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Trading 101

Trading 101: 10 Essential Investment Rules For Rookies

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As you saw in our Trading vs. Investing article, in several ways, value investing is the polar opposite of trading. That said, in other regards, the two different approaches are very close to each other. Following your investment rules with discipline, for example, is as important in investing as it is in trading. In short, objectivity, patience, dealing with emotions, and other “soft” skills are very important for both methods. The actual rules and best practices to follow, on the other hand, are usually unique for trading and investing.

Also read: 10 Essential Trading Rules for Rookies

As with trading, there are rules that are more important for beginners than they are later on in an investor’s career. In several ways, staying in the game is more important than your initial results, as with experience you will naturally evolve, find your comfort zone, and be able to focus on your edge. The following rules are addressing the most basic mistakes that rookies commit, while also focusing on the cornerstones of investing that will jump-start your career and boost your returns.

Let’s jump straight into it.

Good investing is simple, don’t complicate your analysis

This is probably the most important rule that should be taught on financial courses before anything else. Keep it simple! Buy great assets for a fair price. That sentence is the key to investing. Sophisticated models are often just tools for justifying a “gut” decision, or worse, convincing yourself that your initial decision was wrong. Don’t fall into that trap!

Think about it, what makes a great company for example? It has an edge over its competitors, has a solid and growing market where it sells its products, and has a history if innovation and flexibility. These simple rules are almost always enough to find investment candidates, and if the valuation is also favorable, you will have the margin of safety to act upon your analysis without taking on unnecessary risks.

Valuation matters in the long-run but it’s not a timing tool

One of the common mistakes of newbie investors, including your humble author himself, is that you will be looking for “the Holy Grail” measure that will help you decide whether or not a company or stock or a market is overvalued, undervalued, or fairly valued. The truth is that there are several measures that come close enough, but investing is far from being a valuation-only game.

This is especially true if you try to base your timing decisions on valuations. As Keynes once said, markets can stay irrational longer than you can stay solvent. The emphasis on timing is crucial, as valuation should be incorporated into your analysis, but don’t expect the market to turn higher just because the asset got undervalued, or crash because it’s overvalued. As an investor, you have to accept that even long-term price trends might be products of mass psychology, economic trends, government intervention, and so on. On the long run valuation drives returns, but short-term it says nothing about the direction of the market.

Start investing in businesses that you know

The competitive edge, the stable and growing market, and the history of good decisions seem like very easy filters for companies, but they are only easy if you know the business that you are dealing with. Otherwise, you might be basing your decisions on false assumptions.  Of course, this goes for all other forms of investments, from farming to antiques.

If the most successful investors stick to a few industries that they are familiar with, why would a beginner venture into unknown territories? Using your knowledge and interests can give you the edge in the beginning of your career.

Markets show the value of the last trade, not the “real” value of assets

Maybe the biggest fallacy, which is common even among financial professionals, is that they treat the price of an asset as the one and only truth out there, without thinking about the mechanics of markets.  That puts the “valuation” of assets into totally unrealistic heights near the top of bull markets and to insanely cheap levels at the bottom of bear markets.

For an individual investor these are great opportunities, but remember, on average investors will never be able to realize those prices. Why? Because if every owner of the given stock appeared on the market to buy or sell, the realized price would be way lower or higher than the quote that you see on your screen.

The tide of a bull market lifts all “ships” but a bear market hurts even the best companies

One of the most important lessons for an investor comes from the fundamental change in risk appetite between rising and falling markets. Bull markets tend to be long and a lot of times boring affairs for an investor, as valuations get richer and richer across the board, quietly reaching levels where it will be very hard to pick bargains. On the flipside, your holdings will deliver great returns, with relatively low volatility, a lot of times much more than you’d ever expected. Value these times and be patient until you notice the signs of change.

On the other hand, you have to know that when markets tank, even the best companies can suffer great losses. Sentiment turns bleak, and panicked investors run for the exits, often pushing valuations way below any reasonable level. If you are confident in your decisions you will hold on to your investments and even add to your holdings rather than dumping them on the market.

Be greedy when others are in panic and cautious in times of euphoria

Another rule that is attributed to Warren Buffett, but if you understand the previous rules it’s just a small logical step. That said, this small step is often the hardest, on market bottoms, everything looks gloomy, everyone thinks the world will end, and even as your analysis shows bargains all over the place, you will most likely hesitate to “pull the trigger”.

Conversely, near tops you will have plenty of excuses to ignore the warnings signs that pop up, as the economy will be great, investors will be piling into risk assets, and prices will seemingly keep on rising forever. Still, these times should be used to gradually lower your exposure to prepare for the inevitable sobering.

This time it’s not different

Panics and bubbles almost always give way to extreme opinions and baseless speculation, with a “new era of investments” or a “plateau of high valuations” on one side and “the collapse of the financial system” or the “end of the economy as we know it” on the other side. These theories help in justifying the irrational nature of markets, while also feeding the excess sentiment, but don’t be fooled, 99% of the times they will have nothing to do with the reality. Base your decisions on your analysis and common sense, rather than wild predictions and unfounded projections.

Successful investing is about patience, excitement shouldn’t be your goal

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If you are having lots of fun while investing you might be doing something wrong; too much exposure, leverage, too concentrated bets could all give you thrills, but usually at the cost of way too high risk. Most of the times, a good purchase is in segments that are totally forgotten, and considered “boring”. Think about it, what are the chances that you will find deeply undervalued assets in a hyped market?

Also, exciting market moves are characteristics of a bubble, and although bubbles are great to ride all the way up, a disciplined investor will likely exit them a bit early. But that’s not a bad thing, bubbles are only easy to trade in hindsight, and although you won’t sell at the exact top, that last 10% won’t make a huge difference if you have been participating in the trend since the start.

Patiently waiting for great opportunities and sitting out boring advances are crucial and underrated skills—work on them.

Sometimes doing nothing is the optimal strategy

This rule is closely related to the previous one, but it’s crucial to understand, especially in today’s environment, that most of the times investors don’t have to be active. The media, sell-side analysts, and your broker are all there to tell you otherwise and encourage you to trade. This often leads to investors mixing trading with value investing and losing perspective.

While it’s common to think that the next big turning point is close, and someone out there is just nailing it, the reality is that trends will usually go on much longer than anyone expects. If you are waiting for a boom or crash every month, then you should revise your expectations, even if once you will inevitably be right.

Buy assets that you would be happy to hold if the market was closed for years

A good purchase should be one for the long run, a good business or a good productive asset at a fair price shouldn’t be the function of market prices. Sure, if the price of your holding triples overnight (thanks to a takeover bid for example) it might be the good decision to cash out immediately, but in general, your investments should “work” without a constant market.

That, of course, means that apart from a liquid safety sum, you shouldn’t rely on your investments as a continuous source of income, rather a long-term source of wealth. This mindset will help you immensely both in your investment and portfolio decisions.

What’s next?

After these basic rules, we will take a look at the most reliable valuation measures that can help you decide what the fair price of an asset should be. That’s a crucial step towards successful investing, but don’t forget, the Holy Grail is not an algorithm, it’s common sense.

Previous article: Chart Patterns, Part 1

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.6 stars on average, based on 347 rated postsTrader and financial analyst, with 10 years of experience in the field. An expert in technical analysis and risk management, but also an avid practitioner of value investment and passive strategies, with a passion towards anything that is connected to the market.




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2 Comments

  1. Gabriel

    May 14, 2017 at 4:56 am

    Great guidance. When you favor value investing, it can be tempting to dip into trading as the markets go crazy on a daily basis. It is good to be reminded that patience is a great skill in itself.

  2. sjoenne

    May 21, 2017 at 10:07 pm

    Good guidance !
    What are your thoughts on Aragon (ANT) and SiaCoin(SC)??

    Would be great if there was a chatroom available inside hacked.com

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Trading 101

Trading 101: 4 Reliable Chart Patterns in Crypto Trading

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Graph

In our previous piece on chart patterns, we pointed out that the way to use patterns is to judge probabilities that a certain move will happen rather than to view them as some holy grail in the market (which unfortunately doesn’t exist to my knowledge).

Although they aren’t holy grails, chart patterns are some of the best tools we can use to trade the markets with a surprising degree of accuracy. For example, some estimate that a well-known pattern like the head & shoulders have an accuracy of more than 80% when it is complete. Very few indicators can match that!

In this article, we’ll go over the 4 best chart patterns to use in crypto trading, teach you how to spot them in the charts, and show you how to trade them.

1. Head & shoulders pattern

Since I already singled out the head & shoulders as the most accurate pattern, let’s start with this classic chart pattern that most people have heard about and probably have an idea what should look like.

head and shoulders

The head & shoulders pattern generally signals a reversal in the market, as it is essentially a failed attempt of a trend to move higher. As we know, an uptrend is defined as a series of higher highs and higher lows, but in the case of the head & shoulder, the last trend wave fails at making a higher high and higher low, and a new downtrend is initiated. The opposite pattern, known as an inverse head & shoulder, signals a shift from a downtrend to an uptrend.

Since the head & shoulder is so well-known by now, and the logic is based on simple trend trading, it is often considered to be the most reliable pattern in trading. It can often be easier to spot on a line chart as it can help you filter out all the clutter otherwise found on candlestick charts.

2. Bull flag

This is a continuation pattern and is also considered one of the most reliable bullish patterns we have. Sometimes also called a pennant or a wedge, these names all essentially refer to the same thing.

Bull flag

The bull flag is formed when price enters a consolidation phase following a strong uptrend. What really happens when price is consolidating is that the market is gathering momentum for the next burst up. It is a natural part of a trend where those who have been with the trend from the beginning are taking the opportunity to realize some of their profits, while new traders are entering the market and positioning themselves for the next run-up in prices.

3. Cup and handle

First introduced in William O’Neil’s book How to Make Money in Stocks, the cup and handle pattern is a bullish chart pattern that is very well-known in the stock market, but also appears to work well in other markets.

According to O’Neil, the pattern should span a period of 1 to 6 months in the stock market. In crypto, where everything moves faster, this period can safely be cut in half. For the pattern to be more reliable, we would ideally want to see a significant rise in trading volume near the end of the handle as price begins to rise. A buy order should be entered as price breaks above the high made by the right side of the cup.

The logic behind the pattern is the same as for the head & shoulder and trend waves: the cup represents the bottom in the market and the handle creates a higher low, which by definition means that an uptrend has started.

4. Rectangle

The rectangle is a similar pattern to the bull flag and trading channels, where price appears to be “stuck” between two imaginary lines on the chart. The more touches we have between these outer lines and the price, the more reliable the pattern is considered to be.

The rectangle is a trend continuation pattern, and often becomes a waiting game for traders since it is difficult to tell exactly when the price will break out of the pattern. However, the pattern is fairly reliable at predicting the direction price will break out in. The rectangle can be either bullish or bearish, depending on the direction of the preceding trend.

The pattern can be traded either by placing an order when price is close to the lower end of the rectangle with a stop just below the lower line and then waiting for price to break out. Alternatively, you can place a buy order just above the upper end of the rectangle in hopes of catching the trade as the price breaks out. The danger with the last option is that fake-outs where price spikes up just to fall back down do occur quite frequently. As always in trading, taking a slightly more conservative approach may serve you well over the long-term.

Featured image from Pixabay.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.3 stars on average, based on 37 rated postsFredrik Vold is an entrepreneur, financial writer, and technical analysis enthusiast. He has been working and traveling in Asia for several years, and is currently based out of Beijing, China. He closely follows stocks, forex and cryptocurrencies, and is always looking for the next great alternative investment opportunity.




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Trading 101

Lessons from The Turtle Traders

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turtle traders

For those of you who haven’t heard about the so-called turtle traders before, I’ll give you a brief recap here: “The turtles” were a group of laymen traders who were chosen more or less randomly to be coached by two of the pioneers in trend-following trading; Richard Dennis and William Eckhardt.

While Dennis, who had already made more than $100 million in the markets, were convinced that anyone could learn to trade, Eckhardt argued that Dennis was a gifted trader and that it would be extremely difficult for someone else to replicate his success. Unable to come to an agreement, the two men figured that the only way to settle the dispute would be to conduct an experiment where they would teach ordinary people their own trading system, and then measure the results.

As the story goes, the turtles became hugely successful, and Dennis was proven right.

Their story became known to world mainly through Michael Covel’s books Trend Following and The Complete Turtle Trader, where he shared some previously unknown details about the very simple trading strategies and methods used by “the turtles.”

Although the turtle experiment took place back in the early 1980s, the lessons learned from the experiment are as valid in today’s crypto market as they were in the commodities market Eckhardt and Dennis were trading in back then. In this post, I therefore wanted to share some of methods used by the turtles that can hopefully help you improve your own trading performance as well.

If you are interested in learning more about the methods the turtles used, I recommend reading Covel’s book to get the full story.

ATR as stop-loss

Using the Average True Range (ATR) indicator as a trailing stop-loss is something I learned from Covel’s book about trend following and that I’ve used successfully over the years, as I wrote about in another post about a trend following trading strategy.

Generally, the idea of using trailing stops in trading is that it allows you to ride the trend for longer, without taking on unnecessary risk. It is also in the very essence of trend following trading that traders should not try to predict where a trend will start or stop, but instead simply react to what the price is telling them. In this context, if the price breaks through the ATR line you have drawn up on the chart, it is telling you that the trend has ended and it is time to get out of the trade.

The ATR is calculated based on the volatility of the asset, which means that perfectly normal market movements will be classified as noise, and only extraordinary movements to either side will lead to price breaking through the ATR line.

TradingView has a very useful built-in indicator for using the ATR as a trailing stop called “ATR Stops.”

Maximum 2% risk on each trade

Since the turtles used the ATR as their stop-loss, the risk in terms of pips on each trade would naturally vary depending on the asset they traded. However, by adjusting their position size, they still managed to keep their risk at no more than 2% of their trading account on any one trade.

Pyramiding

Pyramiding is the concept of adding to a winning trade as time passes. This is pretty much the opposite of conventional value-based investing wisdom, where it is usually preached to buy low and sell high. The turtle traders, on the other hand, were not afraid to buy high and sell when things were moving against them (buy high, sell low).

The turtle traders usually didn’t move in with the full position size that their risk management allowed on the first order, but would instead spread out their orders and buy more as the trade moved in their favor. For example, they would enter an order with a position size that kept their risk at 0.5% of their capital as a trend started to form, and then enter new orders as the trend continued until they reached the 2% risk that their system allowed for.

This protected their downside if the trade moved against them from the start while at the same time enabled them to ride the trends until the end.

Reduce risk during losing streaks

The turtles were very aware of the emotional drawdown that follows a loss in the market, and they understood that because of this, losses tend to follow each other and create losing streaks from which traders sometimes never recover.

Because of this, Dennis and Eckhardt introduced a rule saying that if an account is down by 10%, the trader must adjust his risk as if he has lost 20%. With a smaller trading account left, the trader would then be forced to reduce his risk on each trade in order to stay within the maximum 2% risk allowed on each trade.

Not only did this save the turtle traders’ trading capital, but it saved their emotional capital as well.

Keep it simple

Lastly, it is important to remember that the exact trading system the turtles used was relatively simple and straightforward. Trend following trading is often like this, and it has been proven over and over again that simple and robust systems beats complicated strategies. As Richard Dennis was quoted as saying in the Market Wizards book:

“I always say that you could publish my trading rules in the newspaper and no one will follow them. The key is consistency and discipline. Almost anybody can make up a list of rules that are 80% as good as what we taught our people. What they couldn’t do is give them the confidence to stick with those rules even when things are going bad.”

Featured image from Pixabay.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.3 stars on average, based on 37 rated postsFredrik Vold is an entrepreneur, financial writer, and technical analysis enthusiast. He has been working and traveling in Asia for several years, and is currently based out of Beijing, China. He closely follows stocks, forex and cryptocurrencies, and is always looking for the next great alternative investment opportunity.




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Trading 101

Trading 101: Determining and Trading Trend Strength

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Trend-following trading remains the most popular approach to trading in the retail segment, both in crypto and other markets. However, before taking positions in the direction of a trend, it is crucial to determine if the trend is gaining or losing strength. As trend traders, we need to make sure we are only taking trades in trends that are building up, and not those that are fading.

While we have covered the basics of trend-following trading in the past, and also revealed several trend-following strategies, we will here focus on how you can determine if a trend is worth trading, using both systematic and discretionary tools.

Trend waves and pullbacks

Studying trend waves and pullbacks during a trend forms the basis of a discretionary approach to determining trend strength.

In a trending market, small pullbacks signal strength in the trend. If each pullback is getting increasingly smaller as the trend continues, we can say that the trend is picking up momentum. Another thing we often see in strong bullish trends in that the pullback is not really a pullback, but rather a sideways consolidation of the price. This indicates that bulls are strongly in control of the market, buying up even the smallest dip in prices.

On the other hand, as pullbacks get larger and occur more frequently, we can take it as a sign that the trend is losing momentum and the price may reverse into the opposite direction soon.

Moving Averages

Moving Averages are probably some of the best-known tools for trend traders, and for good reason. They are incredibly simple to use, and can provide powerful signals in almost all markets.

The most common way to determine trend strength with Moving Averages is to apply two Moving Average lines to the chart; one slower and one faster. For example, combining the 20 and 50 period Moving Averages is a common strategy among swing traders in both forex, stocks, and crypto (the lower the period setting of the Moving Average is, the faster it reacts to changes in the price).

In a strong uptrend, we should have the faster moving average staying consistently above the slower Moving Average. If the distance between the two moving average lines grows, it means that the trend is gaining momentum, and if the distance between them shrinks, the trend is losing momentum.

If the two lines cross over each other, this is often taken as a sign that the trend is about to reverse. Many successful trend-following strategies follow the simple logic of buying an asset when the faster Moving Average crosses over the slower one, and selling an asset when the slower Moving Average crosses over the faster one.

Price rejection

What we call rejection of higher or lower prices in technical analysis is most easily spotted using traditional candlestick charts and looking for long wicks sticking out either above or below the “body” of the candles, as in the screenshot below.

Price rejection

In this chart, we can clearly see that we had a strong bullish trend and that the price attempted to extent the trend further, but repeatedly got rejected by the market. After four attempts at going higher, this market lost all bullishness and went into an extended downtrend.

Relative Strength Index (RSI)

As the name implies, RSI is an indicator that measures strength. In just the same way as we define an uptrend in price as a series of higher lows and higher highs, the RSI line should also make higher lows and higher highs when the market is trending up. In non-trending (range-bound) markets, the RSI generally moves sideways and stays between readings of 30 and 70.

As trends come to an end, we sometimes see divergences between the trend of the RSI and the price itself. For example, price may be making a new higher high, while the RSI line fails at making a new high, or even makes a new lower high, as we have two examples of in the screenshot below:

RSI divergence

Average Directional Index (ADX)

This is the classic trend indicator that many traders still use. The indicator consists of a red line and a green line and it basically says that a green line above a red line means we are in an uptrend. In the opposite case, a red line above a green line would mean that we are in a downtrend. If the two lines are close together it means that the market is not clearly trending, but rather stuck in a range.

Trend-following strategies sometimes make use of the ADX indicator in combination with Moving Averages to find strong price trends to ride. The ADX could then help determine the strength of the trend while for example cross-overs of two Moving Averages could serve as entry and exit points.

Which one should you use?

Perhaps unfortunately, which specific indicator to use in your trend-following trading really comes down to personal preferences. There is no right or wrong indicator to use, nor is there any right or wrong way to combine indicators and create your own trading strategy.

That said, most traders try to avoid combining indicators that are measuring the same thing. For example, ADX, Moving Averages and MACD are all considered trend indicators, while RSI and Stochastic are considered momentum indicators. In other words, you could combine Moving Averages and RSI, but should avoid combining Moving Averages and ADX with each other.

Experimentation is also fine, but instead of trying to learn how to use lots of different indicators, a better strategy is generally to use a few and become an expert at them. They are all powerful in their own way, it just comes down to the trader to master them.

Featured image from Pixabay.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.3 stars on average, based on 37 rated postsFredrik Vold is an entrepreneur, financial writer, and technical analysis enthusiast. He has been working and traveling in Asia for several years, and is currently based out of Beijing, China. He closely follows stocks, forex and cryptocurrencies, and is always looking for the next great alternative investment opportunity.




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