Make peace with not catching every move

• Posted by hcpg
 
• on April 7th, 2013

We had two conversations about a particular  trading topic on Friday — one was with a long time sub we like very much, and the second was with an internet Troll we blocked after a few minutes.   The gist of it is this:     The one thing traders have to accept in order to have any type of peace with their job is that they will not be able to catch every move, every turn in the market.   That’s not what short-term trading is about.

Trading is about coming up with strategies that yield good risk/reward returns.  Now for us often this is waiting for a support long at a certain point — we sometimes try to catch it short before it hits that point, but often we’re not successful and instead just wait for our spot.     Let’s say stock HCPG is hovering at 52 and we see multiple support converging at 46.    We have a good idea that at 46 we will be able to catch a very good risk/reward trade.    Over the next two days it does go from 52 to 46, a 6 point move down, but we’re not able to catch it short, that is it does not set up in any strategy that we know that offers good risk/reward for the move.    At 46 though we buy with 50 cent stop.  Over the next two days it rallies to our target of 48 and we sell it all.  For us that is a solid trade, our meat and potato trade, catching 2 points on 50 cent stop.

The internet troll comes along and says, ha ha, while you were looking for a measly 2 points I caught the 6 point short.    That’s where the internet troll shows his real colors, that of the infamous noob.  We are patient; we wait for everything to line up, and then pounce.  A stock could move 10% before we make our move looking for 2%, and that might sound crazy to a non-trader, but that’s the way it works.  Just because a stock moves 10% doesn’t mean it’s easy to catch.  We only trade what falls in our strategies, nothing else.   We miss moves ALL THE TIME.   Every trader does.  That’s not what trading is about.  The other obvious point is risk/reward, 4x your risk is the same if you risk 50 cents and make 2 points, than when you risk 5 points and make 20 points.

Unless you make your living off OPM,  comparing yourself against market benchmarks is counter-productive.   If market goes down 20% for two years and your fund goes down “only” 8% you are a rock star fund manager.  However, if that happens to us, we’d have to shut down.   Short-term traders like ourselves are all about consistency, being able to pull consistent profits from the market, no matter the condition.   Our PnL does not correlate to market %.   In fact some of our biggest profits are made in flat markets while we tend to under-perform in slow grind-up markets.   As traders know, the more volatility, the better.  The goal of trading for us is not to beat a certain benchmark %, or to be in the top 10% of any list, but to be able to make a good living year in, year out.  Every month we want to be able to pull money out to pay the bills that sustain our lifestyle for our families, and save whatever is extra — which basically is what every worker wants.  That’s about it.

As for future internet trolls– we’ve been trading for 16 years.   We’re good at what we do and we’ve proved that on the stream with real-time calls over and over again now for over four years, and in our newsletter for seven years.   If you want to follow us, great, be quiet and learn.  Don’t criticize, don’t offer advice, and if you don’t like what you see, simply hit that Unfollow button.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

Trader’s edge: Overcoming the Distancing effect

• Posted by hcpg
 
• on June 9th, 2011

Modern civilization demands abstraction, and money is the ultimate signifier.    Most of our interactions are removed from reality.     This distancing effect is a common part of our life.  We buy an iPhone and all we think about is the dollar price, we don’t think beyond  the money — about the life of the person who actually helped construct the phone at Foxconn.

We buy our meat from companies that do everything they can to distance you from the idea that what you are eating was actually a live animal that was butchered.  It’s not even called “Cow part”, it’s called a Rib-Eye, another distancing effect.

The distancing effect is even more exxagerated for traders.  Money is already an abstraction, for traders it’s taken to a different level where money becomes an electronic number, green and red, bobbing up and down like in a pin-ball game.    Compare this to a carpenter who works for an afternoon, makes $100, and goes home with the money knowing what bills the money will pay. Every hour that passes he knows that he has pocketed another $25.     The connection is tangible.

Back in the bubble days (tech bubble, 1999) I was in a car with a buddy prop trader, going out for dinner, driving too fast down the highway.   We got clicked by a ghost cop car halfway down the route and my buddy was stopped an issued a ticket.  He was pretty flippant and I’m sure the cop was happy to give him the $250 ticket.  We drove off and he laughed, “Ha, I made that much in the first two minutes of the day”.   He didn’t care about the ticket , he had no connection to money, and incidentally enough, to risk.He blew out in 2002 and we lost touch.

The lack of respect for what you gain and can lose is directly related to how quickly traders blow out their accounts.   What is essential for new traders, especially prop/daytraders, is to make a physical connection between those flashing red and green lights and income.  Basically, what is needed is to try to overcome the distancing effect — to realize that those flashing lights represent hard-earned money and thus do everything in your power to follow the strategy/plan/discipline.    In this business to lose money is unbelievably simple.  On the other hand, to become a professional trader who can pull money consistently out of the market is quite difficult.  The first step in this quest is to respect those flashing lights.

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When knife catching is not knife catching

Originally published May 10, 2011

We’ve tweaked this strategy as the years have passed and here is quick outline of the main points of sector support buying:

1. For the most part we prefer to get involved with ETFs over stocks, or at least put the size on the ETFs and smaller size for the stocks.    This type of trade boils down to confidence, and for us it’s much easier being confident in an ETF than a stock.

2.  This one is very important — it can’t just be one stock hitting support, it has to be the whole sector.  The more stocks hit support at the same time, the closer you are to a bounce.

3.  Best time to add is the day after a trend-day down.  The sweet spot for buying support is in the morning sell-off after a trend-day down.  That’s when the best bounces come.  However sometimes market ends at the lows (this is what happened to miners on Thursday) and then gaps up on Friday.  This is the reason we partial in on different days, because it’s very difficult to time the exact bottom.

4.   Best support buys are when it’s not on fundamental news.  For example we wouldn’t buy support on cloud stocks after bad earnings. Period.  We stayed away from buying the dip after Japan nuclear crisis because we couldn’t “game”  the situation (too bad, bounced great).   But buying “margin pukes” is probably the BEST time to buy support as there is no change in the fundamental scenario.

5.  You don’t anticipate this type of trade, patience is key.  You have to wait until there’s blood and then partial in — and never all in on one day.    It’s all about buying power and allocation — you have to give yourself concrete levels for adding.  As long as the rubber band stretches past support, you can add.  Once you’re in overshoot territory your adds will lower your cost basis and eventually your target will be your first entry at initial support.    The first target of overshoot is always the first support.  For example let’s say you want to get into an ETF called OO.  The sector is deeply oversold and many stocks in the sector are hitting support at the same time, similar to what happened here.   You start your first partial at 50  which is long term support, and add near the close at 48.   You’re now in overshoot territory.   Next day it opens at 46, and you add more.  Sector starts bouncing.   Since you’re in overshoot the  primary exit for first partial now is the support that you first started buying, 50, but your cost average is now 48.   However, it can also happen in which we are not “feeling” it and do not wait until target and take the profit earlier.   Either way, once you get the bounce, your stop automatically becomes the low, no matter what.

6. The exit plan if things go badly:   if the stocks start basing over the next few days, then you need to start lightening up and taking losses as any basing diminishes the rubber band snap back effect.   As said, once the bounce comes that low becomes the stop.   If the bounce is not enough for you to get out of your positions profitably and you go back to the lows then you will have to take the loss, which can be quite significant.   We hate to jinx ourselves but, to date, after 14 yrs of trading, this has never occurred in which we bail on the entire position without a bounce for significant losses.   There is always a bounce in ETFs.    However, what can  occur (and has happened to us in which we have scratched the trade or gotten out with some damage) is that you get out on the initial bounce but with losses  when sector  bounces weakly and you feel like it’s your best chance to exit before your position goes back through the lows .

7. One last thing:  for 90% of our trading we will not go into a trade unless we feel that our risk reward is around 3:1.   This means if we risk 1 point we expect to make 3 points.  This is very common for traders and is a very sound strategy.   This means that even if you’re wrong 50% of the time, you still are profitable due to the 3:1 ratio.     However, for this particular strategy this is not the case.   Sometimes  our profits are less than how much our unrealized losses were but we still consider it a good trade.  For example, let’s say we start buying on support and add on overshoot.  At the lows we are down 40K unrealized.   Sector bounces and we get our first target and start partialling out, bounce stalls and we exit everything for 20K profit.   Now most traders will tell you this is not good trading as you were down/risked 2x more than your profits.   However, it’s the way it is in the strategy and we haven’t been able to change it — what makes us override this red flag is the extreme consistency of wins the strategy yields.    The only time we can endorse a strategy in which the risk is more than the reward (for example 2x) is when the strategy has an incredible win rate.    Again, this could be a turn off for many of you, and that’s understandable.  This strategy is definitely not for everyone.

8.  There are three places where traders often make errors:

a) Getting in too early.   They put on a small position early and then see it become quite red and start adding.  Don’t even start that original position until there’s blood in the street.  Disasters start slowly and this is a prime example of it.  They use up all their buying power and cannot lower their cost average.  When the bounce occurs it’s not strong enough for them to go green and they exit with losses.  This is THE most common error a support trader can make.

A  2% pullback on a strong momentum stock could be a nice entry, but only if you get in on reversal with stop under — we would never use the described strategy for stocks near their highs.   It has to be a fast (the faster the better) deep pull-back, often when stocks are hitting the 200SMA or at least 100SMA.    Even the 50SMA often is not enough for us to enter this strategy (but yes on individual support buys which are very different than what we’re describing here — for those we wait for reversal, buy, and put stop on that low.  We never add and we always have a defined stop).

Additional nuance: we don’t always wait for the ETF to hit major support (even though it has to be very close) but the leading stocks in the sector.

b) Buying a broken stock instead of  buying oversold into support on longer-term bull trend.     We would never get into a broken stock just because it’s “cheap”.  In our business nothing gets cheaper faster than an already cheap stock.    When we say we’re buying on “support”,  it automatically means that the long-term bull trend is intact.    If it’s a broken chart, by definition, there is no support.

c) Not waiting for whole sector to hit support.  Probably the main reason we’ve had such consistent success with this strategy is that we simply wait for whole sector to hit support simultaneously.  If you want a recent example look at the charts from last week’s post here.

The ETFs that we use most frequently for this strategy are OIH XLE KOL JJC XME GDX GDXJ SIL SMH QQQQ, and when it’s with the Ags then POT CF MOS AGU as basket.

We’re primarily break-out traders but there is no strategy that has rewarded us more consistently over the years than buying baskets of deeply oversold ETFs hitting simultaneous support while in longer term bull trends .  We hope these detailed notes explain how what some perceive to be “knife catching” is not knife catching at all, but just a good short-term trading opportunity.

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Trading Thoughts

Wisdom doesn’t necessarily come with old age; it comes through experience, learning, and above all, self-analysis.    The same is true in most professions, sometimes a bad doctor/teacher/plumber stays  a bad doctor/teacher/plumber until he retires.   Two exceptions are sports — if you’re a bad athlete you’ll be cut and that’s that, and trading — if you’re a bad trader you will blow out.    However, the analogy still holds true for everything in the middle ground.  There are traders who are good enough to pay the bills year over year but their PnL never reaches the “comfort” zone.   In our experience there are a few things that can be done to help advance the improvement curve.
1.  You have to analyze your actions.   Trading, like life, is all about patterns.  The newer you are the more analysis you need to do: profit analysis, risk analysis, trading journal.   We did this for years and still keep a PnL Excel graph on a daily basis.  When an anomaly occurs, we write a paragraph beside it to describe what we were doing to cause the anomaly, good or bad.    Writing the HCPG newsletter  for 5 days a week for 5 years is now a form of journal writing for us — it forces us to make concrete what is potentially abstract.   The act of writing lends clarity to one’s thoughts and enables the next stage of understanding.  Starting a blog, even if it’s private, and writing out your trading plan is an excellent method of trade introspection.

2.  You have to be hungry to become better.   Is there any more humbling career than that of a trader?  As the years go by the learning curve flattens but it should never stop.   There is always room for improvment, always.
3.  Having a trading buddy/mentor/community to bounce ideas off  is a fantastic catalyst for advancement.   Many moments of enlightenment for us have come through the discussion with traders of strategies, building upon each other’s thoughts until you reach a new level of understanding.
4. You can’t be afraid to lose.   We read years ago a trader who said: “Trying to avoid losses in trading is like trying to avoid breathing in life.”  Losing money is part of the job, it cannot be avoided.   You cannot trade well if you are in constant fear of losing.    That’s what risk management is for, that is what stops do, they take away the fear and help a trader stand back and let the trade unfold.

5. Once you get the basics of strategy and risk management down it all becomes mental.    For active traders at this stage of  our career it’s all about conviction.  We touched upon this issue in a post a few months ago —  if we start to second-guess ourselves, it’s game over.   Traders know this, and that’s why in a tight trading group it’s a faux pas for any one trader to talk negatively about another’s live position.   It’s the reason we never ask anyone’s opinion about a trade.   If we have to ask then it automatically means it’s not good enough to take in the first place because the idea doesn’t jump out on one — it’s not a no-brainer, a lay-up.   If we had to point to one reason why we’re still around after all these years it’s because we wait for the trades that jump out — if nothing is good enough to trade step back and become a spectator until the next set-up emerges.  Don’t worry,  there’s always a bus that finally comes around the curve.
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Originally published May 07, 2011

How to run a straight-up business: newsletter case study

We have been running the HCPG newsletter now since 2006.   We are very happy with what we have created over the years and believe that many of the lessons we have learned in running HCPG also can apply to other businesses.   So here’s our case study.
1. Don’t claim anything.    The quality of your product is the only thing that matters.     We could be three punks trading from a double wide in some trailer park,  or we could be three very well-off successful traders.  We’ve never claimed one or the other.  Does it matter?   No, not at all.   All that matters is whether the information we provide can make you more profit than you would have without the newsletter.  Stay with what is relevant.   We stay under the HCPG moniker without providing personal information because frankly, our personal life is no one’s business.   All we do is provide potential set-ups for any one who pays $44.76/month.   You’ll find out very soon (including a 10 day free trial) whether it’s all nonsense or whether it can add to your bottom line.
2. Unless you intend to provide an audited PnL record that you will provide to your subscribers every week never talk about dollars or brag about how much money you’re minting.   You will never hear us talk about money, be it on stocktwits, twitter, or in the newsletter.   You will never hear us say Big Kaching!!   If we’re happy with a trade we’ll say it was a good trade; whether we had 100 shares or 100,000 shares should have no effect on your trading.  Keep your ego out of your business.
3. Be nice and always look at the big picture.  If you’re in it for the long-term as we are (HCPG 5 year anniversary in a few months) then try to build solid relationships with your readers.  Don’t nickel and dime people.  If a subscriber forgets to cancel a trial and gets billed on the 10th day  and emails us that they don’t want to stay on, we refund the money.    We believe that readers should consider us a lucky find — rather than trying to trap people for an extra month because they forgot to cancel in time.   We want readers to stay with us because they want to stay with us.   This is also the reason we do monthly payments.  No contracts, no specials.
4.  Be the best in what you do.    Easier said than done but what will propel you on this path is to specialize.   Find your niche and then be the best.     We only trade high-beta very liquid US equities, mostly in the commodity and tech space.  We’re not interested in trading small-caps, Chinese time-bombs, biotech-time bombs, and while we like to watch currencies and hear about options, they’re not our specialization and you won’t find them in our newsletter.  We want to only talk about things we know very well and frankly, options and forex do not fit into that category.
5.  Teach people.   Subscribers who have been with us  for a good chunk of time  know our strategies as well as we do.   Create a community and  build bonds and you will see the benefits of organic growth.
6.  Keep your cool.   When you are writing the newsletter or posting on twitter/stocktwits you are representing your company.  Don’t get emotional, or get into cat fights with other traders.    If you are dying to rant then open up a personal twitter account and go nuts.   But everything that comes under your company name should reflect professionalism and integrity.   Don’t get us wrong, we love to joke around, and believe that’s an important part of relieving stress in a very stressful job.   But you won’t find HCPG losing it in a temper tantrum.
7.  Don’t fret about the competition.     We often retweet posts from our competitors, and consider many of them as online friends.   Don’t be afraid.   There’s always room for a quality product in the market.


(originally published April 09, 2011)