How to Trade or Invest
5 Jan 2017 ● 11:48 AM
If you are confused about how to trade/invest when you have an opinion or follow one then you do need to get yourself a lesson in trend following. Elliott Wave analysis is meant for market forecasting but actual trades have to be taken based on classic technical tools that give you levels to manage a trade. It is my belief in this process that I do not give calls or tips. I do the difficult part of taking a view and take the flak for it when wrong.
However to successfully make money you will need to add Position sizing to either your investment decisions or trading decisions so that you can minimise losses and maximise gains. So I would expect you to learn some of that. In today's note I will give you a head start on this.
If you do not know how to trade at all then you first need a lesson in trend trading however if you want to know which trend to trade you have come to the right place. Learning to trade involves knowing.
1. How to buy/Sell
2. Time to monitor trades, to get out of losing trades
3. Understand support resistance
If you know the above then you will not be asking what to do but in which direction.
Yesterday I got an email asking me what should I know about trading as I am learning for the first time. My answer:was to learn the following -
A. To manage a trade
B. To manage ones mind
The tools that you learn in the first 3 steps help you to manage your trade. Managing your trade is not about being right 100% of the time. Some people have come to expect that from a paid service on the stock markets because tip services have now become a fish market out there and many offer super high accuracy. In my world accuracy is not defined as a 100% strike rate but a 60-70% strike rate. It involves knowing how to deal with when you will be wrong which is 30% of the time or more depending on your trading system. In a strongly trending market that can go up to 80% but in a non trending market down to even 50%, so your long term average might even be 65%. But if you choose a slightly higher trading time frame 70% is achievable. [Automated mathematical models work at +/-50% strike rates of lower]
That said how do you deal with the 30%. First know that you cannot know when you are going to be wrong and therefore we cannot outguess our own trades or those of our advisor's. We have to manage our trades. This means position sizing. So the 4th point in the list above has to be
4. Know to use basic tools like Moving averages and swing high/low to manage your trades.
If you do not know this my video on position sizing on the home page of indiacharts introduces you to the techniques you need to master.
Managing your mind on the other hand is a far deeper subject which involves getting yourself to do what your system tells you to do without any feelings. Position sizing is a far less emotional technique because you never give up or build your entire position in one stroke so it allows you to function slowly. In that sense it aids mind management.
Having mastered the above all you are going to then need is to focus on the trend. Elliott Wave analysis is the only method that allows for trend forecasting and takes you to the domain of high probability trading. While it is only a few hundred pages of reading to learn for some reason many find it hard to pick up. Reading the work of a EW trader is then the only way forward. But it is still essential to understand any work you read to know what he/she is talking about. To do so abreast yourself with Elliott Wave Basics and for this too I have put out a video on my Homepage for all to see. Also Elliott Wave International has free Chapters of the book on their website when you sign up for their free club.
Knowing the rules and form of EW will also allow you to also judge whether what is being written by anyone on the subject is genuine or not.
You may wonder that I am pushing you to learn more but that is the starting point. The reason to push is so that you can move away from tips expecting a 100% strike rate to getting the right market view and then managing your trades in line with the view. The importance of putting EW+Position sizing together is because you may know the trend but not the strength of the trend. You cannot forecast time. And time is the most misunderstood part of the science. Position sizing uses tools that are used by trend followers to build a position in the direction of the trend. EW gives you an idea as to which direction you should build a position in. Position sizing means using a bunch of tools to build a position so that only one confirms at a time giving you..."TIME" to do so. You are therefore buying time to build on your original judgement of the market [similar to an SIP, using TA indicators].
I have added a position sizing model to my Nifty Daily forecast that I change at the end of each day. And it involves things like higher tops and bottoms or the days close. Closing above or below averages. All of these do not happen at the same time but over time. So when the market completes a 5 wave decline your Position size may only be 10% long. When it closes above the 20 dma it may go to 20% long, if some indicators confirm, 30% and so on. Sometimes after the first 10% the low might break and you have to exit the 10%. But your view might not change.
It is far easier to exit 10% of your trade than 100%. Having no position allows you to think rationally about your view and stay prepared to buy back the 10% the moment the market again tells you that the view is right. Because this is a process and can involve a few entry and exits from time to time the smaller size also ensures 3 things.
1. The cost of building the position during the non trending up down phase is low
2. The losses or draw down of the system is lower than it would be otherwise.
3. Your entry price average is always below the current market price, because we buy on the way up. or sell on the way down. We do not buy the dip.
4. Mind management is better, as small sizes and lower average buying costs allow us to think with sanity.
I sometimes get a call about taking a static long term position like. Buy hold and roll over on a bullish view for ever doing nothing about it. This sounds great if you do get a high Beta bull market. But in most cases the market will make you pay for holding too long. Just take the case of the last one year in the USDINR. It is up as forecast however the slow move up with many corrections in between have meant that it took a long time and roll over of each future costs 40 paise per month. One year of roll over means 4.80Rs. That is a lot. The USDINR ended calendar 2014 at 63 and is was at 66.50 in 2015. If you rolled over all year long you would be losing money. For this reason too position sizing which is actively managing your positions in line with your view is a better idea.
Last but not least A lot of Technicians whom I have trained sucessfully on TA and EW have failed. The reason is not that they did not learn the subject, I teach with passion. The reason is always without fail, learning the manage your mind. The fear of going wrong is the most common fear that kills the entire process and leads to a lack of discipline, or just makes traders numb and they stop taking action or putting calls. There are many other mental flaws that even advanced successful traders face and have to overcoming. Mind Management is a complete subject in itself. A good read for this is the Classic 1923 book, Reminiscences of a Stock Operator, By Edwin Lefevre.
Successful trading or Investing is a Process not an Event!
Good luck trading and Investing!