Trading And The Markets Q&A | Answers To Readers Questions

Last week as my facebook page hit 11,000 followers I asked my facebook followers to send me their questions to be answered on this blog.  Not all the questions posed where trading related (one was about who cuts my hair).  In any case, I have selected below the questions that I felt were worthy of interest and importance.  I have only included the first names of the people who sent the questions (bracketed in italics).

Q. Who’s fault is it for the financial crises in Euro Zone? Politicians or bankers?  (Sadaat)

A. There are some who have suggested it is a collective fault with the banks and the people (as we borrowed the debt). I disagree. I believe the people are not to blame here. The banks should have known better as they call themselves the financial “experts”. They got us into this mess because of unbridled greed and by relying on bogus mathematical models to calculate RISK. Those models used inaccurate data which told the banks that the odds of “subprime” borrowers defaulting on their mortgage in case of a fall in house prices was extremely unlikely.

Q. Gold has been rising forever now. Is there a bubble in the price of Gold? (Ambrish)

A. Good question. A bubble forms when everybody is extremely bullish on a stock or commodity which implies that we have probably reached an extreme point. That means everybody has already bought and there is nobody left to buy, thus causing the bubble to burst. That is what happened in the year 2000 when the dot-com bubble burst. But one thing is clear: markets are irrational. Despite the dot-coms being over-bought in 1999 they continued to rally until the spring of 2000. So who knows? Even if it is in a “bubble” Gold has potentially just ended a correction in a bigger up-trend. And as long as it is trending higher, the trend is our friend. Keep an eye on it as it reaches the 1900 region as that will be a major test for it.

Q. What general safeguards would you have in place to ensure we can never again make the mistakes in the ways which brought us to this inglorious cliff-edge? (Nick)

A. I am not sure any safeguard is going to work. Human beings are irrational by nature. Our irrationality is the one thing that Wall Street exploits to make money from financially illiterate and naïve investors. As for preventing another similar crisis, we have to rethink the way we approach RISK. We know that the mathematical models the banks used to measure risk were hugely flawed. So we need models that measure and take into account extreme and unthinkable events. As market participants, people need to learn how to profit from market downturns or “cliff-edges”.

Q. 5% of people who trade are successful, 95% fail. Yet most of those 95% think they are in the 5%. How does a trader KNOW they’re in the 5% group? And whats the most important thing a trader should do that will put them in that 5% group? (Andrew)

A. The answer is very simple. Trading is the only profession where you can never fool yourself into thinking you belong to the 5% or 10% that actually make money from trading. If you are trading WITHOUT any WRITTEN PLAN or discipline, and consistently breaking your rules, then you are going to lose money (the markets will have no mercy for those traders). So the only way of knowing is by looking at your P&L (profit and loss) table and see how you are doing each month. If you belong to the 90% that lose money then you will not survive long enough in the trading game and you will blow up your account very fast.

Q. W.D. Gann mentioned that the most important factor of trading was the time factor, do you consider time in your trading? (Andrew)

A. Yes. One of the best insights I had into this was from a famous trader, Linda Raschke. Raschke taught me that whenever you see a market that is in a trend, you should always find out HOW LONG that market has been trending. Trends do not continue for very long before they have a correction (or retracement). I have also found the work of Carolyn Boroden into the analysis of time and fibonacci numbers to be extremely useful.

Q. Do you think the Jewish background of Goldman Sachs and its CEO’s is the reason why the USA government is always friendly to Israel and denies Palestine its legitimate right or existence? (Lu)

A. I think we should be careful about bringing racial polemics into this matter. The Nazis tried to argue that case and we all know where that led to. I have Jewish friends in the trading industry who themselves are sceptical about a conspiracy by any race. This is an issue about the few controlling the many – their race or creed does not matter. What matters is what we are going to do about it.

Q. What was your worst trade ever and what have you learned from it? (Daniel)

A. The worst trade I ever did was at the start of my career as a trader. I went long on a stock, and then as it started dropping I continuously moved my stop-loss lower so that I would not incur a loss (thinking it was going to eventually turn around). I ended up losing a lot more than I had originally planned. That taught me a huge lesson to never repeat that again. I am quite happy now to accept a small loss.

Q. Being a trader is not easy job – if some people endorse a strategy proven to be effective by other traders it still may not work for those who are inexperienced, so how can one overcome this? (Milan)

A. Firstly, you should only trade a strategy after you have spent a substantial time TESTING that strategy (with no real money). By testing it you will know the probable win ratios (success rate) and payoff ratios (how many $ you make for every $ you risk) and gain more confidence in applying it. Secondly, never use a strategy that does not fit your personality, otherwise it won’t work. For example, Some traders are suited to longer time-frames and some to shorter time-frames. Thirdly, choose one or two markets and become an expert in those markets (e.g. an index, Gold or the Euro). You cannot become an expert in every market.

Q. how do you reckon people from southern Europe should act to protect their assets in case of a euro breakdown? (Luis)

A. I think people from everywhere should take measures to protect their assets. This is not just a European problem, it is a global problem. The main thing people should do is to invest in themselves and their financial education so they do not fall prey to Wall Street’s deceptive practices. In regards their stock assets, they can buy put options against their holdings which acts similar to an insurance policy on your assets. Also they can buy inverse index ETFs (e.g. DOG the Dow Jones Ultrashort ETFs) which make you money in case of a market crash. Both of these instruments carry a large degree of risk so a lot of care should be taken.

Q. What will be the effects of a tax on financial transactions and tougher market regulation on both government and markets in the long run? (Nicolas)

A. If there is one thing I find really annoying is all these politicians who know NOTHING about how the market works pushing for a financial transaction tax and more regulation. The only way this economy is going to go back into shape is by LESS regulation and LESS red-tape bureaucracy. Taxation of market participants who are bringing liquidity and money into the market is like cracking a nut with a sledge-hammer.

Q. Do you think that the only solution to the current World economic situation will be like the 1930s which was a World War? (Paul)

A. I hate to sound like a bleeding-heart pacifist (which I am not) but I see a war as a failure and never a solution. Nobody really wins in a war, except perhaps the bastards who sold the weapons and profited from it. I don’t think anything as drastic as a war is likely. But who really knows…?

Q. Have you ever gone bust trading? If so, how many times? (Joe)

A. I think I can safely say that I have never had to face the humiliation of having blown up my trading account. That is not due to luck but because I am an ardent “rule-follower” and have seen the horror stories. I have had friends and trading colleagues who have blown up their accounts. I know one trader who told me he borrowed £50,000 ($75K USD) only to lose it trading forex after 10 months. He did not lose hope though and it made him a better trader.

Q. I am thinking of getting a haircut in the coming weeks, which European Bond do you recommend I buy so I look fashionable for this winter? (Deus)

A. Brilliantly worded question. I am afraid I don’t dabble in the European Bond market, but I do trade the US 30-year Treasury Bonds (trade, not hold). Bonds do well in times of economic crisis, as investors turn to safer assets. If the stock markets break lower (and that is an IF) then I can see Bonds doing very well. Until then, I would not touch them yet.

Q. What filters do you use for day trades so you can narrow your choices? What filters do you use for swing trades? (Madhav)

A. For day-trading I start looking at the Daily charts to see the big picture and then zoom into the 60 minute charts. I find that the 60 minute charts keep you in the flow of the market. You need to find out where momentum and the trend is heading on those higher timeframes. I also find using pivot point extreme levels can be very helpful. I am not a big fan of using too many indicators so try and keep it simple. For swing trading, I start looking at the Monthly charts, then the weekly charts and then look at the Daily charts for identifying an entry and an exit. The weekly and monthly charts keep you on the path of least resistance.

Q. Do you think we are in a depression? (Christopher)

A. I don’t think we are in a depression, although I wish we were – that would make a lot of assets cheaper to buy. At the time of writing the markets are down approximately 10% since their summer highs. That is not enough as an indicator to show we are in a recession let alone a depression.

Q. When (and I pray if) we see systemic failure and sovereign defaults, where would be best to invest? (Mykey)

A. There are a lot of debates about this. The best place to invest may not be the safest. You also have to make sure that if you are using a brokerage to invest your money, that the brokerage itself does not succumb to the liquidity risk and sink with the battleship (as happened after the collapse of Lehmans in 2008). Personally, in such an economic mess, if you can short the market, then go short on stocks and the indexes. But if you don’t like shorting then investing in real estate (as long as you buy in the right area and you have done your research properly) is not a bad idea either. I know people may disagree with me on this but at least a piece of land or real estate will not go to zero – but stocks can.

Q. Could euro displace dollar and become world’s reserve currency in the future? (Panos)

A. I think that was the original concept of the Euro at the time of its birth, but now I would highly doubt it unless some fundamental shift (or miracle) takes place in the structure of the Eurozone. The problem with this currency has always been the erroneous assumption that a single interest rate and currency mechanism can work for a bunch of nations with conflicting industrial and political cultures (e.g. comparing Greece and Germany). I don’t think the US Dollar is all that safe either as it is very probable that future nations are going to call into doubt even the US Dollar’s place as the world reserve currency.

Q. Signal services or trade what you see? (Edward)

A. Definitely trade what you see. I have a deep distrust of signal services and in any case, you need to find out their track record before you sign up to one of those.

Q. What are the impacts if Greece quits EU? (Ranger)

A. Nothing but pain and misery for the Greek people who are the innocent ones in all of this. Undoubtedly Greece will face massive inflation and a devaluing of its currency. However, there have been successful stories of nations pulling themselves up by the bootstraps such as Argentina.

Q. What is your biggest loss or gain in a day? (Joe)

A. May 6th 2010 – my account dropped by 57%. That was the day that a “technical glitch” happened in the US Stock Exchange. I managed to make the losses back eventually but it was not easy.