March 24, 2016
In this report, I’m going to outline the three of the biggest factors that sabotage the majority of stocks, options and ETF traders and show you the steps that you can take to avoid falling into this trap!
One of the most interesting things that I’ve learned over the past 30 years of professional trading has very little do with the mechanics of trading stocks, options or ETFs and more to do with the human mind and more importantly human behavior.
There’s something about human nature that’s truly remarkable and at the same time absolutely fascinating.
When it comes to making consistent profits from the financial markets, most people are by far and away their worst enemy!
Essentially, I find that the great majority of retail traders get in their own way and make things much more complicated than they have to be…and ultimately sabotage themselves and ruin the possibility of achieving consistent profitability over time.
Retail Traders Utilize Trading Tools That Were Created before the First Man Landed on the Moon and Expect Them to Compete with Multi-billion dollar Hedge Funds!
The first big mistakes that traders making consistently is utilizing indicators that were specifically designed and created to work with the commodity market and assume that they will work with stocks, options and ETFs.
The problem with this theory is the fact that commodities, currencies and futures are predominantly trending markets, while stocks are predominantly counter trend markets and indicators that work well with trending markets are not nearly as effective with counter trend markets.
Furthermore, the great majority of technical indicators are lagging indicators that reflect what already happened or occurred in the past.
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What does that mean? It means that you are relying on something that happened in the past to help you gauge future price movement…that’s equivalent to driving your car while looking at the rear view mirror and that will cause you to crash!
Take the moving average indicator which is probably the most popular technical indicator of all time. The indicator was designed in the late sixties to help gauge trends in commodity markets.
During this period of time commodities trended very strongly and the moving average was especially effective because of the massive trends in commodities during that period of time.
But the moving average indicator was never intended, designed or tested with stocks or any type of equities markets in mind and neither were dozens of technical indicators that come preloaded with your online stock broker software.
If you think about it logically, you will realize that the great majority of technical indicators were created over 40 years ago, when the stock market showed very little volatility or directional movement…as a matter of fact the average daily range for most stocks at that time was less than $.25 and any form of speculative trading was strictly limited to the commodities, currencies and futures markets.
But over 40 years later, millions of traders use the exact same indicators to gauge price movement in equities without any degree of success!
Fortunately, there’s a very simple way to gauge stocks, options and ETFs that works amazingly well and doesn’t rely on indictors that were created, designed and tested for different types of financial markets over 40 years ago.
Relative Strength or Comparative Strength Analysis Tells You Exactly What Stocks Are Being Purchased Aggressively By the Largest and Most Aggressive Funds in the World!
Over the past 20 years, large hedge funds have come to dominate the stock market. If you think about it logically, you will realize that it takes massive amount of volume to move large cap stocks like Google, Tesla and Amazon…and only the biggest mutual funds have the buying power to accumulate millions of shares continuously over several days or weeks at a time.
Institutional money continuously rotates money into the strongest stocks and money out of weaker stocks.
The stronger one stock becomes the more money flows into that stock and out of weaker ones...that’s how the biggest growth stocks on the planet move higher ad gain momentum continuously over several weeks or months and that’s how the biggest stocks in the world double and triple in price and remain resilient to short term stock market corrections.
Comparative or relative price analysis is the process of comparing the percentage increase in value of one stock to another stock during the same time period.
The example below is a simple demonstration of comparing 4 different stocks over a 2 month time period. The odds are strong that stock D will continue to outperform all other stocks because at the present time the biggest funds in the world are accumulating this stock aggressively and the odds are relatively high that they will continue to purchase this particular stock if the relative strength continues at this rate.
This type of analysis is much more powerful and effective than relying on indicators that are derived from price action that already happened in the past…something that has no forecasting value for stocks in the first place.
I typically analyze relative strength on a 2 month, 4 month and 6 month time frame and target stocks that are part of the NASDAQ 100, the biggest tech and growth stocks in the world.
These stocks have strong institutional sponsorship, liquidity and most importantly the potential for massive price appreciation… and that makes them ideal candidates for relative strength or comparative strength analysis.
And most importantly, this is how multibillion dollar hedge funds decide which stocks to buy and which ones to sell and something you should consider incorporating into your trading.
Comparing Current Volatility to Past Volatility Is One of the Best Ways to Determine If Stocks Will Continue Trending or Will Become Choppy!
I’m going to let you in on a little secret...something that most institutional traders have known for years, volatility or average daily price movement when compared to past price movement can give us a very strong indication of future price movement.
While this may sound a bit confusing, it’s actually very simple…let me show you by way of example.
Take a look at the Amazon chart below. Notice that during the entire period of time the level of daily volatility is fairly consistent…in other words the day to day price fluctuations are fairly even across the entire time period.
This tells me that the odds of seeing further price appreciation is fairly probable, since volatility levels have not increases substantially.
If volatility increases or spikes, it usually means there’s a shift or a change of balance between buyers and sellers and the stock or ETF will begin either stagnating or moving sideways and possibly even turn around and begin trading lower.
The QQQ ETF example that you see below is a good example of a major spike in volatility, with the trading range being roughly 3 to 4 times the average daily range over the past 2 months.
When I see such strong spikes in volatility, especially after a significant trending period, it tells me that the stock or ETF is getting ready to stagnate and become range bound or alternatively begin trading lower instead.
I can tell you from over 2 decades of professional trading, running a hedge fund and back testing just about every methodology under the sun…change in volatility is one of the most significant factors that determines whether or not the trend will come to an end and it’s something that most retail traders completely ignore.
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Take a look at the two charts below…notice how one goes straight down while the other one goes straight up.
To give you a better understanding…the chart on the left is the chart of the stock market during the worst part of 2008, while the chart on the right is the chart of the long bond during the exact same period of time.
As you can clearly see from the example above…when the stock market trades lower, the bond market trades higher. This is called flight to quality and when stocks trade lower, investors shift or rotate out of stocks and into safer class of investments, which is fixed income or the bond market.
If you look at any major stock market correction, you will see that bonds trade higher when stocks trade lower, it’s that simple.
Why is this important? Because trading the long bond is how just about every large multibillion dollar hedge fund offsets risk instead of relying on stop loss orders. This can cause your position to be stopped out prematurely, before the big move occurs!
And if there’s anything worse than being stopped out of a stock…it’s getting stopped out before the stock begins to trade higher, which will not only cause you to take a loss, but it would also cause you to miss out on the profit potential too!
In the past, before ETFs were created, traders had to go to the futures market and trade the 30 year long bond or the 10 year Treasury note. Unfortunately, this required understanding of the futures markets and required a hefty margin, since each futures contracts face value is equal to $100,000.
At the present time, traders don’t have to worry about learning how to trade futures, understanding contract expirations or having to trade large sized account to enjoy the benefits that come with holding a portion of your portfolio in the long bond.
Over the past 10 years however, hundreds of different ETFs were created, which trade in shares just like any stock, but at the same time track the performance of numerous commodities and/or currencies.
In short, there are several assets, such as the TLT or the EDV or even the leveraged TMF, which track the performance of the long bond almost tick for tick. This gives the retail trader the advantage of having the long bond in their portfolio, without the downside of having to trade large futures contracts instead.
I wanted you to see for yourself…the degree of correlation between the actual futures contract and the ETF.
On the left side is the long bond ETF which shows trades exactly like a stock, there’s no contract roll overs and you can buy as little as 1 share or 50,000 shares, which means you can utilize it effectively in either a small account or a large account.
The chart to the right is the actual 30 year long bond futures contract during the same exact time period. The 30 year is a fixed sized contract that professional hedge fund managers utilized for decades to offset risk while holding stocks instead of relying on stop loss orders.
Let’s Put Together Everything I Covered!
To summarize, the great majority of technical indicators were never created, designed or tested with stocks in mind.
Most indicators are lagging indicators that reflect what already happened in the past and do not work effectively with counter trend markets such as the stock market.
Applying lagging indicators to the stock market is equivalent to driving your car while looking at the rear view mirror.
Relative strength or comparative strength analysis follows the strongest stocks in favor of weaker stocks and gives traders the best possible indication of what stock is going to continue moving higher in the near term.
Moving ahead, measuring volatility levels in comparison to past volatility levels can give you a much more accurate indication of whether the stock is going to continue trading higher or stagnate…with much better accuracy level than the great majority of technical indicators.
Over 30 years of back testing 3000 different stocks and 20 different commodities clearly demonstrates that sharp increase in volatility levels will causes most financial assets to lose their directional movement and begin congesting or reverse the trend in the opposite direction.
And lastly, we’ve learned that including the long bond in your account to hedge against downside risk can drastically increase the percentage of winning trades and decrease the overall risk and volatility level to your trading account, without having to rely on stop loss orders to protect against downside risk.
Each and every one of the three factors that I’ve covered today is grounded in extremely basic and prudent investment principles…that would even make Warren Buffet Proud!
Over the past several years, I’ve utilized the exact same principles that I’ve shared with you today with a few different trading models.
To give you some comparative numbers, during the past 6 years, the SP 500 increased in value close to 90 percent, actually the return is roughly 88%.
The Titan trading strategy, which is the trading model that I described in today’s article, generated over 2600% return during the exact same 6 year time period.
Imagine the returns if you traded options instead of the stocks, the returns could potentially be up to 10 times higher.
Keep in mind, we didn’t short stocks, use leverage or margin, avoided any type of black box systems, no waves, complicated math formulas…we simply took the most basic investment and trading principles and turbo charged them for oversized returns.
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