Wise quotes from Bernard M. Baruch:
I highly recommend the book (one of the best I ever read):
My Own Story - written by Bernard at the age of 87 in 1957.

Bernard Baruch was a stock market speculator who became a millionaire by age 30 in the early 1900’s and eventually a statesman and advisor to multiple Presidents during WWI and WWII.

Wikipedia:

Bernard Baruch was born in Camden, South Carolina to Simon and Belle Baruch. He was the second of four sons. His father Dr. Simon Baruch (1840-1921) was a German immigrant of Jewish ethnicity who came to the United States in 1855. He became a surgeon on the staff of Confederate general Robert E. Lee during the American Civil War and a pioneer in physical therapy. His mother’s Sephardic Jewish ancestors came to New York in the 1800s and were in the shipping business. In 1881 the family moved to New York City, and Bernard Baruch graduated from the City College of New York eight years later. He eventually became a broker and then a partner in the firm of A. Housman and Company. With his earnings and commissions he bought a seat on the New York Stock Exchange for $18,000 (~$458K in 2007 dollars). There he amassed a fortune before the age of thirty via speculation in the sugar market. In 1903 he had his own brokerage firm and had gained the reputation of “The Lone Wolf on Wall Street” because of his refusal to join any other financial house. By 1910, he had become one of Wall Street’s financial leaders.

• A speculator is a man who observes the future, and acts before it occurs.
• If a speculator is correct half of the time, he is hitting a good average. Even being right 3 or 4 times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he is wrong.
• During my eighty-seven years I have witnessed a whole succession of technological revolutions. But none of them has done away with the need for character in the individual or the ability to think.
• Age is only a number, a cipher for the records. A man can’t retire his experience. He must use it. Experience achieves more with less energy and time.
• Do not blame anybody for your mistakes and failures.
• Every man has a right to his opinion, but no man has a right to be wrong in his facts.
• I made my money by selling too soon.
  I never lost money by turning a profit.
• Most of the successful people I’ve known are the ones who do more listening than talking.
• Never pay the slightest attention to what a company president ever says about his stock.
• Whatever failures I have known, whatever errors I have committed, whatever follies I have witnessed in private and public life have been the consequence of action without thought.

Please note that these simplified quotes don’t even scratch the surface of the contents of this book - it may even be an insult to list so few.

I ran a post on Friday titled, Stock Bias Test, which has become one of the more popular pages on my site in only a few days. My site doesn’t generate a large number of comments per blog post, maybe 2 to 4 per post on average, but this topic got more than 30 people to respond (a huge success in my “comments world”). I guess I do a poor job in sparking conversation based on what I write.

Anyway, everyone seemed to like the exercise of analyzing the charts without a ticker symbol or frame of time.

I asked a few questions:

• Which stock would you buy below based on the nameless & dateless charts? (listed 1,2,3,4)
• How would you rank them in order of technical characteristics?
• Would you avoid buying of any of the stocks below based on price and volume?
• Would you short any of the stocks below?

Overall, many of you struck out and did not get the analysis right but I do have to say a that a few of you did a wonderful job.

The best response in the comments that I could find clearly comes from Alex who runs a blog on his google pages.
He nailed every chart (I wonder if he figured them out) as a few of you did.

#1 is the strongest buy. The last candle on #1 sets the high of the chart, therefore it’s moving into uncharted terrritory with no overhead sellers. Also, the last dip down to the 40-period line was on low and decreasing volume, thus few sellers there. Then it spiked off the 40-period MA with strong volume. Then it continued the uptrend for 5 candles.
#3 would be my second strongest buy for similar reasons, but I’d like to see what the next few candles do.
#2 & #4 I would leave alone because of the heavy selling volume on the last dips. But I wouldn’t short them because they are still above the 40-day MA.

I had to hide Aurelien’s answers for chart #3 as he guessed it: AAPL.

Steven Mac may have summed up the approach to the analysis the best by saying:

While the exercise is based upon price & volume alone or techincal aspects, for the record I wouldn’t move into a position unless I can see at least:

1) Risk-to-Reward.
2) RS Strength
3) Industry Group/Sister Stock Information
4) Fundamentals on Ownership
5) Overall Market Direction Factor

Overall – it was a great exercise and a wonderful success. I plan to do more of these in the future (possibly bi-weekly if everyone stays interested).

The original snapshots of the charts I uploaded on Friday are highlighted in blue (on the charts below). As you can see, #1 (BIDU) and #3 (AAPL) were super successful and #2 (MS) and #4 (BSC) broke down.

Proper risk/ reward setups and sell rules would have saved you from losing large amounts of money in MS and BSC so don’t worry if you got them wrong. Worry if you got it wrong and then avoided selling a clear loser.

I was inspired to write this educational piece after listening to the audio interview between Tim Bourquin of Trader Interviews and Brian Shannon of Alphatrends.net, also the author of Technical Analysis Using Multiple Timeframes. Brian’s book starts shipping on June 7, 2008, a book I had the pleasure to read as an advance copy; I definitely recommend his work. I will be posting a complete review of the book within the next week.

• Which stock would you buy below based on the nameless & dateless charts? (listed 1,2,3,4)
• How would you rank them in order of technical characteristics?
• Would you avoid buying of any of the stocks below based on price and volume?
• Would you short any of the stocks below?

Tim mentioned that a couple traders he recently spoke with have written code within their charting software that allows them to strip the company name and ticker symbol off of the charts. I find this absolutely amazing – a tool I would pay for in a heart beat.

These traders do this to avoid the human biases of the companies they are trading. Humans tend to rationalize their thoughts and decisions based on what has happened, what is currently happening and what they think will happen.

For example (one provided in the interview that I agree with): Many traders are starting to talk about a bubble or possible top in oil. Now, I don’t know if oil is topping but I have been avoiding some oil and energy stocks in my own research based on the indicators of my screens. I truly can’t tell you if this is based on the biases of what I have been reading and hearing or the based on my screens dropping clues.

I typically avoid old time blue chip stocks such as GM, IBM and MSFT but maybe I wouldn’t do this if they were making a move and I didn’t know what company I was trading because the ticker symbol was stripped. I did analyze IBM earlier this year but I avoided the write-up for as long as possible because it has underperformed for much of my adult life.

Anyway, take a look at the stock charts below and let us all know (in the comments) which ones you would buy, sell or do nothing. I will post up the full charts with ticker symbols and dates in a couple of days. Some of you may be very surprised to see what stocks they really are and may question your own conclusions once the company names are revealed.

Good luck – let’s see what everyone comes up with (leave them in the comments section). Click through to see charts 2 through 4.

Read more »

Let’s take a look at how EV or expected value can help us become better traders and understand how to measure risk in the market (or life in general). EV can be considered the equivalent of expectancy in the poker world so I think it’s a great read for everyone striving to gain an edge in their trading (or at least understand how an edge can be quantified).

Wikipedia Definition:

In probability theory the expected value (or mathematical expectation, or mean) of a discrete random variable is the sum of the probability of each possible outcome of the experiment multiplied by the outcome value (or payoff). Thus, it represents the average amount one “expects” as the outcome of the random trial when identical odds are repeated many times. Note that the value itself may not be expected in the general sense - the “expected value” itself may be unlikely or even impossible.

In simpler terms:
Expected Value (EV) is the amount of money you can expect to earn over time by making a calculated decision in a specific situation.

The expected value from the roll of an ordinary six-sided die is 3.5 (how do we get here):

Rolling each number has a probability of 1/6.
Multiplying the values with their respective probability gives us 3.5 or:
1 * 1/6 = 1/6
2 * 1/6 = 2/6
3 * 1/6 = 3/6
4 * 1/6 = 4/6
5 * 1/6 = 5/6
6 * 1/6 = 6/6

We get to 3.5 by adding them together:
1/6 + 2/6 + 3/6 + 4/6 + 5/6 + 6/6 = 3.5

What if the die was weighted and we know that the number “6″ has a 50% chance of coming up? We will assume that the other five numbers still have a uniform distribution (equal chance of coming up in regards to each other):

1 * 1/10 = 1/10
2 * 1/10 = 2/10
3 * 1/10 = 3/10
4 * 1/10 = 4/10
5 * 1/10 = 5/10
6 * 1/2 = 3

The expected value from the roll of this weighted die is 4.5.
We can now bet a weighed and non weighted die and know the outcome of our bets and determine the profitability, if any.

Now, let’s pretend we are flipping a coin with two betting scenarios:

Scenario #1:
We bet on the outcome, and receive even-money (we bet $1, we will win $1) on our bet. In this case, if we flip the coin 100 times, we can expect to win 50 times, and expect to lose 50 times. Overall, we win $50, and lose $50, breaking even. We have neither won nor lost any money (and over time, we will not expect to win or lose any money), so our EV is 0.

Scenario #2:
We bet on the outcome, and receive 2:1 odds (we bet $1, we will win $2) on our bet. In this case, if we flip the coin 100 times, we still expect to win 50 times, and expect to lose 50 times. But, the 50 times we win will earn us $100 (50 * $2), and the 50 times we lose we will still only lose $50. So, over 100 flips, our profit will be $50, or an average of $.50 ($50 / 100 flips). Our EV is the average win/loss per flip, or $.50. for every time this flip occurs so we can expect to make $.50.

Like expectancy in trading (a couple of trades will not give you the anticipated outcome of your system), you must understand that these EV outcomes will only take place over time, the long run. Both expectancy and expected value do not apply to short term results (we must make hundreds, if not thousands of trades, flips or rolls to expect the calculated outcome of the game.

I once read this from a poker article:
“ it’s not important to know the exact EV of a situation (in fact, with all the variables and unknown in poker, it’s generally impossible), but it is important to know whether a situation is +EV (i.e., you’ll make money long-term) or –EV (i.e., you’ll lose money long-term). It’s also generally helpful to know if a +EV situation is very +EV (i.e., you’ll make a lot of money long-term) or marginally +EV (i.e., you’ll make a little money long-term).”

I couldn’t have said this better when it comes to making trades for a positive expectancy system. We will never know ALL of the variables in the market so the most important part of a trade is to understand if the risk/reward is positive, very positive or negative.

You will be well on your way to consistent profits by understanding the risk and the potential reward of each and every trade you make. As in poker, dice or coins, a +EV or –EV can be determined even if every variable is not known. The name of the game is to play when you know it is a +EV situation or trade in our case.

I would like to focus on several excellent questions discussed
by Michael Covel in his book:
Trend Following: How Great Traders Make Millions in Up or Down Markets

1. How do you determine what market to buy or sell at any time?
2. How much of a market should you buy or sell at any time?
3. How do you determine when to enter a market?
4. How do you determine when to exit a losing position?
5. How do you determine when to exit a winning position?

However, I would like to structure these questions specifically to the stock market (for the purpose of this blog audience) and answer them to the best of my abilities while anticipating comments from readers (for your answers):

1. How do you determine what stock to buy or sell at any time?
Hint: Stock Screens & Scans

2. How much of a stock should you buy or sell at any time?
Hint: Position Sizing and Expectancy

3. How do you determine when to enter a stock?
Hint: Risk/ Reward strategies

4. How do you determine when to exit a losing position?
Hint: Sell Strategies

5. How do you determine when to exit a winning position?
Hint: Taking Profits

I will follow up with detailed answers after you give the questions some thought. Hint: Answers to these questions are all over the blog – see categories and the archives for further clues.