An article featured in this weeks “The Economist” is about the cyclically adjusted earnings ratio, (CAPE) as calculated by Robert Shiller of Yale University.
The CAPE averages profits over ten years and is now used by many as an important valuation indicator. The article explains that currently the indicator shows that American shares have hitherto been more highly valued only in 1929 and the late 1990s, periods that were followed by big crashes.
But the article is also balanced in explaining that CAPE valuations are for the longer term view; and that over-value can exist for quite some time.
The CAPE is a similar method developed by Nick and me in 2010 on individual equities. More recently however we have not traded with this method due to there being few suitable valuations on offer.
The CAPE is for the long-term but it is, of course, advantageous to purchase, even for the longer term, at particularly good value.
The article concludes with fund managers being nervous about equity valuations but they (fund managers) find government bonds deeply unattractive. They are therefore stuck with the stock market as the “least dirty shirt” on offer.
Trade entries entered the most are:
(1) On-limit entry trades that don’t activate, lead the way; this means we did not get the price we were prepared to pay for the trade. And that’s fine. (on-stop entries are not part of our strategy)
(2) Next, with a similar number, are break even or near breakeven trades; usually these are trades that did not provide the follow through we anticipated. A difficult area of a trade and a clear strategy statistically works best here.
(3) Further down the score are trades that make target.
(4) Those trades that are profitable but are exited before target due to price action, rather than nerves, are similar in number to those that hit target.
(5) Trades that hit stop or are exited early due to price action are fewer than those that hit target, thank goodness! (importantly, these trades are smaller than the target hit trades)
(6) However, the big leveler on trade entries, and the difference between a consistently profitable trader and everyone else is limiting, zero would be nice, the amount of batty entries. By batty we refer to ego or tired entries, but more often than not they are miss read market reversal entries; a low risk, low probability trade that invariably ends up being vastly more expensive than anticipated.
The simple conclusion is: read the market cycle and price action and stop batty entries.
To be profitable we have to get our stop placements correct:
- Below or above a definite low or high if we’re in a trend.
- An intermediate low or high might be okay in a breakout from a trading range (TR), but the amount traded ought to represent the distance to a definite stop position.
- In a TR, or suspected TR, the stop ought to be equal to the depth of the TR beyond the bottom or top of the TR.
Correct stop positions go a long way to a consistently profitable account. Some would say they (stops) are all the way.
Patience is a virtue, is a phrase that is true in trading.
Trader seminars often provide many strategies based around a trading method. An attendee then looks for a trade, from all of the strategies provided, all of the time.
A recipe for a series of stressful losses.
From all of the strategies taught at the seminar, probably only a few are worth the risk; and of those a single strategy might stand out.
It is better to find that ‘one’ strategy and work it until we’re consistently profitable.
Only then are we to consider another strategy.
We always see opportunities to exit a trade before target.
We see that we’re ‘in the money’ and worry that a reversal will take our gain away.
So, we exit early, grab what we can and then justify that to ourselves.
On the other hand, if we are out of the money, we more often than not hold until our stop is hit (to exit early is an acceptance of any loss against us and we are in hope that a reversal of price will minimise that loss).
That is our nature, but makes for a poor strategy.
We need to reverse this tendency and help to balance the equation.
We need to discipline ourselves to: (1) hold until target and (2) exit a losing trade early if probability favours the stop being hit.
Sounds easy, but probably one of the hardest things for a day trader to do.
As a continuance of my post on ‘learning from mistakes’ I thought that I ought to share some of the mistakes I’ve made (and occasionally continue to make).
We pay a lot of money for our mistakes, so we may as well learn as much as we can from them. I would like to think that ‘once’ for each mistake would be sufficient, but no, daft as it seems, I can make similar mistakes many times over.
The best way for me to learn was to write out the mistake, and lesson it provided, in a note pad. At least that way I’m acknowledging and taking responsibility for the mistake and, hopefully, I will refrain from repeats.
Such posts will be called ‘note book mistakes’. There may be some lessons here for others (albeit I wouldn’t expect the Slow Trader fund investors to gain solace).
The mistakes are based on short-term trading with a price action bias. However, they are broad in context and may apply equally to any trade duration or system.
Richard Thaler, a behavioural economist, received a Nobel prize. Speaking by phone on Bloomberg TV, he said:
“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping, I admit to not understanding it.”
From our fund point of view, we have a couple of lightly traded shares awaiting conclusion, otherwise we are 100% short-term (both long and short) trading of a chosen currency pairing.
We have traded GBP/JPY, changed to USD/JPY and currently we trade GBP/USD. Another consideration for us is AUD/USD.
We moved from GBP during Brexit and for the months after. With regard to price, JPY is consistent, a requirement of our strategy; unexpected volatility is not, therefore the decision, for the time being, to move back to GBP.
We do not hold overnight, so poor liquidity during this period, and an increased probability in a spike in price, is not a consideration.
Trading equities can be very different to currencies, specialization is appropriate.