Wednesday, July 1, 2009
Multicollinearity...A Problem of Plenty Or Plain Ignorance???
John Bollinger states it: "A cardinal rule for the successful use of technical analysis requires avoiding multicollinearity amid indicators. Multicollinearity is simply the multiple counting of the same information. The use of four different indicators all derived from the same series of closing prices to confirm each other is a perfect example."
This is a problem we all have faced at some point of time, when started out with Technical Analysis, actually it’s the problem of PLENTY! With a plethora of indicators available the choice is difficult to make and what adds more to it that most of us get hooked to the indicators without really understanding its underlying constituents and functioning. One can read a very nice writeup on multicollinearity!
Why Is It Hard To Recover Losses???
Many of us must have experienced this phenomenon when started out trading, why is it so hard to recover??? We all are or have been drawn initially into trading with the lure of making easy money. But it’s not important to make money what’s more important is NOT TO LOSE MONEY!!! A very important and a critical fact we fail to consider (or rather choose to ignore) when trading - each time we lose money, it is harder to recover it back. And the more we lose the more difficult it becomes to get back to breakeven. Why?
Assuming we start a trading account with 10000 (just taking this figure so that math becomes easy)!
Lose 10% to 9000 - Now you need to make 1000 on 9000 or 11% to get back to breakeven.
Lose 15% to 8500 - Now you need to make 1500 on 8500 or 17% to get back to breakeven.
Lose 20% to 8000 - Now you need to make 2000 on 8000 or 25% to get back to breakeven.
Lose 25% to 7500 - Now you need to make 2500 on 7500 or 33% to get back to breakeven.
Lose 33% to 6700 - Now you need to make 3300 on 6700 or 50% to get back to breakeven.
Lose 50% to 5000 - Now you need to make 5000 on 5000 or 100% to get back to breakeven.
Loosing 50% and you going to be really prayin hard….making 100% to get your trading account back to breakeven will be nothing short of a miracle! Therefore controlling you risk is very important since you will need to always make more to get back to break even!
While you are at it I would also advise you to read about Risk of Ruin by Kaufman!
Dennis Gartman’s Trading Rules !!!
Ok I have another set of Rulez.These ones are by Dennis Gartman! Trading rules by masters are worth reading and in trying to understand the logic behind them not only improves your trading pschycology but also help in your evolution as a trader. These rules are filtrations of years of hard work and knocks. These rules have evolved both from the brickbats and the bouquets.
1. Never, under any circumstance add to a losing position…. ever! Nothing more need be said; to do otherwise will eventually and absolutely lead to ruin!
2. Trade like a mercenary guerrilla. We must fight on the winning side and be willing to change sides readily when one side has gained the upper hand.
3. Capital comes in two varieties: Mental and that which is in your pocket or account. Of the two types of capital, the mental is the more important and expensive of the two. Holding to losing positions costs measurable sums of actual capital, but it costs immeasurable sums of mental capital.
4. The objective is not to buy low and sell high, but to buy high and to sell higher. We can never know what price is “low.” Nor can we know what price is “high.” Always remember that sugar once fell from $1.25/lb to 2 cent/lb and seemed “cheap” many times along the way.
5. In bull markets we can only be long or neutral, and in bear markets we can only be short or neutral. That may seem self-evident; it is not, and it is a lesson learned too late by far too many.
6. “Markets can remain illogical longer than you or I can remain solvent,” according to our good friend, Dr. A. Gary Shilling. Illogic often reigns and markets are enormously inefficient despite what the academics believe.
7. Sell markets that show the greatest weakness, and buy those that show the greatest strength. Metaphorically, when bearish, throw your rocks into the wettest paper sack, for they break most readily. In bull markets, we need to ride upon the strongest winds… they shall carry us higher than shall lesser ones.
8. Try to trade the first day of a gap, for gaps usually indicate violent new action. We have come to respect “gaps” in our nearly thirty years of watching markets; when they happen (especially in stocks) they are usually very important.
9. Trading runs in cycles: some good; most bad. Trade large and aggressively when trading well; trade small and modestly when trading poorly. In “good times,” even errors are profitable; in “bad times” even the most well researched trades go awry. This is the nature of trading; accept it.
10. To trade successfully, think like a fundamentalist; trade like a technician. It is imperative that we understand the fundamentals driving a trade, but also that we understand the market’s technicals. When we do, then, and only then, can we or should we, trade.
11. Respect “outside reversals” after extended bull or bear runs. Reversal days on the charts signal the final exhaustion of the bullish or bearish forces that drove the market previously. Respect them, and respect even more “weekly” and “monthly,” reversals.
12. Keep your technical systems simple. Complicated systems breed confusion; simplicity breeds elegance.
13. Respect and embrace the very normal 50-62% retracements that take prices back to major trends. If a trade is missed, wait patiently for the market to retrace. Far more often than not, retracements happen… just as we are about to give up hope that they shall not.
14. An understanding of mass psychology is often more important than an understanding of economics. Markets are driven by human beings making human errors and also making super-human insights.
15. Establish initial positions on strength in bull markets and on weakness in bear markets. The first “addition” should also be added on strength as the market shows the trend to be working. Henceforth, subsequent additions are to be added on retracements.
16. Bear markets are more violent than are bull markets and so also are their retracements.
17. Be patient with winning trades; be enormously impatient with losing trades. Remember it is quite possible to make large sums trading/investing if we are “right” only 30% of the time, as long as our losses are small and our profits are large.
18. The market is the sum total of the wisdom … and the ignorance…of all of those who deal in it; and we dare not argue with the market’s wisdom. If we learn nothing more than this we’ve learned much indeed.
19. Do more of that which is working and less of that which is not: If a market is strong, buy more; if a market is weak, sell more. New highs are to be bought; new lows sold.
20. The hard trade is the right trade: If it is easy to sell, don’t; and if it is easy to buy, don’t. Do the trade that is hard to do and that which the crowd finds objectionable. Peter Steidelmeyer taught us this twenty five years ago and it holds truer now than then.
21. There is never one cockroach! This is the “winning” new rule submitted by our friend, Tom Powell.
22. All rules are meant to be broken: The trick is knowing when… and how infrequently this rule may be invoked!
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