Making of a method
So far: Been at this since Feb 2011. Experimented with momentum swing trading, day trading and position trading in equities.
Progress has been made in realizing that while there are many potential methods, the key is fitting the method to the personality and not the other way around.
This journal is about the journey to the fit. I need your criticism and encouragement in uncovering my method.
So what have you liked and disliked about each of the approaches you've tried?
Liked being in cash at market close.
Disliked staring at the screen and sitting in one place for hours. Disliked having no understanding of the why behind short term price movements.
Disliked the limitation of scaling this up.
Liked riding the wave.
Liked the ease of idea generation.
Disliked having the sense that this method would not work too well without market momentum.
Liked being contrarian.
Liked having a view on the 'why' behind the trade.
Liked using naked options to tailor a trade.
Liked big movements in price.
Liked using expected value as a metric for trade selection.
Disliked getting too wrapped up in research and not having enough ideas in the pipeline.
That's a good beginning. The following may also help to provide some clarity. First you have to determine just what it is you want. Then you have to figure out how to go about getting it.
<i>In order to succeed at trading, you must have an edge. Your edge begins with the knowledge you gain through your research and testing that a particular price pattern or market behavior offers a level of predictability and a risk to reward ratio that provides a consistently profitable outcome over time. Without it, one is just "playing" the market in order to have something to talk about on message boards. To get it, you have to know exactly what you're looking for and what to do with it once you've found it. This process is what the journal is all about.
The journal goes through several stages depending on where you are. Once you've decided where you want to concentrate your efforts (at this level, the journal may resemble a diary), then you begin the process of developing a system (or method, strategy, procedure, whatever you want to call it). Here the journal takes on a different character. Once you've developed a tentative/preliminary system, you begin testing/trading it, and the journal adopts a still different character.
The first step is to decide what kind of trader you want to be.
What do you want to accomplish with your trading? Is it recreational? Supplementary income? A part-time job? Do you want to make a living at it? Even the greenest of the green knows whether or not he wants to make a living at it, trade only part time, trade for recreation, trade for the action, trade to have something to talk about with other traders (for whatever reason), trade only long enough to earn money to do or buy X.
Do you have any idea what sort of trading is most comfortable? Long or intermediate-term trading? Short-term trading? Day-trading? Trend-trading? Scalping? (Note here that a short-term trader, for example, does not become a long-term trader just because his stop was hit and he didn't sell; a long-term trader doesn't become a short-term trader because he chickened out and sold too soon. Each of these approaches are selected deliberately and for thoroughly-considered reasons.) How patient are you? How adventurous? Are you a leader or a follower (most people think they're leaders)?</i>
Thanks dbphoenix - and to answer your question.
What I would like to accomplish:
1) To experience mastery and flow through the art of trading.
2) To earn a livelihood.
I choose trading as the art due to many reasons - but a crucial one is that it is something I naturally gravitate towards. It feels right.
I was inspired by this quote from the documentary
'Jiro dreams of Sushi'
“Once you decide on your occupation… you must immerse yourself in your work. You have to fall in love with your work. Never complain about your job. You must dedicate your life to mastering your skill. That’s the secret of success… and is the key to being regarded honorably.”
This is where I am right now.
The big idea: The market is a complex adaptive system. Price comes from emergent behavior. Most of the time there is diversity in the market and prices are more or less efficient providing no real edge. However, there are instances where diversity breaks down and price deviates substantially from efficient levels. Ex: Manias, Panics, Exuberance, NASDAQ 2000, Housing Market, Growth stocks with weak business models. An edge can be developed by identifying areas of diversity breakdown. Being based on core principles, such an edge would be durable.
The idea: Stocks that have a big run up in price are prime candidates for a loss of diversity (herd behavior). Of these, the choicest candidates are those that are very richly valued, i.e. have high expectations built into the price, i.e. growth stocks. Those with weak business models and high expectations would be the best candidates.
Regardless of how solid the underlying business model is, high expectations on rich valued stocks are often not met. Since all of the value is discounted to the present, small changes in expectations can lead to large movements in price as the market reprices the stock at lower multiples.
The key is to come up with a signal that shows imminent likelihood of the stock being repriced. The signal can be fundamental or technical or some combination. Conceptually speaking, this will indicate that diversity is returning and return to the mean is happening.
Examples of fundamental signal: Slow down in deferred subscription revenue growth despite higher guidance for next qtr. Reasoning is that deferred subscription slowdown is a leading indicator of eventual revenue slowdown.
Example of technical signal: Price breaks down from a weekly horizontal channel formed after a long run. Reasoning is that the weekly sideways movement shows that all the post catalyst announcement drift has finished - the stock has been distributing and is now breaking down.
At this point, this idea has no quantification. It came from observing how CMG, AAPL, NFLX and others lose billions to their market value as expectations are repriced. Now I need to quantify as much as possible.
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