Fooled by Randomness by Nassim Taleb one of the guys who made a killing during the 2008 global financial crisis completely takes my mind to a new planet. I like to think of Taleb as a contrarian. What that means is that he has no problem buying while all the talking heads are screaming sell. He is confident about the positions he takes and doesn’t bother to take very key interest on what financial journalists say. Do not believe everything you see on T.V. In fact, if you can avoid taking action on the markets depending on what news and media houses tell you, that’s a sign of maturity. More so if you are a chartist, if you follow price action to the core. Price is king. However, if you’re into macro, a fundamental trader, by all means follow the news closely but do your own research and analysis prior to taking your positions. Taleb taught me how to filter through noise and what to focus on focus. Quoting him he says, “I believe there is a difference between noise and a signal, noise should be ignored, and a signal should be taken seriously”. Taleb usually has CNBC television station on all the time at his office but the volume on mute, simply because it’s one thing to read what’s going on in the markets, it’s another to let a presenter disrupt your thought process with his own opinion while you’re trading. He goes on to explain the place for randomness and probability in trading. That no one is immuned to randomness and you should be prepared mentally for any outcome. My take home crucial lessons from this book would be anything can happen, you don’t need to know what’s going to happen next in order to make money. That every moment in the market is unique. There’s a random distribution between wins and losses for any given variables that define an edge. An edge is an indication that gives you a positive expectation. It gives a higher probability of one thing happening over another.
I mentioned earlier on that price is king. In that regard, John Murphy’s Intermarket Analysis represents another step in the evolution of technical theory. According to Murphy, “With growing recognition that all markets are linked, financial and non-financial, domestic and international, traders will be taking these linkages into consideration more and more in their analysis. Of great emphasis is that no market trades in isolation, that all markets are interrelated and the four key sectors are currencies (Forex), commodities (Futures), bonds and stocks. The bond market is heavily influenced by the commodities, bonds normally trend in the same direction as the stock market, the United States Bond and Stocks markets are linked to global markets and some stock groups such as oil, gold mining, copper, interest-sensitive stocks are influenced by related futures markets”. Technical analysis remains the same no matter the derivative. It’s sort of like the lifeblood of trading, without which, your trading capital is dead. You cannot isolate price action in whatever form it comes whether it’s through trend following, momentum scalping, the use of signals and indicators, chart pattern recognition or whatever means you use to trade. It’s therefore paramount for new traders to have the basics into technical prior to them narrowing down to their trading style and fully recognizing their trading personality.
Let’s shift our focus to the emotions that come to play when real money is on the line. Hersh Shefrin has done a tremendous job in explaining fear and greed. His book, Beyond Greed and Fear gives you insights on the mass psychology of the markets which is primarily what drives the financial markets, one of the cues you should be looking into. He takes us through behavioral finance, some of the lessons you’re not taught in school. In his own words, Shefrin says “behavioral finance is everywhere that people make financial decisions. Psychology is hard to escape; it touches every corner of the financial landscape and it’s important. Financial practitioners need to understand the impact that psychology has on them and those around them”. Greed breeds overconfidence. “Overconfident investors who know a little of behavioral finance can do themselves great harm trying to exploit market inefficiencies. They are not smart investors and do NOT do the following; distinguish luck from skill, know that only some risks are worth taking and recognize that mistakes of other traders produce an extra source of market risk as well as a potential profit potential”. Fear breeds loss aversion. Quoting Shefrin, “Most people exhibit loss aversion. They have great difficulty coming to terms with losses. Consequently, people are predisposed to hold on to their losses too long and selling their winners too early”. Hope springs eternal. “Hope and fear affect the way that investors evaluate alternatives. Fear causes investors to look at possibilities with an emphasis on their desire for security and a potential for the upside”. Do not throw away good money chasing the bad because you can’t keep your emotions in check. When doubt creeps in, it’s time to exit, as simple as that. When you have hit your profit target, it’s time to exit. Take it from me, learned that the hard way.
Finally, this remarkable woman has some interesting stories. Those that keep you glued to your screen, you can’t catch a break. Kathy Lien in her book Millionaire Traders, How Everyday People are Beating Wall Street at its own Game will give you valuable lessons you can employ in your trading journey. To be continued…….
