Extraordinary returns follow extraordinary discipline. Discipline in buying and selling, and maybe the most important one of all, holding. Developing the conviction to hold is something that I’ve learned over time. It didn’t come easy.
Don’t bother finding the next multi-bagger if you aren’t going to develop the conviction to hold it
From my experience, the only way to hold onto a big position after it makes a big move is to know the underlying company better than anyone else. Greed and fear will test your resolve, so you need to learn to keep these emotions in check. You need to believe in your due diligence and form an unwavering conviction.
You need to constantly assess your positions and openly listen to counter arguments. Only then will you have the conviction to hold multi-baggers because you will understand all sides to the story. You also need to develop a thick skin. If you are not ready to be criticized for your convictions than you aren’t ready to make real money.
The truth is if you know what you own at all times, you’ll know when to sell.
In many cases the stocks I’ve owned were better buys after they doubled then when I initially bought them. Stocks should be sold when your maintenance due diligence shows something has changed. If you know the story better than anyone, you’ll likely get clues well before the rest of the market. When a company performs, and the story hasn’t changed, stop trying to change it. Enjoy the ride. A big part of successful investing is becoming content doing nothing. If you are in great companies, a lot of times your biggest risk is boredom.
Remember, there are no day traders on the Forbes 400 list. Learn to be content holding and doing nothing.
“Patience is power. Patience is not an absence of action; rather it is “timing”it waits on the right time to act, for the right principlesand in the right way.”— Fulton J. Sheen
A multi-year run is made up of a bunch of mini-cycles that can last weeks or months. During these times the stock can become undervalued or overvalued.
All my winners had one thing in common, I was always averaging up. Most of my losers had one thing in common, I was always averaging down. I normally buy my positions in thirds as my conviction grows. If something doesn’t check out along the way I’m not stuck in a huge position.
Margin of safety = if your investment thesis is completely wrong you will still make money
With most of my winners, I bought this final third 100%+ higher than my first third.
When you find yourself constantly averaging down it’s normally a sign that your ego has taken over. You’ve convinced yourself you have to be right, but you forget that being broke and right is the same thing as being wrong. Your ego clouds your judgment and slows your thinking. Many investors have gone broke trying to prove the market wrong, and you certainly aren’t going to prove yourself right by throwing good money after bad.
Successful investing isn’t about being right all the time; it’s more about the ability to identify when you are wrong quicker.
It helps you filter out the daily ‘noise’ and allows you to ride those big trends with confidence. Our natural inclination when profits are growing fast is to ‘take the money and run’, or use a shorter-term chart to try and get the ‘answer’ you want. Restraint and discipline is needed when investing and for good reason. When money is riding on your decision it is important to stay on for the ride for as long as we can to get the best result. Making ‘decisions on the run’ or disregarding trading plan boundaries that you know work is dangerous and can cause emotional conflict and mixed trading results. The majority of stops and reversal levels hit during the week are not confirmed by our weekly time frame, which bases all its decisions on Friday’s close. That’s our price benchmark.
To my constant surprise trends often extend to levels we could only have dreamed of when we entered a trade and too often we throw in the towel too early because the profit is irresistible. Selling too early is a common mistake and if we have rules we should stick to them. So again the weekly time frame is there to protect you from that inclination.
As a weekly investor it’s a process we need to endure and hopefully as you develop as an investor this will become easier for you as you watch a stock pull back but then go back up again. That’s what trends do. The reason my stops are set at predefined levels is that as a weekly investor I must make allowances for the fact that a stock will naturally pull back before it then rallies again.
My premise is that nobody knows where the top is so why try. You will fail repeatedly. The aim is to be consistent in our decision-making and to make money, not get tops and bottoms. That’s an unrealistic and unachievable objective. So I aim for consistency of actions which breed’s consistency of results.
The benefits of weekly data is to avoid the damaging distraction of intra-week noise and in turn it allows a little more time for ourselves. It is one of the many controls we use to help us focus us on the big picture. The discussion centered on getting a real perspective on the market action and not to be distracted by inconsequential daily noise.
As investors we have to understand that what trends do is, they pullback. It’s natural, and it’s healthy. It consolidates rallies meaning sentiment or crowd behavior is not ‘over heated’. These are important aspects to understand when trading to help us not get rattled or emotionally distressed which is a common affliction. Trading is about control and behaving in a cool, calm manner so we shouldn’t be troubled by these counter moves, unless our stops are triggered.
Anticipation doubt and worry are all emotions we can entertain if we want to. It’s a bit like the choice we make with regard to taking losses. It is your choice. If you don’t want big losses to occur you simply don’t let them happen. Using the weekly time frame and only looking at the market once a week can be very refreshing and liberating.
But in another facet of market behaviour we get stocks that run on relentlessly with only very small pullbacks, if any. Current examples may be A2M, TWE, CTD and QAN. They are exciting, they can also be dangerous but they offer great profit generating potential. We need a heavy dose of discipline to trade these moves effectively and of course an ability to divorce yourself from the heightened emotions that usually surround them. They eventually all come back to earth with DMP probably being our most recent example of a stock carrying the weight of market expectations that when not met cause a correction to occur, to put it mildly.
Stockradar’s entry strategy is based on an understanding of price and volume movement, and the belief money management, and not necessarily market knowledge, is the most effective way of managing trades and the excesses of greed and fear. To me they are two separate things. As perspective and reality is lost by the crowd the irony is that that is what drives the excessive price moves and by using money management tactics we can be capitalise on them very effectively.
Money management provides a degree of insulation from market excesses by using stops, in this case to protect profits, rather than limit losses. Market traits, fundamentals and valuation metrics may change over the years but price action does not change it still moves up and down driven by sentiment.
Holding the hot stocks, (that cause the positive ‘skew’ in your portfolio), and avoiding the dogs, (that ‘drag’ your portfolio down), is a path to success on the stock market.
Drop the dogs
Let’s firstly take the second issue of avoiding the ‘dogs’. The simplest and most effective filter I know of is that if a stock starts trading in a consistent pattern of lower lows and lower highs, drop it, now. It’s likely to drop further. I’d rather be in cash if not another equity that is actually moving higher. Already we have made great progress in knowing what not to hold and improved portfolio performance.
Hold the hot stocks
Let’s now take the other side, how do we ensure we hold the hot stocks. Again a simple filter is, if a stock that trades in a consistent series of higher highs and higher lows it is in an up trend state and those we know not where they stop. Yes valuations are stretched on these stocks but remember markets always trade to excess and as long as the trend holds it means they are rising and making you money.
While the information is readily available, evidence shows that it can cause a kind of momentary paralysis in investors that leads to a slow reaction in prices. And when you get the extra kicker of a positive earnings surprise from a stock that’s trading at a 52-week high, this so-called ‘post-earnings announcement drift’ has been shown to be even more extreme. But while all this sounds quite negative, it arguably creates an opportunity for investors who are aware of it.
For a start, new highs have the credibility of being used by popular investors like Mark Minervini and William O’Neil.
Influential research on them was published by Thomas George and Chuan-Yang Hwang in 2004, which found that they were a major driver of momentum. Momentum is the tendency for price trends to persist over the short to medium term, and it’s often linked to how investors think and behave.
George and Hwang reckoned that investors used the 52-week high as a reference point, or anchor. They found that when new-news comes along about a company, it can take days, weeks or even months for the price to shift upwards because of this ‘anchoring’ effect. In essence, existing investors are simply slow to bid the price higher, while onlookers are reluctant to buy at the new high. This is where the term post-earnings announcement drift comes from.
It makes sense that a stock trading at a new high is capable - and even likely - to produce an earnings surprise.
on average, companies that issue extreme positive surprises see more muted share price action the closer their prices are to their 52-week high. But crucially, this corrects itself over time and the prices of these shares rise much more strongly on subsequent announcements. So the lesson for investors, as far as this evidence goes, is that it can pay to accept the discomfort of buying stocks hitting new highs - especially when they’re beating earnings expectations, too.
The momentum effects that are triggered by new highs have been found to be powerful and can continue to drive prices higher over many months. Combined with another momentum driver - strong positive earnings surprises - the most recent research points to a more pronounced upward drift in prices over time. Buying shares hitting new highs is undoubtedly a tough strategy for some investors, but the evidence still points to momentum being one of the most powerful drivers of returns in the market.
Remember: Investing isn’t about just picking stocks.
Two things to always keep in mind when it comes to stocks:
1 - The professionals are almost always wrong. As William Bernstein, author of The Intelligent Asset Allocator, says: “There are two kinds of investors, be they large or small: Those who don’t know where the market is headed, and those who don’t know they don’t know.”
2 - It’s mostly just noise. If you’re a long-term investor (and you should be) you don’t need to check your stocks every day. You don’t even need to check your stocks every WEEK. The daily changes in stocks are almost always noise — plain and simple. And very few (read: almost none) of your investments will be determined by the news of one day.
Context is king in evaluating equities
Strong markets often swing way above the 22-day EMA. This is when prices have got right away from the consensus of value. This is where the amateurs buy. The only basis for buying away from the 22-day EMA is what Dr Elder calls the "greater fool theory" - that you hope later to sell it at a higher price to a greater fool that yourself. So, what he does is place buy orders near the 22-day EMA and wait for the market to come back to that level.
You need to revise the price each day as the EMA moves. Dr Elder describes this as being like fishing - you put out a number of lines and then wait for the fish to bite. If the price does not come back to the 22 day EMA, then you do not trade that stock and look for other opportunities at fair value.
Most people have trouble with this system. Our modern society is based on instant gratification. We are impatient to wait for anything - if you drive on our roads, you will know what I mean. They also lack any discipline. This is why most people fail at trading and investing. However, the great traders and investors all display two traits - patience and discipline. That is why they succeed.
Dalio’s principles are rooted in hyper-realism — accept your realities and use the tools and talents you have to move forward. If you operate with such “radical open-mindedness,” “radical transparency,” and “radical truth” — warts and all — Dalio insists you will boost the odds of getting what you want from life. In his view, admitting weakness is a strength — both personally and for an organization.
The main theme is about how to take advantage of failure — what you don’t know and the power of dealing well with what you don’t know. One of the greatest tragedies of mankind is that people hold onto opinions that are wrong, that stand in the way of them making the best possible decisions.
There are only two things that one has to do to be successful: know what the best decisions are, and then have the courage to make them.
What I found helpful is that whenever I would make a decision in the markets or almost any decision, I would write down the criteria for making that decision. By writing it down I would have a recipe so that when the next one of those things comes along, I would be able to look at it and say, how should I deal with it?
I developed this habit: Pain, let it pass, but let me reflect in an open-minded, quality way on it. What most people do is that when the pain goes away, they stop thinking about what to do about it — and the next one hits them in the same way.