Well, you know this is a bull market!

I mentioned last week that I thought the S&P 500's trend remained intact and that the trend was clearly up.   I am now noticing that not only are American stocks strong, but international stocks are starting to look strong as well.

The chart below shows the EAFE index hitting a new high:

The ETF above, which measures stocks in industrialized countries outside North America, looks strong and the path of least resistance is up.  Regardless of any other factors, such as fundamentals, seasonality, Elliott Wave, sentiment, indicators etc... it's hard to argue with the price action: we are in a bull market.

Meanwhile, another ETF, which is comprised mostly of international stocks, is SDIV:

The ETF above has a constructive chart pattern, a bullish all time high, and a 7.77% dividend yield.

LNKD May be Breaking Out

LNKD was not mentioned last week, but it was on my watch-list.   As I write, this stock is on the verge of making a new all time high from a constructive looking consolidation area.   That coupled with an attractive looking weekly chart, makes this stock a buy candidate for me.

Being Right Versus Being Profitable

I recently came across a major study conducted by the Forex broker FXCM.    The study, which examined tens of thousands of real trading accounts and over 12 million individual trades, sheds light on the psyche of the average trader.

After aggregating data on 12 million currency trades, the first conclusion that FXCM came to was that, surprisingly,  the majority of trades are closed out at a profit:

The graph above shows that, for example, 59% of all EUR/USD trades are closed out at a profit.  Does this mean that the Forex market is a mechanism that allows the average trader to consistently profit?

In fact, that is not the case and according to FXCM the vast majority of account holders are consistent losers.   The reason for this is illuminated in the next chart:

The chart above shows that for every single currency pair, the average trade that is closed out at a loss is much larger than the average trade that is closed out at a profit.

For example, the average profitable EUR/USD trade earns 65 pips, but the average EUR/USD loss gives back 127 pips - nearly twice as much.    The average trader, therefore, is a loser, despite winning most of the time.

The reason for this anomaly I think can be found in the field of psychology, in particular work done by psychologist Daniel Kahneman on what is now known as Loss Aversion and the Disposition Effect.

Daniel Kahneman, who recently authored the book Thinking, Fast and Slow, illuminates this idea of loss aversion in the following quote:

There is an asymmetry between gains and losses, and it really is very dramatic and very easy to see. In my classes, I say: ''I'm going to toss a coin, and if it's tails, you lose $10. How much would you have to gain on winning in order for this gamble to be acceptable to you?''
People want more than $20 before it is acceptable. And now I've been doing the same thing with executives or very rich people, asking about tossing a coin and losing $10,000 if it's tails. And they want $20,000 before they'll take the gamble.
So the function for gains and losses is sort of kinked. People really discriminate sharply between gaining and losing and they don't like losing.

Bottom Line:

  • The average trader wants to be right and most traders are right most of the time
  • Despite a high win rate, most traders lose money
  • Most traders lose money because their losses are about twice as large as their winners
  • This can be explained by Daniel Kahneman, who proves that humans find losses about twice as painful as gains feel good. 
  • Trend following traders fight this instinct by strictly cutting losses and letting winners run, thus providing the opposite result of the average trader - they tend to be profitable over time

Trend Trading the S&P 500

Despite some general market weakness, the trend of the S&P 500 remains up, according to my system. The chart below highlights what I classify as the short term trend of the market:

My rules dictate that I should continue buying strong stocks for as long as the general stock market remains in an uptrend.   In other words, this is a buyable dip for me.

Therefore, here are 2 stocks that look strong, one of which I will be buying on Monday:

Thoughts on "Following the Trend" by Andreas F. Clenow

I recently came across a new book entitled "Following the Trend" written by Andreas Clenow.   After reading over 150 books regarding trading, I am now more reluctant to purchase additional books, but I still occasionally do so if the book looks particularly promising.

Here is a thought provoking quote from the author's blog:

Think back to the last few trading books you read. Were they written by professional authors, bloggers and lecturers? If they were, they were likely better written than mine. They were probably more entertaining and offered easier solutions and quicker gains.
I don’t deal in wishful thinking. I don’t sell trading systems. I manage institutional money. I trade for a living.

I concur with the author and have noticed that out of the 150 or so books sitting on my bookshelf, few were written by actual traders with actual track records.   That's a problem. 

Therefore, the book above has been firmly placed on my "to read list".   Finally, here a few other individuals that meet the rare combination illustrated above:

Stocks Uncaged

Here are two stocks my scans found this weekend:

The chart above is an ETF that is breaking out to a new all time high on meaningful volume.  Less importantly, the ETF also has a very hefty 7.98% dividend yield.   My thoughts on dividends:  being a long term trend follower, I benefit from occasionally receiving dividends; however dividends are the icing on the cake, never the cake itself.  


Card Counter Mike Aponte on Having an Edge

I recently re-listened to one of my favourite episodes of Michael Covel's Trend Following podcast featuring former member of the MIT Blackjack team, Mike Aponte.   In my opinion, all of Covel's podcast are a tremendous resource, but this episode in particular is pure gold.

Here is a quote from the interview:

As far as the betting, most gamblers will just bet based on a lucky feeling or even worse when they've lost... they're chasing their losses, which I'm sure happens in trading all the time... Whereas what we did as professional card counters, we bet bigger when we have a real advantage; we know with 100% certainty that we have an edge. Of course that doesn't guarantee we're going to win that hand, but if we just repeat getting that betting volume, maximize that betting volume with an advantage, then that's when we're going to reap the profits.

I think that's trading in a nutshell.   Trend followers know that any given trade is never a guarantee, which is why risk management and position sizing are key, but given that there is an edge, they do reap profits in the long run over the course of many small bets.

Mark Douglas, author of Trading in the Zone, also realized this when he said: 

Why do casinos make consistent money on an event that has a random outcome? Because they know that over a series of events, the odds are in their favor. They also know that to realize the benefits of the favorable odds, they have to participate in every event.

Mike Aponte also noted:

When you've truly mastered card counting, you're not really making any decisions; the cards make all of the decisions for you and I'm sure that's similar in trading too. 

Similarly, when you truly master trading,  you're not making any decisions since the price action will be making the decisions for you. 

High Potential Stocks of the Week

I closed out a few trades this week.   Closed trades are always recorded under the Performance tab of this site.

As usual,  here are two stocks that my scans found this week: