Bruce Kovner: Risk and Personalization

What advice would you give the novice trader?

First, I would say that risk management is the most important thing to be well understood. Undertrade, undertrade, undertrade is my second piece of advice. Whatever you think your position ought to be, cut it at least in half. My experience with novice traders is that they trade three to five times too big. They are taking 5 to 10 percent risks on a trade when they should be taking 1 to 2 percent risks.

Besides overtrading, what other mistakes do novice traders typically make?

They personalize the market. A common mistake is to think of the market as a personal nemesis. The market, of course, is totally impersonal; it doesn't care whether you make money or not. Whenever a trader says, "I wish," or "I hope," he is engaging in a destructive way of thinking because it takes attention away from the diagnostic process.

- Interview of Bruce Kovner in The Market Wizards.

Quote

"To those human beings who are of any concern to me I wish suffering, desolation, sickness, ill-treatment, indignities - I wish that they should not remain unfamiliar with profound self-contempt, the torture of self-mistrust, the wretchedness of the vanquished: I have no pity for them, because I wish them the only thing that can prove today whether one is worth anything or not - that one endures."

- Nietzsche

Trading Advice from Michael Marcus

Q:Having been through the whole trading experience from failure to extreme success, what basic advice could you give a beginning trader or a losing trader?

A:The first thing I would say is always bet less than 5 percent of your money on any one idea. That way you can be wrong more than twenty times; it will take you a long time to lose your money. I would emphasize that the 5 percent applies to one idea. If you take a long position in two different related grain markets, that is still one idea.

The next thing I would advise is to always use stops. I mean actually put them in, because that commits you to get out at a certain point.

Q:What other advice would you give the novice trader?

A:Perhaps the most important rule is to hold on to your winners and cut your losers. Both are equally important. If you don't stay with your winners, you are not going to be able to pay for the losers.

You also have to follow your own light. Because I have so many friends who are talented traders, I often have to remind myself that if I try to trade their way, or on their ideas, I am going to lose. Every trader has strengths and weaknesses. Some are good holders of winners, but may hold their losers a little too long. Others may cut their winners a little short, but are quick to take their losses. As long as you stick to your own style, you get the good and bad in your own approach. When you try to incorporate someone else's style, you often wind up with the worst of both styles. I've done that a lot.

- Both excerpts from the first chapter of Jack Schwager's Market Wizards. Remember to check out DT's site on Tuesday to discuss. The book is elucidating, entertaining and enlightening. (And there's your weekly alliteration fix).

Kurt Vonnegut on the Stock Market

"The name of the book was The Big Board. . . . It was about an Earth-ling man and woman who were kidnapped by extraterrestrials. They were put on display in a zoo on a planet called Zircon-212.

These fictitious people in the zoo had a big board supposedly showing stock market quotations and commodity prices along one wall of their habitat, and a news ticker, and a telephone that was supposedly connected to a brokerage on Earth. The creatures on Zircon-212 told their captives that they had invested a million dollars for them back on Earth, and that it was up to the captives to manage it so that they would be fabulously wealthy when they were returned to Earth.

The telephone and the big board and the ticker were all fakes, of course. They were simply stimulants to make the Earthlings perform vividly for the crowds at the zoo—to make them jump up and down and cheer, or gloat, or sulk, or tear their hair, to be scared shitless or to feel as contented as babies in their mothers' arms.

The Earthlings did very well on paper. That was part of the rigging, of course. And religion got mixed up in it, too. The news ticker reminded them that the President of the United States had declared National Prayer Week, and that everybody should pray. The Earthlings had had a bad week on the market before that. They had lost a small fortune in olive oil futures. So they gave praying a whirl. It worked. Olive oil went up."

—Kurt Vonnegut Jr. Slaughterhouse Five

This was quoted in The Market Wizards by Jack D. Schwager and the reason I am posting this--besides the fact I love Kurt Vonnegut--is because DT is hosting a book club next Tuesday, and he chose The Market Wizards for the first book. I just started reading it (d/led it) and am enjoying it immensely. I'm sure DT wouldn't mind if I invited you to join, so please feel free to click here or on any other links to his site, check it out, and begin reading.

On a side note, somewhat related, I suggest you also check out The American Ruling Class, a movie/documentary with an appearance by Kurt Vonnegut. It follows two ivy league graduates who seek advice on how to live their lives. Anyway, read more about it here or watch it here. I strongly recommend it.

Ozymandias

I met a traveler from an antique land
Who said: Two vast and trunkless legs of stone
Stand in the desert ... Near them, on the sand,
Half sunk, a shattered visage lies, whose frown,
And wrinkled lip, and sneer of cold command,
Tell that its sculptor well those passions read
Which yet survive, stamped on these lifeless things,
The hand that mocked them, and the heart that fed:
And on the pedestal these words appear:
"My name is Ozymandias, king of kings:
Look on my works ye mighty and despair!"
Nothing beside remains. Round the decay
Of that colossal wreck, boundless and bare
The lone and level sands stretch far away.

-- Percy Bysshe Shelley

Was watching the new Watchmen trailer, which reminded me of this poem.

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Do not believe in traditions because they have been handed down for many generations.
Do not believe in anything because it is spoken and rumored by many.
Do not believe in anything simply because it is found written in your books.
Do not believe in anything merely on the authority of your teachers and elders.
But after observation and analysis, when you find that anything agrees with
reason…then accept it and live up to it.
-The Buddha

S&P P/E Insight

While reading through xTrends comments, I found an interesting analysis of the S&P 500 from a fundamental perspective.

Here's a slightly abridged version of eboro's original post:

"According to [Roubini, Shiller, and Shilling], there are essentially 3 types of earnings we should consider when measuring 'market climate' in a bear market. They include: Trailing Earnings, Peak Earnings and Normalized Earnings. The information below was taken directly from the S&P 500 data website:

Trailing EPS: $48
Peak EPS (2007): $84
Normalized EPS (5 Year): $65

Using data compiled by Shiller, let me point out the historic averages of each earnings multiple, as well as the levels they have often reached during cyclical bear movements in secular bear markets (often leading to the “bottoming process”). Note that I have adjusted them based on recent data:

Price to Trailing EPS: historic average of 16.5; bear market low levels of 12
Price to Peak EPS: historic average 13-14; bear market low levels of 7
Price to Normalized EPS: historic average of 15; bear market low levels of 10

Based on our different P/E types, and the levels they most often reach during bear market bottoms, we get the following numbers:

Using Trailing EPS: $48 x 12 = 576
Using Peak EPS: $84 x 7 = 588
Using Normalized EPS: $65 x 10 = 650

I do not think any of these numbers in isolation can effictively predict 'the bottom.' In fact, they are at best 'intelligent guesses' because there is no assurance that past multiples will be witnessed in this bear market, especially seeing as interest rates are so low. The important thing to remember is that they provide a 'probable range of outcomes'; we could see slightly lower earnings with higher multiples or vice versa (for instance, if 2009 earnings were to come in at $40 per share and the multiple was slightly higher around 14 or 15). In any case, if history is any indication, the S&P could reach a low range between 576 and 650, which implies downside risk of 27 to 36% from the current level of 900. Bottom line: the market may still be relatively expensive.

I think the lack of consistency amongst analysts concerning S&P P/E is a result of 'mixing and matching' different earnings with inapropriate multiples. I recently saw an analyst on CNBC claim that the market was cheap by using peak earnings with a bear market normalized earnings multiple. By doing this, she she inputed $84 x 12, thus estimating a value for the S&P around 1000. This methodology seems flawed for 2 reasons: she used only 1 type of earnings, she used the wrong multiple.

Thanks, E"

Thank you, eboro.