My perspective on "the game"

This is another long read...so buckle up.

First of all, some comments regarding Tuesday's beat down. When the market got whacked a few weeks ago due to Egypt turmoil, the sell-off was a one day wonder which didn't surprise me much. Now we got a sell-off due to Libya and what seems to be growing social unrest in other Northern African and the Middle Eastern countries. So, perhaps this time there will be some follow through especially given torrid run we've had in the market and how oil prices have jumped a lot higher this time. But follow through or not, I'm confident this is a just a correction within a bull market. The loser bears who have been decimaited and humiliated beyond belief for 2 years were celebrating Sunday night on the message boards when the futures were down big and today as well. They are thumping their chests as if the market crashed 50% and they recouped all of their losses. And for what? The market is down 2% after just making a fresh bull market high. These idiots act as if they made millions when even if the market drops 15-20% these bagholders would still be underwater big time. I've seen this behavior over and over since the bull market began and it always gave me assurance that days like today were just corrections. Such hubris from losers like this is a sign that Mr. Market is going to spank them some more in due time.

The bottom line is that correction or not, one day wonder or not, odds strongly suggest that the bull market is still in tact. History shows bull markets end when the general public is optimistic about the economy, investors/bankers are greedy and monetary conditions are tight. None of the above are anywhere close to being in existence. Anything less than that is just noise. Events that don't have a material direct impact on broad based earnings will not threaten a bull market aside from creating dips and corrections. Oil prices spiking 7% as significant as it appears to be, it likely not going to effect earnings in a material way. But it's certainty not a positive and with the market up 28% in under 6 months not to mention up 100% in just under 2 years, it provides a reasonable excuse for a pullback. Is this going to be the start of the multi-month consolidation phase I'm expecting? We'll find out soon.....my gut says that the "real" correction won't begin until today's gap is at least filled. Whatever....I'm not going to position myself for a downside trade unless I'm absolutely certain it's going to be more than just a 1-3 day move...and I'm not. I'm happy to stick with my core longs and cash position regardless. Most of my longs are in the energy services sector which actually benefits from this spike in the oil price. They closed flat overall today.

I want to talk a bit about my previous post. Did anything from it really hit home? Reminiscences of a Stock Operator was written over 70 years ago and yet the insights it provides about the markets and human behavior remain true to this day. In this book you will find no mention of things like Fibonacci retracements levels, boligner bands, moving averages, elliot waves and all the other arbitrary t/a garbage that so many people out there use. And yes....all that stuff is garbage in my view. I'm sure you've heard statistics that say something like 90% of traders fail. Well, guess what 90% of traders based their trades on? All of the t/a bullishit I just mentioned. I'm sure there are a handful of traders out there who are successful using a pure t/a approach but I'll tell you right now, such people are in a tiny minority and quite frankly, could simply be very lucky.

I don't think all t/a is useless. In my experience certain chart patterns have been reliable such as consolidations/bull flags in an uptrend. But there's nothing voodo/arbitrary about this pattern. It's simply the reflection of new buyers soaking up shares from profit takers who got in at lower levels. Every big winner I've had in the past 2 years was the result of buying stocks that were in a consolidation phase during an non-parabolic uptrend.

The important things I learned throught the years is exactly what Jesse Livermore in Reminscenses pointed out which is the following

1. When you're right, sit tight and add more to your position. When you're wrong get out early and don't ever average down. Most people do the opposite. They sell winners too soon and hold on to the losers forever while adding more to them. Just because you show a nice profit in your position doesn't mean you should sell. If you have good reason to believe that the price is going to go a lot higher still in the longer run (or lower if you are short) then you need to resist the temptation of getting out in the hopes of getting back in on a correction. You might time it right in the beginning and save yourself a few dollars but eventually you'll find yourself on the sidelines watching the stock soar without you and miss out on the big gains. I'm sure everyone who reads this had made this mistake at least once....including yours truly. This was the lesson Partridge had learned over the years.

2. Big money is made riding trends. This goes hand in hand with the first point. Big money is made riding big trends/themes. I'm sure you've heard about how George Soros made a fortune shorting the pound in the early 90's and how some hedge fund managers made killngs bettng against subprime mortgages 3 years ago. Do you think these guys day traded or used bollinger bands and elliot waves? Their trade was based on fundamentals, they had a thesis and they had conviction/courage to stay the course WHEN THEY WERE RIGHT ABOUT THEM. I wrote this in caps because it's a very important point. You need to have conviction with your position when you are right i.e. showing a profit, NOT when you are wrong. Having strong conviction when you are wrong will destroy you like all these loser bears have been destroyed. But when you have thesis and the market is agreeing with you i.e. you are showing a profit then you need to have the conviction to follow through on your thesis and hold your position untill you believe it has fully played out. Having conviction allows you to be a strong holder not getting shaken out by dips and corrections that the market throws at you.

I realize that it's difficult to be right and sit tight, riding out all the dips and corrections. I know it's also difficult not take profits after your position had a big run up. Let's face it......sometimes our convictions are just not strong enough and we can't resist the urge to trade. So what can you do about this? Designate a portion of your position as a trading position while keeping a core position. This is something I often do. I will designate up to 1/3 of my position as "trading". If you do this, you must have the discipline to not touch your core position until it's time to sell out for good.

There's lots of people out there I'm sure, who would say you need to trade without conviction....they believe the best approach is to have no opinion and just follow the market. Well, I don't agree and it's not that easy to just "follow the market". First of all, the market is not always right...in the sense of what it's discounting. This tends to happen especially during manias and panics. I'm also sure you've heard of the saying that goes along the lines of "the market has predicted 8 of the last 5 recessions" which basically means, it's not always right. So, if you go strictly with the "go with the market" approach you could find yourself long near a major top, or short near a major bottom. It makes you a weak holder unable to successfuuly ride the major trend because you will get easily shaken out by dips/corrections and even worse, get suckered into believing that a correction indicates a change in trend. A lot a loser permabear traders tried to take the "go with the market" approach and could not play the long side successfully because deep down they didn't believe in the bull market which made them weak longs easily shaken out by small dips.

I also believe that if you're going to play this game, play to win big but do it smartly. The financial markets offer you potential for massive financial success but you cannot attain that with diversified portfolio. It will guarantee you mediocracy at best. If that's all you're looking for then fine. But if you're good at predicting financial trends and picking stocks, you need to make significant bets on a handful of positions/sectors to maximize your potential. But NEVER under any circumstances go all in on 1 individual stock/sector/idea. Doing so puts you in a position to get wiped out if you are wrong and no matter how good you are you're bound to get it wrong sometimes.

Getting back to the conviction issue....here's the way I operate. If I have a belief about the market, a sector or a stock I first want to see some evidence that the market is agreeing with me. The only exception I may make to this rule is if I believe there is a mania or panic in it's final innings and I'm looking to bet the other way. In that case, waiting for the market to confirm would mean missing out on a substantial part of new trend because the initial reversal from a mania or panic tends to be fast and furious. But regardless of the circumstances, when I place a trade I only commit 35-50% of my intended position. This way, I can be a strong holder, giving my position plenty of time and wiggle room to prove itself. I will then add to this position only if I'm showing a profit and the position is acting like I expected it to. By trading in such a manner I believe you combine the benefits of trading with conviction and "going with the flow" by trading with the market trend.

The question that traders will struggle with is where do you draw the line between having conviction on a trade (i.e. giving it the opportunity to be profitable) and pulling the plug on it? Well, that depends on a lot of factors and there's really no way of telling where to optimally draw that line in the sand but one thing's for sure is that there needs to be such a line otherwise you'll end up as a bitter, miserable SOB always looking at the market with contempt....not to mention broke.