Peter is a professional trader, Paul is not. Peter has a tested, proven, written trading plan that he follows each time he enters a trade, Paul does not. Peter has agreed to meet with Paul to help Paul become a more successful trader.
Paul was early for his first appointment to see Peter a few days later – he was feeling both excited and apprehensive. Peter had told him he would show him how to use technical analysis and swing trading strategies to trade Stock market trends with confidence – but could he really do it?
Did he have the ability to become a successful trader after losing so much money in the market these last two years? Was he just wasting Peter’s time?
As he waited, he thought about the look Beth had given him when he had told her about his trading losses…the sense of failure he had experienced as she just walked away. The feeling of utter helplessness he had felt as the enormity of his losses had finally dawned on him. He had been so close to financial freedom, but now that had been taken away from him.
He was just starting to feel sorry for himself again when Peter strode into the foyer of the office building and wished everyone good morning – feeling sorry for himself would have to wait until later.
Peter motioned him to follow him to the elevator. Paul did so and they chatted as the lift took them to Peters 30th floor office. It was smaller than he had imagined, just a receptionists desk in the waiting room and one office with a view of the city.
He expected something grander, but the office was functional, and besides, Peter didn’t have a need for any more space as he had only 1 staff member, Kim, his Secretary and receptionist, host, coffee maker and confidant.
The focal point of Peter’s office was his trading screen – a triple screen plasma display monitor over 4 foot wide. “Not that’s a screen,” Paul thought to himself.
Kim brought in coffee and then left them alone. Paul poured them both a cup and took a seat.
Peter gazed out the window towards the city for more than a minute before speaking. “So you want to be a trader?” he finally asked. “Yes, but more than that, I want to be a great trader,” Paul answered, “Like you.”
“How do you know I am a great trader? And anyway, what is your definition of a great trader?” Peter asked.
“I heard you talking at the diner the other day – you certainly know what you are doing, and the market is up 5 days straight and more than 130 points since you bought the S&P 500 Index, that’s 20% in a week!” Paul explained. “I think anyone who can take their profits on the day of a major low like that and then have the ability to turn around and buy…and be dead right, is a great trader.”
“That is true, the Index is up a long way. And yes, I did get in at the low, didn’t I? So I guess, by your definition, I am a great trader,” Peter chuckled to himself.
“How far do you think the market will go up before it has a breather?” Peter asked. “I have no idea,” Paul replied. “Neither do I, that’s why I have placed my sell orders below the daily lows each day in case it turns around again and I’m ready to go short again,” Peter explained.
“It’s not so much picking the low that is important or even necessary, it’s managing the trade as it progresses that makes the money,” Peter added.
“But we’ll get to that later, let’s have a look at a chart and tell me what you see,” Peter said. He opened his charting software and soon they were looking at a monthly chart of the S&P 500 Index. Chart available at Stock Trading Review.com
“This is the last 3 years price history of the S&P 500 – what can you tell me about the direction of the trend?” Peter asked.
“It’s been going down,” Paul replied. “Correct, and which way have you been trading this market that has been in a clear down trend?” Peter continued. “I haven’t been trading it at all, I’ve just been fully invested, losing money,” Paul replied.
“Then you have indeed been trading it, my friend.” Peter continued. “By sitting on your hands for the last 2 and a half years while prices continued to fall, you have been fighting the trend. People who fight the trend always lose money.
“Then, you finally sold in a panic, like all the other small traders who finally gave up hope last week. You sold to people like me. The same thing happens every time there is a correction or bear market – the small traders hang on until they can’t stand to be in the market any longer, they all sell together in a panic and then the market goes up.”
“Tell me, looking at this chart, when did the downtrend start?” Peter asked.
“Well I guess around December, 2000 is where it looked like it started to fall away,” Paul replied. “Correct,” replied Peter.
“That means that from December 2000, there was no reason to be buying this Index, or buying Stocks that were showing the same chart pattern, and there was every reason to have your Stock portfolio hedged if you didn’t sell or have your money in cash.”
Paul looked at the chart and of course it was easy to see the trend was down with hindsight.
Before he could say anything, Peter continued. “Of course, hindsight trading is perfect, so how would you have known the best time to get out of the market or hedge your portfolio?” Paul looked at the chart and said, “I guess when the moving averages crossed over.”
“Correct,” said Peter. “So, for the last 2 and a half years, the trend on the monthly chart was down. “What else does this chart tell you about the market?”
Paul looked at the chart, but he wasn’t really sure what Peter wanted to know. “I’m not sure,” he finally confessed.
“Take a close look at the reactions within the downtrend. Notice that the largest one only managed to go against the trend for 3 months. In any timeframe, a market or Stock that can only go against the major trend for a few bars like this is in a very strong trend.
“Also, the Index was consistently closing below the short term moving average, and always closed below the longer term moving average – this is not something you want to sit through fully invested, holding on and hoping,” Peter continued.
Paul could see now the reason for his huge losses. He had looked at charts before but he had never looked at the big picture. The monthly chart showed the trend clearly – and it had been down. A simple moving average crossover sell signal would have saved his fortune…
“This simple timing system is what I use for my long term portfolio,” Peter continued. “I have 70% of the funds I have allocated to the Stock market invested for the long term in leveraged S&P 500 Index Funds. My investment in these funds forms the core of my Stock portfolio.
“I initially entered when I got a buy signal in 1994 and added more funds each month – 50-70% of my net short term trading profits and other income. I kept an eye on the monthly chart and didn’t get a sell signal until the end of 2000. I was fully invested in those funds from around 500 points to 1450 points.”
Peter then showed Paul a monthly chart going back to 1994. Paul looked at it in disbelief. He was looking at probably the greatest wealth creation trend in history and he had missed most of it because of his short term focus. Chart available at Stock Trading Review.com.
“Remember this Paul,” Peter said as they studied the long term chart, “Wealth comes from looking at the big picture. Many people believe that holding for the long term means forever. I prefer to hold things that are rising in value. If the trend turns down, I take my money and wait until the trend turns up again.
“This strategy of timing the market with a simple moving average crossover has made me a fortune while millions of people in this country have lost their life savings.
“Smart investors always invest the majority of their capital for the long term, but have clear guidelines for preserving it if the trend changes. They only trade with a small amount of money that they are prepared to lose.
“Your trading will be more profitable if you know that you have a substantial portfolio invested long term and it is increasing your wealth. By trading your entire account, and not managing it properly, you risked, and finally lost, most of it.
“And even though I bought a small position in Index futures a few days ago, my long term portfolio is still fully invested in Mutual Funds that trade inversely to the Index – in other words, the unit price of those Funds increases if the Index goes down.
“The trend is still down on the monthly chart as you can see, so that’s the way I want to be positioned with the majority of my portfolio. I think we have seen the low, but I am not prepared to risk my wealth on it. If the trend changes, then I will change with it. As you can see, I don’t have to make decisions very often.
“The market took nearly a year to form a top and start down. It might take a year to form a base if I am right and we are near the low. Patience and emotional control will make you a fortune -fear and greed will destroy your wealth.”
Peter let the enormity of the previous rally and subsequent bear market sink in, and then said, OK, “Now we’ve had a look at the big picture, let’s have a look at the weekly trend.” Chart available at Stock Trading Review.com.
As they looked at the weekly chart, Peter continued, “We know that the monthly trend is down – this weekly chart shows the most recent leg down that may have brought in the low for this bear market. The remaining 30% of my Stock market allocation is used to trade shorter term trends using both this timeframe and the daily chart.
“Bearing in mind that we are looking for trades with the major trend, we are looking to enter this market as soon as it confirms that the fast move down is indeed under way again after each of the bear market rallies that typically come along every few months. I have drawn a swing chart over the bar chart to highlight the swings of the market as it moved lower.
“Tell me what you see here,” Peter asked. “Again I see a down trend – the moving averages are more often than not heading down and the swing chart you have drawn over the bars is making lower tops and bottoms – the trend is definitely down,” Paul replied.
“And still you held on, while billions of dollars was wiped off the value of the Stock market all around you!” Peter said. “You knew the market was going down as you are somewhat familiar with charts, why did you not do anything to protect yourself?”
“I was always told that I should hang in for the long term – that the market always came back, and that it had never failed to make a new price high after every bear market. I guess I was too scared to do anything in case I got out right at the bottom. As it turned out, I did that anyway,” Paul said.
Peter continued, “Notice on this chart that the rallies were also no more than one or two bars. This indicates a very strong trend – not something anyone should be buying into or holding if they want to protect their wealth.
“There were many people buying the dips as the down trend unfolded. This strategy had worked well in the bull market, but it failed miserably when the bear market came along. Every rally failed, forcing buyers to become sellers as the trend continued down.
“Trading the market requires us to adapt – the market has seasons – if we are out of season with the market, we get crushed.
“The rallies were just traps. Every bear market has them, and every time, traders think they have picked the bottom, only to find that they have not.”
Paul looked at the chart and for the first time, with the help of the swing chart overlaid on top of the bars and the moving averages set as they were, he could see how simple it was to determine the trend. Especially the last few weeks – it was certainly a panic.
“Now, let’s have a look at the last few weeks to see what we can determine.” Chart available at Stock Trading Review.com.
“Again, I have drawn a swing chart over the price bars on this daily chart. Once you understand swing charts, you will be able to draw these lines in your mind and you will not need to draw them on your charts any more,” Peter said.
“As you can see, the moving averages are again moving down at a fair clip and the reactions to the down trend are no more than 3 bars. With the Monthly and Weekly trends strongly down, and a daily trend that is showing very weak rallies in this fashion, what else is a trader to do but short sell this market?” Peter asked.
Paul could see it clearly now, the trend was blindingly obvious -why had he not taken any notice before? There had been a fortune for the taking and he had not seen it.
“But how did you know for sure the market would turn on that day?” he asked Peter. “Ah, that is a lesson for another day my young friend. For now, lets make sure you understand trend trading first. Once you know what a trend looks like, you will be in a position to make consistent profits from the market, not before.”
With that, their first meeting was over. Peter had some important visitors waiting in the reception area to discuss a Joint Venture in a property development. It was time for Paul to go.
He thanked Peter for his time and left the office. As walked out through the reception area, Peter called out behind him, “When you get home, set up all the Stocks you owned in a watchlist on Incrediblecharts.com, set it to monthly, put some moving averages on them and work out where you should have exited – that is your homework for this week. I will see you next Wednesday at 8.00am. Don’t be late…”
Paul arrived home with a renewed sense of purpose.
He did as Peter ordered and as he went through his previous portfolio, he saw that he should have sold every Stock he had owned by January 2001 at the latest. He felt disgusted with himself at having not been able to see this sooner, but he consoled himself that at least now he was on the right track.
He was still apprehensive, but he had a chance to put things right for his family. He was determined to make it as a trader, and with Peter’s help, he felt he could indeed succeed…
To Your Trading Success,