The Finance Book Club

Trendline Testing
Vic has already told us that patterns are more reliable on longer term trends so I’m going to use the D1 timeframe, using DIS and start at the beginning of the year, but in 2019 to give us some chances to catch long-term trend changes.

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This is the starting condition. We see the previous low at (A) and a minor low point to hang the trendline at (B).

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But after drawing the trendline and seeing it broken at (C) there doesn’t seem to be enough variation in the ‘line’ (range) to draw a box around it and define the ‘bear’ turning point? So we wait for the range to define itself. It seems like this was the approach taken in the example we were given.

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Do we have it yet? I recall that at least one other author says we need to see something touch at two points. This is just a steady leak down. But if I wait much longer I could lose all advantage from not entering early. Vic has told us the key is to get in early.

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So I come up with this and it appears the uptrend has been broken. The trend is down?

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What do I do now? Redraw the box I suppose?

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This time we’ll get it.

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I guess the trend is still up. Let’s draw a new trendline then?

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I’ll move the ‘box’ lines once I know where to put them. Let’s assume I went long at the break of the upper line. So if we started mid-January we are entering the first trade say 2019.02.20?

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Bloody hell. Well, Vic doesn’t use this for entries, remember. This is all about ‘confirmation’. So if this were a system you’d have to decide whether to exit immediately upon trendline break or upon the second line break. Clearly you’re better off getting out immediately in this case. But now what? Redraw the box again? Or is this a downtrend now? I don’t have enough data to draw a down trendline.

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If I redraw the box, and redraw the bullish trendline according to regulations I see that it’s already broken. If I attempt to draw a bearish trendline it is at a comically shallow angle. I guess this whole exercise is at least telling me I shouldn’t see any evident trend.

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Ok, now I have enough to draw a new bull trendline and price breaks upwards. Would you go long here? Should I have stayed long from the start? The second point of the bullish trendline might be considered a failed break down and a support for a long?

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If you went long, congrats. Now do you keep this very passive trendline? My old buddy Ralffe wouldn’t. I guess we must.

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Maybe it’s not such a bad thing.

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Oh snap, maybe it is! The very next day price gaps down right to the trendline and breaks it. I now notice a bit late that the previous high has failed to break the ATH. I have enough to draw a plausible bear trendline and if I were long this trade I would at least take some off. I guess this level is where the bear entry level should be?

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I suspect here we would go all short?

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Indeed!!

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If you didn’t take something out of that trade you’re regretting it now, as we’re back where we started, but you did, surely. Now we’re looking long again, with a bullish trendline established. To me it looks like we should go long immediately. I don’t know where to put the upper box line, exactly, as it seems like it has been broken even before the trendline. Anyway, go long obviously, but this is a HUGE stop.

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Well, your trendline gets broken, did you exit, or did you use my comically large bottom box line as the stop? I think I’m losing objectivity. Suppose you stayed long, do you now redraw the trendline? It seems like redrawing things is a necessary part of trading this way and Vic has given us no guidance there.

I think I have to admit I can’t entirely dismiss what has been shown but I also remember why I’ve stopped using trendlines. The market doesn’t need to know where you draw your lines, only where you placed your stops. They always coincide.

“Naturally, trading on these rules alone isn’t 100% effective.” Naturally.

1. To avoid getting whipsawed:
   1. Trade only in highly liquid markets that don’t have a history of sudden and large reversals
   2. Avoid highly news-sensitive markets
   3. Take positions only when you can set exit points at support and resistance

2. One disadvantage of this “1-2-3” method is that by the time all 3 conditions are met you’ve missed a large part of the move
   1. Something that can help with this is called the ‘2B’ criterion or ‘213 rule’

3. If price breaks up past a former high but fails to carry through and then price declines below the previous high, that’s a signal of a trend change. In fact it’s such a strong signal it outweighs any of the individual signals of the 1-2-3 method. Well shit. I wish I’d known about this before I started my first test. The tricky bit of course, is defining how far something has to go before we can safely say it has or hasn’t ‘failed’ to carry through.
4. Vic helps us out once again in this regard with these tips on timing for the 213 break (confirmation of the failed breakout):
   1. Short-term within one day
   2. Intermediate (3-5 days)
   3. Long-term (7-10 days)

5. 2B is right about 50-70% of the time when daytrading
6. Allow yourself to get ‘whipped-out’ if price returns to the new trend

The Causes of the 2B pattern

1. These patterns can be explained by what happens on the floors of exchanges
2. Traders use stops
3. Brokers trading their own accounts and ‘locals’ have a ‘vested interest’ in driving prices above or below the stops in order to trigger them
4. ‘Taking out the stops’ or ‘stop hunting’
5. Once the stops are taken out the market ‘readjusts’
6. In the stock market the ‘locals’ are called ‘specialists’ who operate from a ‘book’ - a list of orders to buy and sell large quantities of stock
7. Big traders know the specialists and have a sense of where their book levels are
8. Both groups have a vested interest in moving price to these levels
9. The ‘pack’ follows the big players too
10. Specialists also ride the orders of their clients. The client buys the stock to hold but the specialist buys stock for themselves to sell at regular intervals until their client’s order has been filled. They know the market momentum will be in their favour for as long as they are filling their book order.
11. This is “the most risk-free way to make a lot of money that exists in the financial markets” and it’s the reason that specialist business is passed down from generation to generation.
12. All of this assumes the absence of major news or new developments. Trading on 2B alone without ‘particularized knowledge’ can be very risky, especially in commodities which are news-sensitive

Elliot Wave ABCs

1. Elliot wave is too subjective to be of general use says Vic
2. The exception is the A-B-C pattern for secondary corrections which ‘almost always’ follow this pattern.

“A good way to establish a speculative position during the BC stage of a secondary correction in a bull market is to buy when prices break the trendline established in the BC wave, provided volume has been diminishing on the decline.” Stops at the lowest of the A and C points.

I’ll leave this test as an exercise for the reader.

Hi Clemmo. im an Elliotician i suppose. I started studying EW when i started out. And it took me probably 6yrs to have a reasonable understanding. Maybe i am a slow learner. But after 6yrs i thot i may aswell stick to it otherwise i would have wasted 6yrs of my life

EW is totally subjective imho. As any wave count can have 2, 3 or more Alt counts. And i have seen half a dozen EW counts form different people with different outcomes. Personally i wouldnt bother wasting time to learn it. It is like opening a can of worms. There are far more profitable systems to learn in a fraction of the time

GREAT THREAD But make sure you dont dedicate toooooo much time to it or your gonna miss a lot of trades. Lets get on zoom sometime

T721 I concur 100% with you and more EW is a waste of time and energy . The worst is that "ellioticians believers" have sterilized all rational works on the subject Waves?

If you are interested by Waves here are 2 PDF's which are the best on the subject IMHO

Clemmo17 if you consider this post unfit for your thread I will delete it.

Thanks Paris i will have a look at them. Green pips to you

Your thoughts are always welcome here.

Chapter 8 - What the analysts don’t know can kill you
The main point is that analysts don’t know much more than anyone else. No one can put together a perfectly coherent forecast from all the data.

Vic likes to use moving averages, RSI and Oscillators. Me? Not so much.

This does seem pertinent though:

1. In equities the most useful MA is the 200 day/ 40week

1. Peter Lynch - One Up on Wall St. - common sense is more important than a bunch of facts and figures
2. “The biggest mistake anyone can make in using moving averages or any technical observations … is to fall in love with it.”
3. Never buy or sell stocks because they are ‘expensive’ or ‘cheap’
4. Rate of Change of Earnings Growth - William O’Neil - I’m going to say no longer relevant?
5. Individual stocks cannot be used to confirm inferences as you can with indexes

Chapter 9 - The way the world really works
Vic tells us his economic theories.

1. Economics is like a 10k piece jigsaw puzzle where every piece is the same shade of grey and almost the same shape
2. Only a madman would attempt to put it together
3. Despite this, we can’t ignore economics entirely
4. A huge part of successful speculation rests on being able to anticipate government fiscal policy, and interventions
5. Vic learned economics at university but found it was only instructive in that it taught him the flaws of the thinking in the powers that be
6. Government uses mainly Keynesian ideas
7. Mises, Adam Smith, Frederick Hayek, Hazlitt, Rand, have contradictory ideas
8. Keynes is little more than a sophisticated mercantilist and a builder of bubbles
9. Vic prefers the modern Austrian school
10. There is profit potential in getting in to the government’s bubbles early and getting off before they burst
11. You can learn more about practical econ with on-the-job-training instead of school
12. Vic recoils in horror at the notion that government debt would just keep growing and eventually be written off.
13. Policy makers are moral cowards who are afraid to tell special interest groups they can’t have something for nothing
14. Keynes laid the groundwork for irresponsible debt financing, deficit spending, inflationary expansionism
15. Vic also blames him for making economics incomprehensibly complex and dull (!)
16. Evils brought on by Keynesianism, according to Vic:
    1. Big gov
    2. Countless task forces
    3. High-paid consultants
    4. Innumerable subcommittees
    5. Bureaucracy
    6. Inflated money supply
    7. Taxing excess profits
    8. Equal opportunity
    9. Minimum wages
    10. Social security
    11. Unemployment insurance
    12. Trade barriers
    13. Low cost loans to developing countries
    14. Agricultural subsidies

17. The good news is you can turn the government’s irrationality to your advantage
18. Government profligacy can only end up being paid for by the people’s labours (Jefferson)
19. Vic uses Robinson Crusoe as an example of clever economic policy
20. “The fundamental means of survival available to a group are the same as they are for one person.”
21. The role of money
    1. Money is simply a commodity but with a long shelf life and universally desired
    2. Vic now goes into a lengthy history of money
    3. Saving is necessary to be able to acquire time and intermediate products necessary to accumulate wealth

22. Economics and human nature
    1. Free markets are an invention based on a view of humanity as independent rational beings
    2. Governments don’t make markets they only take them away, when left alone markets arise almost of their own free will
    3. For ex. Black markets
    4. Gray markets
    5. You can’t separate markets from politics because you can’t have an economic point of view without having a view on the nature of human beings
    6. In case we think Vic is getting too abstract he brings up the example of the election of Mitterand, a socialist.
       1. Vic knew his policies would collapse the franc relative to the USD.
       2. He covers 3 weeks later from 4:1 to 6:1 making a ‘substantial’ profit.
       3. In 1983 the evidence of his policies were visible. Prices were increasing at a 12% annual rate.

    7. Government’s purpose is to forcefully redistribute from those who can produce to those who cannot or will not
    8. The supply of money and credit is in political hands
    9. Fundamental policy weapons in the US are taxes
    10. Watch the president, the Fed chair, the Sec. of the Treasury and key congressional leaders
    11. Price controls cause shortages
    12. Price supports cause surpluses

23. “For economic principles to be correct, they must be based on a view of humans as independent thinking beings in pursuit of their own fulfillment. Any other view will lead to contradictions. Mistaken judgements that result in failure when action is taken based on them.”
24. Understand evaluation, production, savings, investment, innovation in order to survive and flourish

Savings, Investment, Credit and Wealth

 

1. Plain saving is setting aside products that will eventually be consumed
2. Capital saving is accumulating goods designed to improve production
3. Saving is a choice based on a discounting of the value of consuming future products
4. Originary interest shows itself through the rate of growth or decline of capital goods
5. The engine of growth is new technology
6. Savings makes investment possible
7. Savings is not unproductive as Keynesians would have it, because it removes money from the supply, increasing its purchasing power
8. Modern government’s inflationary monetary policy makes the idea of falling prices seem bizarre but that’s what happened in the late nineteenth century when the standard of living in the US increased faster than ever before or since.
9. Businesses increased profits during times of falling prices because of currency appreciation
10. Savings provide the basis for the extension of credit
11. Credit accelerates investment in capital goods
12. Accumulation of capital goods accelerates growth of wealth
13. Government income is a burden on the productive capacity of the nation
14. Wealth is consumed when debt is not repaid
15. Vic mentions his $1600 fax machine and marvels at how such a technological marvel can cost so little. (and today they go for about $300, if that. Should we give thanks to the Austrian school?)

Chapter 10 - Booms and Busts
This chapter is a mega-chapter as Vic attempts to teach us economics.

1. Mises: The wave-like recurrence of booms followed by busts is the unavoidable outcome of repeated attempts to lower the gross interest rate via credit expansion. The collapse cannot be avoided; it can only come sooner by abandoning credit expansion or later as a final and total catastrophe of the currency system.
2. The business cycle is like an elaborate pyramid scheme; not necessarily intentional but a result of widespread misunderstandings of economics
3. Mercantilists (Keynes) believe there is an endogenous cause to cyclical fluctuations. The government must find it and intervene to promote stability
4. David Ricardo explained the cycle by analyzing effects of paper money and credit expansion on trade. The cycle is caused by government intervention. Talk about a stalemate!
5. The mercantilists won, and so we have world banks, central banks, operating on fractional reserve systems, in every major industrial country and we have boom/bust cycles
6. Vic now embarks on a history of modern finance going from
   1. The foundation of the Bank of England
   2. The reign of King Louis XIV and the French national debt
   3. Devaluation through recoinage
   4. The wandering gambling Scotsman John Law who advocates for credit expansion and currency inflation. Vic speculates that Law may have unlawfully fathered some of Keynes offspring.
   5. Law convinces the Duke of Orleans of the need for a central bank
   6. Law was the son of a banker, understood the public’s fear of depreciation of coin and his new banknotes established at his new bank begin selling at a premium
   7. He restores confidence in French currency and offers depositors an insurance policy against devaluation of the coin
   8. However the Duke didn’t understand the forces of work and he issues a billion livres of paper currency in an effort to wipe out the public debt
   9. The billion livres were handed out as loans; credit expansion
   10. This causes a speculative boom, expanded domestic production, construction
   11. Law issues more stock for the Company of the Indies
   12. Inflation runs amok, foreign prices are cheap so imports increase
   13. 1720 coin becomes so scarce that foreign trade is becoming impossible
   14. In an effort to stop the run on gold and silver, coin was depreciated to 10% below paper and payments at the bank were limited to 100 livres in gold and 10 in silver.
   15. Law suggested a decree forbidding anyone to hold more than 500 livres in coin, and stopping anyone from buying up precious stones, jewels, under penalty of fines and confiscation
   16. This was a ‘fatal error’. It destroys public confidence in the currency. Law’s stock tumbles.
   17. Law is forced to flee France, his fortune lost
   18. A council audit finds the debt hasn’t been helped but rather increased by 3.1B livres
   19. Unlike today, some of the guilty go to prison. Eventually the disparity between rich and poor leads to the French Revolution and the reign of Napoleon.
   20. According to Vic, every boom/bust cycle follows a similar story.

7. The pattern:
   1. Economic decline (bust)
   2. Social clamour for the government to do something
   3. Necessary market adjustment
   4. An ingenious economic guru links up with gov and offers a plan for recovery
   5. The plan inevitably calls for an end to inflation, balanced budgets, decreasing government deficits, stabilization of the currency against foreign currencies
   6. BUT to achieve this some form of interference in the free market is needed
   7. They amount to nothing more than further credit expansion
   8. Another boom, then another bust

8. Central bank credit expansion causes a misallocation of resources
9. Confuses economic calculations
10. Originary interest is the discounted ratio of the valuation of present goods to the valuation of future goods
11. Originary interest determines how much of the available supply of goods in the marketplace is to be devoted to immediate consumption versus provisioning for the future
12. Market rate of interest tends toward originary interest
13. Gross market rate of interest has 3 components
    1. Originary interest - subjective value of consuming now versus later
    2. Entrepreneurial component - interest portion giving creditors incentive to lend for investment
    3. Price premium - an allowance for the changes in purchasing power of money

14. All components are active in every credit transaction, and they are all constantly changing, and they affect each other
15. Credit expansion messes everything up
    1. Entrepreneurial component drops due to new capital for investment
    2. The entrepreneur cannot distinguish between money available and capital available - the calculation is distorted (??)
    3. Capital goods are diverted away from their best use, encouraging poor investments and capital consumption
    4. Price premium component is subverted due to lag time before it can reflect the rise in prices; therefore it is artificially low in the early stages of capital expansion
    5. Money supply is inflated in fractional reserve systems after credit expansion
       

Is this complex enough for you? Vic is only getting started! This goes on for pages and pages.
Is he right? Is von Mises? Who knows?! Nobody knows. That’s economics.

The Structure and role of the Federal Reserve system

1. Who holds the pump and who holds the need?
2. In France during the Mississippi scheme it was John Law and the Duke of Orleans
3. In the USA today it is the Fed
4. Their power is mind-boggling. The market has become a nation of Fed Watchers, clinging to obtuse policy proclamations.
5. The Fed was ironically first established in 1913 to stabilize the workings of money and credit markets
6. The purpose of the Fed is to ‘give the country an elastic currency, to provide facilities for discounting commercial paper, and to improve the supervision of banking’
7. By 1963 this had expanded to
   1. Counteract inflationary and deflationary movements
   2. Sustained high level of employment
   3. Stable dollar
   4. Growth of the country
   5. Rising level of consumption (note the emphasis on consumption, not production, pure Keynesianism)

   
   

8. The Fed today is virtually another government department, coordinating policies with Congress and the treasury, and foreign central banks
9. The Fed’s big stick is its power to regulate the flow of bank credit and money
10. The Fed has 3 parts
    1. Board of Governors
    2. Federal Open Market Committee (FOMC)
    3. Federal Reserve Banks

    
    

11. 7 presidentially appointed members serving 14-year terms. No member maybe reappointed after server a full term
12. FOMC is the 7 board members plus five presidents from the 12 reserve banks, of which the president of the NY bank is always one. The other four members server one year terms., which rotate among the other 11 districts.
13. 8 meetings per year

How money and credit availability is created and controlled

1. In the early stages of banking history lenders discovered they could issue more gold-or-silver backed bank notes than their actual holdings of silver and gold, as long as the public had confidence in their ability to redeem the notes in coin on demand
2. The Federal Reserve system principles are the same except
3. There is nothing backing the except a government law declaring it to be legal tender
4. AND reserve requirements
5. When the Fed purchases securities it creates on paper the money with which it buys those securities. It writes a check to itself.
6. The ratio of reserve assets to monetary deposits is almost 1:70
7. Vic points out how much power the 12 members of the Fed have
8. The minutes of their meeting are withheld from the public initially but Vic believes they cannot really be a secret to everyone
   1. It’s not credible that with the twelve members, their aides, secretaries, staffs, families, some secrets get out
   2. Vic proposes that the FOMC minutes be secretly distributed to depressed areas of the country where they would be trained to trade in the markets
   3. Using this insider information they would ‘get the jump’ on the rest of the government securities traders
   4. You could virtually end poverty. Vic admits this is not a serious suggestion.
   5. However a select few are getting this benefit anyway

Reserve requirements, fed funds rate, discount rate

1. The Fed funds market is a system that allows banks to borrow excess reserves from other banks
2. The Fed Funds rate is the interest charged on these interbank loans
3. After the Carter admin it was found that targeting the Fed Funds rate is not a sufficient tool for controlling credit availability
4. The discount rate is not the Fed Funds rate. It is the rate the district banks charge for borrowing reserves directly from the central bank.
5. Discount window borrowing is blatant inflation; every bank that borrows this way is writing a check against itself
6. The catch is that borrowing in this way is under higher scrutiny as there is a limit to how many times you may borrow from the window. Borrowers are given a silent but unsubtle message to ‘clean up their act’ and get the funds from their own reserves in the future.
7. The Fed Funds market in comparison is much freer. As long as banks can pay back their own interbank loans they can continue to borrow reserves in the Fed Funds market
8. Interest rates aren’t the sole determinant of the supply of and demand for money and credit
9. No matter what the actual interest rate number is, if both the supply and demand for credit exists money will be loaned and the credit expansion will continue
10. As long as interest rates are on the rise, a loan today is better than a loan tomorrow because the markets realize the purchasing power of the dollar is declining
11. The philosopher kings of the Fed experiment with the economy at our peril

Open Market Operations

1. Open market operations are purchases and sales of securities and has a direct dollar for dollar effect on the reserves in the system
2. A purchase adds it to the banking system and a sale removes it from the system
3. Some operations are more hidden than others
4. 2 basic approaches - long-term and short-term
5. Long term is the outright purchase/sale
6. Short term they use repos (repurchase agreements)
7. Matched sales are the counterpart of repos and remove reserves from the system
8. Vic goes on about this for page and pages but “one thing you can count is that on balance and in the long term, Fed policy will be expansionary, the money supply will continue to expand, and the purchasing power of the dollar will continue to fall.”
9. $1.20 in 1988 was $0.30 in 1961 was $0.10 in 1913. And now? https://www.in2013dollars.com/us/inflation/1988?amount=1.20 about $3.02 says this calculator.

Deficit Spending and its effects on Money and Credit

1. Debt go boom

It’s bad. OK?

How to predict the trend and changes of trend based on Fed and Treasury policy

1. This sounds like the good stuff but nothing much comes of it.
2. Vic’s biggest losses came about when he expected the government to behave rationally
3. Biggest wins came from predicting the consequences of government policies
4. When Bob Dole came out with the biggest tax increase “in the history of the world” (!) Vic assumed Reagan would keep his promise and that the bill wouldn’t pass.
   1. The market fell for 12/14 days
   2. He loses $93k, his 2nd-largest loss ever
   3. The Fed fears the tax burden will drive the economy into recession so they pump money into the system, driving down interest rates, and expanding business
   4. The Fed essentially provides the government with the resources to pay the tax bill

   
   

5. Reagan once again betrays Vic when his ‘revenue neutral’ tax law means taking money from corporations and giving it to individuals causing the market to drop 9/11 days
6. Politicians will take the pragmatic route no matter what they say
7. Fed chairs say nothing with far too many words

The business cycle is the result of credit expansions and contractions induced by government fiat, controlled by monopolies of the Fed and fiscal policy makers. This will induce booms and busts for as long as government controls monetary policy.

I wonder if I could have summed up the last five posts with these two sentences or would we have lost out on importance nuances? At least that's the end of Chapter 10.

Chapter 11 - Managing Money by Measuring Risk

1. There is a way to measure risk in the stock market quantitatively
2. Risk involves chance
3. Chance involves odds
4. Odds are subjective or set subjectively by a pro oddsmaker using probabilities based on a statistical distribution of limited possibilities
5. Poker odds are measurable, concrete, objective
6. Many financial pros believe the market is not like cards, the efficient market or the random walk makes risk measurement invalid
7. Instead they talk about distributing risks or finding value
8. Relative measure of performance
   1. Alpha - measure of quality comparing performance of an individual stock to the market; a value of 1 means on average outperformance of 1% per month; if the market moves up 10% in six months then the stock should move up 16%
   2. Beta is a measure of volatility; A stock with a beta of 2 should be up 20% when the market is up 10% or down 20% if the market is down 10%.
   3. Most money managers buy stocks according to some set formula of alpha, beta, PE, book values, yields and they call this ‘risk evaluation’
   4. However these tools have little to do with real actual risk; they don’t govern Fed decisions, or future events.
   5. If you use these as primary tools in speculation you assume that value is an objective, static concept; value is determined by individual human minds and that makes it a changeable thing

   
   

1. Measuring extent and duration profiles can give probabilities of a market turn

Allocating Capital with Odds Management

1. Risk/reward criterion is at most 1:3
2. Ratio is determined technically on the charts
3. Evaluate where the market can probably go - the target point
4. Establish the point where you have been proven wrong - the exit point
5. Calculate the following ratio
   1. Risk/Reward = Purchase Price - Safe Point / Target Price - Purchase price
   2. This expresses technical risk/reward in terms of maximum probable losses versus probable potential profits

   
   

6. An example Gold trade - October 1989
   1. Bought Gold 1989-10-27 the day the market gave a confirmation of 1-2-3 change of trend in the intermediate term by breaking above the previous rally high of 376.70.
   2. There was also a probable long-term trend change of direction by the same break in the trendline, and the test and failure of the previous low
   3. The market would prove Vic wrong if prices fell back through the buy spot, so the mental stop was set slightly below that point at 375.70.
   4. Target point for the intermediate term was 1989-07-25 high of 399.50
   5. The technical risk/reward then is:

   
   

1. The long term chart looks even better, with a target price of 433.5, resistance at 469.5, and at 502.3, possibly up to 800.
2. Vic says trades ‘this good’ don’t come along often
3. Play the intermediate term or the long term?
4. Vic looks at his tables and assumes the most conservative case
5. Of 18 moves lasting from 3wks-3mos. The minimum move was 9.4%; max 68.8%; median 15.2%
6. This gives a likely rally to 394.5.
7. 50% of all moves rally more than 15.2%, which is 415.4
8. This calls for being aggressive
9. Put 10% of all managed portfolios into gold, buying calls on gold futures, calls on gold stocks, and some gold stocks
10. When price broke 400, scale sell at a substantial profit and hold a smaller long-term position, still highly leveraged
11. This smaller position is lost because the rally is not sustained. Vic is ‘dumbfounded’ but he is saved by his strict money management
12. Exit point provided a small exposure to risk - at most 2%; If it rallied again he could afford to take another position
13. 1. Pick a buy spot, allowing a small loss as exit
14. 2. When price reaches a target level, take enough profits to lock in gains
15. 3. Use a portion of profits to hold a longer position for the pursuit of superior returns; even if the long-term call is wrong, the overall position can be net profitable.

Allocating Capital
Have we not already been talking about this?

1. There is no simple formula to use to tell you the best way to allocate capital
2. Instead make a judgement call based on the widest knowledge possible
3. Vic begins to repeat himself I fear
   1. When assessing risk of being involved in the market
   2. Ask what is the long-term trend? Is it drawing lines, or changing?
   3. How does the current long-term trend fit within the context of history in terms of extent/duration?
   4. What is the intermediate trend? Is it young, old or middle-aged?
   5. What does Dow theory say about the market?
   6. What do the moving averages say?
   7. What do oscillators tell you?
   8. What is the health of the economy?
   9. Fed’s policy to inflation?
   10. Debt levels?
   11. Rate of growth of credit? Of the money supply? Interest rates?
   12. Sentiment?
   13. Sector strength
   14. Etc etc etc

   
   

After some strong material this seems to me pure padding.

Chapter 12 - There must be fifty ways to lose your money

1. After training 38 traders, only 5 didn’t lose their money; despite understanding all the rules they just couldn’t put it together. Why?
2. The $4017 hair dryer. Even a moment’s loss of focus can cause a big loss.

Trading rules

1. Trade with a plan and stick to it
   1. Know your objective
   2. Know your risk/reward
   3. Know all possible courses the market might take and your response.
   4. Confusion is caused by ignorance
   5. Know your timeframe
   6. Then know your stops
   7. Have backup systems in place for when all hell breaks loose (loss of power, internet, etc)

   
   
   

2. Trade with the trend: the trend is your friend!
   1. Well known but easier to violate than you might think
   2. There are 3 trends (short, mid, long)
   3. The long term trend changes least often
   4. Identify changes using the 1-2-3 criterion and 2B pattern

   
   
   

3. Use stop loss orders whenever practical
   1. Know the point at which the market proves you wrong
   2. If you are trading in size you must use mental stops. If you put in huge stop orders you can be sure the locals will hit them if they can (and they don’t need to be very huge)

   
   
   

4. When in doubt get out!
   1. Every long position you hold should be a buy today and every short should be a sell today
   2. You should not close every position when you feel an inkling of doubt
   3. Chronic fear and anxiety will have a crippling effect on you
   4. Have the best possible info

   
   
   

5. Be patient. Never overtrade.
   1. The way to make money is to watch the markets you’re interested in and wait until as many factors as possible are in your favour
   2. Day trading S&P futures there are usually 2-3 opportunities each day. Sometimes there are none.
   3. Each market index, stock, commodity has its own pace, and characteristics
   4. Watch patiently and when all factors come into play act without hesitation
   5. Limit your personal account to < 10 stocks or < 5 commodities
   6. It’s a matter of focus

   
   
   

6. Let your profits run and cut your losses short
   1. The most important rule
   2. Most commonly violated
   3. Assume you are right until the market proves you wrong.
   4. If you have a plan then it simply brings everything together to produce this rule

   
   
   

7. Never let a profit run into a loss (or always take a free position if you can)
   1. Any time you are up 2:1 on a trade, raise your stop, even if mentally, slightly above cost, and take the free position. Now you have everything to gain and nothing to lose.
   2. If the trade reaches 3:1 then close out ½ or ⅓ of the position and raise your stop to lock in a 2:1 profit on the rest
   3. Move the stop to lock in higher levels of profit as the trade goes your way
   4. You might even want to expand the size of your position at strategically selected points

   
   
   

8. Buy weakness and sell strength. Be as willing to sell as you are to buy.
   1. Applicable mainly to speculating and investing
   2. If you are speculating on the intermediate trend the way to maximize profit is to sell during minor rallies and buy during minor selloffs
   3. If you are investing in the long term trend you should sell during intermediate rallies in bear markets and buy during intermediate selloffs in bull markets
   4. The same applies to adding to a profitable position in either the intermediate or long-term trend.
   5. Don’t be afraid to play the short side. Downside moves are faster than upside.

   
   
   

9. Be an investor in the early stages of a bull market. Be a speculator in the latter stages of bull and bear markets.
   1. Investors are mainly concerned with earnings, dividends and equity appreciation
   2. Speculators are mainly concerned with price movement
   3. At some point in every market price inflation begins as value appreciate ends when businesses compete with more dollars for fewer resources
   4. It is impossible to be an investor on the short side so the best way to play bear markets is by moving in and out of the market during primary legs

   
   
   

10. Never average a loss - don’t add to a losing position
    1. Averaging down is nothing more than a rationalization, hoping to avoid being wrong or to recover losses against the odds
    2. There are strategies that seem like averaging down but are not really.
       1. If you are looking for an intermediate shorting opportunity in a bear market, the best time to short is into a minor rally; if the market has been down four days in a row, in what appears to be a primary leg in a bear market a good way to short is to sell the market on the first up day.
       2. If the market is up two days then the odds of it being up a third day are ‘relatively low’ so you could increase the size of the position on the second up day.
       3. If it is up a third day then the odds of being up a fourth day are less than 5% so you could short again.
       4. But if the market is up 4 days in a row there’s a ‘strong possibility’ that the intermediate trend is in fact going up and it’s time to close the position. The reason this is not averaging a loss is that you have a plan and a point at which you admit you were wrong. You would be counting the number of days up/down and have established an exit point for the price level that would prove you wrong. Averaging down has no limits and closing it is subjective, emotional.

       
       
       

    
    
    

11. Never buy because the price is low or sell because the price is high
    1. There are no ‘bargains’ in the market
    2. Historical highs and lows mean little
    3. Unless you see a sign of a trend change, the chances are that the trend will continue.

    
    
    

12. Trade only in liquid markets
    1. Trade the front month in the commodities and currencies and the active high-volume stocks and options

    
    
    

13. Never initiate a position in a fast market
    1. A fast market is one that move so far that the people recording the transactions can’t keep up with the pace of the price changes
    2. In a fast market what you see on a screen is not necessarily what you get
    3. The info is unreliable so don’t trade.

    
    
    

14. Don’t trade on the basis of tips. Trade with the trend, not your friend.
    1. No matter how strongly you feel about a stock or other market, don’t offer unsolicited tips or advice
    2. The only way your friend knows something the rest of the market doesn’t know is if it’s ‘insider’ information and trading on such info is illegal.
    3. When a tipster wants to give you information, avoid that person

    
    
    

15. Always analyze your mistakes
    1. A losing trade isn’t necessarily a mistake
    2. A mistake isn’t necessarily a losing trade
    3. Mistakes are often caused by fear not ignorance; to conquer fear you have to admit that you have it

    
    
    

16. Beware of ‘Takeunders’
    1. This is basically a duplicate of 14. Beware tips about mergers where the net effect is to have the stock you buy be a buy-out target instead of the buyer.

    
    
    

17. Never trade if your success depends on good execution
    1. One of the biggest losses of Vic’s career happens because of a misquote
    2. Even trading ‘just a few lots’ on a test run can move the market 3 ticks (3 ticks on entry and 3 on exit).

    
    
    

18. Keep your own records of your trades.
    1. Brokerages record everything for you but they also make mistakes.
    2. Write down the date, time, instrument, buy/sell, opening fill, closing fill for each order
    3. Compare your records with your broker’s

    
    
    

19. Know and follow the rules
20. The 85% rule
    1. You need to be as close to 100% mentally, physically, emotionally to make a living trading in the markets
    2. If you can average 85% you can do well
    3. Be prepared to lose money in ways you never dreamed of
    4. Shoot for 100% but be satisfied with 85%. Unexpected problems always come up.

    
    
    

Chapter 13 - The commitment to make it happen : emotional discipline

1. There is no difference between successful living and attaining financial goals
2. Vic has seen many individuals destroy their lives chasing success on Wall St.
3. Success is a state of being, not the attainment of any particular goal
4. It’s important to have goals but they alone don’t ensure success.
5. Success requires complete dedication to reality.
6. The difference between those who succeed and those who fail, according to Vic:
   1. Not intelligence
   2. Not knowledge
   3. It is the will to execute knowledge

7. Consider weight loss
   1. The most difficult part isn’t knowing what to do (eat less and exercise more) it’s making the decision to do it and sticking to it

8. Vic uses the character of Mr. Spock to represent ‘the house divided’
   1. Spock is a being at odds with his nature
   2. Half human - the emotional half
   3. Half vulcan - the logical half
   4. Inner turmoil and frustration

9. The comparison of Org the caveman versus Bill, the Trader
   1. Org reacts to his surroundings with fear and adrenaline
   2. So does Bill
   3. However Org is acting in accordance with his true nature and his fear and adrenaline serve him well when he needs to kill a wild boar
   4. Bill’s fear stops him from selling at his mental stop and ruins his chances to get back in to a trade that was well-reasoned but whose timing he got wrong

10. Ayn Rand’s ‘irrational values’
    1. What man loves or hates depends on his ‘standard of value’
    2. If our standard of evaluation is consistent with our nature as rational beings then every value, belief and goal that we have is consistent and lifesaving.

11. Spock vs. Rand
    1. Spock chooses to deny the existence and validity of emotions because they are irrational and negative
    2. Rand defines the direct logical connection of emotions to values and values to reason; accurate values are valid and determine the integrity of emotions

12. When traders make bad choices they are reacting to some misplaced value judgement that may be holding them back. The examples Vic gives is someone who thinks all people are born evil and so should spend their lives in atonement; such a person cannot make a success of trading markets
13. Attempting to integrate false or conflicting beliefs into the hierarchy of values causes mixed emotions and may provide motivations for behaving self-destructively.
14. Vic uses his experience day-trading S&P futures.
    1. Trading as much as 30 times a day
    2. He gets many poor executions which he finds frustrating and raises his blood pressure
    3. For the sake of his health he considers the alternatives open to him
       1. Stop day-trading the S&P500
       2. Expect to be cheated when does trade them
       3. Continue getting angry and risking his health to make money

    4. He choose a combination of 1 and 2. He trades less often and when he does trade, he resigns himself to getting robbed.

15. Emotional discipline is the source of consistency
16. “I have yet to meet a totally consistent, integrated person, and I’m not going to hold my breath while waiting. To expect that people can grow up in this difficult world with all the crazy philosophies that exist, inherit the pressure of their family’s errors, reap the contradiction of a troubled educational system, try to make a living, put their entire value system in perfect integrated order, and simultaneously change their emotional responses to fit their value structure is simply stretching the bounds of probability.”
17. Strive for integrity
18. To trade well:
    1. Establish goals
    2. Acquire knowledge of the markets
    3. Define rules of trading that work
    4. Execute in strict adherence to the rules

19. Discipline is training to act in accordance with a set of rules
20. Emotional discipline is an active and ongoing process
21. Accept your emotions as simply existing, not as a villain, but as an integral part of yourself
22. Emotional discipline helps build a sense of confidence and control over your actions
23. Will to execute means having the power to carry through on a plant of action designed to achieve a goal. The ability to decide.
    1. In this state the plan becomes less a matter of choice and more a matter of necessity
    2. The plan becomes a value; integrated into your subconscious it is actually supported by your emotions
    3. Enhances your ability to act, reduces frequency and level of conflict; becomes a source of consistency in thought, actions, feelings

24. Denying emotions like Mr. Spock is the wrong way to handle the conflict of emotion and reason
25. Emotions are determined by values we choose
26. Fighting your emotions as a trader, creates turmoil
27. Take control of your mind with emotional discipline
28. Eliminate contradictory values and beliefs