S3 Vacation Day - 8/21/07

Today was another vacation day for the market. The drift is generally higher, but there were no real dramatic moves.

I have been taking this time to reflect on strategy.

There are two interesting new technologies that I am experimenting with on IB. On is the charting software. It looks different from what I am used to. I am learning to use it. In particular, I am learning to think in the 15 min bars time frame. I am using it to better set my risk/reward parameters.

The 15 min colored bars allows me to measure the risk in price and time, and to try to capture moves defined in those bars. What I am trying to do is to capture 3 to 4 trending bars, and to guess how much each bar is worth. Its like Linda Bradford Raschke talked about learning to trade like sight-reading music.

I am also trying to apply her idea of trading constantly.

The second technology is the use of trailing stops. This is a way to automatically reduce your risk as the market moves in your favor. The beauty of this way of doing things, is that you reduce the chance of "letting a winner turn into a loser."

Well, actually, depending on how you use the trailing stop, it can turn into a loser, but as the market moves in your direction, the amount of risk that you can give back is lessened.

The other beauty of the trailing stop is that it allows you to take out some big winners. Rather than capping off your profits, you can let the market dictate how much you can make instead.

LESSON: Trailing stops are great in a trending and volatile market.

In a choppy, flattish market, trailing stops will simply not work, unless you really clamp down on the stoppage amount.

The S3 pattern is not breaking the highs and letting us blast off. Nevertheless, it is not breaking the lows either. The range is 1460 to 1434. We'll continue to chop around, but it looks like we are trying to post higher highs.

Esoterica

From TheStreet.com:

Esoteric products like "Power Reverse Dual Currency Bonds" -- popular with Japanese retail investors -- "leave the system vulnerable to sharp price swings," Dow says. "It's hard for the Fed to get its hands around these things -- they don't know where the bodies are buried. The underlying economy looks good, but financial accidents can take on dimensions you never thought of. This is no time to be a hero."

QUESTION: Can anyone explain what "Power Reverse Dual Currency Bonds" are?

QUESTIONS - 8/19/07

1. Are we facing a Financial Armageddon?
2. Are we facing the tipping point where the current state of technology or thinking is being overwhelmed by reality?
3. How much thinking is being done by machines vs. humans?
4. Where do ideas come from?
5. Where do ideas go?
6. How are ideas stored?
7. Is sentiment more valid than news?
8. How do I dissect memes?
9. How does the meme interact with sentiment?
10. Do machines have sentiment?


MORPHEUS: Why not? A sentinel for every man, woman, and child in Zion. That sounds exactly like the thinking of a machine to me.

Stages of Grief

Elisabeth Kubler-Ross' five stages of grief when facing a terminal illness.

1. Denial - No way, I'm not sick; it can't be me!
2. Anger - Damn it! Why me?
3. Bargaining - God, help me! I'll do anything to get out of this.
4. Depression - I just can't go on, I can't stand it. I give up.
5. Acceptance - This is the end; I'll try to go in peace with dignity

MORTGAGE MELTDOWN - 8/10/2007

The press is describing this week as the Mortgage Meltdown. This is the crash everyone knew would happen, but no one did anything about. Certainly, Bear Stearns did not prepare for it. Nor Goldman Sachs. Nor AQR or James Simon or Sowood Capital or any number of hedge fund masters of the universe.

Their excuse: THE MODELS STOPPED WORKING.

George Soros was right when he said that the social scientists have elevated themselves to the level of real scientists. And I might add that the real scientists have elevated themselves to the level of temple priests. Using all their statistical models, these people have the air of invincibility. Its like they are donning priestly ropes and entering into the Holy of Holies, something us mere mortals are not allowed to do.

OK, so how did I do. It was the best of times, and the worst of times.

The good news: I have hit a new high in my equity.

The bad news: I had to take some serious pain to do so.

Mark Cook says that the best advice that he had was from Linda Raschke who told him, "If you continually trade, you will make money." If you have an edge then keep trading. Keep trading till it hurts. Keep trading till your capital is gone.

What was stopping me was fear. Once you've resigned yourself to the idea that you could lose all your capital, then the fear is gone, and you just keep plowing ahead. After a while, if you've made every mistake there is to be made, and you still have money, then you're bound to MAKE money.

On Friday, 8/10, my signal was S2. Intensity was high. Instead of using the canonical rules of shorting (which would've worked also), I noticed that recently these have been excellent buy signals. Combine this with the rise in mentions of 1987 & 1998, this lead me not only to buy futures but to buy stocks.

I bought 1434, 1437, 1441, and I sold 1449,1450,1455. My target has gone up to 15 points during this high volatility period.

LESSONS:
1. Use TRAILING STOPS. This is an excellent way to automatic reduce your risk, and sometimes allow you to capture outsized moves.
2. When you have an edge, TRADE MORE.
3. Have CONTINGENCY PLANS worked out ahead of time.

Finally, YOU CANNOT OUTGIVE GOD. I have committed my profits to the Lord. I will be clearer about this accounting wise.

STOP THE INSANITY - 8/8/2007

It should have been an easy profitable day for me. But 3pm is the new Witching Hour. Anything can and will happen.

I bought 1495.25 and was looking good with the market at 1510. It was exactly as I had predicted. We were in the midst of the mega short-cover rally.

But then at 3pm, everything turned. Was it a liquidating hedge fund manager? Was it China dumping bonds? Who knows.

I was outside, and I did not have a trailing stop. I went from a 15pt profit to a 8pt loss. DUMB, DUMB, DUMB.

I should be smarter than this.

LESSONS:

1. Style drift. I tried to be Barry Bonds. I tried to hold out for a 2 day home run. I should've stuck to my 10-15pt winner target.
2. Trailing stops. Use them!
3. Prepare for anything. If I cannot watch the screen, then you need Gene to watch it for you.

I should be smarter than this now, but I'm still making very basic mistakes.

There are sins of omission and sins of commission. Yesterday, I made basic mistakes of omission.

That having been said, the market is just totally crazy right now. But the calls are still ok. The market has some logic to it.

ICHIRO VS. BONDS

Traders have a basic tension between whether they want to trade like Ichiro or Bonds. Should they eat often but small? Or eat seldom, but in huge quantities?

My basic strategy is an ICHIRO strategy. I try to get on base often with a large variety of hits. Don't go for the home run swing, but if you sense a weak pitcher, be ready to take it out of the park.

Ichiro is beguiling to pitchers because he can hit almost any pitch, and he can place it all over the infield and outfield. His speed means that even on a dinker, he can outrun the throw and get a hit.

I want to be able to get my hit ratio up to 65%, and have my winners outpace my losers by an order of 2:1.

That is something that I was able to do in the past, but it is not an easy statistic to maintain over time.

The problem that traders run into is that they don't know whether they are Ichiro or Bonds. They don't have a clear view of their strategy.

It is important to stick with your strategy.

That being said, YOU NEED TO ALLOW YOURSELF BATTING PRACTICE WHERE YOU CAN PRACTICE BEING BOTH.

We are all weak and easily tempted to drift styles. That is why have a paper trading account is good practice. It allows you to be creative and reckless, and learn something about yourself without destroying PNL in the process.

DEAD CAT S3 - 8/2/2007

These are some meditations on S3s.

The S3 yields meaning depending on whether it is in a BULL regime or a BEAR regime.

BULL: buy signal.

BEAR: sell signal.

We are in a BEAR phase which means that this S3 is indeed a DEAD CAT BOUNCE.

Playing the Dead Cat is tricky. The first Dead Cat in a bear cycle is almost inevitably a short. I should play with with larger size. The 2nd and 3rd are much more tricky as they can turn into BUYS pretty quickly. I would just ignore those or trade in small size, and wait for the following day's signal for a set-up to possibly buy.

Today's Dead Cat is tough because it is the 3rd in the series.

During the BEAR MARKET is 2002, it was a good trade to short the Dead Cat with a stop above the highs. However, recently that trade hasn't worked out too good. I was stopped out today on a trade that eventually I could've made money with.

I have also noticed that with S3s, you get these little breakages early in the morning, but they don't lead to further buying.

Basically, the information gained from the behavior of an S3 is more useful than trading the signal itself.

LESSON: trade the S3 lightly, unless it is the 1st in a series. Then, up your trade from the information gathered.

STRATEGY: Wait till the morning to place you short. If the highs hold after 1hr, you can short and wait one day. If the highs are slightly broken, you can short in the breakage, and wait to cover on a mid-day retracement.