contradictions??

I received a question from a reader whom I respect greatly and thought it would be good to answer to the group.

This reader said ...  

I have a question about seemingly contradictory views: On your blog Wed. you ended with:  "The market is in charge ... don't fight it, just sit down, shut up, buckle up and enjoy the ride!", but  earlier you commented that riding the trends was a fool's errand:  "Since my suggestion to buy on October 5th, we have enjoyed a 7.3% gain.  Ironically if you hadn't been in the market for the entire year and only invested over the past four trading days (from 10/5 through today), you would have blown the doors off 99% of all hedge funds, mutual funds, money management firms who are all firmly planted in the negative for the year.  Quite bizarre to think about, but another good example that timing is everything in the market." 

I am wondering: do you see these as in conflict and if so how do you reconcile the differences: the one, ride the trends, seems at odds with, try to pick the time to get in and out and if you can't pick, stay out. 

Great question Paul ... and thank you for taking the time to ponder this!  Ok ... you caught me ... I'm totally full of it ... like most stock brokers, investment gurus, etc, I am just picking and choosing what I say based on what the market is doing at that moment so it'll make me look smart.  

JJJJUUSSTTTT kidding.  At least I hope I'm kidding ... I dont think I'm full of it, am I ???   :)

First off, I want to clarify the above quote.  I am fairly certain I never said riding a trend is foolish, atleast I hope I didnt, because this is absolutely how I make money in the market!  What I think I said was that 'buy and hold is dead'.  Buying a position and holding it for 13 years does not guarantee you will beat the market averages during those 13 years (as we have seen).  

As I think you know, the market doesn't move in a straight line, but rather moves in a jagged fashion.  When the market is going up, what you generally see is a 'higher high', then a 'correction' to a 'higher low' (higher than the last low), and then a new 'higher high' and so on. These jagged 'trends' occur on all time frames as small as a few minutes to 10's of years.  so, where as over the past 13 years you would have made nothing if you 'bought and held', if you could predict the future and buy at the bottom of each move, and sell at the top, you would be a quite wealthy person.

It's so simple ... just buy at the right times and make a fortune!!

Looking at the picture above of the Nasdaq since 1996, you can see there were 3 long term strong moves up, and 2 long term strong moves down.  And of course, there have been many, many more intermediate and  short term moves as well including the current one we are in.  By the way, notice how small the current downtrend is in the bigger picture!

So, you ride the trend for as long as it exists and then hop off when it no longer exists.  Is that "buy and hold" ... I suppose, although I consider  traditional Buy and Hold longer term.  The mutual funds and investment houses of the world want to encourage you to buy into the market and just leave it there until you need it.  5, 10, 15 years or longer.  Basically they want you to forget about managing the money and just let it accrue (hopefully) while you don't need it.  But looking at the picture above, if you were to know ahead of time the tops and bottoms ... making 6 simple trades over those 13 years would have resulted in a tremendously different return than just 'buying and holding'

So ... how do you know when a trend is starting or stopping???  Good question!  It obviously isn't easy otherwise we would all be rich, but that is what I have devoted my life to over the last few years and I hopefully my track record speaks for itself.

The first rule of thumb in all of this is that you aren't going to be able to enjoy the entire move up or down, that IS indeed a fool's game.  Trying to predict (ahead of time) a market top or market bottom is simply impossible ~ and foolish.  You might get it right sometimes, but you probably will go broke in the process.  In fact, there are A LOT of traders that are shorting the market right now because "it just can't keep going up as it has" and although their thought process is correct, it is foolish to try and anticipate the next move.  

The goal is to see a change occurring and hop on board as it starts to take place (not before though!).  I also adjust my position size as the change becomes more and more evident.  I start with a small position as I see confirmation of the change in trend, I will continue to buy more if the new trend holds and is not a fakeout.

As you probably know, I sent an email on October 5th at 7:00am Mountain Time suggesting you to get long in the market ... well the actual 'bottom' was the day before and the market closed up roughly 2% on that day.  SO, I didn't catch the absolute bottom of that move, but happily caught the other 10% of the move.  And now am out again, even though the market may move up another 5% before it changes course again.  So, I ride the trend for as long as it is obvious to me that there is one, and hop out when the trend is over or when the risk is too great to stay on board.

I have used the train analogy before that you 'don't get in front of a speeding train'.  Imagine if someone saw a train coming at them and said ... "it's bound to run out of gas soon, so I'm going to cross the tracks".  Well, sure their logic is not incorrect ... it is bound to run out of gas 'soon', but is that 'soon' a minute, a day, or a week away ... I'm certainly not going to bet my life on it!!  

My logic in the market is the same.  In fact, if you read my last post, I am waiting right now for the market to 'run out of gas' and expecting it to Monday or Tuesday ... so does that mean I should short the market today?  Absolutely not, because there are few signs of weakness now and therefore I wait for more evidence.  As I mentioned above, I am not planning to catch the absolute top or bottom.

Now, with that said, as you know I have sold all my long positions and am in cash over the weekend in anticipation of a change in trend, but I feel that is different.  Being cautious because a change MIGHT be coming is much different (in my opinion) than being on the offensive.  I feel it is one thing to protect your money, and quite another to risk it on a possibility.  I call this, picking my battles so I can live to fight another day.

When I first started out, I had a hard time accepting that trading the market is all about probabilities.  No trade is certain, which is why risk management is SOOO important.  You could see the same setup happen 100 times in the past with the exact same outcome each time, and you take the trade and it fails.  The market is just too complex to be able to predict it with total certainry.  You never know for sure whether your analysis will result in success until after the trade is over.  

So, is it a random walk like some have predicted ... can a monkey throwing darts at a board of stocks have better results than me?  He might once or twice, but over time absolutely not. 

My intraday and end of day analysis helps me to decide what I think the market is doing, going to do and has done ... and I setup my positions accordingly.  If all signs point to up, then I get long aggressively, but if only 70% of my indicators point to up, I may take small positions here and there and if 50% point to up, I probably sit in cash OR at the very least stay with the current trend and lighten my positions.  

On October 4th, my end of day analysis showed the most strength I had seen in months causing me to be quite bullish and send out an email encouraging you to get in the market.  Could I have been wrong ... of course!  It is important to note that I am not necessarily predicting the future, but rather trying to interpret the present in a bullish, bearish or neutral way and then use probabilities to try and profit from it.  

Hopefully you understand the difference between the two.  Being wrong is just a reality in the market, the sooner you accept that, the more successful a trader you will be.   I spent a great deal of time in the beginning of my career trying to find a 'Holy Grail' that would predict the market perfectly every time and eventually concluded that a perfect 'indicator' doesn't exist.  It is just probabilities ... simple statistics ... if you know your probabilities you can limit your losses and maximize your gains.  

I have a 64% win/loss ratio currently.  That means I am profitable on 64% of my trades, and have a loss 36% of the time.  This actually is quite a good ratio fyi ... I know trader's that have as low as a 38% win/loss ratio and are quite profitable over time.  this sounds horrible, but let's face it ... if you put on one trade that returns 100%, and 99 other trades that lose 1% ... you will be up for the year.  So, you trade knowing that you will have losers and protect yourself accordingly.  You don't have to be right too many times as long as when you are wrong, you don't stay wrong for long.  As long as the percentage gained outnumbers the percentage lost ... all is good.  

And of course, knowing my probabilities, I can get more aggressive on certain trades and not take other trades in order to maximize my roi.  To use a real example, for me, since February 14th (the day I started officially tracking my trades) I have earned a 76% return on my trades, but my portfolio is only up 23% (compared with the s&p being - 3.22% for the same period)   What this means is that if I had traded an equal amount on each trade my portfolio would be up 76% right now, but based on my risk analysis of each trade (before I placed the trade), I adjusted the size of my position therefore reducing the risk but also ultimately the return.  So, my aggressiveness in a trade is tailored to my analysis.

Another important clarification is that the market is constantly changing, so I could be bullish when I go to bed, and bearish when the market opens (based on new evidence that is presented).  There are just too many factors at play to ever be 100% sure in one direction or another.  So, was I wrong when I went to bed ... maybe, although I like to think I was right based on the facts I had at that moment and that as new facts emerged my opinion changed.  If a doctor sees a patient at night and says "you look great, you can probably go home in the morning", then he comes in, in the morning only to see the patient looking deathly ill ... was the doctor wrong??  You base your opinion on the facts you are given and that's all you can do.

So, there you have it Paul ... I went wayyyy off tangent here, but hopefully I answered your question and along the way helped you to understand my thought process to making profitable trading decisions.  Buy and Hold is dead, but riding trends is certainly not.  

 Thank you again for your question, I hope I have answered it and more so, I encourage you (all) to ask more questions along this journey.

Have a great weekend!