Ten Thoughts on Trading/Investing

 

Ten Thoughts on Trading/Investing

 

1) Talking about the markets is fine and dandy. However, all investors need to know when to buy and when to sell. Even famed long-term investors sell. Buying without having an idea of the conditions that will trigger a sale is a recipe for disaster.

 

2) Technical Analysis (TA) works. There is also a place for fundamentals (provided one takes a quantitative approach).

 

3) Not all TA methods are equally robust or effective. The less dependent the system is on parameters, the better (I owe this vital insight to Gary Antonacci, author of “Dual Momentum Investing”, a CMT association member and speaker).

 

4) Mean reversion systems work for short-term trades. Trend-following fares better with longer-term trades.

 

5) Short and long term depend on your timeframe. If one uses 5 minutes bars long term will be one day. If one uses daily bars long term will be more than 6 months.

 

6) Most trend-following systems are good at reducing drawdowns (increasing the Sharpe ratio) but not so good at outperforming Buy & Hold (B&H). Basic trend-following techniques like moving averages outperform B&H with a trick: By using monthly bars (which in actual trading is close to untradeable, as they hide the potential for a colossal drawdown, as was evidenced in March 2020). Most trend-following systems underperform B&H when using daily bars. Thanks to the concept of secondary reaction, the Dow Theory outperforms even when using daily bars.

 

7) Any claim made by a technical or fundamental analyst should be backed by a record of the actual trades taken. Cherry-picking trades from a chart and making the “system” look great is easy. To deliver a track record spanning many years under all market conditions is quite another thing. One should insist on records. It irks me when I read a book on TA, and I see lots of charts, patterns, and successful trades, but the author fails to provide the record of all ALL trades taken over a long period.

 

8) Good trend-following methods (as the Dow Theory) coupled with relative strength (that is, buying the asset class with better performance over a determined lookback period) is a great way to reduce drawdowns and further increase outperformance over B&H.

 

9) Your trading system should work across many markets (robustness). This is why even if your focus is stocks, bonds, whatever, you should know that your system lends itself well to being applied to other markets. The Dow Theory passes this test. When it comes to US stocks, Schannep's Dow Theory is the very best.

 

10) Know your system inside out. It is the only way to develop the confidence you’ll need when the unavoidable period of underperformance comes. Mastery is critical to stay the course.

 

Sincerely,

Manuel Blay

Editor of thedowtheory.com