Learning to Trade 102

"Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it."
~ Will Rogers.

Perhaps the major concept essential to successful trading is that it is a statistical operation. One is never certain a trade will work out. There are numerous independent interferences that can go wrong--and often do. What one does, or had best do, is enter those trades that offer the best odds of advantageous outcome, and abandon them quickly when they go adverse.

Stacking the odds favorably can be as simple as trading bullishly only on bull markets, or trading bearishly in bear markets. Seems a simple concept, but it is surprising how many otherwise intelligent traders continue trading for price appreciation in bear markets--and get their heads handed to them.

Before the advent of Exchange Traded Funds (ETFs), one had to have a margin account and a short-selling mindset to favorably handle bear markets. Now bear-market ETFs allow any account that can purchase individual stocks to purchase bear-market ETFs. A bear-market ETF rises as the market segment it mirrors sinks.

So, statistically one can stack one's odds favorably by simply buying an appreciating stock, in a leading group, in an advancing market. In a bear market, like 2008, one buys a bear-market ETF, of the most disfavorable group.

Another example of stacking odds favorably is covered in special situations where one can observe human nature operating to extreme. In the markets, these bubbles almost continually happen, and once one is aware, one can easily spot them. This was true of the dot-com market of the 1990s, the housing market of the last decade, or the oil runup of previous years. An example of investing in the oil bubble burst is covered in a previous entry, "Bubble Bursting." It uses an ETF, or actually, an Exchange Traded Note (ETN), to profit from the deflation of oil from $147 to $35 per barrel, providing an opportunity to generate a 1000% return in 9 months.

Such bubbles are always forming and will inevitably burst. The only requirement is one have sufficient independence of mind as to be outside the herd mentality.

The patterns covered by the Bulkowski books recommended in the previous trading entry are simply statistically favorable situations one can take advantage of. The most favorable pattern, the high, tight flag, happens surprisingly often, yet few are really aware it exists, much less how favorable it is. It rises an average of 69%, hits its target 90% of the time, and has a breakeven failure rate of virtually 0%. This pattern requires a stock that appreciates 100% in two months (Bulkowski reduces this to 90% without diminishing performance), then enters a flag or pennant. One buys when it breaks out of the flag or pennant, sets a stop loss, and moves that stop loss up as the price appreciates. Simple.

If one were to take advantage of two of these per year, making say an average of 50% each time, one would have a marvelous year. There are more than two of these per year, and one need only hunt those stocks that have either doubled or appreciated 90% in the last two months. One could make a living with just this one pattern.

Why don't more people do this? First, few people know of it and fewer still have the personal self-discipline to use the knowledge advantageously. The greatest impediment one finds to successful trading one sees in the mirror each morning. The markets are a microcosm of life, in that respect. The greatest challenge we all have is self-mastery, and surprising few people in life succeed, inside or outside the markets.