An End to the Bull E-Book

Gary Norden

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 356

Veröffentlichungsjahr: 2014

Beschreibung

Go beyond technical analysis tools with this comprehensive look at trading analysis

Strategies for successful trading analysis for all markets are out there, but they're not often found in books for the general public. So what are the secrets that professional traders know, but aren't willing to share? An End to the Bull: Cut Through the noise to Develop A Sustainable Trading Career is a robust, honest resource that presents an alternative approach to the markets, combining traditional technical tools with fundamental analysis, behavioral finance, and other key concepts to enrich readers' trading knowledge. The author's comprehensive, educated look at the topic fills a huge need in the trading community, and is ideal both for novices and experienced traders.

In An End to the Bull, Norden suggests that total reliance on traditional technical analysis can lead to failure, and has ended in disappointment for many. The book offers up a unique approach for anyone looking to establish a sustainable trading career based on a combination of the most tried-and-true methods. While it focuses especially on trading in Australia, the book is a useful resource for international traders at all levels.

• Explains why change is needed in trading analysis and presents a revolutionary approach used by successful professional traders
• Shares the core techniques and strategies to build knowledge and establish a business-minded attitude
• Discusses more advanced ideas crucial for all traders, including understanding volatility and the typical flaws of behavioral finance
• Gives solid advice for traders anywhere in the world

An End to the Bull takes the mystery out of trading analysis and puts the power to navigating markets into the hands of readers.

Leseprobe

AN END TO THE BULL

CUT THROUGH THE NOISE TO DEVELOP A SUSTAINABLE TRADING CAREER

GARY NORDEN

First published in 2015 by John Wiley & Sons Australia, Ltd 42 McDougall St, Milton Qld 4064

Office also in Melbourne

© Organic Financial Group 2015

The moral rights of the author have been asserted

Author:

Norden, Gary, author.

Title:

An End to the Bull: cut through the noise to develop a sustainable trading career/Gary Norden.

ISBN:

9780730311447 (hbk.)

9780730311478 (ebook)

Notes:

Includes index.

Subjects:

Brokers — Australia.

Stocks.

Dewey Number:

332.62

All rights reserved. Except as permitted under the Australian Copyright Act 1968 (for example, a fair dealing for the purposes of study, research, criticism or review), no part of this book may be reproduced, stored in a retrieval system, communicated or transmitted in any form or by any means without prior written permission. All inquiries should be made to the publisher at the address above.

Cover design by Wiley

Cover image (top): © iStockphoto.com/kvkirillovCover image (bottom): © iStockphoto.com/omergenc

Disclaimer

The material in this publication is of the nature of general comment only, and neither purports nor intends to be advice. Readers should not act on the basis of any matter in this publication without considering (and if appropriate, taking) professional advice with due regard to their own particular circumstances. The author and publisher expressly disclaim all and any liability to any person, whether a purchaser of this publication or not, in respect of anything and of the consequences of anything done or omitted to be done by any such person in reliance, whether whole or partial, upon the whole or any part of the contents of this publication.

Contents

About the author

Acknowledgements

Introduction

Part I: The need for change

Chapter 1: The Financial Junk-Food Industry

Traders play a different role from brokers and analysts

The ‘other’ junk-food industry

Accepted wisdom — trying to separate fact from fiction

Chapter 2: Real trader psychology: our desire for short cuts

Representativeness

Availability bias

Anchoring

Conservativeness

Overconfidence and overoptimism

Hindsight bias

Confirmation bias

Cognitive dissonance

A broker demonstrates biases in action

More on System 1 and System 2

Chapter 3: Time to break free

Why do you want to trade?

Lifestyle implications

You need to be an independent thinker

Ditch technical analysis

Trade to win

Random rewards — a dangerous business

Part II: Building the foundations

Chapter 4: Knowledge

Markets

Derivatives

Short-selling shares

Data

Specialisation

Chapter 5: Watchlists

Information and noise

The role of watchlists

The importance of following different markets

Using watchlists to help overcome biases

Trade the markets

Include positively and inversely correlated markets

Watchlists help us to build context and better understand markets

Beware stock closing prices

Constructing watchlists

Other information to be gathered

Using the watchlists to trade

Think laterally

Watchlists and our core principles

Chapter 6: It’s a business; treat it that way

Which broker?

What to pay for

What capital is required?

Time required

Practise properly

Plan B

Tax advice

Re-evaluate

Chapter 7: Position sizing and management

Position sizing

Entering a trade

Setting targets and stop loss levels

Managing trades

Trailing stops

Relating these techniques to our core principles

Part III: The next level: incorporating more advanced concepts

Chapter 8: Pricing In

What is good (bad) news?

Examples

Iluka

Probability and magnitude

Pricing in and position sizing

Reflexivity in markets

Conclusion

Chapter 9: Volatility

What is volatility?

Using historical and implied volatility in our trading

Trading in times of high volatility

What does high volatility look like?

Chapter 10: Become the bookmaker: how the pros trade

Be the bookmaker

Flow trading

Conclusion

Appendix

Index

Advert

End User License Agreement

List of Tables

Appendix

Table A1

Chapter 5

Table 5.1

Chapter 9

Table 9.1

Table 9.2

Chapter 10

Table 10.1

List of Illustrations

Chapter 8

Figure 8.1 QBE Insurance chart

Figure 8.2 Iluka chart

Chapter 9

Figure 9.1 comparison chart of Telstra and FMG

Figure 9.2 FMG volatility

Figure 9.3 FMG daily chart

Guide

Cover

Table of Contents

Part I

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ABOUT THE AUTHOR

Gary Norden started his trading career at the age of just 18, trading equity derivatives for a Japanese investment house. He was the youngest ever trader in that firm’s history.

Gary went on to enjoy a successful career as a trader in the City of London. At the age of 23 he became head of LIFFE options for NatWest Markets and he later held senior trading positions at Credit Lyonnais Rouse and ING Financial Markets.

Gary has also spent many years trading futures and options with his own capital, both in the trading pits of LIFFE and on computerised markets.

Since moving to Australia in 2003 Gary has developed an international reputation as a financial markets consultant, trading mentor and author.

Gary’s first book, Technical Analysis and the Active Trader, was published in 2005 and exposes technical analysis as little more than poorly performing rules of thumb. The book was also translated into Chinese and Korean.

Gary has written for publications and websites around the world, including Your Trading Edge, Stocks and Commodities, www.trade2win.com and www.bullbearings.co.uk.

Gary has a reputation for challenging assumptions and thinking outside the box. He is driven by a love of trading and a desire to help new traders gain access to a more professional standard of information and education. Gary pulls no punches in his attacks on the parts of the financial industry that he believes lead traders down the wrong path.

2014 marks 25 years since Gary started his trading career.

For more information on Gary, visit www.organicfinancialgroup.com.

ACKNOWLEDGEMENTS

To Wendy, Isaac and Anna.

It took a number of years of thinking over different formats and ideas before this version and title jumped out at me. From that moment until publication was literally just a matter of months, and credit for that must go to the team at John Wiley & Sons in Australia. Sarah Crisp was the acting acquisitions editor who helped me frame the project and was so supportive and helpful in the early stages. Following the completion of the manuscript Lucy Raymond and her team ensured that the editing, permissions and publication processes went as smoothly as possible. My sincere thanks to Alice Berry, Keira de Hoog and Allison Hiew who took me through those processes.

I would like to thank Phil Tana, Steve Hossen, Joshua Green and Grant Carter for reading through all or parts of the manuscript and providing their comments and opinions.

Finally I would like to thank my wife, Wendy, both for her support and encouragement and for reading through and editing the manuscript as it was being written.

INTRODUCTION

‘Stocks are going up.’

At first reading I would suspect that most readers would not have an issue with that statement. It’s quite common for us to hear such claims, and most of us would have made similar statements during our trading lives.

But what does it really mean? Does it mean that all stocks will go up? Surely not, as even during bull markets some stocks will fall. The reality of markets is that some stocks rise and some fall each and every day. Reducing this action to a simple generalisation is lazy, and poor analysis. What if the overall stock market does go up but other assets or inflation rise further? In that instance those who bought stocks may actually have lost out.

There is an incredible amount of bull$**t in this business. (I will call it ‘noise’ from now on.) Despite huge progress in the understanding of trader psychology and decision making, noise is still prominent in the trading and investing industry. There are a number of reasons for this (as I explain in chapter 1) but most relate back to the domination of the media by brokers and analysts, instead of traders. Currently most retail traders are, unsurprisingly, confused by all the noise and they too often end up following unreliable analysis.

In my first book, Technical Analysis and the Active Trader, I exposed the flaws of technical analysis, one of the most widely used forms of analysis in the business. I showed that chart patterns, moving averages and other technical tools are unreliable and result in losses for the majority of traders who use them. In this book I will expose a number of other trading myths, some of which have become accepted wisdom. Unfortunately our business is infested with myths, and trying to overturn them is no easy feat.

To me, the statement ‘Stocks are going up’ is akin to saying ‘Cars are fast’. Some cars are and some are not — and it can also depend on what we are comparing them to. Compared to horses, cars are fast — but compared to aeroplanes, they aren’t.

Would you buy a car from, or value the advice of, someone who makes statements such as ‘Cars are fast’? Yet in this business, each and every day, traders are listening to and acting upon claims from such people. Here is my first piece of advice: ignore ‘experts’ who make generalisations such as ‘stocks are going up’ or ‘stocks are cheap’ and ‘stock XYZ is going to $10’ — they are unlikely to be traders; they will be sell-side individuals. Traders tend to speak differently, weighing up various risks, and the world seems a lot greyer to them (as opposed to black and white).

However, as I explain in chapter 1, most people prefer to hear simple, clear statements, whether they are valid or not. Ask a decent trader what direction stocks are heading and the answer will include an analysis of risk, a separation of different sectors or classes of shares and a discussion of various outcomes. That is why traders make lousy brokers — most retail traders and investors would think that such a response shows weakness because they have been led to believe that ‘real experts’ can make clear, simple forecasts. This is wrong, and is one of the many beliefs that many readers will need to unlearn.

There will be many views in this book that you may find hard to accept at first reading; at times you may even feel uncomfortable because I will challenge some of your current views and expectations. I have become used to that reaction from some sections of the trading community, particularly technical analysis–based traders. When I was presenting to a group of traders following the release of my first book I was met with the statement, ‘But what you’re telling us is completely different from what everyone else is saying’. My reply was blunt: ‘The majority of traders lose money, so I’m quite happy to be different from them.’

In that sentence is the essence of this book. To succeed as a trader you will need to break free from the herd and be comfortable making your own decisions. There is no comfort in doing what everyone else does and failing with them. If you are someone who likes doing what others are doing, then you should reconsider trading.

As I have said on many occasions, the day that the analysis and trading techniques that I use become the norm for most retail traders is the day that I stop trading. If that sounds at odds with the fact that I have written this book, the reality is that I know it is unlikely that this book will ever become the accepted blueprint for most retail traders, as it requires too much independence of mind and resistance to accepted wisdom. In the same way that I knew that when Technical Analysis and the Active Trader was published, no matter how unreliable I showed technical analysis to be, it would continue to be widely used.

My aim when trading is to make good decisions based on the information at hand, and that is what I would encourage readers to learn to do. I rarely try to make predictions of future price movement. (To quote Yogi Berra, ‘I never make predictions, especially about the future’.)

I would imagine this sounds odd to many readers; accepted wisdom is that traders are trying to forecast the future prices of financial contracts. However, there is a lot more to trading than that simplistic view. We need to weigh up various risks and alternative outcomes, incorporating the potential magnitude of moves as well as the probability. I will examine and explain these ideas later on.

Short cuts in trading are typically short cuts to failure. I realise that many retail traders are time-poor, with high expectations of success, but I’m not here to tell you what you want to hear — I will tell you what you need to hear. That will differentiate me from most writers and, as stated before, I’m comfortable with that.

Trading is a difficult business involving decision making that humans have not evolved to cope well with. Sometimes there will not even be a ‘right’ decision; it can depend on your risk tolerance. It is important, though, to make decisions based on sound information and to cut through the noise. I hope to show you how to do that.

Many trading courses and books teach a style of trading that involves finding an indicator that ‘works’ and then applying that to your chosen market. This is a simplistic way to trade. It’s like a golfer only using a seven-iron; no matter how good he gets at using it, there will be times when his club can’t help him. My suggestion is that we embrace as many different techniques as possible so that we can try to find the right trade for the right market condition. Market conditions change, and we need to be able to adapt our trading accordingly.

I should say that I do not claim to have ‘cracked’ this business or to be some kind of ‘superstar’ trader. I started my trading career at the age of 18 and have enjoyed more than two decades as a trader. Trading is the only career that I have known and it has been good to me, but I write this book as much as an observer as a trader. By that I refer to the many traders that I have seen fail, and the extensive research that behavioural psychologists and economists have uncovered over the past twenty years or so. This exciting research tells us a lot about our tendency to look for short cuts in our decision making, and our inability to make sound judgements. We need to learn from these studies, and I will endeavour to show what types of decisions and analysis are dangerous and ways to overcome them.

I would also encourage you to read Fooled by Randomness and The Black Swan by Nassim Nicholas Taleb. They remain, in my opinion, the best books about trading and this business in general.

This is not a ‘How to trade like Gary Norden’ book; the ideas and techniques I suggest are used by many professional traders, but they have not permeated through to the retail sector, due to the domination of the sell side. It is also important to state that I do not consider the ideas and techniques set out in this book to be set in stone. I am always looking for ways to improve my analysis and decision making, always looking at new behavioural research to help me understand what biases or short cuts I may be using. It is vital for all of us to constantly re-evaluate our techniques and make improvements where necessary. Don’t ever think, ‘That’s it, I’ve made it!’ because, as I have seen on many occasions, the market has a way of taking from those who are overconfident.

The ideas and strategies laid out in this book represent what I understand and believe to be valid at this time; if and when new ideas come to light, then I will be more than happy to revisit my ideas and make adjustments. Again, I hope that readers understand (or learn to understand) that it is not a weakness for us to state that we do not know everything and have scope for improvement. Many great thinkers, including John Maynard Keynes and George Soros, have been criticised for changing their views. However, as I will explain, changing our mind can be a strength, not a weakness — if supported by a change of facts.

I will show that it is actually crucial for traders to seek information that conflicts with their views rather than supports them — if this sounds odd now, it should become clear later. Again, this is all part of the significant difference between the ideas that I present and those you will almost certainly have read elsewhere.

At all times I will endeavour to explain why I use a certain strategy or technique so that you can understand the thinking behind it. Time-poor retail traders often want a simple trading plan or technique that they can simply deploy time and again; that is not the approach I use or teach, and if you are serious about trading you shouldn’t either. To have a chance of enjoying a sustainable career you will need to understand what lies behind the technique or trade, so that you can learn from mistakes and improve your analysis and trading.

Humans are prone to short cuts when making trading decisions, and I will explain what those short cuts are and what you need to do to try and overcome them. This is one area that for some will be easier said than done.

I recognise that an increasing number of traders are favouring an automated approach and, while this book is aimed primarily at manual traders, there are still many lessons for automated traders to learn. In particular they will need to find ways to incorporate concepts such as pricing in into their trading. Each market is different and, no matter what or how we trade, our techniques will need to include an understanding of how our market works.

Finally, I must state again for the record that I do not believe that everyone can become a successful trader. It should be possible for many people to improve their techniques and decision making, but I doubt whether most can enjoy sustained profitability; there are simply too many psychological weaknesses to overcome.

The analogy that I use is golf. I know that, no matter how many golf lessons I have, I do not possess the ability to become a professional golfer. Even if Tiger Woods or Adam Scott were to teach me, this would probably not affect my ability to become a professional who performs in front of thousands of people. Sure, they should be able to help me improve my game and tell me the key ingredients of a good swing and getting the club into the right position, but being successful at golf is more than simply understanding what to do; it’s having the ability to do that under pressure. There are many scratch golfers in the world, but how many can earn a good, sustainable living from golf? My guess is less than 1 per cent.

Daniel Kahneman, Nobel laureate and expert on behavioural psychology, is doubtful that we have the potential to control the biases that weaken our decision making. While I will show some techniques that will help you if implemented correctly, from experience I know that some people just struggle to continually make good decisions. Facing up to losses and cutting losing trades in particular is one area that many people struggle with, no matter how many times they are told to do so.

I hope that all readers will take something from this book. For those of you who have the potential to become successful traders, I hope that I can point you in the right direction and help you avoid the avoidable pitfalls that afflict so many. For those of you who may decide that trading is not for you, hopefully this book will save you from losing substantial sums to the financial junk-food industry — if that’s the case, it’s still a worthwhile read.

Trading is a great challenge and I wish you well on your journey. As always I welcome all feedback and endeavour to reply to all emails.

Best regards, Gary Norden [email protected]

Part IThe need for change

In the first part of this book I investigate some of the problems and pitfalls that beset traders. Some are self-inflicted, while others are the result of poor advice and unreliable suggestions from a sector of the financial world that I describe as the ‘financial junk-food industry’.

In order to begin our journey to a more sustainable trading career, we first need to understand the pitfalls that we will come across so that we can navigate through them and eventually learn to ignore them completely.

I show that we are all prone to using short cuts, which can help us in other areas of our life — but, unfortunately, they will hurt our trading. I explain these short cuts and, as we progress through the book, I continue to show ways to try to overcome them. Our focus should be to make sound decisions based on real information.

Chapter 1The Financial Junk-Food Industry

In This Chapter …

I explain some of the reasons why retail traders can be led in the wrong direction and end up employing unreliable analysis and trading techniques. There is a strong element of mythbusting in this chapter, and no doubt I will offend some in the industry with my views. I am not easing readers in; from the outset I will be confronting you by challenging widely held assumptions and views.

Traders play a different role from brokers and analysts

During my time as a convertible bond trader I received an email from a salesperson from a large US investment bank. The email contained a research piece about a convertible bond that his firm was recommending; the piece ran to a number of pages, and it looked comprehensive. Skimming through the research I disagreed with some of the assumptions that were underlying the analyst’s view that the bonds were cheap. Later that morning I received a call from the salesperson asking what I thought of the trade idea, and whether I would like to buy any of the bonds. My first question was, ‘Do you have any of the bonds or will you need to go to the market to buy them?’ His answer was that his firm had $10 million of the bonds on their books, ready to sell.

I now had all the information I needed to decline the trade. Here is what had probably happened: another trader sold $10 million of these bonds to this US bank, or the bank had them on its trading book. The bank then decided to sell these on because they didn’t want them on their own trading book. This is usually because they believe the bonds are too expensive. An analyst was then tasked with preparing a research piece advocating the cheapness of the bonds, which required the inclusion of some dubious assumptions. The brokers could then go out and sell the bonds. This is often how the sell side works.

In my writing I use the terms ‘buy side’ and ‘sell side’. I would expect that for many readers it’s the first time they have heard of or read those terms. In the professional industry (investment banks, hedge funds and so on) they are commonly used and well-understood terms but, as with many other aspects of the professional trading business, this knowledge is not evident among retail traders. So my first task is to explain what they mean and why it’s important for you to understand the difference between them. Once you do, much of the rest of this chapter, and perhaps this book in general, will be clearer.

Sell side

It is probably easier to start by looking at the sell side. The sell side of the industry is tasked with selling products such as shares and bonds. The two most common jobs on the sell side are brokers and analysts. Investment bank desks have a third position: salespeople who are in effect institutional brokers who sell to hedge funds, managed funds, and so on.

It’s very important to understand that brokers and analysts are employed to sell; they construct stories, research papers and so on, designed to help them and their firm achieve their goal. As commissions and therefore income are increased by selling more, hopefully you can understand why selling is so important in the financial world. For company analysts, for example, sell recommendations are usually rare because they understand that most share market investors only trade from the long side (they buy shares), so sell recommendations will not help them achieve their goal of generating commissions for the company.

Brokers are typically paid on a commission basis; the more commission revenue they generate, the more they get paid. Personally, I see this as a conflict of interest; how can they give their clients the best advice when they need to generate commissions to earn a living? There will undoubtedly be many days each year where no decent trade ideas can be generated, and traders should be patient and do nothing. But brokers will struggle if they give that advice to their clients.

Some argue that it’s not in the broker’s interest to churn and burn clients, as they will continually need to get new clients. But that is exactly what occurs each and every day, hence the need for broking firms to continually advertise. If their advice was really that good, word would spread quickly and clients would recommend the broking firm to their friends. In my experience this is the exception, not the norm.

If you watch any of the 24-hour financial news channels, the various industry faces that you see and hear will almost always be brokers and analysts. They have simple, clear messages, present well and have all the attributes of salespeople — which is, after all, what they are. Similarly, quotes in newspaper or online articles are usually from brokers and analysts too; they are the faces of their organisations, and presentation is as important as knowledge for many of them. Sell side individuals who appear regularly on TV or in the wider media can command higher salaries simply due to their profile, regardless of their performance or the accuracy of their recommendations. (If sell side individuals were paid on performance, like traders, I’m sure they would on average earn far less than they do.)

Buy side

Traders, hedge fund managers and even pension (superannuation) fund managers are on the buy side of the business. These are the individuals and teams who make the trading and investing decisions, and they carry the risk of the trades. They receive daily calls and emails from those on the sell side trying to sell them various trades or investments, but their job is to critically analyse those recommendations, as ultimately it is the trader or fund manager’s job to make the trading decision. Those on the buy side rarely appear in the media, and it does not matter how they present, because they are paid to deliver in terms of trading profit or fund performance. Those on the buy side must weigh up the risks of each trade; they stand to lose their job if they consistently enter into losing trades. Compare that with your broker; if he or she recommends a dozen trades to you, which you enter into, and they all lose, which is most likely?

The broker loses their job.

You lose your trading capital.

Bearing in mind that the broker has been successful in achieving good commissions for his or her firm, I would suggest the most likely answer is ‘b’.

My role as a trader is obviously very different from that of brokers. I need to be able to see through the sales techniques and come to my own view on whether these are good trades. Conversely, when I want to sell one of my positions, I instruct our sales team to pitch the trade to their clients. Clearly I will only be exiting a trade if I believe there is little profit left in it, but there are always other opinions and it’s up to the sales team to find reasons to place the position elsewhere. You can see why good salespeople are crucial to trading desks if they can help traders get in and out of trades.

As a trader, there will be days when I decide there is nothing to do. As I am not commission-driven, I am more than happy to sit with my current trade or sit out of the market if that is what my analysis tells me is the right thing to do. My only goal is to keep making good decisions, as good decisions will lead to a long-term, sustainable trading career.

So it should be evident that traders are very different from brokers and analysts. Traders need to be good decision makers, and they need to be patient. They have to weigh up various risks and outcomes, which means that trading decisions are not always simple and clear cut. Sell side individuals, though, are involved in creating reasons and stories why traders should enter into a trade.

If I were to go back to a car analogy, I would explain the roles this way. Analysts are like mechanics — they understand the theory of how the car should run, but that doesn’t mean they can drive the car around a racetrack in the best or fastest way; theory and reality can differ. Brokers are like car salespeople — they are not experts on how the car works (although they know enough to sell to customers) and they also usually don’t possess the ability to be a racing driver and get the car around the track intact and quickly. They are very good at selling cars, though.

Traders are the racing drivers of the industry. They should understand the theory that analysts (mechanics) do, but they must then apply it to the real world. They must understand the past, but they need to make decisions on how they see the road ahead. Regardless of whether the track has been clear on previous occasions, racing drivers are not racing the previous lap; they are racing the current one, and this time might be different. They cannot predict what will happen in three or four laps’ time, because there are too many uncertainties beyond our control. What our driver (trader) can do, though, is to constantly re-evaluate the situation and make adjustments when necessary. Traders do not need, and rarely possess, sales skills, and so would tend to make lousy salespeople.

Don’t get me wrong, brokers do have a place in our industry, in the same way that we use real estate agents and car salespeople. A broker’s role should be to assist a trader, if required, in executing a trade and advising on order flow; brokers that are good at this are well worth using. It is vital, though, that traders learn their analysis and trading techniques from other traders, not from brokers and analysts. As I will discuss, in many instances this does not happen.

The ‘other’ junk-food industry

Some years ago, when my son was about four years old, he asked me, ‘Why do junk-food restaurants sell food that is [allegedly] bad for you?’ (He didn’t use the word ‘allegedly’, but for the benefit of any lawyers who are reading this, I have added it!) The answer was, of course, simple: ‘Because people want it’ and, as we all know, successful businesses are usually built on giving people what they want. Sometimes though, as with junk food, what we want is not good for us.

In trading we have our own ‘junk food’ industry: an industry that has evolved to give people what they want, because that is how firms make money. Unfortunately, though, what retail traders typically want is not what’s good for them. As Cass Sunstein and Richard Thaler state in their book Nudge, firms have more incentive to cater to irrational practices than to eradicate them.

Let’s examine a typical new retail trader. What does he want (and what doesn’t he want) to hear? The first thing he wants to know is that he can and will be profitable. He wants to believe that a simple trading plan with some easy-to-understand entry and exit points can lead to a profitable trading career. He wants a form of analysis that does not take up much time, but that somehow can still deliver great results.

The newbie typically does not want to spend a significant amount of time learning about the mechanics and fundamentals of markets — they want a form of analysis that cuts through that hard work. They do not want to hear that trading is hard work and that many will fail. With these ideas in mind, the new trader will seek out those who provide the messages he wants to hear.

Luckily (or not) for most new traders, the industry is more than happy to tell them what they want to hear. And so begins the exchange of funds from the new trader to the industry. This is all a part of the financial junk-food industry.

One of the key reasons why retail traders are so attracted to the financial junk-food industry is because of the skills of the sell side individuals who dominate it. Their job, as we have discovered, is to bring new entrants into the markets and then to sell them as many contracts or products as they can. A large percentage of the books, courses and presentations for new traders are actually written by analysts and brokers. As many retails traders don’t know the difference between traders and brokers, they will use these resources when learning to trade.

Take this example from an advertisement for a seminar for would-be traders. The presenter of the seminar who was supposed to be teaching the new traders was described as ‘… formerly head of technical analysis … for over 17 years. Learn from an experienced trader’.

Not only is this person an analyst, but he is a technical analyst (which is often just an astrologer of the markets, as discussed later). He is not a trader — the statement saying so is incorrect.

As both Taleb and Kahneman have explained, people prefer simple, clear messages and the sell side is very good at providing that. They tell you that there are straightforward paths to trading success, or ‘secrets’ that they are only too happy to share (for a price).

I’m sorry to burst the bubble, but there are no secrets and there are no easy ways to success — but there are many short cuts to failure. If anyone had a simple technique or strategy that could be easily copied and implemented, then they would not be sharing it with you. To navigate through the noise you will have to avoid the tendency to veer towards the simplistic, and take on board ideas that may seem more complex and even less certain. As Taleb has argued, people tend to favour and reward the providers of misleading information, who are typically optimistic and overconfident, rather than reward the usually more sobering truth-tellers. As you progress through this book, I would ask you to keep that thought in mind.

Accepted wisdom — trying to separate fact from fiction

As I suggest in the introduction, there are many pieces of accepted wisdom, generally spread by the sell side, that I believe do not stand up to scrutiny and are not accepted by most professional traders. Accepting these ‘facts’ and incorporating them into their trading is another contributing factor to the failure rate of retail traders. So let’s look at some of these.

Myth one: Longer term trading is easier than short-term trading

The first one that I will discuss is the view that short-term trading is too volatile, and that trading over a longer time horizon is easier. The first point to make is that, if longer term forecasting is easier, why do analysts have such a poor record with their recommendations? Studies have typically shown that analysts’ forecasts are inaccurate — and often by a wide margin. Studies have also shown that most long-term fund managers under-perform their benchmarks.

Almost all the professional futures traders that I have met (including those wily old floor-traders) trade with a very short-term outlook (intra-day). You may be surprised to learn that most investment bank traders are also short-term traders, trading in and out of the order flow that their institution sees. (By ‘order flow’ I mean the daily activity [orders] that comes to the bank’s desk, often as a result of sell side actions.) There are actually very few longer term proprietary traders at investment banks — too many have suffered large losses. So while the bank’s sell-siders are pushing long-term views, the bank’s own traders and capital are put to use in short-term strategies typically benefitting from the business that the sell-siders generate.

If we look at this issue from a trader’s perspective (as opposed to the perspective of an investor who may be looking for gains including dividends and tax incentives) I would argue that short-term trading offers a better outlook.

If we were to examine any contract (it could be AAPL.US stock or gold futures) and I were to ask you to tell me where it will be trading in say six months’ or 12 months’ time, you would probably find it very difficult to give me an answer that you have any confidence in. Of course, analysts (both fundamental and technical) have their targets and opinions but, as I have already stated, these are usually incorrect. If we take the view (which we should) that the essence of trading is to gain a good understanding of our risk and reward so that we can implement good trades, how can we do so on this long-term horizon when we really have little idea where the contract might be trading such a long time away? So many events could happen over a 12- or even six-month horizon that I simply do not believe that traders can make robust judgements.

However, if I were to ask you to give me your estimate of where AAPL.US stock or gold futures will trade tomorrow, it is likely that you would be able to provide a possible trading range that turns out to be more reliable. What if I asked you to tell me where those contracts will be in one hour’s time? Or even in two minutes’ time? Your estimates of potential highs and lows and a trading range, and therefore risks and rewards, will improve the shorter the time frame we look at.

Also, the potential for event risk diminishes with a shorter time frame. We cannot even imagine the range of potential events that could hit markets over a six- or 12-month period: EU debt issues, China slowdown, US debt ceiling, US Fed tapering — these are just some of the issues that have occurred over the six to 12 months just past, and the reality is that we have no idea what could happen over the coming year or so. Option contracts, and in fact all insurance contracts, have embedded in them the fact that there is more event risk, more risk possibility, over the longer term compared to the short term. Yet many traders simply ignore this fact when it comes to other products such as equities.

Since behavioural finance studies have shown that traders and investors often make poor (some would say irrational) decisions, I have seen it argued that trading for a short-term horizon must be more difficult. The argument is that this irrationality is only a short-term phenomenon and that over time rationality will win. I simply do not hold this view.