Investor & Trader Similarity (Stock picking)

Ever since these two terms come into existence, there are arguments of which is the better among the two. Not only that, the list of differences among the two goes on and on. From time frame to stock picks to method of play, differences after differences were listed out. Pros and cons of the two schools of thought were being raised. But for now, let us put all the differences aside and let us look into the basis and find the similarities, shall we?

I’m sure some of you will be thinking,” Wow…. Wait a minute…. Investors and traders… Similarities?” Actually there are a few, not to mention that both are to make money through stocks… Agreed? Haha… This is one similarity already… How about that for a good start?

Ok… Now we move on to some more serious ones…. Let us look at stock pick.Basically we say that investors and traders choose their stocks using different methods right? We say investors use Fundamental Analysis (FA) but traders uses Technical Analysis (TA), right? I’m sure you will agree if I say TA is made up of methods and tools to assess the interest or demand of the crowd towards a particular stock, by using MACD, EMA, RSI, etc. There is no doubt about that. This is what people call as the “Trader’s Style”, to buy a stock that is in demand. Now, investors actually also do the same thing, only the method they use is different. They use FA instead of TA. Why do I say that? Let us look into the basis of FA. FA is composed of areas like earnings, P/E ratio, ROE, NTA, etc. Actually, what are these methods measuring? It is to assess if the company is fundamentally strong. Correct? Now, why do investors choose fundamentally strong company? Have you ever wondered what are the real reasons behind that? Well, some say that they want to make sure the company is strong and is earning money. Well, that may be the reason, but actually investors uses FA to value a company’s performance in order that they will be able to select a company which will have price appreciation in the future because the demand for their stocks will increase. They believe that a fundamentally strong company will continue to become stronger and as time goes, the demand will always be on the hike. So, the price will go up together with the demand in the long run. Which means FA is the same as TA, they are used to decide if the stock will be in demand. And both investors and traders choose stocks that will be in demand... The only difference is the time frame… FA looks a lot further into the future.

So actually, there is a similarity when it comes to stock picking among investors and traders, both pick a company with the believe that the price of the counter will go up after their entry due to the increase in demand. There are a few other similarities that will be posted in the future… In the mean time, let us embrace both our investing and trading brothers and sisters in understanding and peace... hehe...

Testing… Testing..

I picked this interesting test done by Dr. Shapiro in the book “Trading For A Living”written by Dr. Alexander Elder. Do try this out for it is very important concept to grasp in stocks, so please be honest. First, try not to think too much and use your instinct or feeling to answer, then try again after thinking properly and carefully… See if your answers are the same before proceeding to the explanations, hehe… this can be quite fun:

Part 1:
If I give you two choices: 1) A 75% chance to win RM1000 with a 25% chance of getting nothing. Or 2) A 100% chance to get RM700. Which would you go for?

Part 2:
If you are given two choices: 1) A sure 100% loss of RM700 Or 2) 75% chance of losing RM1000 but a 25% chance of loosing nothing and keep all your RM1000?


Explanations:
For part 1, four out of five subjects will take the second choice. The majority makes the emotional decision and settles for a smaller gain.

For part 2, three out of four will take the second choice, condemning themselves to lose more in their effort to avoid risk, they actually maximize their losses…

Emotional traders want certain gains and turn down profitable risks that involve uncertainty. However, they will go into risky gambles to avoid taking certain losses. It is our human nature to take profits quickly and postpone taking losses. Irrational behavior increases when people feel under pressure.

If you were to look into your account, you will realize that the major burns that you have is a few large losses that was there because of your inability to cut loss. Or it might be the continuous small loss made because you were under pressure to cover back the loss you made. All these only proves once again how important money management and cutting loss is in trading…

Cut Loss & Affordability (Mentality)

Before you proceed to study Technical Analysis and become a trader, please be reminded to get your mentalities right. To me, the first thing that you need do before you even think of becoming a trader is to calculate how much money you can afford to loose. Pathetic don’t you think? People go into stocks to earn money, but this stupid guy tells me to think about how much I can loose first?

Wait… Let me explain…. First of all, technical analysis (TA) is not a miracle method that can give you 100% accuracy. No matter how much you have read, how many charts you have studied, how great indicators are, technical analysis is just not correct all the time…. Especially when you are just starting to try this technique. You may hear your friends or some super guru on TA tell you about this miracle setting or indicator that will help you pick out winners… But once you try things out… You may find that it is just not that simple… So many things can go wrong… Misinterpretations, misleading and contradicting indicators, unexpected change in crowd behaviour… etc… So, how can you make sure that you are correct 100%? Whether you like it or not, TA is actually using the chart to predict the behavior of the crowd based on history… But whipsaws do happen… a simple bad news may cause mass panic which leads to panic selling…

The key to be a successful trader is to survive all this mistakes long enough in order to find the correct way to get it right… Which is why the rule of thumb for trading is to “keep loss small and let profit run”.

But how small is small? When to cut loss? This will be discussed further in future postings… But to make it simple, when you enter a trade, there has to be a buy signal that you use. It doesn’t matter if it is trend, MACD, Moving average, breakout… etc. But you must know why you entered in the first place… So, you must be prepared to cut loss once you find that the reason is no longer there… For example, if you entered because of uptrend, you must be prepared to cut loss once you realized you made a mistake when the price violates the trend.

However, another important point to remember about cutting loss is affordability. As we know, the financial status of everyone is different and this can affect the cut loss level to a certain extent. Some people like to say that your cut loss level should not be more than 2% of your capital. I would like to say that your cut loss level should be kept to the amount that you can afford if you were to make 5 consecutive losses, or 2 % of your capital, whichever lower.

With this affordability in mind, you will use them when choosing counters. I think we should not enter a trade when the cut loss level is above your affordability. It is safer to pass those trades. So, please remember this two points, Cut Loss & Affordability when you choose to trade.

Happy trading…

Be independent, but do not go against the crowd

How do you make decisions regarding your trade? According to Dr. Alexander Elder in his book “Trading for a living”, a successful trader must think independently. He needs to be strong enough to analyze the market alone and carry out his trading decisions. Sounds simple huh… Maybe not for everyone. Most people are sucked into the crowd and start to behave alike. The crowd behaves in a predictable manner because their actions at many times are repetitive and primitive. So, if you are able to think independently and make wise decisions, you will be able to take money away from crowd members.

However, there is one very important and crucial point to remember. Although I said that we should be independent in our decision making and we should not go against the crowd. As I have mentioned in my previous posts, the price of stocks are determined by their supply and demand. These two factors are directly determined by the crowd. If the crowd suddenly increases their demand for a particular stock, the supply will be short and the price will rise. The demand may be unjustified or may seem ridiculous to you, but you should not be going against it. The crowd may be stupid, but they are the most powerful force that will determine your gain or loss. They are the one that will determine the trend, so you can either tag along, or you stand aside.. Do not attempt to go against it. For example, you do not buy on a downtrend and you try not to sell in the middle of an uptrend. The more you are able to manipulate the behaviour of the crowd, the more successful you will be in the stock market.

So be independent without going against the crowd.

News and Effects

Good news! Good news! Good news about a particular counter is out everywhere.. newspapers, television.... You name it.... Maybe a large dividend, large project, huge profit... Anything.... Now, the basic instinct that we have is that when good news is out, the counter will sure have demand... When there is demand, the price will rise... So we jump in and grab the share by hook or by crook.. Whatever price also we are willing to pay as long as we get it fast. Then we can always sell at a higher price. This can be called, “Buy on news”. Is this concept true? Well, I would say the chance is 50%. Why do I say so? Let us investigate further....

Never forget that there is a group of people called speculators out there that will turn this logic upside down. They will cause the effect of “Sell on news”. They will snatch up the shares of a particular company before the news even came out. They will somehow get the information far earlier than anyone and they will start buying the shares at the lower price… Once the news is out, they will sell because by then the price would have risen and they take away the profit. Because speculators normally would grab a huge number of shares, so when they sell, they will cause the price to drop significantly.. And by then, everyone would panic and start their panic selling mode.. So the price will dip….

Case study: Stocks like Tebrau and UEMWRLD was rising tremendously before the announcement of the Nusajaya project.. By right, when the news actually came out, the shares should rise, but they took the other way instead….

So, “To buy, or not to buy?” Hehe… This is a tough question… That is why I don’t normally go for speculative stocks… But to know if there is already speculation in, you can tell by looking for clues. If the price of the stocks suddenly rises tremendously with super high volume for no particular reason, both from fundamental or technical point of view, it is a clue that something is fishy. Especially when there are rumours around about the company getting a huge project, etc… Be extra careful.. For those who have a huge taste and tolerance for risks and want to try out these stocks, you need to be very familiar with technical analysis… Make sure you enter early, place your stop loss plan… and FOLLOW it.. Try not to fall into the “last man on the block” syndrome.. That means, don’t be the last to enter or leave the building. Meaning don’t be the one to pay the highest but sell at the lowest price for the stock… Hehe…. These kind of stocks is like air filled balloons, they jet up when the air is released, but once all the air comes out, it makes a fast vertical fall…

Good luck and happy hunting…