Tuesday, August 16, 2016

The starting point for any trader - what are your beliefs?

I've talked in the past about the importance of constructing your own trading method which is based around your beliefs.

But how do you start this process?


One way is by creating and answering a series of questions related to trading - these can cover areas such as your basic ideas about the markets, the amount of time you have available to trade, your personality, and what you think are important elements which would help you make money. Physically write them down, or key them in on a word document.

Below are some examples of the questions you should ask yourself:
  • Do you believe there is an edge in entering and exiting positions based on intra-day or end of day prices?
  • Do you have the patience to sit in a winning position for several weeks or months if required, until an exit signal is generated?
  • Do you have sufficient time each day or week to plan and perform on your intended timeframe?
  • Do you need to know about the directors, the key shareholders (and their holdings) of the company you are looking to trade?
  • Based on your chosen timeframe, do you need to to take into account ecomonic data releases, interest rate decisions etc?
  • Based on your chosen timeframe, do you need to take into account planned trading updates or earnings releases?
  • Do you believe in identifying certain price patterns or characteristics or price movements?
  • Do you believe there is an edge you can capitalise on by trading with the trend, or in trying to pick tops or bottoms in a market?
  • Do you believe that future price movements can be predicted or calculated?
  • Do you believe there is an edge you can capitalise on by entering on price breakouts, or on pullbacks or retracements within the context of a longer term trend?
  • Do you believe in keeping an eye on trading volume which potentially can help you interpret the price movements?
  • Do you believe that there is an edge in top down trading, by using index and sector price movements or charts to help you with directional bias and timing?
  • Do you believe that you should focus solely on the price movements on the individual stock or instrument you are trading?
  • Do you believe that you need to investigate and understand the underlying fundamentals and performance ratios in a company you are looking to trade in?

These only start to scratch the surface of what areas you should cover, but hopefully it may give you an idea about what questions you should ask yourself.

Your answers should be documented and recorded, and also periodically reviewed - this is because that, as you progress and develop as a trader, your beliefs may change over time. 


Certain elements you may previously believed to be important you end up deciding are not relevant, and vice versa. You may also discover that what you are actually doing in the markets may not mirror your beliefs!

Trading in a manner that matches your beliefs should also make it a lot easier for you from a psychological point of view. If you tried to adopt another successful trader's method which was completely at odds with your basic beliefs, that may cause internal conflict, which can contribute to you being unable to follow the rules as intended.

This process can help you in a number of ways:
  • For a new trader, this can be used to formalise or confirm your initial beliefs;
  • It can be used to help identify certain aspects which should be included in your trading plan.
  • It may help you identify areas in your existing method which are superfluous and can be removed, thereby simplifying or streamlining your process.
As an example - if you see yourself as a long-term investor or trend follower, do you need to access or follow intra-day price data?

If you believe that price is everything, do you need to follow that news feed?

In my own case, my trading and beliefs have evolved, based on my own experiences, continual study and the assistance of other traders who I respect. Some of my own beliefs which have changed over time are as follows:

Following price on the indices

These days I pay no attention to what the indices are doing - I concentrate solely on the price action in the stock(s) I am looking to trade. If I am looking at the indices, that would be with the sole intention of trading the indices. 

I give thanks to Jon Boorman (@JBoorman) for this - from following him on social media and his own blog, I knew he subscribed to this theory. He was kind enough to discuss this with me in detail, which helped clarify my own thoughts. 

The basic argument for this is that the indices respond to price movements in the underlying stocks making up the index - not the other way round. As Jon said to me "If I'm trading Google, I follow price on Google. Why should I care what the index is doing?" Implementing this change helped simplify my own thinking and process.

Volume

This is something I've had a strong belief about for a number of years. I pay no attention to tracking trading volume in a stock. My argument for this is simple - if price advances on only 50% of the typical daily volume, do you only get 50% of the profit? Or perhaps more importantly, if price moves against you on only 50% of the typical trading volume, do you only suffer 50% of the loss?


This follows from William Eckhardt's belief stated in his Market Wizards interview that "pure price systems are close enough to the North Pole so that any departure brings you further south."

Studying company fundamentals

Eckhardt's belief is also the reason why I pay no attention to the fundamentals of a company. Think back to 1999/early 2000 and the dot.com bubble. A lot of those tech companies generated massive uptrends in their stock price. However, lots of people completely missed those moves because they knew that those companies had no earnings.

This belief is also based on the fact that known fundamental data (be it economic or specific to an individual company) is historical, and that price movements can occur before that data is made available to the public at large. As Paul Tudor Jones says "price precedes news."

Of course, one person's beliefs can be completely different to those of anyone else. And no doubt some people reading this will rubbish those specific beliefs that I have mentioned above. But going through a checklist and finding the answers like those above may help crystallise or formulate what is important to YOUR own trading process, and therefore how YOU can make money.

Refer to this for more on my own beliefs, and to this post on the importance of reviewing your own beliefs.

2 comments:

  1. Outstanding article and great supplemental links! Always good to check your bearings and when necessary adjust course. Made me think about where I've been, where I'm at, and where I need to go. Well Done!

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    Replies
    1. Thanks Raven! Glad you found it helpful.

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