In Trading, Bewilderment is a Rule

I’d like to start this post with something a little different.  It’s easy.  Don’t worry.  Just 7 yes or no questions.  Try to answer and see whether you understand trading.  I’d illustrate the rationale afterwards.

Questions:

1.)  All market averages were in overbought territory by all measures known to mankind. Will we continue higher?

2.) The unemployment number was bad, people still do not have jobs.   Will retailer stocks go down?

3.) A stock has been on the uptrend list for 13 consecutive weeks.  Will it gain further momentum next week?

4.) A stock has moved furiously up from 40 to 200 in such a short time (2 years).  Will this go up further?

5.) The market discounts the future through the past and present’s earnings results.

6.) Mr. ABC is very smart with a track record that spans over 20 years generating returns above the market.  An investor who stuck with him has seen his portfolio grow from 1000 to 1Mil.  He recently told the press his investment thesis about a consumer discretionary stock..  It is brilliant, and diligently studied.  He shorted the stocks as he deems the prices unworthy and overly expensive.  Will you follow him?

7.) CDS spreads and bond yields of Portugal, Spain and Italy reached record levels over the past week. Should you include this worrying information in your trading?  Will you adjust your positions?

The Market’s Answers
1.)  All market averages were in overbought territory by all measures known to mankind. Will we continue higher? Yes

The Market’s Answer:  Overbought/Oversold readings should always be looked in context and they should never be your primary point of decision if you are trading individual stocks.  For the week, this did not prevent them to advance further.

2.) The unemployment number was bad, people still do not have jobs.   Will retailer stocks go down? No

The Market’s Answer: Many retailers continue to report better than expected same store sales.  The bifurcated U.S. consumer society is benefiting the two ends of the retail market. Discount retailers like $PSMT and $DLTR are attracting the middle class.  High end retailers and brands ($TIF, $EL, $LULU) are still enjoying growing revenues and profits as the upper class in the U.S. (the 20% of the people that account for 50% of all the spending) keep buying more. International sales are growing too.

3.) A stock has been on the uptrend list for 13 consecutive weeks.  Will it gain further momentum next week? Yes

The Market’s Answer: Coffee stocks continue to be hot. $GMCR has been on the St50 list for 14 consecutive weeks, during which it gained 49%. All trends end at some point, but tops are obvious only in hindsight.

4.) A stock has moved furiously up from 40 to 200 in such a short time (2 years).  Will this go up further? Yes.

The Market’s Answer: $NFLX almost hit the $300 mark on Thursday, two days after the company reported plans to introduce its popular online video streaming service to Latin American countries. Less than 2.5 years ago stock was at an all-time high at $40 and it has been hated ever since.

5.) The market discounts the future through the past and present’s earnings results. No

The Market’s Answer:  Growth and momentum investors don’t care too much about past and present results, but try to discount the future and yes, more often than not it is a discounting of dreams. Sometimes dreams come true. Sometimes they don’t, but that won’t necessarily stop a stock from going from $20 to $100, before it gets back $20 again.

6.)XYZ is smart and has a track record.  Will you follow him? No

The Market’s Answer:The market might be often “stupid” and “short-sighted” and irrational, but it is stronger than you. Eventually you will be right, because all trends end and 99% of momentum stocks become parabolic at some point of time. The question is, are your investors going to be patient in the meantime?

7.) Should you worry about Portugal etc? No

The Market’s Answer: CDS spreads and bond yields of Portugal, Spain and Italy reached record levels over the past week. There is always something to worry about, but that doesn’t mean that you have to worry about things you have zero impact on. Focus on what you can control. Pay attention to your stocks. There are still plenty of good looking long setups, but don’t forget that no market strategy is profitable without proper risk management.

________________________________

The point of the exercise is simple. Bewilderment.

According to most dictionaries, to bewilder is synonymous to disorient ,  to confuse or befuddle, especially with numerous conflicting situations, objects, or statements and to cause one to lose one’s own bearings.- which is essentially to expect the unexpected, and to open your mind as a rule in trading.  The rule in trading is that there are no exact rules.  Don’t believe on your notions of where the prices should trade at.

Emmanuel Derman, more popularly coined as “the Einstein of Wall Street” reminds that all practitioners have to “live with the fact that you are going to have to make crude, false but hopefully useful approximations.”  He even goes further to assert that “in social sciences, stability is much less obvious, perhaps even non-existent, because you’re playing with people and they keep changing the rules.”  

What is true is not always useful.

What is false is not always useless.

There’s no such thing as true or false in the markets.

Maybe it’s better to spend your undergraduate years learning really solid things that will last forever – E Derman

“What is essential is invisible to the eye. ” – St. Antoine Exupery, The Little Prince

-The Faceless Trader

Inspirational References: Stock Twits 50- IvanhoffEmmanuel Derman on Financial Engineering

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