By: Chris Rowe — January 17, 2011
"Newsletter Writers Never Admit Mistakes"
Every Tuesday (the day I write for The Tycoon Report), before the article, I will list one or two "test your knowledge" technical analysis questions and after the article I'll list the answers. I hope you find this fun and I hope it helps you make more trading profits. Sometimes small bites can have a huge impact.
Technical Analysis Questions of the week:
What does the ADX do?
What does it measure?
What does a rising ADX mean?
What does a falling ADX mean?
So there I was, watching and listening as the late comedian George Carlin narrated "Thomas the Train", my almost 2-year old son's favorite show. And then it hit me! One of the most important things for people to do is to admit our mistakes and learn from them.
This is especially true for traders. And last week a reader, "Luis", left a comment after a Tycoon Report article. He said newsletter writers never never talk about their mistakes, and should balance out the hype with lessons on their incorrect calls.
One of the most painful things to do is admit our mistakes. It's just human nature. Since the financial markets are riddled with human nature, it makes them predictable, as human nature never changes and history always repeats itself. So, if you understand either or both, you can profit from it.
The question is whether or not we'll be in the minority that recognizes the flaws of human nature and can go against its grain.
One aspect of human nature is that hardly anybody likes to even privately think about their losses, and most people don't keep a trading diary or even glance back at the last quarter's charts that they called incorrectly. But to be in the successful minority, one must take that pain and look in the mirror.
I'd like to go back and discuss and criticize one of the most incorrectly timed articles that I wrote for you in Q4, and possibly all of 2010: "Warning: 5 Tech Stocks Trading Like It's 1999."
MISTAKE #1. Right there in the title.
"WARNING"? I really said that, huh? If I'm seeing tech stocks trading like it's 1999, then I may want to buy some slightly out of the money call options and make a few million bucks as they double in price. And this was a "warning"?
Of course, I was talking about reducing bullish exposure or hedging the positions, as opposed to getting outright bearish on them. I said the market might even trade up a tiny bit before selling off, but that's no excuse. The S&P 500 has advanced 13% since then. I did see many signs of institutions unloading positions, but savvy institutions sell on the way up and can take many months to do so.
MISTAKE #2. I should never have put a timer ("two more days") on the amount of time funds would have interest in owning these winners.
MISTAKE #3. Assuming that fund managers were going to be sellers of winners to lock in gains through October, just because most of their fiscal years ended at the end of October.
I shouldn't have assumed they were buying the Wall Street darlings in the second half of September just because the third quarter was coming to a close and they were window dressing. I shouldn't have dug my heels in so deep on that theme. Even if funds were window dressing, they can decide, through October and later on, that they want to continue buying stocks. I have to be able to change stance faster than that.
It's not a mistake to trade around scheduled buying cycles, and it's not a mistake to trade based on expected behavior of institutions for tax reasons. But it's bad to dig my heels in to a stance so deeply that they can't be dug out in a reasonably short period of time.
In addition, anyone who knows the seasonal cycles knows that November - January is the strongest time frame -- by far -- for the stock market (generally speaking), and the strongest part of the 4-year election cycle starts from the mid-term year lows to the pre-election year high.
I'm not disappointed in myself here because I "should have known". It's that I knew EVERYONE ELSE who manages money probably had the election cycle in mind and, for this reason, I shouldn't have gone against the grain as insistently as I did.
This isn't to say that I feel I should always have a bullish outlook in late September based on THAT FACT ALONE. It's not about bullish or bearish. It's that I shouldn't assume, or feel so confident in that I'm correct, on something like that.
Breaking it All Down ...
Let's look at the 5 large-cap, Nasdaq 100, very liquid Q3 stocks that I recommended investors either hedge or exit. They don't look the way they did in 1999, but they've made quite a run. The idea of selling them in anticipation of a pullback is one thing I shouldn't have considered. I should always let price tell me what it wants to do, because making sure we don't miss out on gains is one main ingredient to stock market success.
Amazon Inc (AMZN)
The stock has put in negative divergences in the MACD, the RSI, and many other momentum indicators. But I should always let price be the official signal of what's likely to happen next. This stock was breaking all time highs. Stocks that are breaking all time highs should have a huge amount of evidence that they are topping out and, even then, they shouldn't actually be sold unless there is a sell signal from price.
Similar mistake here. I did see a negative divergence (x4) in the RSI, a very reliable indicator for giving sell signals. Although I saw sell signals after negative divergences in this stock, the sell signal from the price itself should have been in place before my commenting on this stock as a sell candidate.
Expeditors International Washington (EXPD)
This one I don't think I made a mistake on. It did trade higher, even though I said I thought it warranted some hedging or exiting (if bullish). But even so, when I look at this in hind sight, I saw sell signals form certain indicators, I saw sell signals and bearish reversal signals from the actual price itself, and there was significant resistance, going back several years, just three points above where it was trading.
It's important for a trader to look back and understand that the "good" or "bad" decision is made before we can know the actual outcome. Just because I said "sell" and the stock moved higher doesn't mean it was a bad call.
This was "overbought" but not over. I believe I had a case of the "anticipations" the day I wrote the article. There wasn't even a negative divergence in momentum. You see, when a stock is trending higher -- strongly -- the momentum indicators become much less reliable. They are already known for being much more reliable for ENTRY signals (if it's moving higher, they are reliable as BUY signals) and less reliable for exit signals. But the fact that the up trend was so strong should have kept my mouth shut about this one -- at least to prevent any talk of selling.
Vodafone Group (VOD)
This one was breaking 2-year highs, which means the trend was strong. Yes, I saw many warning signs on this one. When the up trend line was broken, I should have looked for the up trend to decelerate. I have nothing else to say on this one.
Anyway, I've beaten myself up enough for one day. Sometimes we look back at things and wonder what we were thinking. I think that happens to a person less and less throughout life, as long as we are willing to do the exercises of looking back and identifying those times, and more importantly, analyzing the mistakes.
Humans often only change when we are motivated by extreme discomfort. Believe me, it's discomforting to look at some of the mistakes that I made, in hindsight.
To be in the minority that makes money in the financial markets, we have to do what we can to either avoid human nature, or do the only thing that makes humans change what is in our nature to do: Feel uncomfortable. And that means studying our mistakes.
I hope you've learned from some of my mistakes, and take heed of what I'm saying, because you can only become a much better trader by paying close attention to your own past mistakes. The only thing better than learning from your past mistakes is learning from other peoples' past mistakes!
The ADX is the "Average Directional Movement Index". It's a line that tells us if the market is in a trading range or trending by measuring the degree of the current trend. It's very helpful in determining which indicators are suitable for the current market we are trading in.
When it's rising, the ADX is telling us the trend is strong. In this scenario it makes sense to use moving averages.
When it's declining, the ADX is telling us that we are in or entering a trading market (a non-trending market). In this case, it makes sense to use oscillators.