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Quotable Quotes from Ed Seykota

 
Ed Seykota: 19 Trading Lessons from a Market Wizard

I was reading a bit more about Ed Seykota after seeing The Whipsaw Song.
Ed Seykota became famous after appearing in Jack Schwager’s Wall Street Wizards book. He has an Electrical Engineering degree from MIT and was one of the pioneers of systems trading. He supposedly returned 250,000% over 16 years for one of the accounts he managed.
Below I have categorized some of the quotes that I have come across.
Ed Seykota’s Trading Style
  • My style is basically trend following, with some special pattern recognition and money management
    algorithms.
  • In order of importance to me are: (1) the long-term trend, (2) the current chart pattern, and (3) picking a good spot to buy or sell. Those are the three primary components of my trading. Way down in very distant fourth place are my fundamental ideas and, quite likely, on balance, they have cost me money.
  • I consider trend following to be a subset of charting. Charting is a little like surfing. You don’t have to know a
    lot about the physics of tides, resonance, and fluid dynamics in order to catch a good wave. You just have to be able to sense when it’s happening and then have the drive to act at the right time.
  • Common patterns transcend individual market behavior (my note: i.e. price patterns are similar across different markets).
Overall Rules
  • Trade with the long-term trend.
  • Cut your losses.
  • Let your profits ride.
  • Bet as much as you can handle and no more.
Buying on Breakouts
  • If I were buying, my point would be above the market. I try to identify a point at which I expect the market momentum to be strong in the direction of the trade, so as to reduce my probable risk.
  • I don’t try to pick a bottom or top.
  • If I am bullish, I neither buy on a reaction, nor wait for strength; I am already in. I turn bullish at the instant
    my buy stop is hit, and stay bullish until my sell stop is hit. Being bullish and not being long is illogical.
Only Exit When Stops are Hit and Set Stops Immediately
  • I set protective stops at the same time I enter a trade. I normally move these stops in to lock in a profit as
    the trend continues. Sometimes, I take profits when a market gets wild. This usually doesn’t get me out any better than waiting for my stops to close in, but it does cut down on the volatility of the portfolio, which helps calm my nerves. Losing a position is aggravating, whereas losing your nerve is devastating.
  • Before I enter a trade, I set stops at a point at which the chart sours.
Learn to Get Back In
  • Getting back in is an essential part of trend following.
Hold Your Position Until the Trend is Invalidated, Do Not Let Go of Your Position. Be Willing to Experience Your Anxieties
  • Maintaining a commitment is particularly important when it comes up for a test.
  • Somewhere along the line of keeping your commitment you may get a feeling that you don’t like.
  • If you are willing to experience the feeling, it can transform into an AHA that supports your commitment.
  • If you are unwilling to experience the feeling, you might abandon your commitment to try to make the feeling go away. That only results in having to feel the feeling after all.
  • The more you are willing to experience the feeling of bumping into walls, the less you have to bump into walls.
  • Trading requires skill at reading the markets and at managing your own anxieties.
  • People have a Conscious Mind and Fred. Fred wants to communicate feelings to CM so CM can experience them and gain experience and share it with Fred so Fred can learn how to react. This is how we manufacture wisdom. When we don’t like our feelings we tie them in k-nots and do not experience them. This interrupts the wisdom manufacture process, and draws drama into our lives.
  • K-nots, protect us from truth and keep our lives in drama. To untie k-nots, fully experience whatever appears in the moment.
  • When you keep your eye on the prize and are willing to experience all the feelings that arise, the prize soon becomes yours.
Do Not Shut Out or Ignore Your Fear
  • The positive intention of fear is risk control.
  • People who are unwilling to experience fear tend to take big risks and wind up in big drama in which the risk materializes.
  • People with poor risk control tend to bet heavy. So they tend to outperform others in good markets, and under-perform them in poor ones.
  • Risk is the uncertain possibility of loss. If you could quantify risk exactly, it would no longer be risk.
  • Risk control has to do with your willingness to allow your stop to do its job.
Risk Below 5% of Equity Per Trade
  • I intend to risk below 5% on a trade, allowing for poor executions. Occasionally I have taken losses
    above that amount when major news caused a thin market to jump through my stops.
  • Risk no more than you can afford to lose, and also risk enough so that a win is meaningful. If there is no such amount, don’t play.
  • Speculate with less than 10% of your liquid net worth. Risk less than 1% of your speculative account on a trade. This tends to keep the fluctuations in the trading account small, relative to net worth. This is essential as large fluctuations can engage Fred and lead to feeling-justifying drama.
  • Betting more boldly produces more volatility. Good traders are familiar with both and keep their trading well within their tolerances.
  • I use a rule of thumb that you place less than 10% of your liquid net worth at risk and that you stop your losses at 50% of that – so you have net exposure of 5% of your liquid net worth. If you have a net worth of 1.5 million, you might have liquid net worth (cash, stocks, bonds, etc) of, say, about 500,000 (a wild guess). Then you might place $50,000 of that at risk and cut your loss if you lose $25,000.
  • The idea is to keep the venture below your threshold of financial importance, so nominal ups and downs do not trigger your emotional uncle point and motivate you to abandon the venture during drawdowns.
What Trend Trading Is (Ignore Fundamentals)
  • Reliance on Fundamentals indicates lack of faith in trend following.
  • For Trend Traders, understanding the markets is typically optional, often counter-productive.
  • When an up-trend happens, the price is moving up.
  • Trend Traders get a signal and pull the trigger without regard to the result of any individual trade.
  • Playing for comfort and searching for meanings are both counterproductive to Trend Following.
  • Trend Following systems do not speak about entry and exit prices.
  • Trend systems do not intend to pick tops or bottoms. They ride sides.
  • I don’t implement momentum; I notice it and align my trading with it.
  • There is no such thing as THE trend. Some of the shorter indicators are down while some of the longer ones are still up.
You Don’t Need to Get Caught Up in Intraday Market Movements / Do Not Day Trade
  • Having a quote machine is like having a slot machine on your desk— you end up feeding it all day long. I get my price data after the close each day.
  • Day Trading is an exercise in limiting profits while continuing to pay normal transaction costs. Day trading may provide a way to cover up deep feelings that the trader does not wish to face.
  • Short Term Trading is one good way to realize your intention of reducing account equity.
  • Intraday trading is tough since the moves are not as big as for long-term trading and there is no comparable reduction in transaction cost. In general, short-term trading systems succumb to transaction costs and execution friction. You might simulate your system over historical data and notice how sensitive it is to assumptions about where you get your fills.
  • The shorter the term, the smaller the move. So profit potential decreases with trading frequency. Meanwhile, transaction costs stay the same. To compensate for profit roll-off, short-term traders have to be very good guessers. To improve guessing skills, you can practice dealing cards from a standard deck, one at a time. When you become very good at it you might be able to make money with short term trading.
Prudent Money Management is the Key to Longevity
  • The key to long-term survival and prosperity has a lot to do with the money management techniques
    incorporated into the technical system. There are old traders and there are bold traders, but there are very few old, bold traders.
  • The manager has to decide how much risk to accept, which markets to play, and how aggressively to increase and decrease the trading base as a function of equity change. These decisions are quite important—often more important than trade timing.
  • I have incorporated some logic into my computer programs, such as modulating the trading activity
    depending on market behavior. Still, important decisions need to be made outside the mechanical system boundaries, such as how to maintain diversification for a growing account when some positions are at position limit or when markets are too thin.
  • I tend to alter my activity depending on performance. I tend to be more aggressive after I have been winning, and less so after losses.
Longevity is the Key to Success
  • The profitability of trading systems seems to move in cycles. Periods during which trend-following systems are highly successful will lead to their increased popularity. As the number of system users increases, and the markets shift from trending to directionless price action, these systems become unprofitable, and undercapitalized and inexperienced traders will get shaken out. Longevity is the key to success.
Do Not Pyramid Aggressively
  • Aggressive pyramiding, and other forms of accumulating monster positions are good ways to lose big money, even in a bull market.
The Trader and the Trading System Must Meet
  • Systems don’t need to be changed. The trick is for a trader to develop a system with which he is compatible.
  • My original system was very simple with hard-and-fast rules that didn’t allow for any deviations. I found it
    difficult to stay with the system while disregarding my own feelings. I kept jumping on and off—often at just the wrong time. I thought I knew better than the system.
  • Also, it seemed a waste of my intellect and MIT education to just sit there and not try to figure out the markets.
  • Eventually, as I became more confident of trading with the trend, and more able to ignore the news, I became more comfortable with the approach. Also, as I continued to incorporate more “expert trader rules,” my system became more compatible with my trading style.
  • As I keep trading and learning, my system (that is the mechanical computer version of what I do) keeps evolving.
  • Over time, I have become more mechanical, since (1) I have become more trusting of trend trading, and (2)
    my mechanical programs have factored in more and more “tricks of the trade.” I still go through periods of thinking I can outperform my own system, but such excursions are often self-correcting through the process of losing money.
  • I don’t think traders can follow rules for very long unless they reflect their own trading style. Eventually, a breaking point is reached and the trader has to quit or change, or find a new set of rules he can follow. This seems to be part of the process of evolution and growth of a trader.
  • A trading system is an agreement you make between yourself and the markets.
Embrace Whipsaws
  • Trading Systems don’t eliminate whipsaws. They just include them as part of the process.
Do Not Predict Or Anticipate
  • A computer can follow a system and place orders without making predictions or feeling anticipation. Predictions and anticipations are objects you create. These objects may interfere with sticking to your system.
Take Care of Your Emotions
  • Sometimes I trade entirely off the mechanical part, sometimes I override the signals based on strong feelings, and sometimes I just quit altogether. The immediate trading result of this jumping around is probably breakeven to somewhat negative.
  • However, if I didn’t allow myself the freedom to discharge my creative side, it might build up to some kind of blowout. Striking a workable ecology seems to promote trading longevity, which is one key to success.
  • Gut feel is important. If ignored, it may come out in subtle ways by coloring your logic. It can be dealt with
    through meditation and reflection to determine what’s behind it.
  • One of the best ways to increase profits is to do goal setting and visualizations in order to align the conscious and subconscious with making profits. I have worked with a number of traders in order to examine their priorities and align their goals. I use a combination of hypnosis, breathing, pacing, visualization, gestalt, massage, and so forth. The traders usually either (1) get much more successful, or (2) realize they didn’t really want to be traders in the first place.
  • A fish at one with the water sees nothing between himself and his prey. A trader at one with his feelings feels nothing between himself and executing his method.
Cut Your Losses
  • The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses. If you can
    follow these three rules, you may have a chance.
Don’t Play “Catch Up” After a Losing Streak
  • I handle losing streaks by trimming down my activity. I just wait it out. Trying to trade during a losing streak
    is emotionally devastating. Trying to play “catch up” is lethal.
Take a Break If Necessary
  • Sometimes I get to a personal breakpoint. When that happens, I just get out of the markets altogether and take a vacation until I feel that I am ready to follow the rules again.
A Winning Mindset is Required To Succeed
  • A losing trader can do little to transform himself into a winning trader. A losing trader is not going to want to
    transform himself. That’s the kind of thing winning traders do.
  • The winning traders have usually been winning at whatever field they are in for years.
  • It is a happy circumstance that when nature gives us true burning desires, she also gives us the means to
    satisfy them. Those who want to win and lack skill can get someone with skill to help them.
  • The “doing” part of trading is simple. You just pick up the phone and place orders. The “being” part is a bit more subtle. It’s like being an athlete. It’s commitment arid mission. To the committed, a world of support appears. All manner of unforeseen assistance materializes to support and propel the committed to meet grand destiny.
  • In your recipe for success, don’t forget commitment – and a deep belief in the inevitability of your success.
-END-

Book Review of Bear Market Investing Strategies by Harry Schultz

 
Have $1,000? Here's My Single Best Investment Idea for April | The ...


The full title of this book is Bear Market Investing Strategies by Harry D. Schultz (2002).
Harry Schultz wrote the International Harry Schultz Letter for 45 years, with his last newsletter in January 2011 when he retired at 86. 45 years is a pretty amazing run!
This book is a quick read coming in at ~150 pages. The book quotes frequently from various famous market technicians such as Robert Rhea, Charles Dow, Joseph Granville, H. M. Gartley, etc. I like how the book wrote about some finer points, that a dull market should be interpreted differently depending on whether it is a bull market or a bear market, that the initial decline that starts a bear market occurs on light volume so it can be hard to differentiate it from a normal bull market retracement, and that actions to take during a bear market depends on whether it is an inflationary or a deflationary recession/depression.
I find it interesting that the author quotes a lot from Robert Rhea, who wrote that “An understanding of a secondary reaction is needed by traders to about the same extent as a growing cotton crop requires sunshine”, yet he followed that with “It is usually impossible to pick the turn [peak of a bear market rally] with any degree of precision”, which may explain why Rhea wrote in 1938 that the bear market “may last for a week, a month, or many months”.

GENERAL OBSERVATIONS
Dow’s Great Law of Action and Reaction (50% Principle)
  • Charles H. Dow wrote an editorial published in the Wall Street Journal on July 7, 1900.
  • “It is a remarkable fact in speculation that both the average price of a number of stocks and the price of individual stocks show strong tendencies, both in rallies and relapses, to reach one half of all the primary movement…. When a recovery does not comes near being one half of a decline, it generally means that the primary movement has not been completed and that a new low quotation will be made.”
No Exact Retracement % for Reactions
  • Robert Rhea: If we could say that the great majority of secondaries terminated around the 50% recovery point, speculation would be easy. Unfortunately, careful analysis shows that 7% of all reactions terminate after retracing 40-55%, 27% after tracing 55-70%, 8% after retracing 70-85%, with 14% of all secondary movement extending beyond 85% retracement.
Reactions Are More Violent
  • Reactions (whether in bull or bear markets) nearly always consume less time and are more violent than are movements in the direction of the primary trend.
  • It is not unusual for a 3-week rally in a bear market to retrace 30% to 60% of a downward swing, which may have taken many months to complete.
  • Bear market secondaries often present a bouncing or turn-on-a-dime appearance; the rallies seem to spring from no visible base or area of support.
“Never Sell a Dull Market” Does Not Apply for Bear Markets
  • Dow in 1902 wrote “… the action of the market after dullness depends chiefly upon whether a bull or bear market is in progress. In a bull market, dullness is generally followed by advances, in a bear market, by declines…. in bear markets, prices fall because values are falling, and dullness merely allows the fall in values to get ahead of the fall in prices.”
The Process of Changing Makes Prices Move
  • Jim Sibbet: Whenever a sizable (over 10%) market movement occurs, it continues until the public, generally emotional, changes its mind and joins the movement. At first the tendency is toward disbelief, then gradually a few change, then more, and finally the overwhelming majority change their minds to such an extent that everyone will agree as to the prevailing opinion. When there is a conflict of opinion about the public’s attitude, …, the movement continues until there is no longer any doubt as to what the public’s opinion is.
  • The 1930 rally ran up until everyone was convinced another bull market had started…. Until there is unanimity of opinion, the current uptrends are likely to continue, because there are many people who are yet available to change their minds. Others who have already changed their minds are waiting for a good reaction to buy cheaper. This helps support the dips. It is the process of changing that makes prices move. After everyone’s mind is made up, the movement stops and reverses.
BEAR MARKET SIGNS
Signs That a Bull Market is Ending
  • Sentiment
    • Consumer confidence is high
    • Investor sentiment is bullish while the underlying economic structure continues to weaken.
    • Price earnings ratio are divorced from values of companies
    • Unanimously bullish forecasts.
  • Macro
    • Interest in gold and gold shares pick up.
    • Interest rates are already low
    • Sharp rise in consumer debt, household debt service payments, losses by credit card issuers, bankruptcy filings, and mortgage delinquencies.
    • Lots of public speculation in real estate.
  • Market action
    • Churning action in the stock market.
Signs That a Bear Market is Ending
  • Sentiment
    • Bad news abundant, pessimistic forecasts
    • Low P/E, high yields
  • Macro
    • Credit balances in brokerage accounts are considerable. Large holdings in bonds and other cash-related investments are latent buying power.
    • Real estate prices are down (unless it is an inflationary bear market), empty commercial buildings, foreclosures rise.
    • Bonds are popular, yields are low.
  • Market action
    • Low volume, new lows occurring on lower volumes, rallies occur on higher volume.
Three Phases of a Bear Market (Robert Rhea)
  1. Phase 1 — Abandonment of the hopes that fueled the earlier bull market
  2. Phase 2 — Reflection of decreased earning power and reduction of dividends
  3. Phase 3 — Distress liquidation of securities to meet living expenses
How Volume Changes as a Market Rolls Over (Joseph Granville)
  1. Phase 1: Decline on light volume — professionals are selling, public remains confident.
  2. Phase 2: Decline on heavier volume — professionals are selling, public starts to lighten up
  3. Phase 3: Decline on still heavier volume leading to a selling climax — professionals finish selling, public selling heavily
  4. Phase 4: Temporary rebound — professionals cover their shorts and buy, public continues to sell
Indicators
  • Advance-decline line
  • New highs – new lows
    • Chart SMA (daily number of new highs, 5) and SMA (daily number of new lows, 5)
    • Check that during a reaction that interrupted a major upswing, the new highs line remained on top.
  • Odd-lot balance index
  • Odd-lot trading ratio
  • Odd-lot short sales index
  • Volume
  • 30-week SMA of DJIA (Friday close)
  • 10-day SMA of (advances – declines)
  • Barron’s Confidence index
  • Short interest
  • Short interest ratio
  • Brokers’ Free Credit Balance Index
  • Brokers’ Debit Balances Index
  • Nasdaq indexes
  • Resistance Index
    • If DJIA is up, resistance index = (total issues traded – total issues advancing) / total issues traded
    • If DJIA is down, resistance index = (total issues traded – total issues declining) / total issues traded
  • Leadership index
    • Average price of the daily volume leaders. This shows the kind of leadership in the market.
    • If it falls on upswings or rise on downswings, it’s bearish.
  • Percent of advances index
    • 10-day SMA of (Daily advances / Issues traded)
  • Gold shares index
  • DJIA 10-day SMA of internal volume
    • Formula = SMA (total volume of all DJIA stocks that rose, 10 days) – SMA (total volume of all DJIA stocks that fell, 10 days).
    • Plot this to measure blue-chip strength and use trend lines.
  • DJIA resistance
    • Plot daily volume of unchanged issues. When unchanged volume is high, whatever the market did that day is “wrong” will be reversed the next day.
  • DJIA volume ratio
    • Volume of all DJIA stocks / Volume of the market as a whole. High ratio is bullish, low ratio is bearish.
  • 200-day SMA of advance-decline line
  • Nasdaq volume leaders
    • Record plus and minus action of the top five Nasdaq most active stocks.
    • First day of five consecutive pluses is bullish signal, first day of five consecutive minuses is a bear market signal.
Take Action Only When Indicators Heavily Favor One Side
  • In working with indicators, unless you have truly heavy weight on the side of buy or sell (e.g. 17 buy, 4 sell, 9 neutral), you cannot hope to succeed, on average.
SHORT SELLING
Criteria for Short-Sale Candidates
  • Stock had a large rise in recent weeks or months on increased volume, so people will rush to sell when it breaks down
  • Shows a top area of distribution (large volume but unable to rise further) and has started to break down.
  • Not yet declined more then 10-15% from its secondary peak.
  • Abnormally high P/E ratio
  • Low short interest (relative to free float shares in the market)
  • Avoid thinly capitalized stock or low-liquidity stocks.
  • Better if the stock has hit a heavy oversupply area or a prior support that had broken down earlier.
  • Avoid cheap stocks under $5.
Stops in a Short Position
  • After entering into a short position, place a stop-close-only order (to avoid getting stopped out from intra-day flukes) about one or two points above the downtrend line. You want out of your short at once, not caring if it’s a so-called false break or a genuine reversal.
  • Trail the stop down based on the trend line.
Don’t Hold for Income in a Bear Market
  • Put money you can’t afford to risk into defensive issues such as bonds, preferreds, utilities, Muni’s, or, in the case of an inflationary bear market, bonds and tangible assets.
  • Even living off capital at such times is cheaper in the long run than holding stocks that decline.
ASSET CLASSES PERFORMANCE IN BEAR MARKETS
Real Estate Performs Differently in Different Bear Markets
  • In inflationary bear markets (i.e. bear markets due to high inflation), real estate is seen as a haven and prices rise.
  • In bear markets where inflation is low and the currency firm, real estate prices will usually stay firm in the early stages, but will decline as the bear market deepens.
  • If headed for a depression and you aren’t married to your home, sell before the property falls much, rent rather than own.
  • In a deflationary recession, interest rates usually decline, so try to refinance any mortgages.
Bond and Cash-Equivalents
  • In an inflationary environment, hold bonds of other currencies that are not suffering from high inflation.
  • Else, having a major portion of your portfolio in bonds (Treasury bonds with 5-10 year maturity of quality corporate bonds) and bank accounts at interest is prudent.
Tangible Assets
  • In an inflationary recession, stamp or coin collection, jewelry, rare stones, antiques, art, old cars values are likely to increase much more than the increase in inflation.
  • In a deflationary recession, all things will decrease in value.
Gold
  • In times of uncertainty, gold rises regardless of whether the climate is deflationary or inflationary, though gold usually rises more during times of inflation.
  • In the early stages of a bear market, buy a 10-15% investment in gold bars, gold bullion coins and gold mining shares — all three.

-END-

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