This article was written by myself and was originally published in three parts on @WheelieDealer’s website, you can find it here: http://wheeliedealer.weebly.com/educational-blogs/
The mindset of a winning trader
AIM is home to all sorts of guttersnipes and ne’erdowellers, crooked directors, and pumpers who’d ramp their Gran in if it meant they could sell for their 10%.
It’s very easy to be suckered into a story about the next big thing because as humans we are predisposed to a great story, but unfortunately, the story seldom turns out as expected.
Therefore, one needs to exercise caution and be aware of their own weaknesses. If it’s excitement and the jackpot you crave, then head to the casino as it’s much cheaper.
Stock trading is no different to any other sport. It requires focus, effort, and a willingness to evaluate and improve. Those who have competed in sport at a high level will have an advantage though this is in no way necessary.
There are many great traders in the market today, certainly, ones who are much better than I, and having learned from many I sincerely believe anyone can do it if they are willing to learn.
The information is out there and freely available for anyone wishing to do so, and there exists a vibrant Twitter community for UK stocks, with many people happy to help and share information and experiences.
I can count myself lucky and be grateful to far too many people to name, for I was in a position to start trading and investing full time within a year of my first trades. Whilst a lot of this was down to my own desire to learn it would not have been possible without the existing community.
The following post is just some of the lessons I’ve learned on my journey, and I have highlighted in bold takeaway points and quotes from my favourite books and traders, which are listed in the final post of the article and available in Wheelie’s bookshop. I hope that some of you will find the following useful.
“Winners focus on winning and doing what works – if it’s not working, stop doing it”Mark Minervini
Having the right mindset is imperative. “Oh, I could never invest or trade stocks”.
This one thought immediately excludes the thinker from all future wealth in the stock market. As humans, we only ever feel our thoughts, and if we can consciously monitor how we think we can control our actions.
A mistake is either a crippling setback or an opportunity to learn. Should we fear our doubts or doubt our fears? In the stock market, it’s behaviour and results that count.
“The realization that you are responsible for your results is the key to successful trading. Winners know they are responsible for their results; losers think they are not”Dr Van Tharp
There are very few industries where someone without the right education, without the right connections, and without the right capital can outperform someone who does.
Trading is one of those industries where beliefs and mindsets will ultimately determine your results.
A losing trader can very easily become a winning trader just by deciding to do things differently.
“And when you know what not to do in order not to lose money, you begin to learn what to do in order to win. Did you get that? You begin to learn!”Jesse Livermore
Trading is an arms race – knowledge and speed of execution. You need to execute without haste when the opportunity exists, but it’s no good being quick if you don’t know what you’re reacting to.
If you find something that works, it really doesn’t matter what it is as long as it is making you money. Conversely, if you keep losing money – stop doing it!
Review your trades. Evaluate the process. Re-test. Repeat.
“A 25% loss needs a 33% return to breakeven. A 50% loss needs a 100% return to breakeven. Are you smarter than the market? I’m not”Mark Minervini
Stock market clichés such as “cut your losses” are repeated because they are true – without a stake, you can’t trade. It’s that simple.
Unfortunately, many people new in trading start counting their profits before they are even earned, and end up becoming anchored to their wished-for price.
I was lucky in that I had the fortune to hear about other people’s colossal wipe-outs which terrified me, and as I had very little money to fritter away my initial profits and losses were small and I worked hard for them.
By chance, I immediately avoided the knockout that sets beginning traders back or finishes their stock market endeavours completely with the loss of both capital and confidence. For example, a family friend lost untold amounts in the Dotcom bubble and concluded that all stocks are risky, and has missed out on nearly two decades of stock market value creation.
This narrative is so powerful that my family still has a deep distrust of stocks. If you can continue after any initial losses, there is plenty of time to learn the craft and learn how to consistently churn out money from Mr Market.
It’s easy to be a bit shaken and have confidence in your trading dented after riding the Carousel of Claptrap Trades but you must continue and keep cutting your losers.
If legendary trader Paul Tudor Jones has to tape “Losers average losers” above his monitor to remind him about the dangers of averaging down then you can bet that it’s important.
“Risk control is the most important thing in trading. If you have a losing position that is making you uncomfortable, the solution is very simple: Get out, because you can always get back in”Paul Tudor Jones
In my case, Mr Market was not content with being cheated and allowed me to make a great deal of money very quickly, at which point he delighted in showing me I was no different to any other stock trader who begins to think they needn’t pay as much attention to risk.
They were losses big enough for me to never want to be in that situation again. Cut your losses and you vastly improve your odds of success – I genuinely believe that if every trader managed their losses better their trading would improve volumes overnight.
“Fate does not always let you fix the tuition fee. She delivers the education wallop and presents her own bill, knowing you have to pay it, no matter what the amount may be”Jesse Livermore
It’s much cheaper and more encouraging to learn from other peoples’ mistakes. Just remember, if you can’t temper your emotions and manage your risk Mr Market will be sure to keep you in line.
We live in an unprecedented age where knowledge is no longer a privilege; it is easily accessible online and without cost.
Paul Scott (@paulypilot) and Graham Neary’s (@GrahamNeary) Small Cap Value Report (published every day on Stockopedia) really helped me to develop my analytical skills and to broaden my knowledge of UK small-cap stocks. It’s free.
Websites such as WheelieDealer’s and various others are also free. @conkers3 has interviewed and published nearly 50 interviews with private investors.
Tuition fees in the form of trading losses do not have to be high if you are willing to do the work before jumping in with your hard-earned cash (and why would you not be? Losing money is no fun – trust me on that one).
Buying and selling in stocks is not a zero-sum game. Unlike the bookmakers, the odds are stacked in your favour
Many people believe the stock market is a zero-sum game and that for every winner there is a loser. Time is infinite, and markets regularly make new all-time highs, which shows that value and wealth are constantly being generated by the stock market. It is true that much of that value is created by the market leaders. Still, if you invested in a FTSE 100 tracker for a period of ten years between 1996-2016 there was a 95% chance you would have made money by being in the market according to a study done by AXA Self Investor. The average total ten-year return was almost 70% – that doesn’t sound like a zero-sum game!
But it depends on your playing field..
In the opposite end of the stock market from 1995 to 2015 over 72% of stocks listed on AIM declined in shareholder value (AIM – 20 years of a few winners and many losers, Financial Times, 2015). That suggests that for every one winner there are nearly three losers! In more than 30% of cases, shareholders lost more than 95% of their investment (ibid). If you ‘invest’ in AIM, you’d better be prepared to lose all your money, because it is not such an unlikely situation.
Despite what you are constantly led to believe, risk is not quantifiable. You cannot define it on a spreadsheet.
The problem with risk is that many have the wrong definition. It doesn’t come from statistics or numbers. It doesn’t come from low beta or high alpha. It comes from not knowing what you are doing. It comes from not understanding what you stand to lose and gain. The ‘risk’ of investing in AIM shares is higher, but so are the returns, and due to the inefficiency there are often trades which are heavily skewed with a risk/ reward ratio in your favour. In my opinion, larger market cap shares are riskier. They barely move and when something goes wrong they drop 30%. Can you read and understand Vodafone’s balance sheet? I can’t. I’ve got no idea what a convoluted controvertible constructible bond is and so I have no edge. When you’ve got ten brokerage firms all covering Boohoo with their own specific teams dissecting every part of the discounted cash flows it’s very difficult to compete. That’s not to say you shouldn’t ever buy these stocks, because as an investment Boohoo has been stunning, but trying to gauge any short term edge through fundamental analysis is pointless. It can be done in small caps, but just because a stock is listed at £5m and has £10m in cash doesn’t mean that everyone is suddenly going to buy it and close the value disconnect.
Play where the big boys and the ‘smart’ money don’t
With many institutions not bothering to invest in stocks below a certain market cap, this creates a huge pricing disconnect with which the knowledgeable can use to their advantage. A slightly negative RNS that may impact a stock price by a few % on a liquid market can easily wipe 30% from a company’s valuation as punters and hot money sells out. If you know the company, and you understand the reason for the drop, and if the catalyst still exists, you are in a position to make a judgement call on attempting to capture a quick move by buying the drop and selling into the rally. Small companies that issue excellent results can often see prolonged rises as institutions buy-in and hoover up stock (see HVO in recent weeks due to Woodford buying).
If the market was efficient, then stocks trading at discounts to NAV wouldn’t exist. The Efficient Market Hypothesis assumes that every market participant knows all of the available information and prices it accordingly, but that is just not true for the AIM market. A handful of trades can move a price 20%, and so forced buyers and sellers can create disparities to take advantage of. The inefficient market provides opportunity. Even in stocks that are worth £100m, one private investor can shift the price with a few thousand pounds of buys or sell if the stock is held tight.
In an inefficient market – YOU are the edge
Mr Market is the fairest employer of them all. He does not discriminate against race or religion, nor care about sex or for age. If you want to compete at a high level, that means putting in the effort needed to achieve that. I recall Paul Scott remarking at Mello that he couldn’t understand why people kept asking him how he found all of his stocks. The answer was and remains surprisingly simple: Get up at 7am and read the RNSs! Those who have a broad knowledge of the stocks in their chosen playing field are in a position to contextualise the RNS and react the quickest when material news is released. As well as reading the RNS announcements every morning, I use filters on SharePad (read my SharePad review) to add to a watchlist of ca. 500 stock charts that I review on a nightly basis. This helps me to spot accumulation and bases in stocks and stalk entries on my favourite technical setups. Do the work. Show up. Compound this knowledge over time and your edge will develop.
One of the brilliant things about the AIM market is that every now and again the punter’s dream stock appears, the ‘ten-bagger’ – a stock which appreciates in value ten times from its original point. These are, of course, rare, but they come along every now and again to keep punters playing the roulette wheel. For every one person who manages to catch one, there are many more who have lost money trying to do so. There is nothing wrong with punting money around if that’s what people want to do, but they provide liquidity for people who do want to make money and have worked harder. If you have no edge, then quite simply you’re being used as liquidity for someone else who has one. I’ve yet to catch a ten-bagger stock, but multi-baggers are real and they are achievable for those who do their homework and time their entry right.
“And for a sucker play a man gets sucker pay; for the paymaster is on the job and never loses the pay envelope that is coming to you.”Jesse Livermore
When you are the edge, your goal is to take money from those who’ve not worked as hard as you. When you make the conscious decision to become a winning trader you will go through the motions required like a successful athlete who strives to stack the odds in their favour. Failure to prepare or to not treat risk with proper respect will eventually show up (or not show up in this case) in your pay packet.
Trading traps and hindering biases
Everyone is obsessed with entry, but it should be the other way around. Obsess about your exits.
Many traders focus on entry but this is only 50% of the trade. An entry gets one into a trade but it is the exits and their cumulative profits and losses which will decide your success as a trader. It’s been proven that with a random entry and managed exits one can make money net of fees (Van Tharp). High probability entries are great, but if you are constantly selling for a 30% loss and taking your profits at 20%, those same high probability entries are worthless. I believe exits are much more important than entries as not entering can’t lose your money.
“Investing is not a points scoring game – you win by limiting your mistakes as much as possible… A pilot does not score points by getting to the airport quicker but by doing all of his checks, not making mistakes, and landing at the destination safely”Free Capital
You need to play to win to consistently churn money into your account, but you need a stake to play. Therefore, capital preservation is key. By focussing on the downside and knowing your maximum drawdown before entering (and sticking to it) the risk is then to the upside. Focus on not making mistakes – the market offers ample opportunities to increase wealth and you don’t need to be on every stock to reach your destination.
“The kind [of stock] that makes an investor of you against your will by the simple expedient of falling into a trance the moment you go long of it. The chap who is compelled to lug a corpse for a year or two always loses more than the original cost of the deceased; he is sure to find himself tied up with it when some really good things come his way”Jesse Livermore
If, like me, you have ever made the mistake of becoming a long term trader from a short term investment, then falling into this hypnosis can be detrimental to your success and your returns. Opportunity cost is real, which is why I often sell a stock that is rising in order to buy something which I think will make go up even faster. There is logic in my method for doing so: my goal is to take trades where the risk/ reward is skewed in my favour. By thinking objectively about your positions on a nightly basis after the market has closed, it helps one to see positions where the risk has now increased substantially and the reward is now not so slim. Think of risk as constantly evolving and not a static concept. The notion of ‘house money’ too is nothing more than a gambling fallacy. The money is real – but it’s not yours until you’ve banked it. If you wouldn’t now enter the trade at its current level, should you really be holding all of it? Or should you be taking some risk off the table?
Beware: the cheap trap!
Another gains goblin you should try to avoid on your journey is Mr Cheap. He cunningly tries to tell you that a stock is now cheaper because the price has fallen or the PE is low. What a ludicrous proposition! A stock that has a falling PE could be because its profits have fallen but its share price has fallen further. Is that the sort of stock you really want to own? Furthermore, if you are buying a stock that is not yet profitable, what happens when the cash runs out? A stock that goes down does not necessarily go back up. Those who were buying cheap shares like Carillion and Conviviality because the share price couldn’t go any lower were sadly surprised. They did go lower. They all went to £0 and everyone lost all of their money.
If you ‘invest’ in a stock that is not making money then they will inevitably need to raise more at a discount. Don’t think for a second that the directors will work for free – they still need paying and they’ll use your money for it.
Believing directors blindly is another mistake I have had the misfortune to make. I suspect I am not the only one, and I certainly won’t be the last, but allowing a director’s comments on a rampcast to prevent you from selling when you know you really ought to and then be done by a deeply discounted placing leaves a sour taste in the mouth.
Sometimes speaking to management can be helpful in that they can help to explain parts of the business and answer some of your questions, but trying to gain an inside line is a sucker play (and we all know what pay a sucker play gets). If what the directors say sounds good it would be in an RNS if it were material. If it is material and it is not in an RNS, then they are breaking the law by disclosing market sensitive information and you should be extra careful of everything else they say. Be aware of confirmation bias and the fact that management and especially CEOs are salesmen. They want you to buy more stock because they want the share price to go up.
Lifestyle directors are no different to salesmen peddling snake oil.
Some directors actually specialise in this spiel; their companies never achieve anything yet they continue to rake in hefty six figure salaries paid for by shareholder money. Lifestyle directors whip out the begging bowl every few months to boost the coffers, usually with a story about how they’re doing to drill or mine a hole in the ground, which often ends in tears when the music stops. You can make good money trading these stocks, as where these directors fail in the operational capabilities they more than make up for in ramps. A good example of these types of trading plays is UK Oil & Gas, which at one point last year was worth more than top quality oil & gas companies SDX Energy and Serica Energy, despite not having produced a single drop of oil (1p to 10p!). Some ramps are so powerful they are almost evergreen – the “Gatwick Gusher” pump has multibagged UK Oil & Gas many a time. I’ve already set my alarm for the 2019 ramp where they promise a lot, achieve nothing, and make me a load of money.
“The speculator’s chief enemies are always boring from within. It is inseparable from human nature to hope and to fear”Jesse Livermore
Stock trading is incredibly different to stock investing. They require completely different mindsets and skillsets. An investor who sees a fall in price with no underlying reason for the movement senses an opportunity to acquire more of the company for a cheaper price. A trader who impulsively averages down is a schmuck. Commit to what you are, and do not be a short term trader who then switches to being long term investment. Decide what the position is and stick to it. Trading and investing at the same time is possible but only if you realise that they are two separate concepts and treat them as such.
“The cotton showed me a loss and I kept it. The wheat showed me a profit and I sold it out… Of all speculative blunders there are few greater than trying to average a losing game”Jesse Livermore
Be aware of the disposition effect. This has cost many a stock market speculator money in terms of both opportunity cost and bigger losses, as they sell what goes up and keep what goes down. If your gardener pulled out your plants and watered the weeds – you’d fire him! Apply the same logic to yourself.
This does not mean that averaging down is always a bad idea, but if your entries are correct then you should not be frequently selling for a loss at support, only to see the stock bounce back and have you kicking yourself. There should be a clear objective reason for doing so and you need to be extra careful of managing the trade. If you always cut your losses instead of averaging down, you’ll never be in the position where you take a big loss because you kept buying more and more. Remember, the market can stay irrational longer than you can stay solvent.
“Markets are never wrong – opinions often are”Jesse Livermore
A trader needs to constantly monitor their emotions and how they feel in order to protect against themselves. Lose your opinions, not your money. Every day, you’re only ever one trade away from doing serious damage to your portfolio and to yourself. Trading on tilt (poker term for frustration or emotional breakdown) or where you are no longer capable of making objective decisions can not only set you back months but completely wipe you out. To protect against on this, I like to look at my positions nightly and imagine what could happen, and know where I’m getting out. If you don’t plan and you end up in a pressured environment, can you really trust yourself to make the optimal decision in the heat of battle? I have found out that I can’t, and so I created checklists. I don’t trust myself. But I trust a process and try to stick to it.
“Nowhere does history indulge in repetitions so often or so uniformly as in Wall Street. When you read contemporary accounts of booms or panics the one thing that strikes you most forcibly is how little either stock speculation or stock speculators today differ from yesterday. The game doesn’t change and neither does human nature”Reminiscences of a Stock Operator
Greed. Fear. Hope. Regret. These four emotions repeat themselves in every market participant without fail (unless you’re reading this and are not actually human but in fact a high-frequency trading algorithm). Greed has people overexpose their positions. Fear of missing out has people chasing spikes. Hope has people grimly holding onto losses when their stock collapses through support and is in freefall. Regret causes self-inflicted damage for not selling out when they still could’ve. Whenever you feel one of these emotions – remember this: Mr Market is testing you and trying to see if you will do something stupid. Emotions have no place in the high stakes trading arena.
“They say you never grow poor taking profits. No, you don’t. But neither do you grow rich taking a four-point profit in a bull market”Jesse Livermore
You need to run winners to provide the fat tail on your bell curve but at the same time not taking some risk off the table as the stock moves up in your favour distorting the risk/ reward against you is silly. Holding all of your position that is 200% up in a few days – who is the risk/ reward favouring? It’s certainly not you.
“Fear and hope remain the same; therefore the study of the psychology of speculators is as valuable as it ever was. Weapons change, but strategy remains strategy, on the New York Stock Exchange as on the battlefield”Reminiscences of a Stock Operator
Nowhere is this psychology more pronounced than on the bulletin boards. I have found these to be a useful indicator of the general sentiment of a stock – though definitely not to be relied upon – but if there are 500 posts and several posters are talking about a 30p party when the stock price is 3p, you can bet there’ll be some volume. And where there is volume there is volatility, and so there exists a trading opportunity. Ultimately, it’s volume that pushes stocks higher, and I have found this to be a brilliant indicator. Stocks that have a high chance of amounting to nothing and a low chance of striking the jackpot attract punters like a moth to the flame; the reason being that humans prefer the small chance of winning big than the high chance of winning little. Ed Croft from Stockopedia has done a quality video which can be found in the bibliography at the bottom.
These are the stocks where the multibaggers exist – often a small market capitalised stock with a new exciting strategy or asset. They are almost always unprofitable but could become the next big thing if they do something. ‘If’ being the key word here.
“By a judicious investment of a temporary character..”Reminiscences of a Stock Operator
It rarely pays to stick around in these stocks. Stocks that rise quickly and can fall just as quick. When a trader crosses the line and becomes a believer in the story, their money can be considered as good as gone. For no matter how high the stock goes he truly believes in the merits of the co and considers himself an ‘investor’, and so he rationalises himself into holding for a higher gain but does not create an exit plan. And regardless of how low it goes he seeks out confirmation bias from bulletin boards, vague news stories that provide a tenuous speculative link, and refuses to hear any rational logic which may suggest he is wrong. The believer may even end up throwing good money after bad.
Block your eyes with wax lest you hear the siren’s song
Never fall in love with a story. One of my biggest winners was CloudTag, and once it became clear CloudTag didn’t actually have a working product I realised I had to get out and started selling on the way up. I rode the stock from ca. 2.75p to a high of 15p – it ended up reaching 24p at its peak! Whilst this stock put money in the pockets of many punters (both long and short), others lost thousands and I even heard one story of a poor chap who put his money he’d saved up for a house deposit into the stock only to watch it delist.
“One of the most helpful things that anybody can learn is to give up trying to catch the last eighth – or the first. These two are the most expensive eighths in the world”Jesse Livermore
Picking bottoms and calling tops is a fool’s game, and working out how much you ‘could’ have made is unnecessary self-inflicted pain. I bought the gap on PYC and traded this from 1.4p to 5p – but that same stock carried on going to 30p. Was I annoyed? A little. But Harry Hindsight only ever appears to tell you so after the event, and I made the best objective decision based on the facts at the time. It was a great trade. These stratospheric rises happen rarely but enough to keep people holding on to the next one – the best anyone can do is to plan their trades, and then do their absolute best to trade their plans.
“I never buy at the bottom and I always sell too soon”Baron Nathan Rothschild
Punters buy and sell in herds. They say greed climbs a wall of worry but fear takes the express elevator down. When everyone is buying and the price is rapidly rising, it’s probably not a bad idea to think about selling some. If you’re unsure – sell half. That way, you have banked a gain and can still benefit from the upside. When the fear strikes it’ll be a crowded exit.
Always put downside first and know how much you are willing to lose maximum, and keep the risk to the upside. Take some off the table as the stock moves up. We’re not here to catch the top – we’re here to make money. No matter how high the stock is, or how many times it’s bagged, there’ll always be someone there to tell you it’s going higher. Always.
“.. like a real philanthropist of the type that is so abundant in Wall Street – the sort who loves to put millions into the pockets of friends, acquaintances and utter strangers alike”Reminiscences of a Stock Operator
You can find these tipsters everywhere. Some of them are good, and some of them are bad. It can pay to listen to the good ones, as they can be helpful in providing leads for you to do your own research. Never buy anything that you have not done your own research on, because no matter who the tipster is, you do not know their risk profile, their position size, their portfolio, their entry, their exit… Tips can be useful leads only – if you treat them as anything more then you are the one to blame if it goes wrong.
Tips can come from many places: paid for tip sheets, well known investors, stock market columns in the newspapers. Very often they can move prices and so it is well worth being aware of the major players. Sometimes there are trades just by jumping on tips, and selling out. First in, first out! Some people mock others who buy tips, yet those are the ones making the money. I know who I’d rather be.
In the microcap world, literally anything can move a stock. Recently, Ross Group moved 200% because someone posted on a bulletin board that there was a sentence in the annual report that the board expected the number of employees to increase in the next financial year, suggesting that the board might do something compared to the previous nine where they did nothing. It doesn’t make any sense, and it doesn’t have to either.
There are some Twitter accounts that are capable of moving stocks. Last summer, almost everything one account tweeted about rocketed. They had the golden touch, blessed was any share that they cared to mention. It didn’t matter whether the stock in question was fundamentally solid or absolute junk. To profit from this, I set up a column in Tweetdeck to follow all of their tweets, and for a period I was entering every stock they posted about within 30 seconds. This was brilliant as I could silently sell into the liquidity coming in to make a quick scalp (it is illegal to promote a stock whilst selling your position – not that this stops anyone, of course). Obviously, once this stopped working, I stopped doing it.
Twitter and bulletin boards can be helpful to find trades. A stock that is up 100% because it’s been pumped on hot air via the bulletin boards is not a high risk trade to short if volume is thinning. Knowing which stocks are the ramp du jour means you can let the rampers do the hard yards and meet them at the finish line to collect your profits.
A low price for a man to pay for not having the courage of his own convictions! It was a cheap lesson
The other side of stock market tipsters is those that want you to sell. I find it incredibly hard to believe people actually bother to try and convince others to sell so they can then buy in cheaper, but they exist. It would be less effort learning to trade but they don’t seem to ever grasp that. You can find some of these dopes on bulletin boards where they keep coming back weekly for years on end, where they pretend they are altruistically trying to stop other private investors losing money. Perhaps they lost money once and are now bitter. Perhaps they are short. Perhaps they developed a weird fetish for the stock and keep coming back. Some of these can be credible and convincing, and some of them may even have a modicum of truth to them – but do not let them get into your head without good reason. If you do, they are robbing you of a learning opportunity. You will only learn by making your mistakes. It’s OK (and encouraged) to hear the bear case, but do not let someone else sway your mind unless it is fully your decision. Many of the people who frequent bulletin boards to talk stocks down continuously are losing traders who, quite literally, have nothing better to do, and so most can be dismissed without further thought.
There is much that I have learned from the stock market, but there remains even more that I don’t know. My own weaknesses are financial analysis and that I have yet to experience a market where everything is going down rather than up (and many other weaknesses I’m sure). You don’t need to know a lot. It’s very easy to make money in the stock market if you can exercise discipline and a sound approach to trading risk management. As long as the market exists there will always be new ways for people to spoof it. Look at the Online Blockchain interview in recent times with Clem Chambers – it is complete baloney and yet the price still multi-bagger.
Understand the cost
There is a cost to everything. Of course, there is. Just like Instagram, on Twitter, you are only seeing highlight reels. Not everyone makes money on every trade. Not everyone makes money trading. It’s a very rock star to sit by the pool, make more money than you used to make in a month, then close your laptop and go for lunch and enjoy the rest of the day free. But anyone who claims it’s easy is either 1) selling you something, or 2) lying. If large, relatively low-risk returns were simple, then everyone would be doing it. I love full-time trading but there have been months where I made more than my last annual salary and months where I couldn’t turn a single penny, and at that point, you begin to wonder if it was all such a good idea. You need mental resilience and the capital to afford it too.
Warren Buffet got lucky. Does he have an incredible skill? Of course. He spent 12 hours a day locked away reading for years on end. But for every Warren Buffet, there are thousands more like him who didn’t make it through no fault of their own. That’s luck, and that’s life. If you go all-in on each trade each time you can get rich quick but eventually you will be wiped out. Even if something is almost certain to be nailed on, at some point you will inevitably experience the surprise at some point.
It’s the low risk trade that can actually be the highest risk – because it is deemed low risk you position size higher because of it. A personal example of mine was the 100% CoS workovers in Anglo African Oil & Gas back in May 2017.
Cash is King
A company that only had £100,000 on the balance sheet at the end of December and has £30,000 operating cash outflow per month probably needs funding in April to continue operations (£30,000 x 3 = £90,000 meaning £10,000 left). You can often avoid buying into obvious situations where the company will issue more equity in a discounted placing by understanding a company’s cash balance by looking at the balance sheet and the statement of operating cash flow.
On balance sheets, never trust the ‘headlines’ in the results. Directors say “strong balance sheet”? It’s probably propped up by intangible assets. Profitable? Check and see if it is net profit and a profit figure before exceptional costs. A one off disposal for £10m profit means they actually made a £9m loss if profit after tax is only £1m. There are games played here. Learn them.
Liquor, ladies and leverage
The three ways to go broke according to Charlie Munger. Leverage should be used with caution (though that does not imply the other two should not) as you can end up owing more than you deposited. Just because you can take a position for £20k but only need to put up £2k of cash doesn’t mean that you should. A 15% swing downwards in this example would relieve you of 100% of your cash and owing £1,000 more (I believe recent ESMA rules will change this somewhat to not allow accounts to go into negative equity but this does not remove the need for extreme caution with leverage).
Take your profits, play probabilities
The “what if I’d held my entire line at 300% up how rich would I be?” thought is dangerous. You need to be in it win it but only a gambler would not change his position according to the risk/ reward, and gamblers always lose in the long run. I don’t see any poor bookmakers.
An amateur places their entry on the support line, and their stop just beneath it. This is the obvious place for stops and so price will head towards the liquidity and shake a lot of stops out. It’s better to actually enter the trade where those stops are as you can then exit much quicker if the trade appears to be wrong. Support zones, and not support lines. Everyone sees the same chart; think about where other market participants are getting in and out by looking at previous highs, support, trendlines etc. The closer you enter to the point where the trade would be wrong, the higher the risk/ reward is in your favour.
Charts can be boring, but there is nothing boring about making money
People use charts because they work. It doesn’t matter if they’re a self-fulfilling prophecy or not, charts give you an edge against those who don’t use them or can’t read them accurately. I spend at least an hour every night going over charts after the market close, but this allows me to continuously generate trading ideas from stocks making all-time highs, heavy volume (signs of accumulation/ seller clearing), and stalking entries on stocks I like but do not yet offer a high probability entry.
Review your trades
If you constantly find yourself making the same mistakes, then you’re in a position to fix them. Ultimately, you should be looking at 1) how generate more winning ideas, 2) how to make more money from your winners, and 3) how to lose less money from your losers.
You don’t have to trade every day. Boredom trading used to be a problem for me and the only winners were the brokerages who earned their commissions. Losses hurt your physical and emotional capital. Ask yourself “is this trade likely to make me money” and if the answer is no, sit on your cash. This question also allows you to focus what matters – asking if a stock is good is not the right question, as just because a stock is good does not mean that it will go up. Thinking objectively in terms of risk/ reward will greatly benefit your trading. Having a 5% stop to hit a 50%+ gain – what is the probability of that ever happening?
Don’t trade your P&L
Points, not pounds. As soon as you start thinking about winnings and losses in terms of reality you allow emotion an entrance into your head. If I ever thought about just how much actual money I shifted around into some of this AIM junk and what that money can buy in reality I’d go bananas.
Further on emotions, don’t allow a stock to infiltrate your speculation on price. A business is not the share price. It’s just a number. A stock is a financial instrument used by a trader to increase his capital. Nothing more. Nothing less.
The art of the big bet
There are times when you should bet big (it makes no sense having conviction buy positions the same size as normal trades) but these risks should never be big enough to knock you out. Let your P&L grow by lots of smaller wins and use these small wins to finance larger risk when the opportunity comes.
You’re going to make mistakes
I make mistakes all the time. Just try not to make the same ones repeatedly, and it’s the really big mistakes that cost you which you can defend against. If you’re not making mistakes then you must be a very good trader, so please contact me immediately so I can learn from you. Don’t beat yourself up!
You can make money or you can make excuses, but you can’t make both
I’m convinced there are only three types of traders: Trader 1, Trader 2, and Trader 3 (I do not recall where I read the three types of trader concept, but I have added my own detail as it really stuck with me).
Trader 1 has no ideas and no plan, and makes his decisions based on what he reads on bulletin boards or how he feels. He has a big enough win every now and again to keep his balance afloat and occasionally tops up his trading account with money from his salary. He wants action and excitement, and so he tries to trade every day. He may even openly admit he is just a gambler and after a bit of fun. Hitting the jackpot is his first priority. I call him liquidity.
Trader 2 has ideas but does not have a plan, and tries his best to follow these ideas based on logical thought and what he sees in the market. Trader 2 is capable of taking money from the market because it’s not difficult, but every now and again he’ll do something idiotic that will set him back quite a bit, or dent his confidence at the time where the opportunities are in abundance, because he didn’t have a plan. Making a profit is his first priority.
Trader 3 has ideas and also has a plan, and tries hit utmost best to stick to it. He understands that losers average losers and is not afraid to buy or sell based on indicators that he has back tested and found to be reliable. Trader 3 has a habit of banking profits into price strength and consistently makes money from the market based on following probabilities in various scenarios that he has researched. He knows he doesn’t have to trade daily, and waits for the right opportunity. Protecting capital is his first priority, because no capital means no trading.
Everyone is a genius in a bull market
I started trading in March 2016 and went full time in January 2017. In that period markets have only ever gone up. Aside from Brexit and the recent Dow Jones plunge, there has been very little volatility or periods that have really challenged anyone who has only been trading a few years. There will be entire trading teams in the City that have only ever known low-interest rates. At some point, there will be a serious correction, where the true test will come. If you can keep your capital whilst others are losing theirs, the opportunity will be huge coming into the early bull market. A full-time trader cannot afford to lose their capital in sub-standard trades.
“What we learn from history is that people don’t learn from history”Warren Buffet
Like the Tulip Bubble where a single bulb could buy prime Amsterdam real estate with servants for six months, Bitcoin leapt from $3,000 a coin to $20,000 in just under twelve months. But those who were calling it a bubble at $5,000 missed a three-bagger move. Those who bought at $20,000 are nearly 75% down. Lose your opinions, not your money. The price is always right.
I truly feel that I could give away all my secrets and it wouldn’t make any difference. Most people can’t control their emotions or follow a system.
Thank you for taking the time to read my post. I am always happy to answer any questions through my Twitter (@shiftingshares), but please be aware that I cannot give advice as 1) I do not wish to be responsible for your financial decisions, and 2) this would be illegal.
The bibliography contains some classic investment tomes in, though for trading it is rather more useful to read around behavioural finance, human psychology, and why people do what they do.