Zen Simplicity in Stock Trading

I developed the Stock Trading Riches system when I became fascinated with the idea of a pure Zen trading system. It would use no news reports, indicators, charts, or parameters to distract you from Now. It would be able to handle any market condition.

I turned to jazz, improvisation, Taoism, simplicity, and minimalism for inspiration.

I ended up building a simple and minimalist trading system around an old, obscure, 19th century Wall Street formula called constant value investing.

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Author Interview on "SellingBooks.com"

Here is an interview I did for my book "Stock Trading Riches" on the book site "SellingBooks".

Here is a nugget from the interview:

What inspired you to write this book?

Years ago, I became passionate about stock trading, and spent hundreds of hours and thousands of dollars on books, DVDs, seminars, etc. Those techniques never worked for me and I got frustrated. A light bulb went off when I read a book called “Zen in the Markets.” I decided to focus on the present moment and simplicity, and developed a successful trading system that almost feels like meditation. I love sharing it with others who are interested in trading and investing.

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My Trading System

I became a very successful trader after I developed my trading system.

My complete system, along with information on possible variations, effects of commissions, and beneficial tax strategies, are detailed in my book, Stock Trading Riches, which is available on Amazon.com.

I don't want you to just follow my system - I want you to start thinking critically, and develop your own system, that you feel comfortable with.

My system is like zen or tao. The market fluctuates and I am at peace with whatever it does. The system has no optimized parameters - it simply uses the formula for each stock to see how many shares it should own NOW. It makes no assumptions about the future or remembers the past.

I am "one with the market" in the present moment, and buy low - sell high.

Here is an example with Amazon.com yearly prices. Just imagine having a whole portfolio, where you buy some stocks at the top, some in the middle, and some at the bottom, all feeding and pumping cash, as the markets cycle over years!

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Successful Investing Is About Finding A Simple Strategy That Works

My experience has been that successful investing is about finding a simple strategy that works, and then having the patience and discipline to stick with it - even when it is not performing in the short term.

Over short periods of time, randomness has a bigger influence. A lot of investors get impatient, and they then abandon the system and switch to trying something else.

With hedge funds and mutual funds, a lot of it is about needing good short term results to attract new money, so they keep trying complicated stuff to avoid any down performances - this helps keep them from getting good long-term results.

On this blog, I did write about a book called "The Hedge Fund Mirage", which is critical of that whole industry:

http://simple-trading-system.blogspot.com/2012/02/who-really-benefits-from-hedge-funds.html

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Stock Trading vs. Football

When I was younger, and played the early versions of electronic football, I almost always went on fourth down - even from my own side of the field. I wanted to score quickly and often, and rack up points. What usually happened, however, was that I was stopped and ended up losing the game because the opponent always had better field position.

Now, being older and wiser, I always root for the Bears (my hometown team from Chicago) to play safe and conservatively. I would never think about going on fourth down unless it was late in the game and my team was behind. Also, when my team is looking at long 3rd downs (such as 3rd and 15), I don't automatically expect them to try a long pass. I'm ok with them gaining a little yardage, punting it away, and waiting until the next possession.

Similarly, you have to be patent when stock trading. When I was younger, I wanted to see success right away. I ended up losing a lot because I day traded and used futures, options, and margin trading to leverage my way to success.

My profits went up (and my stress down) when I stopped trying to make quick profits. Instead, like football, I started playing safely and conservatively.

Since day trading left me stressed with no edge, I switched to long term trading, which I found suited my personality much better. I also stopped using margin, futures, and options because they masked my edge. They left me dependent on short term luck to avoid margin calls.

I realized that one of the reasons I was impatient to day trade and make profits was that I didn't trust longer term trading systems. So, I took a few years off trading and did nothing but system design and testing until I proved to myself that my long term trading system had an edge.

I designed the system to suit my personality and needs. I then became passionate and excited about trading my system and knew that I would make money over the long term - even if I could not see profits in the short term.

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Kindle Version Of "Stock Trading Riches" Reaches Top 100 Business and Investing Best Seller List

Today, the kindle version of my book Stock Trading Riches reached the top 100 on the Kindle Business and Investing best seller list.

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For Many, Trading Dreams Turn Into Frustrations

Many people get interested in trading after hearing about rich hedge fund managers, or getting a slick sales brochure from a "trading guru" trying to sell his latest system.

They see the well-chosen examples from the sales literature, understand how the system works, and then day-dream about the fortune they will make.

Then, they start trading and either under-perform the markets (if involved with un-leveraged stocks / funds), or else lose a substantial portion of their principal (through futures and options).

I know this, because it also happened to me. When I first started trading, I read all the gurus' literature, and decided that making a living from trading would be easy. I started day dreaming about what I would spend the money on.

Of course, I since learned that it's not that easy to get rich quick trading.

On the other hand, many frustrated would-be traders then completely quit trading and investing. This is a mistake because everyone needs some exposure to stocks and the stock market - otherwise your retirement savings will suffer "losses" through not keeping up with inflation.

I found the middle-ground between aggressive and conservative investing: I created the Stock Trading Riches system.

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Who Really Benefits From Hedge Funds? - Review of Simon Lack's "The Hedge Fund Mirage"

The wealth of top hedge fund managers is the stuff of legend, but how about their clients - the "sophisticated" investors such as pension funds and wealthy individuals?

As Wall Street veteran Simon Lack says in his new book The Hedge Fund Mirage, "Who can name even one hedge fund investor whose fortune is based on the hedge funds he successfully picked?"

According to Lack, only a handful of superstar hedge fund managers made most of the industry's profits. As a broad investment class, he finds hedge funds to have been a terrible place to keep your money:

"If all the money that's ever been invested in hedge funds had been put in Treasury bills instead, the results would have been twice as good."

An even more shocking conclusion from the book is about the fees that hedge funds collect - which really kill any hope of a good return.

After crunching the data, Lack found that, from 1998 - 2010, investors made $70 billion, while hedge funds pocketed $379 billion in fees!

In conclusion, Lack feels that the fault doesn't lie with the hedge fund managers, but with the "sophisticated investors".

I agree, because one thing I have found during my almost 20 years of trading experience is that, in finance, people believe the complex and exotic is superior. They feel sophisticated and intelligent when, at cocktail parties, they can brag about investing in sexy things like hedge funds.

Every time I tried to trade sophisticated, leveraged instruments like futures or options or on margin, I underperformed or lost money. Instead, when I switched to trading plain old stocks using the Stock Trading Riches formula - which is simple, dull, and boring - I started doing very well.

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Ground Hog Day, Stock Trading, and Probability

Today is Ground Hog Day, and ABC News had an article on Punxsutawney Phil (the famous groundhog from Pennsvlvania).

The legend is that, if the groundhog sees his shadow, then winter will be 6 weeks longer. If it is cloudy, and he doesn't see his shadow, then spring will arrive early.

The ABC New article states that "It turns out the ultimate prognosticator- and his copycat counterparts- are wrong more often than they are right."

It then also states that "An analysis by the National Climatic Data Center found there is no correlation between Phil's predictions and the actual weather."

What's interesting is that, technically, these 2 statements contradict themselves. Being "wrong more often than right" is not the same as "no correlation" - and this has implications for developing a trading system.

If you develop a system for predicting the weather or for trading stocks, if your system does terribly, then you haven't failed. You would simply reverse the interpretation.

The worst thing that can happen when testing a trading system is not losing all your money - it's getting random results.

For example, if you tested a system of buying stocks on the first Tuesday of the month and selling 3 days later (this is a made up example), and you lost money 84% of the time, then this might not be a failure.

Why? Because this means you could short stocks on the first Tuesday of the month, and buy to cover 3 days later - which would win 84% of the time. (Of course, you would have to confirm that the total amount of money made on the winning trades exceeds the total amount lost over the 16% of the time where the rule failed).

The result you would not want would be to find that the rule broke even and gave no meaningful advantage. This would mean that, no matter which side you took, you would not expect to make enough to cover your trading costs (commissions, slippage, etc.)

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Seven Year Return on My "Stock Trading Riches" Portfolio

For the past 7 years (2005-2011), I have exclusively used my Stock Trading Riches system to manage my portfolio.

While I lagged the market in 2011, I have beaten the S&P 500 over those 7 years:

Year, Me, S&P 500

2005, +13%, +4.91%

2006, +14%, +15.79%

2007, +22%, +5.49%

2008, -40%, -38.49%

2009, +44%, +23.5%

2010, +22%, +13%

2011, -5%, 2.11%

My portfolio has had a cumulative seven-year return of +57.38% vs. +12.32% for the S&P500.

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Finished The Yearly Rebalancing of My Portfolio

Today I finished rebalancing my portfolio, as required by the Stock Trading Riches system. This involved buying or selling each stock that was under or over my constant value target by at least 10% - so that each stock position was now at the constant value.

This year, I did it in two parts: sales last Friday and the buys today. This was because I now keep the majority of the cash portion of my portfolio invested in a no-load short-term bond fund.

After selling the gainers, I then calculated how much more money I would need to complete the buys, and then placed a sell order for the mutual fund on Friday. Today, the mutual fund sale proceeds were in my account, and I used them to complete the buys.

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The Importance of Stock Market Capitalization For Building A Diversified Portfolio

Stocks can be separated into 4 groups, according to their market capitalization:

1. micro caps - below $300 million

2. small caps - between $300 million and $1 billion

3. mid caps - between $1 billion and $5 billion

4. large caps - over $5 billion

I talk in more detail about market cap analysis in my book Stock Trading Riches because it's important for investors to allocate their portfolios among all market caps to provide diversification, avoid cyclical returns, and take advantage of "regression to the mean" (e.g. one market cap segment outperforms another, but then they converge).
Market cap is calculated by multiplying the number of shares outstanding by the share price. For example, if stock ABC issued 6 million shares, and the price of each share is $6, then ABC has a market capitalization of $36 million.

In general, micro caps are new companies that are just hitting their stride. Small caps tend to have their infrastructure in place and are in growth mode. Mid caps are big regional or national companies. Large caps tend to be established multinational corporations.

Stocks within each market cap share important characteristics in the areas such as growth rate, risk, dividends, visibility, and international exposure.

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Successful Traders and Investors Keep Their Emotions in Check

To succeed while trading the stock market, you need to be able to control your emotions. You can't become angry or fearful when you are on a losing streak. Alternatively, you can't become euphoric or greedy when you are winning.

Individual stocks, the stock market itself, and trading systems all run on cycles. They will enter money-making modes some of the time and then, without warning, switch.

The only thing we can predict 100% is that, whatever the current state of the market, it will eventually switch, and then eventually return.

If you jump out of the market when it is down, there is a good chance that you will miss the rebound. Similarly, if the market has been strong for a long time, and has reached fantastic heights, you can't become greedy and buy a lot, because the market may fall.

To keep myself from trading impulsively on emotion (and losing), I developed a simple trading plan that lightens my positions as they reach high levels, and starts scaling in as my positions go down.

As a result, I built up my positions at good prices, and scale out as the market goes higher.

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Stock Trading is Like Football - They Both Require Patience

When I was younger, and played the early versions of electronic football, I almost always went on fourth down - even from my own side of the field. I wanted to score quickly and often, and rack up points. What usually happened, however, was that I was stopped and ended up losing the game because the opponent always had better field position.

Now, being older and wiser, I always root for the Bears (my hometown team from Chicago) to play safe and conservatively. I would never think about going on fourth down unless it was late in the game and my team was behind. Also, when my team is looking at long 3rd downs (such as 3rd and 15), I don't automatically expect them to try a long pass. I'm ok with them gaining a little yardage, punting it away, and waiting until the next possession.

Similarly, you have to be patent when stock trading. When I was younger, I wanted to see success right away. I ended up losing a lot because I day traded and used futures, options, and margin trading to leverage my way to success.

My profits went up (and my stress down) when I stopped trying to make quick profits. Instead, like football, I started playing safely and conservatively.

Since day trading left me stressed with no edge, I switched to long term trading, which I found suited my personality much better. I also stopped using margin, futures, and options because they masked my edge. They left me dependent on short term luck to avoid margin calls.

I realized that one of the reasons I was impatient to day trade and make profits was that I didn't trust longer term trading systems. So, I took a few years off trading and did nothing but system design and testing until I proved to myself that my long term trading system had an edge.

I designed the system to suit my personality and needs. I then became passionate and excited about trading my system and knew that I would make money over the long term - even if I could not see profits in the short term.

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"Stock Trading Riches" Spreadsheet

Yesterday, I received an email from a "Stock Trading Riches" reader who had a question about the spreadsheet (it is a free download for people who buy the book, in either format - paperback or kindle).

His spreadsheet question was:

In the "number of shares" column I notice that you are checking for a 10% price change between the current years price and the previous years price. This is ok in Year 1 and Year 2 but in the longer term you are not comparing the current years price to the initial Year 1 price. So what could happen is you could have a steady increase/decrease of less than 10% every year over a number of years (cumulatively > than 10% over a number of years) but none of them will trigger any selling/buying as the price is being compared to the prior year. Was the sheet deliberately designed this way?

My answer was:

What the basic system does in real life is only rebalance if the stock has moved 10% or more from the last time it was rebalanced. So, the spreadsheet should actually not compare the current and previous values, or the current and first. Instead, it should compare the current value with the last value where a rebalance occurred.

I don't know how to do that in Excel. So, I put the 10% check between the current and previous row just in case a value isn't 10% apart. But the best way to use the spreadsheet is to manually exclude prices less than 10%.

So, if the monthly prices were 100, 99, 95, 97, 85,... you would put in 100, 85 in the spreadsheet.

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The Best Trading Systems Are Beautiful and Simple

The best trading systems are simple and minimally beautiful - at most, they only use a handful of indicators or formulas, and they implement a simple model of the market.

They don't aim to explain market behavior rigorously and precisely like an economist - instead, the model aims at robustness, where it lets you manage your risk appetite and set the odds in your favor.

The purpose is to give you an edge - like the house has in a casino game. It won't win every trade, but it will have a positive expectation where, over time, you can expect to make more money than you lose, thus letting you build your account over time.

If a trader attempts to develop a complex system that could win every trade, then that is a set-up for failure. As systems get more complex, they have more moving parts - which results in unpredictable interactions and bugs that will eventually cause your system to blow up and suffer heavy losses.

With a simple system, your ego may not be satisfied - it will tell you that you are smart enough to come up with something more accurate, so you will lose less trades - but your bottom line account balance will benefit.

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The Return of Dividends

When I was a short term trader, dividends did not mean anything to me.

When I switched to long term trading, I not only eliminated stress and reduced expenses, but I started to enjoy seeing the dividends depositing into my account like a cash register. Cha-ching!!

Historically, dividends were a big component in the total return of stocks.

Then, in the 1990's, they became only a small component of the total return, and dividends were out of favor. We were in a raging bull market, and companies were pressured to favor growth over dividends.

Investors were hypnotized by the bubble and said: "Why should companies give out dividends (which were fully taxed) rather than invest that money in growing their market share, buying back stock, or buying the stock of other high-flying companies?"

Then, the Dot Com Crash happened, Bush cut the dividend tax in half, and investors pressured companies to pay out dividends.

Since the market has been choppy for the last decade, dividends have returned to their historical place as a big part of investors' total return.

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"Stock Trading Riches" is now available in Kindle format on Amazon.com

My book "Stock Trading Riches" is now available in Kindle format on Amazon.com.

Since this is a new format, it's priced for now at $2.99.

They did a good job in the conversion - I saw that the stock tables and programming scripts display well, and the links are click-able.

You don't need to own a Kindle to buy this edition. You can download free readers for PC's, Mac's, iPads, etc.

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The 401k Backlash

In the last year or so, I have seen a lot of articles bashing the 401k.

This is interesting because the 401k seemed to be sacrosanct. All through the 1990's and into the 2000's, financial planners and the financial media drilled into our heads about how important it was to save for retirement, and a 401k was great because you "paid yourself first", got the power of tax deferral and, perhaps, got a company match.

But, many 401k plans have drawbacks - the main ones being that the fund choices tend to be poor. This is because the funds don't have to sell themselves to the individual investors. Instead, they just have to sell themselves to the investors' employers.

For the employers, their money and retirement are not on the line, and administering the company's 401k plan is not a core function of the business.

Personally, I think that you should only use a 401k plan if your company matches - and then only put in enough to get the maximum match.

You are better off putting the rest of your investments into Roth IRAs and/or taxable accounts where you can get long term capital gains - which can be canceled through capital loss harvesting (which is explained on page 28 of my book Stock Trading Riches).

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How The Debt Ceiling Debate Could Affect Interest Rates

At the end of the day, after they make points with their followers, I believe democrats and republicans will compromise and raise the debt ceiling.

However, all the current arguments, posturing, and waiting until the last minute has not given confidence to either consumers or the debt rating agencies.

The ratings agencies are quick to downgrade these days, because they are on the defensive about their role in the financial crisis. Critics said that they turned a blind eye to risk.

There is a chance that, even with an agreement to avoid default, at least one ratings agency may downgrade U.S. debt.

How would a downgrade affect ordinary people like you or me?

First, the interest rates that the U.S. must pay would go up. This would make interest on the national debt an even higher component of government spending. Secondly, the treasury rates are used to set all other interest rates. If the treasury rate increases, so would all mortgages, car loans, etc.

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