In today’s Money Weekend…markets are composed of humans and humans are emotional creatures…removing the red-tinted glasses…it’s all about managing risk…and more…
Welcome to my new weekly chat about trading stocks.
I hope you’ll check in every Saturday with a coffee in hand and settle in to learn all you can about trading the markets without losing your shirt.
My passion for trading started on the Sydney Futures Exchange trading floor as a wet-behind-the-ears recruit to Swiss Banking Corporation Dominguez Barry in 1992 (now UBS).
I immediately fell in love with the excitement of being in the pits when all hell broke loose.
My job was to stand behind the trader and take the orders from the broking desk using hand signals and then let the trader know what they needed to do. I had to keep track of all the open orders that remained unfilled and let the desk know when orders were done.
Most of the time it was a pretty simple job for a newbie. But when the sh*t hit the fan, it was an adrenalin rush like no other. Especially when you misinterpreted a hand signal and told the trader to sell 200 instead of 20 as you were told to do. Oops.
It was great fun being a part of it. 600 mainly young blokes earning too much money and having fun doing it.
You could count in milliseconds the time it took from the bell ringing at 4:30pm to ordering your first beer at the Brooklyn. Good times.
But I digress. What were the lessons learnt from standing in the pits and working the phones for years on the futures floor?
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Humans are emotional creatures
It was that markets are composed of humans and humans are emotional creatures.
Especially when it comes to money.
I had completed a business degree with a double major in accounting and finance. I knew I was interested in stocks from an early age because I asked my dad why stock prices moved the way they did, and I wasn’t satisfied with his answer.
Little did I know my search for an answer would take decades to unfold.
The lessons learnt on the journey weren’t the ones I expected to receive. Most of the answers weren’t related to the markets but were about me.
Trading is a great microcosm of life. When you are living in denial the markets will chew you up and spit you out in a flash. If you are full of hubris you can expect karma to come in the form of a decimated account.
The more you think you know, the less success you have. When you become humble and accept your ignorance, you start to move forward.
Becoming proficient at trading involves letting go rather than building up more knowledge. It involves asking the right questions and allowing the answers to surprise you.
Removing the red-tinted glasses
The more stubborn you are about what you think you know, the less you see. If you put on glasses with a red tint, everything looks red. If the answer is blue, it really doesn’t matter how much time you spend looking; you ain’t finding nothin’.
Learning how to take off your own red-tinted glasses to see things as they actually are is a difficult task. If your mind tells you that the answer is red and you look out and see everything agreeing with what you think is true, there is no need for you to question whether your whole paradigm is flawed.
If you’ve become used to seeing everything as red it can be frightening to take the glasses off, not knowing what you’ll find.
My aim with these weekly instalments is to show you what I found once I had taken off my own red-tinted glasses.
I’ll discuss the psychology of trading and show you how I built my model of market behaviour to help guide my decisions. I’ll show you stocks that I like and explain why I like them based on my fundamental and technical method.
As far as I’m concerned, fundamental analysis is just as important as technical analysis. It is where they meet that you find the best trades.
I’ll show you how I manage risk by using mean reversion to create free options. But before we get there we need to understand the framework of the model.
We need to start at the beginning and work our way towards the answers that I’ve found.
We love stability. Being involved in the markets is anything but stable.
To make sense of the immense complexity we have to simplify ideas so we can comprehend. But then we are at risk of mistaking the map for the territory.
A model of market behaviour is just that. A model. It exists to make sense of something that is beyond our ability to comprehend.
My own model of market behaviour has been built from the ground up over the past few decades and while it may seem quite simple at first blush, it is anything but.
I don’t consider it the beginning and end of market behaviour and don’t profess it to be the path to limitless wealth.
It is the model of market behaviour that I needed to build to answer the questions I asked.
It’s all about managing risk
At the end of the day it all comes down to one very boring sounding thing:
Risk management.
If we accept that no one knows the future and have experienced the immense volatility that stocks display, the most important thing anyone wanting to get involved in the markets must understand is risk management.
But the path to that understanding is very interesting indeed.
Understanding risk and working out how to deal with it involves working out our own psychological flaws and those of others.
When you have made a million mistakes yourself and can predict the mistakes others will make, you can use their errors to guide your own decisions.
When I discuss trading with you each week I will be delving into my technical analysis model, which is based on understanding that the patterns we see in charts are the result of traders being whipped out of their positions whether long or short.
Knowing where their stop-losses are and understanding that prices often oscillate around central gravitational points whether the market is trending or range-bound can be used to build a trading plan.
The only goal we have is to increase our chances of reaching an initial target before being stopped out of a trade.
That is literally all that matters.
Everything I discuss will have that goal in mind.
If you are one of those sceptics of any form of technical analysis and think it’s a bunch of baloney, I want you to focus on the idea that technical analysis is a risk management tool.
It isn’t trying to predict the future. It’s about building a map of how others are positioned and understanding when the market is in and out of balance. It’s about working out where you are proven wrong.
If you can work out where you are proven wrong, you can start building a plan. If you haven’t got a clue where you are proven wrong, you are making arbitrary decisions.
I hope I have whetted your appetite to find out more, and that you will join me every Saturday as we delve deeply into the markets and our own psychology to become better traders.
Regards,
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Murray Dawes,
For Money Weekend
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