Hi, this is your Trader of Stocks. Let me explain to you where I believe the winning edge is to be found in today’s noisy markets. Globalisation, the internet and social media create a superficial environment which is great for connecting with others but very harmful to your attempt to make money trading stocks.
Brave New World
The mass adoption of the internet and social media over the last decade changed the way how we interact with each other. It also changed how we search, find and evaluate information. In the last century this was mostly achieved by reading books or learning stuff from people around us who have been experts in their fields. The first two decades of the 21st century put those century old principles of knowledge transfer and proper learning upside down. Today, it’s no longer about finding information, but about protecting yourself from harmful and false information.
Many seek quick answers to complex questions via the internet these days. What they find on the first pages of Google are mostly blog articles written by professional bloggers or websites which provide superficial snippets of information. Once those sources are exhausted people go to social media where they are fed with a vicious mix of fake news, polarized zebra thinking or straight out propaganda cleverly spread by so called ‘experts’. As a result of being exposed to a myriad of hidden agendas the legitimacy of experts is questioned and people start to seek the opinion and confirmation of like-minded people by joining various social media hubs.
All this is especially harmful when you want to study a field where valuable information is scarce such as stock trading.
Clever business men (or women) surely exploit this desire for self-empowerment by providing cleverly designed social trading products (e.g., Robinhood, Traderepublic, Stocktwits). There is a lot of money to be made so you can’t really blame them.
Without understanding the environment you will not know where to look for your winning trading edge! The following saying is still true today:
If you don’t know what your winning edge is, you don’t have one!
But before we talk about the winning edge in todays markets lets briefly browse through history to better understand how generational breaks, technological super cycles and black swan events influence the public opinion and public’s approach to the stock market.
First half of the 20th Century
Most trading books written in the early 20th century are honest, logical and free from any sort of marketing gossip. This fits the general spirit of the times which was fueled by great scientific and technical advances. This era extended all the way into the later part of the first half of the century when marketing gradually superseded the desire to understand how stuff truly works. However, one reason for that was surely that devices became too abstract and complex to be broken down into easy to understand principles once electronics/computers found widespread adoption.
A good example of the Zeitgeist have been the automotive commercials at the time. I remember one car commercial which explained how differential steering works in detail. I actually watched it a while ago when I tried to understand how this part of a car actually functions. Remarkable educational value from a commercial with the intend to sell you a product. You gotta watch it!
To draw the line back to trading we have to understand that during that time stock market information for the public was scarce. Traders called themselves speculators until the great depression aftermath attached a negative meaning to the term. It was clear that non-professional stock speculation was all about psychology and adhering to contrary views. The hard-to-learn skill for traders was the ability to read the ticker tape. Drawing stock charts by hand and calculating pivots and moving averages was nothing more than a simple tool. Private ticker tape machines were expensive and rare so most active speculators back then lived and worked in the vicinity of a stock exchange.
“Extraordinary Popular Delusions and the Madness of Crowds” by C. Mackay, 1841.
“The Art of Contrary Thinking” by H.B. Neill, 1951.
This early golden age of speculation ended with a bang in 1929. Markets changed and risk management became more prominent in the following years.
Second half of the 20th Century
During the great depression legendary traders such as Richard Wyckoff or Jesse Livermore continued to actively trade the markets but have not been able to match their pre 1929 success (This is very comparable to the .com bubble run up). During that time many books have been published about the principles of stock speculation based on the prior golden period. Up to this point it was the widespread public opinion that you have to be close to Wall Street in order to be a successful stock speculator.
Tip: If you read books from that time, pay attention to the publish date. There can be a difference between the ones which have been written during the run-up in the heat of the moment and those who came later once the dust settled. Rather focus on the former ones! The same is true for the .com runup and William O’Neils classic ‘How to make money trading stocks’ which was published during the run up in 1995.
In an essence this simple procedure helps you pick the brains of traders who wrote their books during a time when they were mostly in sync with the markets.
The believe that you need to be close to the exchange was challenged when Nicolas Darvas, a professional dancer from Canada, made millions in the stock market in the 50s by successfully acting on ‘old’ information via the daily newspaper. He adopted decade old principles of price pivots, tweaked them and eventually came up with his own box theory. He had huge success with this simple, almost trivial, technique. This makes clear that new or better data is completely irrelevant for traders.
Darvas’s edge can be summarized as follows:
He followed his own observations with conviction and did not rely on the opinion of others. He learned what worked based on his own trading history. His situation did not allow him to watch the markets intraday let alone react to intraday volatility or news. It was therefore impossible for him to overtrade!
He acted in complete solitude without having to deal with Wall Street and once he failed forward long enough, he couldn’t help but make a fortune.
“How I Made $2,000,000 In the Stock Market” by N. Darvas, 1960.
In the following years and even up to this day traders adopt his box theory without understanding that his winning edge was his ability to dodge the noise and trade in isolation. Traders love to cherry pick the pieces which are easy to grasp and ignore the more elusive concepts. The real edge is usually to be found in the latter though.
The space race in the 1950s accelerated the development/adaption of the personal computer just like the .com bubble accelerated the development/adoption of the internet 50 years later or like the recent little pandemic crash fueled this transition over to internet related remote technologies even more.
Personal computers empowered professional traders to conduct studies, backtest strategies and apply fancy technical analysis. During the 70 and 80s even non-professional traders have been able to hone their edge by having access to sophisticated printed stock charts with overlaid technical indicators which helped them to identify the strongest stocks. Later on they also began to have access to real time intraday charts. William O’Neil played an important role as he formulated a system which simplified trading by adding easy to understand labels.
It is scary and tough to buy a stock which blasts higher into fresh all time high territory. However it is much easier on your mind when you remove part of the uncertainty by knowing that this is a proper ‘cup and handle’ chart pattern you are looking at.
During that time much was theorized about the markets. Are they efficient? Is trading a zero-sum game? There were even some Nobel price laureates who tried to outsmart the market just to fail in spectacular fashion.
If the most intelligent problem solvers are unable to make constant profits then maybe the winning edge has nothing to do with super intelligence after all. Reportedly the egos have also been strong with LTCM. At least their egos prevented them from seeing the limitations and flaws of their awesome dynamic market model.
The stock market was in a secular bull market in the second half of the century ignited by the mass adoption of computers which was then further fueled by the upcoming internet revolution.
Personal computers and fresh innovative companies encouraged a new generation of young traders to pile into the stock market.
From 1995 to 1999 the winning edge was obtained by fearless overtrading in hot speculative .com stocks. Needless to say that most over-night millionaires from that historic period lost it all during the prolonged bear market which followed. However there have certainly been traders, skilled enough to profit from this insane climax run, who didn’t lost it all during the aftermath.
I actually picked one of them as my ‘trading guru’ during my initial learning years.
Early 21st Century
In 2000 the markets changed for good just like they did in 1930. Inexperienced traders who made money by chasing strength in .com stocks slowly faded away. Risk management again came into the focus and yet again books were published about how to make money in the markets based on the recent historic run up. Traders who missed the run up or got hurt now digged deeper into CANSLIM in an attempt to create certainty by following a strict rule set.
What followed was a generation of uninspired traders who generally lacked the ability to think for themselves. Guess who was one of them as well. Having strict and well formulated rules without much leeway is alluring to novice traders and it takes years to understand that such an approach prevents you from maturing as a trader. You can’t compete with the best when you never remove those training wheels. That’s simply not how it works.
Instead of learning how to think and act like the developer of a trading method (read: O’Neil), many became buyers of a simplified product with a shiny frontend. This again matched the Zeitgeist and was very much comparable to the simplification of computers via easy to use frontend user interfaces such as Windows. While CANSLIM surely worked for those who were quick to adopt it around 1995 it didn’t work that well for many late adopters like myself.
You can argue that some die hard O’Neil followers even turned this into a cult where they became obsessed with precise rules and following superficial fixed values thus killing all creativity in the process.
Don’t get me wrong! O’Neil’s style is totally sound in my opinion and also helped me grasp the market back then when I had no idea what I was doing. However, the picturesque labels and precise rules can make traders greatly underestimate the markets ability to derail your perfectly formulated plan.
Fast forward to the aftermath of the financial crisis which gave birth to a new generation of self empowered traders who did not rely on decade old books but began to embrace social trading instead. This trend started in 2008 with FinTwit and StockTwits and arguably cumulated just recently in reddit driven pumping schemes of over-shorted stocks.
The enabling technologies/products for this development have been cleverly designed zero-commission social trading apps which practically act like brokers. In 2020 even the last one has understood that when a product is free, you are the product. Any aspiring trader should challenge such a business model. The social trading crowd knows it all and they believe in their own ability to manipulate the market as a group.
The parallels to the .com runup are undeniable and those traders will likely face difficulties once the market environment changes again. Nothing wrong with exploiting an temporary trading edge but one needs to recognize the moment when this temporary edge begins to fade.
Today’s Winning Edge
In my opinion, the winning edge as a trader in today’s noisy markets is to be found in the principles which where outlined in the original work published in the early 20th century. The law of the stock market is that the majority must lose so that only few can succeed. It is therefore mostly driven by mass psychology in the short term and by technological super cycles (Electricty > telephone > computer > internet > decentralization > …) in the long term.
Therefore the first step is to make sure that you are detached from the masses and follow your own conviction. In today’s market this means to be detached from social trading, FinTwit, reddit and company. You must also be detached from financial media or at least must learn how to interpret the news in a contrary way around inflection points.
Feel free to learn about my daily and weekly swing trading routine which allows me to block all the noise.
Journalists, analysts and TV heads can connect two dots (sometimes three) and draw basic -common sense- conclusion from it. However, they have zero clue how the markets really operate or at least have no clue how to beat it. It’s simply not their job and not a skill they need to posses in order to earn their living. Don’t let the big news machinery influence your trading. All the information you’ll ever need is in the charts.
Action of individual leading stocks will tell you all you need to know to time the tides of the market in advance.
The second step is to first control the risk and only then go on and focus on profits.
“The Nature of Risk. Stock Market Survival and the Meaning of Life” by J. Mamis, 1991.
“The Battle for Investment Survival” by G.M. Loeb, 1931.
The third step is to understand that you are here to make your account grow and not to get a thrill from the moves in individual stocks. The grass is always greener somewhere else but that misses the point.
The fourth step is to truly understand that there is no winning trading system which you can discover early on. There is also no better data or superior indicator which you can find online. The secret to trading success is your skill which is develop via quality trading practice. Once you possess that skill you can trade any entry method you want. You could even simply buy stocks when they leave boxes to the upside 😉
Another step is to be driven by an intrinsic motivation to beat the markets. You can’t afford to be outer-directed and you shouldn’t trade for self-esteem. Be a step ahead and shape your own destiny by following a non-conforming path. This state is represented by the highest stage in Maslow’s hierarchy of human needs.
This here is a great excerpt from ‘The Roaring 2000s‘ by H. S. Dent:
“Both the individual and the collective pass through distinct stages of development. Despite the fact that, as individuals, most of us clearly mature into adults over the course of a single life, humanity in a broader sense has remained at a more childlike, immature stage of psychology…”
The above paragraph does a great job at explaining why it is possible to develop a CLEAR winning edge as an individual trader over the masses simply by being in full control of the psychological side of the market.
According to what I experienced over the last 5 years, I believe that it will take the new generation at least another 5 years to mature. During that time experienced traders will continue to see a big boost to their winning edge if they adhere to time-proven psychological principles.
A major, and oftentimes neglected part, is portfolio management. As a trader you should employ proven statistical methods to learn what works and what doesn’t. At the same time you must master the art to read stock charts and approach trade handling as if you were an athlete with the idea to ingrain behavioural patterns over time. Practice, practice, practice!
Recommended book on the topic: ‘Definitive Guide to Position Sizing‘ by V. Tharp, 2013.
Read this out loud: There is no point in trying to become an active swing trader when I am unwilling to go over a myriad of charts each day. You don’t have time for this? Well the truth is that the market doesn’t care. You can try to outsource part of the process by following a trading service but that must not be an excuse to skip your own practice.
You can be lucky as an investor and buy and hold the right stock for decades. However luck doesn’t work in trading as it is all averaged out over time.
Do you think Darvas figured out the Box theory over night? Or do you think that O’Neil looked at a single chart, saw a cup shaped pattern and knew instantly that this represented a low risk pattern? You must at least try to copy their journey and not only rely on their end products.
There is nothing wrong with adapting techniques from others, but you must not skip your own practice!
I am definitely not here for the likes and I couldn’t care less about what other traders or TV heads have to say about the markets. Trading is personal and anti-social per definition! At least when you want to be successful. Without silence you won’t be able to hear whats going on inside yourself. But you have to, because that’s where the winning edge is hidden.
I am not here to be ‘liked’ by Wall-Street or Main Street.
I am here to carefully hone my edge and have my peace.