For some new to the trading (as opposed to investing) game, I think the most compelling lessons of the current cataclysm are revealed by the disasters apparently wrought on the once mighty. From the Icahns to the John Henrys (even his Red Sox lost) to a countless number of hedge funds — even I’ve heard to the likes of Paul Tudor Jones — people with extraordinary trading histories have taken huge — if not fatal — hits.

As the song says, “know when to fold em.” Its why my best rule is that which says I get out altogether with the first loss. The first loss is the best loss. In any case, always have an exit strategy.

Not. It sounds pretty reasonable from what I can gather from the explanation. I just don’t think I can be that disciplined. I have not really traded before this year. But, the overwhelming evidence of a coming crash and the discovery of the ultrashorts I could use in my IRA persuaded me.

I stayed out in the late 1990′s also. As someone with a lot of tech knowledge, it seemed like a complete fraud.

In fact, we know all that with some precision. Just look at the monthly data. If you plot year-over-year rates of change in home prices, sales of existing and new homes, and initial and continuing unemployment claims, you’ll see that (a) the rate of change of existing home sales bottomed in January, (b) new home sales bottomed in April, (c) home prices are now in the process of bottoming, (d) personal saving flipped from negative to positive in May, and, given the level of unemployment claims in December 2007, (e) unemployment claims are going to bottom next month. “Bottoming” meaning that the declines or increases have started to slow down rather than continue to speed up. Real personal consumption expenditures peaked in May and so the rate of change should bottom in the second quarter of 2009. We also know that foreclosures related to sub-prime adjustable rate resets are peaking in the current quarter, etc.

Note that these trends, particularly evident in the employment data, are remarkably similar to trends in previous recessions. That is, so far this recession has been more or less vanilla. This point was made by Stratfor in their commentary yesterday:

“The crisis is routinizing itself. We mean by this that the economic pattern — as opposed to the financial — is taking a recognizable form. We have slowed somewhat more rapidly than normal, but commodity prices have plunged early in the piece. We would expect bad numbers in the last quarter, but possibly not as bad as some have said. The problems will persist through the spring, but we should see recovery in the summer. We are in recession, and it looks pretty much like what we saw in the past two recessions. It certainly doesn’t look anything like the 1970s. Interest rates aren’t through the roof, and we don’t have double-digit unemployment and inflation. So in trying to benchmark this process, the United States is behaving better than most expected, and in line with what we have seen in the past.”

Yes, this is going to be longer than your average recession, but, assuming it started in January, it has already been longer than your average recession. That is, we are a long way into this recession and we are now getting more visibility regarding how and when it will terminate.

The economy is going to get worse before it gets better, but, as Buffett says, “if you wait for the robins, spring will be over”.

I would be pleased to share with you or anyone else how I trade the market. However, I am sure that I would bore hell out of the participants on this blog with an explanatio0n of my “system” as it were. Let me offer a few, hopefully brief, comments.

THE DARK SIDE

You will probably not want to read more after I explain the downside to my approach. As soon as I lose money on a trade, I exit the market totally. For example, from August 1996 through July 2000 I did not make a trade. Greenspan called it “irrational exuberance,” but I called it “irresponsible idiocy.” I also did not make a trade from August 2006 through August 2007. (I did have a day job that paid the bills.) I did not “miss opportunities,” I happily missed losses because even in retrospect I have no way to explain or trade those markets. I was well aware that both periods were bubbles leading to disaster, but I could not forecast the end.

THE BRIGHTER SIDE

In the vernacular of Wall Street my approach is that of a “quant.” I let Mother Market take me into and out of the market. There are no forecasts. The system has five basic principles:

(a) It is a probabalistic world: I use some relatively simple models to calculate the probability of a trend continuing or reversing — I don’t forecast the trend.
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(b) The only certain forecast of Mother Market is that “the market reverts to the mean.” But what is the “mean?” People use trend lines, regression lines and moving averages. Instead, I use the New York composite, the Mother of all indexes. More precisely, I use the 21 day MA of the NYSE.

(c) The NYSE always leads in defining the market trend. I don’t trade the NYSE but I do trade the NDX and S&P in terms of their divergence from the NYSE.

(c) I am almost always both long and short, the ratios differ over time, depending on the probabilities of trend change.

(d) I scale into long and short positions. 5, 10, 15 and 20% market reversals lead to 25%, 50%, 75% and 100% positions either long or short depending on market direction. In other words, a low probability (at least once upon a time) 20% uninterrupted market move up will leave me 100% short and vice versa.

Given this oversimplified description, many will find the holes. It ain’t that simple but, as confessed above, uninterrupted up moves take me out of the market.

What system do you generally use? I can’t see how any long term profitable system cannot include some type of expectation of what’s going to happen, at least in the very short term.

I don’t mind getting ideas from others on this board. I think them out myself to see if I think they are worthwhile. For example, leftback’s advice to buy SRS looked very promising, although it took until Sept. to pan out. My only problem with it was my stupid execution so I only made about 25% instead of doubling my investment.

On triplesec’s misadventure, I felt sort of the same way. I had independently come to the conclusion that there would be a bounce and jumped in whole hog too early as I tend to, and got overleveraged with some calls. But, I made it all back and then some this past week. And, I can’t blame Barry for that: his advice was “dipping your toe in” with stop orders in place, which is what I should have done. As for jumping too early, Rothschild said when asked how he made so much: “Because I never buy at the bottom and always sell too soon.”

If one predicts, on 11/1/08, that a diversified portfolio is likely to be higher in value at some unspecified point in the future, that prediction is going to be vindicated sooner or later.

Of course, making a bullish forecast in November of 2008 is worth far less to anyone than making a clear cut bearish forecast in October of 2007.

The lesson you have learned is the lesson all traders have learned sooner or later. Remember the first three rules of successful trading:

1) NEVER, NEVER, NEVER take any advice or let anyone else influence your trading decisions. To do so merely reveals that you do NOT have a systematic and disciplined approach to investing. A surprisingly large and varied number of displined investment approaches can be successful over time. Stick with one and ignore all others.

2) See Rule #1 — repeat it often.

3) NEVER, NEVER, NEVER base your investment strategy on market forecasts.