In Trading – Good Advice or Bull-t that Just Sounds Good?
I am going to borrow the title of today’s column from a recent piece of Jason Zweig of the Wall Street Journal who is using to make other points -- but I liked it so much that I will appropriate it for my own means. Mr. Zweig often writes about the various behavioral weaknesses of investors and his advice which leans very heavily towards passive, patient long term investing is generally very valid -- FOR INVESTORS. But if you are going to trade you better forget every one of those ideas.
As the great investor Ben Graham, who Mr. Zweig quotes, once noted stocks have prices companies have values. Exactly. If you ever want to learn how to trade well, the idea of “undervalued” or “overvalued” better be erased from your brain. We don’t trade value. We trade price. And very often the right trade is actually opposite of what the proper value should be. It’s one of the reasons why I never spend a minute of my time trying to prognosticate the “value” of any currency any further than 24 hours forward.
But there is so much bulls-t advice in the trading industry itself that I thought we should try to set the record straight. This week Kathy and I did a live trading seminar on Wall Street with a small group of traders from around the world and some of those very bad ideas cropped up. So I thought I’d summarize the three most odious notions that continue to circulate in trader’s minds.
1. Have a high risk reward ratio (risk $1 of loss for $3 of profit). Bulls-t, bulls-t, bulls-t. Anytime I hear someone on Wall Street pontificating about how they never take a trade unless it has 4-1 r/r ratio I know they have never laid a penny of their own money on the line. You know what has a great r/r ratio? The lottery. As the New York Lotto ad goes -- have a dollar and a dream. And a dream is all you will ever get. The markets are brutally efficient. They don’t leave dollar bills lying on the floor that you can pick up for a quarter. There is a direct correlation between rate of success and the amount of risk you assume. Even most HFT algos trade with a NEGATIVE risk reward ratio because the computers know if you want to earn money you need to work for it and that means assuming more risk than reward.
2. Don’t Overtrade. Bulls-t Bulls-t Bulls-t. If by “don’t overtrade” you mean don’t place many random trades without any thought to entry or exit. Then yes I agree. But if you mean don’t trade a lot because it will cost a lot commission and you will just make your broker rich -- then you are total idiot who doesn’t understand trading at all. You know who made their broker obscenely rich? Steve Cohen. Marty Schwartz. Paul Tudor Jones. Michael Steinhardt. You know who also became obscenely rich in the process? The very same guys I just mentioned. The best traders in my room all have the highest commission bills. High commissions costs guarantee trading success, but they certainly dont guarantee failure and in fact more often than not they are a sign that you are doing something right.
3. Trade with Trend. Almost never is that a good idea. Trend only occurs in the market 20% of the time so that means you have an 80% chance of failure whenever you try that strategy. On an intraday basis the odds are even worse. And it’s almost always better to trade noise rather than trend if you are day day trading. Even if you are position trading it’s better to get into a trend trade on a counter trend move. Ever since I helped Kathy tweak her entries that way she has nailed 54 out of the last 61 trades for nearly 90% success rate trading “with trend”.
Jason Zweig is right. On Wall Street there is a lot of advice that sounds good but really isn’t. In trading the same dynamic take hold. So its about time we actually started to follow good advice, rather than the well worn lies of gurus that just sound good.