanisms of trading, as outlined in later chapters.
Day Trading Insights
Insight 1: Discipline and Work Ethic
It is extremely easy for day traders to fall into bad habits. You start out by getting up early to prepare for your trading day, maybe researching, checking news items and company announcements.
But slowly you start your working day later and later. After all, nothing happens before the market opens? My advice is simple: Keep to regular hours, or your spouse will start to see you as “unemployed” and, therefore, easy to ask you to fetch groceries or the children from school. I have an office that is less than 10 meters from where I live, but every day I get up at the same time, get dressed for work, and go to the office. I take regular breaks, but my work day is established.
I think there are some important steps you can take before you start your life as a trader. Establish a pattern. Do as much of the groundwork yourself and focus on the activity that you need to really improve. Learn the rules. Once the rules are ingrained and mastered, you develop a sixth sense of when you can get away with stretching or even violating the occasional rule.
Personally, I set two full days aside not to trade. This takes me away from the green and red flashing lights (sell and buy orders) on my computer and permits me to do research. After all, if I am to succeed, I need to be ahead of the pack.
One last word on the subject: Take responsibility for your own trading decisions. Ignore tips. Do not listen to anyone, but your mentor. Even then, you must ultimately make up your own mind on what and when to trade.
Insight 2: As a Trader—Love Famine! Love War!
One of the most basic and important concepts a day trader must fully comprehend is supply and demand. If there is a demand for a product, someone will fill it. You have to find that demand and work out who will fill it.
For instance, in early 2010 the newspapers were filled with Africa’s “worst famine” in decades. The demand was obvious—food. Someone had to deliver the goods?
Analysis showed that there weren’t many companies which could do the job efficiently and immediately. A few phone calls revealed that I was indeed correct. A particular company in Southern Africa had won a tender to assist world aid groups to deliver food to famine regions. So, think of supply and demand in terms of buyers and sellers.
Even though supply and demand is the basis of fundamental analysis, you, as a trader, must have a solid understanding of simple economics and its impact on price trends and support-resistance levels. The other side of the coin is that too much analysis can kill any potential trading opportunity.
Don’t forget that patience is a definite virtue in day trading and a strong belief in yourself the ultimate weapon to succeed. The only absolute certainty is that share prices will fluctuate.
Insight 3: Always Have Future Goals in Mind
What are you working for? Is day trading a hobby or a career? If it is the latter—you need to build wealth for your retirement. How you do this will depend on a number of factors, including your age, time horizon for investing, personal and family situations, and attitude toward risk?
Income may be the goal for retired people, leading to a selection of shares with a focus on dividend payment. Accumulation will probably suit people planning for retirement or their children’s education. A goal to get rich quick indicates a desire for higher risk and thus an aggressive trading strategy.
Your planning should define what kind of investor you are and set clear financial goals. The worst approach is to continually change your investment strategies. Stick to one good plan unless exceptional and unforeseen circumstances arise.
Insight 4: Experience and Skill = Instinct
Undertaking in-depth fundamental analysis and understanding the complexities of technical triggers will help you make informed decisions on what to buy and what to avoid. But will it make you rich?
When markets become chaotic and extreme volatility becomes the norm, technical analysis and fundamental variables at times become useless. Irrational behavior cannot be analyzed or predicted. Your instincts are often all you have to rely on under such conditions. It is at such times that good trading instincts, together with experience, become the mainstay to success.
Finding opportunity during times of volatility depends on you. If, for instance, you know that Company X has a net worth of 100 cents and a prolonged strike action sees the share fall to 82 cents—what do you do? Do you hold stock which you have in your portfolio, or do you buy more in an averaging down strategy? Do you expect the strike to continue or not?
I must stress that all hard work and practice will ultimately pay off. Eventually, you will look at the market and just know what it is going to do. Even when you are out making poor trades and seem to be out of sync, you will know whether to hold, buy, or dump the stock.
Despite stressful conditions, you should have the discipline to stand aside.
Another way to state this is to develop a thread of logic. When something happens in the market, you should—within seconds—have followed the line of logic from the event to bottom-line growth, and thus share price.
For instance:
• A company announces that it is to issue more shares.
• The thread of logic is thus:
More shares equate to a higher issued share capital.
This means that attributable profit will be divided by a higher number shares.
This means that EPS will fall.
If the PE ratio remains unchanged, the share price will fall.
Insight 5: Law of the Jungle
I like to point out to new clients that stockbrokers have spent many years studying and preparing for day trading. It is not reasonable to think that someone without experience can simply come into a new industry and make millions of dollars.
You must be prepared for the reality that most individuals, who feel they have the skills to trade, will fail dismally. Successful traders, contrary to popular belief, tend to be conservative in their approach to taking risk. The true art of trading is knowing when to buy, when to sell, and when to stay out of the market and to do this without being influenced by emotions.
Understand this: You are competing against every professional trader and every online novice and semiprofessional in your country and around the world. You certainly have tough competition.
How can a trader get an edge on his or her competitors in these markets? One method is to develop and follow a strict routine. The purpose is to drive everything from the mind except trading. You cannot focus if you are thinking about gulf, or if your partner or children keep interrupting you at work.
Many market commentators say that trading is more about being mentally prepared than it is about the markets. Poor concentration in an active market can—and often does—see you make poor decisions or ones in haste, and you are likely to lose money. In a geared environment, like the futures market, you will lose even more than your money—you could end up with everything being taken away from you.
Be blunt. Be absolutely clear about your intensions to become a trader. You owe it to your family and to yourself.
Insight 6: The Market is Your Guide
As much as you may love your family and friends and their opinions, ignore these every single time. A professional will follow the analytical route every time and use the market as guide. So, start by understanding four environmental factors that influence markets, namely economic conditions, political factors, business trends, and changes in technology. My point is only trade what you understand; the more you know, the more you can use technical analysis to find opportunities.
My recommendation is to open up a folder on your computer and to create names of companies as you assess them. I don’t expect you to undertake analysis; rather, simply know what these companies do. Look at the share price graph. Over time you will gather additional information, your depth of knowledge will increase and understanding of market will itself be a guide to what to buy.
“Some time ago, I was standing in a major supermarket checkout line and, for the first time in ages, saw people with two trollies.” This simple observation led me to look at the retail sector and in particular food company shares. It was a gut instinct, but using the market as a guide I found very rewarding stocks. These companies started to bring out cautionary announcements, stating that their net profits would be higher than 30 percent. Shares rocketed.
Only use technical triggers to hone in your entry levels. In fact, technical analysis can show you in a picture format when to enter a trade and exactly when to sell. Such analysis gives you that edge. Four types of charts are in common use today; line, percentage, bar, and candlestick charts. These are discussed throughout this volume.
Insight 7: Basics Should Never Be Compromised
• Stock markets lead the economy. This means that what you saw happening in the stock market 6 to 10 months ago will influence the economy today. Stated differently, traders follow the trend, so understanding how the market work allows them to enter and exit trades more effectively.
Contrarians trade against the trend. They buy when the crowd is selling and sell when others are buying. This strategy is not one that should be attempted by novice traders, who must stay with the basics and only attempt more complex strategies as their knowledge base grows.
• Sentiments drive markets. The very first question I was asked when I joined a stockbroking firm in 1990 was: “What is the difference between a company’s net profit and its share price?” Ask yourself the same question every time a company releases excellent financial results, but the share price fall. Or, even weirder: A company releases poor results, but the share price climbs.
The difference is in the sentiment of investors in the market. If a company does well, but the market doesn’t understand or believe the company—the share price will seldom move up or, alternatively, if a company does poorly, but there are signs of a turnaround, the share price will often rise.
Another weird explanation. If a company is expected to do badly, but the poor results are not as bad as expected, sometimes the share price rises. Conversely, if a company is expected to do well, but its positive results are not as high as expected the share sometimes falls.
One way to ascertain the sentiment of the market is to look at share price and price earnings ratio graphs (contact me for software packages which do such analysis; [email protected]).
• Trends and volume go together. New traders want too much, too quickly. They rush into a trade and often sell too late. With experience, you will be able to size up market movements better and more effectively. Most of your successful trades will come out of the middle of a move. For example, you don’t enter a trade when the nine-day moving average flattens out and begins to move higher. This is usually too soon. A better time is when the 21-day moving average crosses the 9, giving some confirmation of a trend change.
Insight 8: Never Hesitate
If you can’t afford to take losses, the pressure to win will be too great for you to be able to function efficiently. When all indicators are confused, go with your instinct. There will be times when you will win and there are times when your stop loss will kick in and you will have limited your losses.
Confusion does beget hesitation, which can be very expensive for a trader. A good trader never lets anything emotional prevent him or her from hitting the buy or sell button. Losing is an integral part of trading. You will lose at the beginning of your trading career, in the middle of your career, and even when you have become a professional trader.
The correct procedure is:
• Have a strategy.
• Follow that strategy.
• If you decide on a trade, don’t hesitate.
Insight 9: You Are Allowed to Walk Away
There will be times when trading becomes truly and unbelievably mind-blowingly boring. You may not believe this, which is part of the mystique of stockbroking. However, there will be times when markets move sideways for months, not moving up or down enough to make trading profitable. During such times, the answer is to walk away. Shut down your trading monitors and go back to reading and researching.
Or—you can contact the company secretary of a company you wish to analyze and tell them that you are a shareholder. You may only have a single share in that company—who will know? Many companies have tours of their factories and so on. A visit may give you new insight.
Insight 10: Its Okay To Be Paranoid
Throughout my years in stockbroking, I have seldom seen analysts give a “Sell” signal on a share. Experts tell me that it has something to do with the owners of the brokerage also being shareholders in the company being analyzed. What I have seen, which is tantamount to a “Sell” signal is a recommendation that suggests that investors should “Buy Below” a certain amount. This suggests that if the share price is over that particular amount, then it is overpriced and should be sold.
When Enron took its dive in 2002, only one analyst warned that something was amiss. The terminology used by analysts reinforces the bullish slant of their advice. Everything is a strong buy, a buy, an accumulate, or a hold. An analyst who screams “sell” is brave in the world of trading.
Insight 11: Building Wealth Takes Time
There have been times when clients have said: “I know nothing about trading, but I want to do this for a living. I want to start with $2,000 and turn this into a $1 million by the end of one year.”
What is wrong with this statement?
With absolutely no stockbroking education or trading plan, no idea of what it takes to become a day trader and so little money, they want a miracle. My answer is almost always the same: “If I could turn $2,000 into $1 million, I would be a billionaire or at least turn water into wine.”
My recommendation is simple. If you have $2,000, use it to learn. Start with gathering information, books, and trading manuals. Join share mentoring programmes and go to lectures and workshops.
Some experts have labeled markets as chaotic systems. According to one such expert, mathematicians have shown that chaotic markets are not random. The essence in relation to stock markets is that market chaos is always followed by greater efficiency and controls. For instance, world markets crashed in 1987 by more than 40 percent, with many countries facing the worst recessions since the Second World War.
Many economists and industrial experts on global markets made the following statement: Chaos only focuses on a narrow aspect of the problem.
There is certainly a world inflation problem—but the problem is concentrated in specific industries and not in all sectors across the globe. In fact, World Bank economists say that this is not a consequence of globalization, but rather internal excesses of the past, that were promoted by first-world demand.
Unsuccessful and frustrated equity dealers want to believe there is an order to the markets. They think prices move in systematic ways that are highly disguised. Many want to believe they can somehow acquire the secret to the price system that will give them an advantage. They think successful trading will result from highly effective methods of predicting future price direction.
The truth is that the markets are not predictable, except in the most general way. Successful trading does not require effective prediction mechanisms. Successful trading involves following trends in whatever timeframe chosen and the trend is an edge. If an investor follows a trend with proper investment strategy methods and good market selection, he or she will make money in the long run.
Therefore, is market price movement highly random? Or is there a long-term trend component attached?
There are two related problems for traders:
• Following a good method.
• Following the method consistently.
Sage Advice 1: Analyze Personal Trading Behavior
Investors move funds into equities with a view to making money, but often do this without devising long-term plans. After a while some investors speculate and find that they are making money faster than their financial advisors have recommended. For these investors, the trading process has become a betting game and often the motivation to make money becomes almost subordinated to desire of making more money.
Sage Advice 2: Speculators
The norm is that the market will ultimately catch up with speculators. In addition, investors must be wary of depending on others for their success. As recommended by experts, be part of the entire planning system.
Obviously, traders need help from stockbrokers and analysts to assess statistical databases. It is important not to become obsessed with failure, which is an easy trap to fall into. Therefore, you are responsible for the ultimate result. Until you accept responsibility for everything, you will not be able to change your incorrect behavior.
Sage Advice 3: Proven Methods
When applied consistently and diligently, many simple trading methods do work, but traders must acquire the ability to test any trading method before these are used. It is also important to become proficient in the use of computer systems that test a particular approach or a variety of approaches. Learn the correct way to test and evaluate trading approaches.
Investors and traders must develop an approach that works for them and one which makes them feel comfortable.
Boiling Volumes Down to Basic Rules
There are basic rules in trading.
• Have total discipline.
• Take responsibility for your decisions.
• Have a trading and strategic plan.
• Develop trading rules and stick to them.
• Understand technical triggers.
• Carry out strategies without hesitation: either entry or exit points.
• Manage risk.
• Manage your funds.
Volume 3 discusses and sets out fundamental and technical systems to become a professional trader.