Wall Street Craps – 2012 Global Ebook Finance Award-Winner

CONSIDER PLACING SOME BETS EARLY: Pay special attention to quiet “selling exhaustion bottoms” because this type of market turn goes straight up, does not pause to correct, and leaves overly cautious investors behind at the starting gate.

An example of this would be a string of seven or more negative trading days in the widely followed Dow Jones 30 Industrial Average, where the volume becomes increasingly lighter with each passing day. This would ideally occur after a long drop in the general market, where investor sentiment has turned from fear and panic to hopelessness and apathy. At this point, it might be worth risking some well-placed chips in anticipation of a turnaround in the market. Remember that your job is not to be “perfect” in timing the market — it’s to consistently play a high-percentage winning strategy over time.

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Comment: Timing stock market purchases is about finding the right range in time to make your move. If your indicators point to a potential bottom and you want to make gradual purchases, it will require some of your buys to be early. These will often feel a bit wrong at the time but you must resist the temptation to be perfect in this aspect. If you save all of your ammo for the perfect absolute bottom, you are more likely to be left behind when an overnight news event from someplace like Europe causes the market to open up by 300 points.

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“Some of the best trades come when everyone gets very panicky. The crowd can often act very stupidly in the markets. You can picture price fluctuations around an equilibrium level as a rubber band being stretched — if it gets pulled too far, eventually it will snap back. As a short-term trader, I try to wait until the rubber band is stretched to its extreme point.”

Linda Bradford Raschke ~ Professional trader

TIME YOUR BETS WITH INCREASED PRECISION: Buy when the market is ready to go up. Don’t buy just because it’s done going down. There’s a natural lag time between internal changes in momentum and external changes in prices.

Like dropping a rubber ball, most stock market bottoms bounce a few times before the downward energy has been fully exhausted. Therefore, it’s entirely possible that the lowest price of a stock candidate may not be the ideal point in which to buy it from a timing standpoint. That’s because the market can end up sitting near the lows for several weeks, while tying up your capital and testing your nerves.

Again, the ideal time to buy a stock for trading purposes is when it’s ready to go up in price. This is often a misunderstood concept to amateur stock market players, who try to follow a simple “buy low and sell high” strategy.

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Comment: The actual way that a market finds its way to an eventual bottom has an uncanny way of always appearing slightly different. So don’t get locked in to any set pattern of the way a bottom should look. However, it’s important to know that the internal bottom always precedes the external bottom. The external bottom is the point in which the momentum has waned and the direction is about to turn up.

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“It’s important to distinguish between respect for the market and fear of the market. Whiles it’s essential to respect the market to assure preservation of capital, you can’t win if you’re fearful of losing. Fear will keep you from making correct decisions.”

Howard Seidler ~ Professional trader

LOOK FOR THE OBVIOUS COVER STORY: Every major stock market bottom has a media story attached to it, which causes the public to panic out of fear or lose all hope. Often this story will appear on the cover of a widely read national publication, such as Time Magazine or Newsweek.

An example of the associated headline might be: “The Recession Is Official!” Since fear and greed are the primary motivating emotions in the stock market, the appearance of such a cover story coincidentally marks the maximum point of investor’s fear and negativity. At this juncture in the market cycle, the selling of stocks has almost entirely been exhausted. Yet a sustainable turnaround to the upside is about to begin.

Remember these classic words credited to Baron Rothschild, an 18th century British nobleman and member of the Rothschild banking family: “The time to buy is when there’s blood in the streets.”

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Comment: The news is always negative near the bottom in prices. But at some point, the market will no longer respond to the downside and instead defy the obvious and start moving up. This happens when the last unsophisticated investor or trader has decided to panic out of fear and finally sell.

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“When good news about the stock market hits the front page of the New York Times, sell.”

Bernard Baruch ~ American stock market speculator (1870-1965)

KNOW WHEN CASH IS KING: In a downward trending stock market, the buying power or relative value of your cash assets automatically goes up.

In other words, your money goes a lot further when the items in the store go “on sale.” That is exactly what’s going on when stocks drop in price. Always remember that being in a 100% cash position or out of any stock market positions allows you the emotional freedom to quickly enter into new trades when market extremes in prices and investor sentiment create timely buying opportunities. Realize that it’s a good thing for stock prices to plummet when you don’t own anything. Instead, declining prices offer cash-rich investors and traders an opportunity to buy stocks while they are “on sale.”

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Comment: Sitting safely in a 100% cash position allows you to enjoy a market that is in decline. Not only are you not losing money like everyone who has long positions, but you are also “keeping your powder dry” for the next buying opportunity — at lower prices! So don’t get caught up in simple asset allocation plans that only allow 5% to 10% in cash because there are plenty of times when your cash position approaches 100%.

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“Be comfortable holding cash. Nothing in nature is as powerful as a void and that’s why ‘cash’ is so difficult to hold.”

Bennett W. Goodspeed ~ Author of The Tao Jones Averages (1983)

RECOGNIZE THAT THE “DON’T PASS” BET SEEMS SMARTER: The bearish argument always sounds more intelligent than the bullish one. But for success in trading the stock market, always remember that there is a big difference between appearing smart and being right.

When you’re analyzing the stock market for trading purposes, it’s wise to remain mentally and emotionally neutral. Don’t fall prey for either the optimistic or the pessimistic point-of-view on the stock market. Choose instead to monitor the market in an unbiased way, so that your decisions are based on facts instead of opinions. That way, you won’t be seduced into unwarranted actions by the subtle unconscious influence of authoritative contrarian media figures in the investment world. (Note: The “Don’t Pass Bet” in the game of craps is the wager that is designed to pay off when the normal “Pass Line Bet” loses. In other words, betting on failure seems like an intelligent bet because it goes against the wishes of an unsophisticated, over-exuberant crowd.)

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Comment: In the 1980s, I found myself reading a lot of bearish material from the likes of economist Elliot Janeway, market technician Joseph Granville, Elliot Wave expert Robert Prechter, Dow Theory Letter’s Richard Russell, and gold expert James Dines. And while it made for interesting reading, I discovered that I had developed a bearish bias towards the stock market. And while these advisors made intelligent evaluations about the stock market, I found them to be largely wrong about the eventual outcome. In hindsight, I would have done a lot better by simply buying the recommendations of my full-service stockbroker at E.F. Hutton. The lesson was to avoid being persuaded to the negative just because it sounds more intelligent and less hyped.

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“As a very successful investor once said, ‘The bearish argument always sounds more intelligent.’”

Peter Lynch ~ Author of One Up On Wall Street

DON’T BET AGAINST A STREAK: Respect the power of a strong bearish or bullish trend in the stock market. Don’t bet against a market that moves relentlessly in one direction. Sometimes market moves will defy the odds for longer than your money or stomach can hold out.

It’s worth noting that a great deal of money has been lost by investors who don’t properly gauge the strength of a stock market move. It is far wiser to let the power of a stock trend wind itself down before trying to guess when a change in direction will occur.

If you do make such an untimely bet, be sure that you have the discipline and courage to cut your losses short in order to live to trade for another day. Losing lots of money in a short period of time does more than hurt your bank account —it also destroys the vital self-confidence to take action on your future opportunities. (Note: Many investors have misunderstood the popular advice of “buy when everyone else is selling.” If the selling is panicky in nature, buying is analogous to “trying to catch a falling knife.” What you really want to do is buy when everyone else is done selling. It’s when the selling has been exhausted that low risk opportunities become available. Otherwise, what you’re actually doing is trying to make fast money with more risk instead of with less. Buying during a market panic is just plain risky!)

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Comment: There is a natural tendency to bet against a trend that has persisted without you being onboard for the enjoyable ride up. But when market momentum is strong, it tends to go longer than anyone expects. The market also has an uncanny way of producing one last “overshoot rally” which causes the last doubters to finally throw in the towel. And that’s when the trend is about to change.

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“I believe that only short-term price swings can be predicted with any precision. The accuracy of a prediction drops off dramatically, the more distant the forecast time. I’m a strong believer in chaos theory.”

Linda Bradford Raschke ~ Professional trader

AVOID BEAR MARKET & BULL MARKET TALK: In the game of Las Vegas craps, the dice are often described as being either “hot,” “cold,” or “choppy.” In the stock market, expect any of these to appear, but think of them more as “streaks” and not “trends.” As savvy players will attest, most of the time the tables are in varying degrees of “choppiness.” (Note: The word “choppy” means short, irregular, or abruptly shifting runs of luck.)

Don’t make the common mistake of falling in love with long-term investment scenarios that prevent you from taking necessary actions in your short-term trading account. Save your long-term bull market and bear market discussions for when you’re sitting on the sidelines, out of the market, and have nothing to lose by taking a stand for the sake of intellectual entertainment.

Otherwise, your long-term investing views will naturally cause you to make critical errors in short-term trading decisions. On the other hand, the funds that you’ve portioned off as “security assets” are designed for long-term holding. It’s only in regards to your “security assets” that you should entertain any thoughts and discussions about bull and bear markets. (Note: Bull markets are long-term upward price movements in the general stock market. Conversely, bear markets are long-term downward movements in prices.)

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Comment: While the discussion of long-term stock trends makes for interesting conversation, it also has the unwanted side-effect of messing up your shorter-term decision-making. It is important to note that the stock market operates on three cycles at the same time –– short, intermediate, and long. So it’s often the case where the present stock market may be in a short-term rally within an intermediate and long-term downtrend. In my opinion, the best way to estimate the size of a rally is to determine the amount of time that was spent in the preceding downtrend. There seems to be symmetry in terms of time when it comes to rallies and declines.

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“Wall Street has a uniquely hysterical way of thinking the world will end tomorrow but be fully recovered in the long run, then a few years later believing the immediate future is rosy, but the long term stinks.”

Kenneth L. Fisher ~ Author of Wall Street Waltz

GET RICH IN THE DARK: Savvy players don’t share their opinions while playing the game. They quietly go about their business – playing correctly, making good money, and avoiding attention.

The temptation for amateur players is to share their opinions and early successes with almost anyone who will listen. But this type of naïve behavior has a way of locking an investor into their stated opinions. And as far as trading the stock market goes, a wise player must be able to turn on a dime and take decisive actions when underlying indicators point to a change in direction. In order to play the game correctly, investors must be willing to go against any previously stated positions without any regard for what other people may think about them.

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Comment: This advice comes from the gambling world. It is closely related to avoid the jinx. When things are going well for you, it’s the proper time to lie low and be humble. This is probably the exact opposite of what most amateurs are inclined to do….but precisely what the pros do. So when good fortunes come your way have the class and composure to handle it smoothly and quietly.

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“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”

Charles Mackay ~ Author of Extraordinary Popular Delusions and The Madness of Crowds (1852)

IGNORE OTHER PLAYERS & THE DEALERS: Don’t get distracted by what other people say or do concerning the stock market. Combining different strategies will only cloud your thinking and prevent you from taking correct decisive actions. Remember that there will always be a well-qualified expert with convincing advice to take almost any position on the future course of the stock market.

The obvious truth is that no one really knows that outcome. As wise investors, we must not be fooled by the convictions or credentials of any expert and their opinions. What matters in the area of stock market advice is only the accuracy of the thinking and wisdom of the philosophy behind it.

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Comment: In terms of market analysis, you want to get to the point where you have enough experience working with the key internal indicators that you can trust your own decisions. Understand that when you are in an emotional state of uncertainty, you will be inclined to be swayed by what other people think and do. However, the one place where other people’s opinions matter is when you see a consistent pattern to cause you to look at them as “contrary indicators.”

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“It’s not the bulls and bears you need to avoid — it’s the bum steers.”

Chuck Hillis ` Portfolio Manager at Hillis Partnership