Winning Edge Trading E-Book

Ned Gandevani

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Trading Series
• Sprache: Englisch

Seitenzahl: 321

Veröffentlichungsjahr: 2009

Beschreibung

An innovative and comprehensive approach to profitable tradingin these turbulent times Winning Edge Trading shows how to trade any market forgreat profits. Using the unique and innovative trading strategiesand systems outlined here, you can trade stocks, ETFs, and futuresto achieve market-beating returns. Written by system developer Dr.Ned Gandevani, this book provides an antidote to active investorsand traders who are frustrated by stagnant and declining markets.Dr. Gandevani shows you how to maximize your profit whileminimizing your risk with his innovative and comprehensiveapproach, and then reveals how to profit from market swings. Inaddition to providing a simple and easy-to-execute trading system,Dr. Gandevani also explains how you can determine your risktolerance and choose a compatible system for maximumperformance. * Details the tools used to trade short or long time frames * Explores how the Relative Strength Indicator and DetrendedPrice Oscillator can help you determine when to enter and exit atrade * Discusses psychological issues involved in active trading,including the inability to take a loss, overtrading, tradingpersonality, and system compatibility Winning Edge Trading contains the information you need tobecome a successful active investor and trader in today's dynamicmarkets.

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Preface

Acknowledgements

PART I - The New Trading Paradigm

CHAPTER 1 - The Great Stock Market Meltdown

PRIMARY CAUSES OF THE CURRENT FINANCIAL CRISIS

DEALING WITH THE EMOTIONAL TOLL

RESCUING YOURSELF FROM FINANCIAL DISASTER

TRANSITIONING FROM INVESTOR TO TRADER

CHAPTER 2 - Introducing the New Trading Paradigm

ONLINE TRADING

FLEXIBLE AND ACTIVE MANAGEMENT

EXCHANGE-TRADED FUNDS

MORE CHOICES, BETTER TRADING OPPORTUNITIES

NEW MARKET CONDITIONS

INTERMARKET ANALYSIS DYNAMICS

FUNDAMENTAL ANALYSIS, HELP ME NOT!

CHAPTER 3 - Pitfalls of the Old Investing Paradigm

BUY AND HOLD

INVEST FOR THE LONG TERM

HEAVY RELIANCE ON FUNDAMENTAL ANALYSIS

LIGHT PORTFOLIO MONITORING

ASSET SELECTION BASED MERELY ON ASSET-SPECIFIC RISK

TIME TO TAKE CHARGE

PART II - Trading Instruments and Markets

CHAPTER 4 - Understanding the Financial Markets: Common Stocks

WHAT ARE FINANCIAL ASSETS?

TYPES OF TRADING MARKETS

CHARACTERISTICS OF THE COMMON STOCKS MARKET

CHAPTER 5 - The Exchange-Traded Funds Market

CHARACTERISTICS OF ETFs

ADVANTAGES AND DISADVANTAGES

SECTORS AND TYPES

SPONSORS

ETFs: ATTRACTIVE TRADING INSTRUMENTS

CHAPTER 6 - The Futures Market: Financial and Physical Commodities

CHARACTERISTICS OF THE FUTURES MARKETS

LEVERAGE OPPORTUNITIES

PART III - Trading Tools

CHAPTER 7 - Fundamental Analysis

WHAT IS FUNDAMENTAL ANALYSIS?

FINANCIAL STATEMENTS

EQUITY VALUATION METHODS

FUNDAMENTAL ANALYSIS CAN’T DELIVER TIMELY INFORMATION

CHAPTER 8 - Technical Analysis

TOOLS USED FOR TECHNICAL ANALYSIS

TECHNICAL INDICATORS

MARKET RETRACEMENT LEVELS

FIBONACCI RETRACEMENTS

CHAPTER 9 - The Winning Edge Trading System Market Model

THE MARKET AS A SYSTEM

CONTRACTION/EXPANSION PRINCIPLE

FEAR IS STRONGER THAN GREED AND HOPE

HABITUAL PATTERNS

MARKET TRENDS

MORE OBSERVATIONS ABOUT MARKET BEHAVIOR

TREND-LINE ORDERS

WINNING EDGE MARKET MODEL

CHAPTER 10 - The Mechanics of the Winning Edge Trading System

ENTRY SIGNALS

EXIT SIGNALS

THE SYSTEM’S PROTECTIVE STOPS

CHAPTER 11 - The Winning Edge System for Day Trading

DAY TRADING E-MINI S&P FUTURES CONTRACTS

DAY TRADING QQQQ

CHAPTER 12 - The Winning Edge System for Intermediate-Term or Swing Trading

SWING TRADING S&P FUTURES

LONG SIGNALS FOR S&P FUTURES CONTRACTS

SHORT SIGNALS FOR S&P FUTURES CONTRACTS

CHAPTER 13 - The Winning Edge System for Long-Term or Position Trading

POSITION-TRADING RUSSELL 1000 INDEX FUTURES

LONG SIGNALS FOR RUSSELL 1000 FUTURES CONTRACTS

SHORT SIGNALS FOR NASDAQ FUTURES CONTRACTS

SHORT SIGNALS FOR NASDAQ FUTURES CONTRACTS WITH NO RSI CONFIRMATION

PART IV - Investment Psychology

CHAPTER 14 - Trading Psychology and Your Trading Personality Profile

TWO PILLARS OF SUCCESSFUL TRADING

WHAT IS PERSONALITY?

WHY IS PERSONALITY IMPORTANT TO TRADING SUCCESS?

PERSONALITY THEORIES

PERSONALITY TYPE THEORY

PERSONALITY TRAITS THEORY

NATURE OR NURTURE?

GENOTYPE AND PHENOTYPE

FIVE-FACTOR OR BIG FIVE MODEL

CHAPTER 15 - The Trading Personality Profile Test

FIVE-FACTOR MODEL OF PERSONALITY

WHAT THE TPP TEST REVEALS ABOUT YOU

TRADING PERSONALITY PROFILE SAMPLE TEST

TPP OR OCEAN SCORE GUIDE

REVIEWING YOUR TPP SCORE

CHAPTER 16 - The Successful Trader’s Blueprint

CONSTRUCTING YOUR TRADING SUCCESS BLUEPRINT

SET SMART TRADING GOALS

THE TRIPLE-A FORMULA FOR SUCCESS

SEE YOU AT THE TOP!

APPENDIX A - Toxic Assets and the Modified Mark-to-Market Valuation Method

APPENDIX B - About Winning Edge Trading Strategies

Notes

Index

About the Author

Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding.

The Wiley Trading series features books by traders who have survived the market’s ever changing temperament and have prospered—some by reinventing systems, others by getting back to basics. Whether a novice trader, professional or somewhere in-between, these books will provide the advice and strategies needed to prosper today and well into the future.

For a list of available titles, visit our Web site at www.WileyFinance.com.

Copyright © 2010 by Ned Gandevani. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, [phone], fax [phone], or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, [phone], fax [phone], or online at http://www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

TradeStation® and EasyLanguage® are registered trademarks of TradeStation Technologies, Inc., an affiliate of TradeStation Securities, the use of which has been licensed to TradeStation Securities.

For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at [phone], outside the United States at [phone] or fax [phone].

Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com.

Library of Congress Cataloging-in-Publication Data:

Gandevani, Ned, 1958-

Winning edge trading : successful and profitable short- and long-term trading systems and strategies / Ned Gandevani.

p. cm. - (Wiley trading series)

Includes bibliographical references and index.

eISBN : 978-0-470-56183-6

1. Investment analysis. 2. Technical analysis (Investment analysis).

3. Investments—Psychological aspects. I. Title.

HG4529.G36 2010

332.64-dc22

2009021677

I dedicate this book to my dear family, who have been amajor source of inspiration in my life: my patient wifeMieko and my beautiful girls, Ariana, Analisa, and Malisa.

Preface

The purpose of this book is to help people learn how to become successful as traders and active investors. Designed with both the novice and the professional in mind, it is chock full of useful information for traders at every level. With the major changes in the stock market and all the confusion and misinformation that have surrounded it recently, this book offers essential advice for thriving in this field, even in adverse conditions. There are multitudes of people out there (perhaps you are one of them) who have lost a great deal of money and have no idea what they should do now. The solution is not to panic; the solution is to become educated in the new dynamics of today’s market.

Part I begins with an analysis of the great stock market meltdown that had serious ramifications for the world economy in 2008. We demonstrate that traders who did not have a robust trading system in place were not equipped to handle the volatility of the markets. We explore the various causes of the crisis in some detail, delving into the financial history that led up to it.

We see how the housing “bubble” burst and the adverse impact that event had on the overall economy. We also see how credit dried up and various banks and other financial institutions failed.

A “rescue plan” is then introduced—not the kind that comes from the government but a realistic strategy for trading in this new environment. The concept of making the transition from an “investor” to a “trader” is outlined, highlighting the many benefits of the latter approach.

New market conditions, emphasizing flexible and active management, are considered, along with factors such as trading volume, volatility, and intermarket relations. The section ends with a comparison of the older methods and the newer ways of trading.

Topics considered in this section include flexible and active management, intraday trading, diversification, and tax efficiency.

Part II begins with an exploration of the various types of trading markets. We also examine things such as profit-and-loss calculations, regulations, and taxes. Strategies involving things such as leverage, short-selling, and margin buying are introduced.

Part II introduces the many challenges of trading stocks. These include things such as fundamental valuation methods, which utilize different financial ratios such as price-to-earnings (P/E), earnings per share (EPS), price to sales, price to book, and other ratios.

Futures markets, including various types of futures commodities, are explored as well, in a good degree of detail.

Part II also goes into some detail regarding various challenges when it comes to trading in today’s markets. The concept of “mark to market” is also explained, as are exchange-traded funds (ETFs). Technical analysis and fundamental analysis are compared and contrasted. The Fibonacci concept is studied in some detail as well.

Part III begins by describing how the market operates as a system. We consider different types of systems and the roles that fear, greed, and hope play in the market. Habitual patterns, cyclical behavior, and market trends are discussed, along with various observations about the market’s behavior.

In this part we also begin an in-depth exploration of the Winning Edge Trading System. We discover that it has various types of signals, including long, short, and exit signals, and we examine various protective stops, too. We also see how the Winning Edge System can be used successfully for day trading, intermediate trading, and “swing” trading.

We also describe a day-trading system for e-minis futures. This demonstrates how you have a better chance to become successful if you execute the signals successfully and with proper discipline. Taking a short signal in the S&P 500 futures contracts is explored as well.

Part III concludes by examining things such as Russell futures contracts and ways to cover or exit your trades.

Part IV contains an in-depth discussion of personality profiles. It closely examines the various scientific theories of human behavior and goes into detail on the most prominent ones. It demonstrates how and why it is so important that a trader’s system be a good match with his or her individual personality. The futility of working with a system that is incompatible with your unique character traits is explained, and we discover the secrets of using our own particular habits and ways of thinking to our financial advantage as professional traders.

Not only is each personality profile studied in great detail, but so is the concept of personality itself and its importance to trading. Two primary approaches to studying human personality are considered: the ideographic approach and the nomothetic approach.

The ideographic approach is briefly presented. It encompasses the major theories such as Freud’s psychoanalytic theory and humanism, social, and cognitive theories. The second approach to the study of human personality, the nomothetic approach, includes personality types and traits theories, which try to study the similarities and differences between individuals and categorize them.

Other approaches that are studied include social-cognitive, humanistic, and dispositional. We discuss various personality tests and their relevance for determining the best kind of trading system for each individual to adopt.

Winning Edge Trading provides you with a practical and proactive approach to your investment and trading activities. The recent financial market crisis proves once and for all that the old paradigm of investing does not yield profitable and sustainable investing returns. Billions of dollars in public wealth have been destroyed. The majority of the investing public lost their hard-earned fortunes and retirement hopes just by listening to the advice of long-term investing proponents. Winning Edge Trading offers you a new alternative to the investing myth of the “buy-and-hold” strategy. This book presents you with a new way of investing based on long-term and strategic planning but short-term and tactical management.

NED GANDEVANI May 2009New York

Acknowledgments

My efforts for this book could not have come to fruition without the great help and hard work of Meg Freeborn, my development editor, and the prudent guidance of Kevin Commins, executive editor, at John Wiley & Sons. Thank you!

—N. G.

PART I

The New Trading Paradigm

CHAPTER 1

The Great Stock Market Meltdown

The turbulent U.S. economy and stock market have recently encountered a chaotic and challenging chain of events. The year 2008 may be recorded as the worst year ever for the phenomenon of wealth destruction for investors and traders. Despite the massive $820 billion U.S. government bailout, the stock market has continued its spiral sell-off and meltdown. For early March 2009, the Standard & Poor’s (S&P) 500 index, since peaking at an all-time closing high of 1,565.15 on October 9, 2007, had lost 57 percent. The Dow had lost nearly 54 percent since closing at an all-time high of 14,164.53 on the same day in 2007. Since hitting a bull-market high of 2,859.12 on October 31, 2007, the NASDAQ had lost 56 percent.

Investors suffered a great blow when the S&P 500 plunged to a 13-year low as fears of a prolonged recession sparked a massive selloff, closing at its lowest point since April 1, 1996. However, as investors experience their biggest-ever losses in pension funds and investment portfolios, some financial gurus and advisors continued to spew out “stay the course” advice. They dispense this so-called wisdom as though we hadn’t learned the hard lesson of listening to their irresponsible and downright fraudulent advice just months before on some of Wall Street’s long-term holdings, such as Lucent, WorldCom, Enron, Merrill Lynch, and Bear Stearns.

Wall Street today is encountering its most disastrous crisis in decades. The demise of Lehman Brothers and Bear Stearns, the federal bailout of mortgage giants Fannie Mae and Freddie Mac, and the forced sale of Merrill Lynch to Bank of America are on the growing list of casualties in this ongoing financial crisis. As of July 10, 2009, the Federal Deposit Insurance Corp. (FDIC) announced that 79 banks failed in 2008 and 2009.

According to an FDIC press release dated August 26, 2008, “rising levels of troubled loans, particularly in real estate portfolios, led many institutions to increase their provisions for loan losses in the quarter. Loss provisions totaled $50.2 billion, more than four times the $11.4 billion the industry set aside in the second quarter of 2007. Almost a third of the industry’s net operating revenue (net interest income plus total noninterest income) went to building up loan-loss reserves.”

A great deal of consumer wealth has dissipated as a result of recent stock market losses; consumers now have far less money to spend. Unemployment has been rising as well, so overall there is less money in the economy. Without this money circulating in the economy and with nothing to replace it, it is hard to see where the resources will come from to generate an economic recovery.

According to the Washington Post of October 8, 2008, a top Congressional budget analyst said, “The stock market’s prolonged tumble has wiped out about $2 trillion in retirement savings over 15 months, a blow that could force workers to stay on the job longer than planned, tighten their wallets and possibly further stall an economy reliant on consumer spending.”1

Many investors have been shocked to open their 401K, individual retirement account (IRA), and pension funds statements to see a tremendous loss in their nest-egg savings. What happened? they ask, dumbfounded.

A quick glance at the prices for stocks held by the majority of the investing-class population amply illustrates the ugly side of the “investing for the long term” theory. Table 1.1 depicts 15 of the most widely held stocks in pension funds, mutual funds, and institutional and investor portfolios. As an investor you might have experienced the agony of opening your monthly statement, only to see the latest loss in your investment and pension fund portfolio. You have no doubt noticed how drastically your equity account has depreciated if you were holding any of the well-publicized “sound” investment stocks, including National City Corporation (NCC), Morgan Stanley (MS), Fannie Mae (FNM), Freddie Mac (FRM), Wachovia Corp. (WB), General Electric Co. (GE), Apple Inc. (AAPL), Washington Mutual (WM), American International Group (AIG), MBIA (MBI), Ambac Financial Group (ABK), Citigroup (C), Lehman Brothers Holdings (LEHMQ), Merrill Lynch (MER), UBS (UBS), Bank of America Corp. (BAC), General Motors Corp. (GM), or Ford Motor Company (F).

According to Bloomberg News, about 56 percent of hedge funds posted losses in October 2008. They lost 18.3 percent in 2008, their worst year on record.2 Their total loss amounted to $350 billion globally in 2008, the highest on record.3 Hedge fund assets fell $100 billion in the month as investors withdrew their money and funds were forced to sell stock, exacerbating the severe volatility that pounded global markets during the month. Hedge fund assets totaled $2.497 trillion at the end of the third quarter, according to HedgeFund.net, a hedge fund data provider.4

TABLE 1.1 Price Changes for Some of the Most Widely Held Stocks, 2007-2008

Data source: Yahoo! Finance.

The demise of Bear Stearns and Lehman Brothers, for years seen by investors as reliable, represented two of the more prominent failures, reinforcing the fact that many institutional and professional traders were caught by surprise when the current financial crisis struck. Their trading systems and risk management strategies, which were based on some market model that had presumably worked well in the past, were unable to foresee the financial markets’ meltdown.

The events of 2008 have led to seemingly peculiar and strange market behavior for many active investors and traders. Traders who lack an organic market timing method and a robust trading system have been unable to cope with the current market volatility. You could be like the many active investors and professional traders who have lost a great deal of money by trying to apply an old system to new market behavior. Despite your disciplined methodology and your best efforts to follow a trading system, you might be finding that your trading losses are growing faster than your profit. Maybe it’s becoming more challenging and difficult to trade your favorite security and market. Times have changed—but your way of thinking has not!

Needless to say, to be successful at trading you need a sound system that is resilient enough to adapt to different market conditions. All trading systems are rule based, and the simpler systems seem to be more successful and adaptable when there are major market shocks. However, to develop a system, you need to have a realistic view of market behavior. In other words, without a valid and sustainable market model, you can’t develop a robust system. And without a robust system, you cannot become a successful trader. What you must always keep in mind is that a thriving and profitable trading system, which is a collection of rules and trading strategies, has to be based on some realistic market model that explains market behaviors in varying conditions.

In this book I present you with my Winning Edge market model, which is nonlinear and based on dynamic system behavior. Furthermore, I show how you can develop a winning system based on my model. Before we proceed any further, however, let’s see what is so unique and different about recent market price actions. To do so, we first review the current market conditions to build a foundation for developing a robust system.

PRIMARY CAUSES OF THE CURRENT FINANCIAL CRISIS

The current financial crisis is attributed mainly to three factors: cheap money due to low interest rates; excessive borrowing by three economic sectors (consumers, corporations, and government); and lack of proper oversight and vigorous standards.

Low interest and cheap money were available for all, with less discretion. As a prolonged response to September 11, 2001, Federal Reserve Chairman Alan Greenspan cut the overnight Fed rate 13 times, to a mere 1 percent effective rate. After the stock market crash in 2000 and the bursting of the tech sector bubble, this action carried down all the major indices. It seemed that investors once more learned that “irrational exuberance” leads to a correction in market participants’ mindsets and financial settings. The NASDAQ index fell 60 percent while the S&P index and Dow Jones, two other major equity market indices, fell 50 percent and 40 percent, respectively. However, the housing market was on a path to reach an “exuberant” growth.

The stage was set by Baby Boomers at their peak productivity, by low interest rates, and by Bush Administration policy that encouraged banks to lend to low-income sectors and poor neighborhoods under the Community Redevelopment Act. Finally, the relaxed lending models used by Freddie Mac and Fannie Mae contributed to the creation of one of the highest-ever price appreciations for the U.S. housing market. Hedge funds and financial managers kept pumping more cash and funds into ever-heating housing sectors. Quasi-government agencies such as Fannie Mae and Freddie Mac, which had the unofficial backing of the government, purchased all types of mortgages, called papers, either grade A, B, or C. The clever investment bankers seized the opportunity to make more profit by buying these papers in bulk and securitizing them in more values to sell them to money markets, pension funds, insurance agencies, and public investors. Wall Street and the financial markets were shifting into a new gear to create a highly artificial and shallow economic expansion.

However, homeowners used their houses like automatic teller machines to withdraw more funds under home-equity lines of credit (HELOCs) for all types of discretionary and unwarranted expenses and speculative investing in real estate and hedge funds. Corporations kept buying their own shares to boost up their stock prices by borrowing more money and issuing more debt. The U.S. government and the Bush Administration were on a shopping spree of their own kind and kept spending, to become the second largest spender and holder of deficits since the FDR Administration.

In the past few years, about 60 percent of our gross domestic product (GDP) growth was the result of big government spending. The other 40 percent was primarily from the housing bubble. However, as the saying goes, all good things must come to an end. Some of the subprime borrowers were not able to make their mortgage payments because the interest rate was going up. They rushed to sell their real estate. Consequently, as more supply came to the market and there was less demand, prices had to come down. As the housing market fell and real estate prices dropped, the vicious market meltdown cycle began. Consequently, more borrowers and homeowners had more difficulty making their monthly mortgage payments, resulting in an even greater price drop. However, some homeowners found that their houses were less valuable than the amount they owed to the bank. This led them to file for bankruptcy and leave the houses for the banks to foreclose on.

Securitization of mortgages created a huge supply of mortgage-backed securities (MBSs), which were sold to mutual funds, money market funds, pension funds, and insurance agencies. The Wall Street genius investment banks went even further. That is, if mortgage-backed securities were sold to investors, they created collateral mortgage obligations (CMOs), some of them very high risk and below investment grade. To push these securities into financial distribution channels, our clever financial engineers created credit default swaps (CDSs) to insure the CMOs, MBSs, and other bonds and papers so that the sellers of debt instruments could convince buyers to buy their bonds. Now MBSs and CMOs were in big trouble. However, as the CMOs, MBSs, and other structured debt instruments got into trouble, the CDS market and the insurance market got into hot water, too. Giant international insurance agencies such as American International Group (AIG), which insured a large number of CDSs, were not able to keep up with payment defaults. As AIG went under, the foundation of the CDS market, which had grown to about $6.5 to $7 trillion, was shaken.

As the housing prices dropped and more homeowners were forced into foreclosure, the values of MBSs and CMOs dropped as well. Furthermore, since 2001 the financial institutions reporting rules had changed from cost-basis to mark-to-market value. (See Appendix A for more information on valuation methods.) During the housing market rise, financial institutions had been quite happy and felt rich because they could show very valuable assets on their financial balance sheets. Consequently, showing high-valued assets enabled them to borrow more and create stronger leverage.

However, as the housing prices fell, the same institutions did not have much to show for it. Moreover, since they had to report based on mark-to-market, either there was no market for their assets or it was very low, about 25 to 30 percent of original prices. This meant that each asset had to be devalued.

New Federal Reserve Chairman Ben S. Bernanke presented the situation at the National Association for Business Economics 50th Annual Meeting in Washington, D.C., on October 7, 2008:

. . . financial systems in the United States and in much of the rest of the world are under extraordinary stress, particularly the credit and money markets. The losses suffered by many banks and non-bank financial firms have both constrained their ability to lend and reduced the willingness of other market participants to deal with them. Great uncertainty about the values of financial assets, particularly more complex and opaque assets, has made investors extremely reluctant to bear credit risk, resulting in further declines in asset prices and a drying up of liquidity in a number of funding markets. Even secured funding has become expensive and difficult to obtain, as lenders worry about their ability to sell collateral in illiquid markets in the event of default. In addition, many securitization markets, such as the secondary market for private-label mortgage-backed securities, remain closed or impaired.5

The equity and stock market sold off to react to a financial crisis that seemingly began in the United States and soon spread across the globe. As the credit market dog was wagging its stock market tail, more financial problems came into play. The liquidity crisis changed to a confidence crisis. The central banks in the United States and across the world tried to calm the market anxiety by injecting more liquidity and reducing the overnight rates.

Fed Chairman Bernanke continued:

AIG’s difficulties and Lehman’s failure, along with growing concerns about the U.S. housing sector and economy, contributed to extraordinarily turbulent conditions in global financial markets in recent weeks. Equity prices have fallen sharply, the cost of short-term credit, where such credit has been available, has spiked, and liquidity has dried up in many markets. One money market fund’s losses forced it to “break the buck”—that is, the value of its assets fell below par—an event that triggered extensive withdrawals from a number of money market funds. Those funds responded to the surge in redemptions by attempting to reduce their holdings of commercial paper and large certificates of deposit issued by banks. Some firms that could not roll over maturing commercial paper drew on backup lines of credit with banks just as the banks were finding it even more difficult to raise cash in the money markets. At the same time, a marked increase in the demand for safe assets—a flight to quality and liquidity—resulted in a further drop in the value of mortgage-related assets and sent the yield on Treasury bills down to a few hundredths of a percent.6

In the following sections, we preview methods that you can use to deal with the current financial market meltdown.

DEALING WITH THE EMOTIONAL TOLL

Don’t count on the market or on government to rescue you. You need to be proactive and take matters into your own hands. It’s easy to blame the market and feel petty, falling into the victim mindset. If you are like many traders who experienced great losses in their investment and equity accounts, you might have gone through four distinct emotional stages: denial, anger, helplessness, and hopelessness.

First you went into denial due to total shock over the unexpected losses you experienced. It might have taken some time for you to realize what happened and what consequential changes you had to make to your lifestyle and spending habits. However, as time passed and you watched more TV reports, read more articles, and heard more financial news, you gradually came to an emotional realization about what occurred. You understood that a financial crisis had swept the nation, wiping out the majority of your equity.

Then perhaps you grew angry as the second stage of dealing with this phenomenon. You felt upset and aggravated and couldn’t take it anymore. You felt like screaming and expressing your anger. But then the anger passed and you moved on to feeling helpless. You felt you had lost control and there was nothing you could do to stop the massive loss and burden on your life. As the catastrophe spread to other financial institutions and companies, you recognized this is a massive market correction that was becoming a great market meltdown. You decided to follow the advice of the best financial advisors. You invested in the top-name hedge funds, which had enjoyed an impressive return in the past five years or so.

As you continued dealing with your losses, you reached the last stage: feeling hopeless. You started to experience emotional withdrawal. You didn’t feel like socializing with your friends and kept quiet in family and social gatherings. Sometimes you felt like you wanted to sleep forever and shield yourself from the burden of your financial losses, which had created a glum outlook for your life. You could care less what came next.

This stage, if not dealt with quickly, could create a major psychological problem for you. This is the time when you need to take control of your financial destiny again, seeking solutions and, if necessary, professional advice.

If you are among those who have been holding the bluest of stock market blue chips, hoping that they go back up so you can at least break even, here’s some sobering news for you. Your stocks and investments need to have moved up 1,000 percent in some cases, or even more, just to reach the price they were before this great stock market meltdown! If you think this is incredible, think about Freddie Mac’s stock price, for example; it was $37.18 on October 31, 2007, and dropped to $0.25 on September 17, 2008. It would take more than a 14,000 percent increase just to reach the original price for breakeven!

It’s time to look for a real plan and implement a real solution to get you out of such a financial mess.

RESCUING YOURSELF FROM FINANCIAL DISASTER

The past is past; there is no sense feeling bad about your past losses. Take your past as an expensive life learning lesson and move on. Remember, there is no way you can control market behaviors. But you can control your own behavior. Here is a five-step process for rescuing yourself from this financial disaster:

1. Don’t blame the market, or anyone else, for your investing losses.

Even people who’ve built careers studying economics were caught by surprise when the recent market turmoil struck. If professional investors were hard hit by the crisis, you obviously weren’t going to emerge from it unscathed. And don’t blame the market itself, either. It is simply a function of various factors and the dynamic ways in which they interact with one another. Accept what has happened—and the fact that the markets as well as your financial situation will not snap back to the way they were—and move forward. Life goes on, and the life of the market does, too.

2. Take personal responsibility for the things that you can control.

Whatever you do, never adopt the mentality of a victim. Whatever losses you have taken, you know that investing always comes with a certain amount of risk. You can never truly win at something if there is zero chance of losing. I urge you to use this sobering realization as a launching pad for greater success in the future. It is a sign of wisdom and maturity to know the difference between those things that are within your control and those that are not. You must learn to skillfully control and benefit from the former and bravely accept and endure the latter.

3. Become a trader.

As part of taking control of your own financial destiny, you should take a more active role in your investing. This means becoming a more active trader. The main difference between an investor and a trader is the frequency of their decision making. A trader makes more investing decisions with the help of a system. A trading system is a collection of trading rules that have been tested in various market conditions through a back-testing process (against historical data) and have proved to constitute a sound and robust system.

Never forget that you are captain of your own financial ship, so to speak. Steer her in the right direction and you are headed for a happy destination. But it is also your duty and obligation to yourself to be a vigilant watchman, on the lookout for any icebergs that may loom on the horizon.

4. Learn a winning investing plan and trading system.

To become a successful trader, first and foremost you need a proven and sound trading plan or system. In this book, I’ll teach you about my Winning Edge System that can help you become a successful trader.

5. Trade your plan.

Having a winning system is an essential part of your trading success. However, you need to work your plan and implement it properly. To execute your plan flawlessly with no emotional burden, your trading system should be compatible with your personality and psychological makeup. In this book I provide you a test that can identify your important personality traits. By knowing your trading personality, you could achieve a much higher level of success and execute your trading plan under stressful market conditions.

The essence of this rescue plan is taking an active role in creating your own financial destiny. Devise a proper strategy to adapt to those events that are not under your control. However, be proactive and implement a sound plan to achieve your financial prosperity and success. This begins with transforming yourself from a passive investor to a proactive trader. Consequently, for maximum performance you must plan for the long term but monitor and execute your plan in the short term.

TRANSITIONING FROM INVESTOR TO TRADER

One of the most important steps to achieve your financial rescue is to transform yourself from a passive and long-term investor to a proactive trader. You could become a part-time or full-time trader, but if you invest actively and decide what to invest in and how to monitor your investment portfolio and positions, you’re a trader.

Make sure you go into your trading endeavor with both eyes wide open, realizing how the investment world has changed. There’s an important mental shift that you need to make to begin your journey toward financial independence and success. You need to fully comprehend the various drastic changes that have taken place in terms of the way investments work. To become a successful trader, you should have a better understanding of the new market conditions, which is the topic of Chapter 2.

CHAPTER 2

Introducing the New Trading Paradigm

The investment world is in the midst of a paradigm shift. This change might be stressful and cause many losses for traders who fail to recognize it or for those who do indeed recognize the change but fail to adapt to it. Conversely, traders who wisely utilize the new conceptual framework of the financial system will succeed and enjoy better performance from their trading.

The new paradigm of trading offers you opportunities to achieve higher performance with less risk in a speedy manner. This represents a major departure from what was once, not long ago, commonly accepted practice. Now, short-term and flexible investment management and decision making are the order of the day. They replace protracted, inefficient, long-term buy-and-hold strategies that are no longer practical in today’s investment environment.

New concepts, such as the exchange-traded fund (ETF), for example, are swiftly replacing mutual funds, its old counterpart. This is because traders display more inclination toward risk in exchange for higher performance by embracing hedge funds and other exotic investment strategies.

To be a successful trader and achieve great performance from your trading, you need to change the way you were taught and trained about investing. The old ways of doing things are simply not going to work anymore. You need to learn and understand new concepts, tools, and trading models that are more suitable and productive for the current information age. The advent of technology has enabled us to obtain information faster than ever. The Internet makes all the information you might need only a simple mouse click away. There’s no longer any need to get locked into an investment idea or any particular stock. That type of conundrum belongs to the old ideas we were taught that insisted that to make a great return we should buy and hold for the long term, since that was the only way to be profitable. Otherwise, we were told, we were trading “noise.” However, we saw many of Wall Street’s darlings drop from their historical high to almost zero while we held them. So much for buy and hold!