Peter is a professional trader, Paul is not. Peter has a tested, proven, written trading plan that he follows each time he enters a trade, Paul does not. Peter has agreed to meet with Paul to help Paul become a more successful trader.
Paul was early for his first appointment to see Peter a few days later – he was feeling both excited and apprehensive. Peter had told him he would show him how to use technical analysis and swing trading strategies to trade Stock market trends with confidence – but could he really do it?
Did he have the ability to become a successful trader after losing so much money in the market these last two years? Was he just wasting Peter’s time?
As he waited, he thought about the look Beth had given him when he had told her about his trading losses…the sense of failure he had experienced as she just walked away. The feeling of utter helplessness he had felt as the enormity of his losses had finally dawned on him. He had been so close to financial freedom, but now that had been taken away from him.
He was just starting to feel sorry for himself again when Peter strode into the foyer of the office building and wished everyone good morning – feeling sorry for himself would have to wait until later.
Peter motioned him to follow him to the elevator. Paul did so and they chatted as the lift took them to Peters 30th floor office. It was smaller than he had imagined, just a receptionists desk in the waiting room and one office with a view of the city.
He expected something grander, but the office was functional, and besides, Peter didn’t have a need for any more space as he had only 1 staff member, Kim, his Secretary and receptionist, host, coffee maker and confidant.
The focal point of Peter’s office was his trading screen – a triple screen plasma display monitor over 4 foot wide. “Not that’s a screen,” Paul thought to himself.
Kim brought in coffee and then left them alone. Paul poured them both a cup and took a seat.
Peter gazed out the window towards the city for more than a minute before speaking. “So you want to be a trader?” he finally asked. “Yes, but more than that, I want to be a great trader,” Paul answered, “Like you.”
“How do you know I am a great trader? And anyway, what is your definition of a great trader?” Peter asked.
“I heard you talking at the diner the other day – you certainly know what you are doing, and the market is up 5 days straight and more than 130 points since you bought the S&P 500 Index, that’s 20% in a week!” Paul explained. “I think anyone who can take their profits on the day of a major low like that and then have the ability to turn around and buy…and be dead right, is a great trader.”
“That is true, the Index is up a long way. And yes, I did get in at the low, didn’t I? So I guess, by your definition, I am a great trader,” Peter chuckled to himself.
“How far do you think the market will go up before it has a breather?” Peter asked. “I have no idea,” Paul replied. “Neither do I, that’s why I have placed my sell orders below the daily lows each day in case it turns around again and I’m ready to go short again,” Peter explained.
“It’s not so much picking the low that is important or even necessary, it’s managing the trade as it progresses that makes the money,” Peter added.
“But we’ll get to that later, let’s have a look at a chart and tell me what you see,” Peter said. He opened his charting software and soon they were looking at a monthly chart of the S&P 500 Index. Chart available at Stock Trading Review.com
“This is the last 3 years price history of the S&P 500 – what can you tell me about the direction of the trend?” Peter asked.
“It’s been going down,” Paul replied. “Correct, and which way have you been trading this market that has been in a clear down trend?” Peter continued. “I haven’t been trading it at all, I’ve just been fully invested, losing money,” Paul replied.
“Then you have indeed been trading it, my friend.” Peter continued. “By sitting on your hands for the last 2 and a half years while prices continued to fall, you have been fighting the trend. People who fight the trend always lose money.
“Then, you finally sold in a panic, like all the other small traders who finally gave up hope last week. You sold to people like me. The same thing happens every time there is a correction or bear market – the small traders hang on until they can’t stand to be in the market any longer, they all sell together in a panic and then the market goes up.”
“Tell me, looking at this chart, when did the downtrend start?” Peter asked.
“Well I guess around December, 2000 is where it looked like it started to fall away,” Paul replied. “Correct,” replied Peter.
“That means that from December 2000, there was no reason to be buying this Index, or buying Stocks that were showing the same chart pattern, and there was every reason to have your Stock portfolio hedged if you didn’t sell or have your money in cash.”
Paul looked at the chart and of course it was easy to see the trend was down with hindsight.
Before he could say anything, Peter continued. “Of course, hindsight trading is perfect, so how would you have known the best time to get out of the market or hedge your portfolio?” Paul looked at the chart and said, “I guess when the moving averages crossed over.”
“Correct,” said Peter. “So, for the last 2 and a half years, the trend on the monthly chart was down. “What else does this chart tell you about the market?”
Paul looked at the chart, but he wasn’t really sure what Peter wanted to know. “I’m not sure,” he finally confessed.
“Take a close look at the reactions within the downtrend. Notice that the largest one only managed to go against the trend for 3 months. In any timeframe, a market or Stock that can only go against the major trend for a few bars like this is in a very strong trend.
“Also, the Index was consistently closing below the short term moving average, and always closed below the longer term moving average – this is not something you want to sit through fully invested, holding on and hoping,” Peter continued.
Paul could see now the reason for his huge losses. He had looked at charts before but he had never looked at the big picture. The monthly chart showed the trend clearly – and it had been down. A simple moving average crossover sell signal would have saved his fortune…
“This simple timing system is what I use for my long term portfolio,” Peter continued. “I have 70% of the funds I have allocated to the Stock market invested for the long term in leveraged S&P 500 Index Funds. My investment in these funds forms the core of my Stock portfolio.
“I initially entered when I got a buy signal in 1994 and added more funds each month – 50-70% of my net short term trading profits and other income. I kept an eye on the monthly chart and didn’t get a sell signal until the end of 2000. I was fully invested in those funds from around 500 points to 1450 points.”
Peter then showed Paul a monthly chart going back to 1994. Paul looked at it in disbelief. He was looking at probably the greatest wealth creation trend in history and he had missed most of it because of his short term focus. Chart available at Stock Trading Review.com.
“Remember this Paul,” Peter said as they studied the long term chart, “Wealth comes from looking at the big picture. Many people believe that holding for the long term means forever. I prefer to hold things that are rising in value. If the trend turns down, I take my money and wait until the trend turns up again.
“This strategy of timing the market with a simple moving average crossover has made me a fortune while millions of people in this country have lost their life savings.
“Smart investors always invest the majority of their capital for the long term, but have clear guidelines for preserving it if the trend changes. They only trade with a small amount of money that they are prepared to lose.
“Your trading will be more profitable if you know that you have a substantial portfolio invested long term and it is increasing your wealth. By trading your entire account, and not managing it properly, you risked, and finally lost, most of it.
“And even though I bought a small position in Index futures a few days ago, my long term portfolio is still fully invested in Mutual Funds that trade inversely to the Index – in other words, the unit price of those Funds increases if the Index goes down.