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Let’s not mince words: Yesterday’s market action – down 1.75% on heavier volume — was a shellacking:

DJIA 12715.93 -213.66 -1.65%
Nasdaq 2991.22 -55.86 -1.83%
S&P 500 1358.59 -23.61 -1.71%

We are now rather oversold, and are due for a bounce. What I want to look at is the quality of the market internals during this period. It will provide some insight into how far we could bounce back, and where support might be if and when this reaction rally (2-7 days) fails.

I find whenever I discuss these sorts of technical actions, people get confused by the apparently conflicting perspectives (“You sound bearish today and bullish yesterday“). The key to understanding these are your holding periods and timelines. The wiggles in the day-to-day action mean different things to traders, investors, and company insiders.

My holding period is typically measured in quarters and years. But I feel compelled to be aware of what takes place over weeks and months. Shorter time periods than that — hours and days — are so noisy as to be meaningless to me.

Sometimes it appears market participants are disagreeing when they are really just looking at different holding periods.

Investors should never try to “play the squiggles” — using long term valuation measures to trade in and out for a quick profit rarely works. I’ve seen many a good investment turned into a trade — dumped on initial strength shortly after establishing the position for the quick winner, only to watch it run away over the next year. Its usually accompanied by this hackneyed phrase: “No one ever went broke taking a profit.”

Actually, they do. You need big winners to offset a lot of little losers, and small winners don’t help. Its like snatching defeat from the jaws of victory.

Traders who allow a short term position to turn into an investment are usually doing so because they got caught leaning the wrong way and are refusing to admit their error. Rather than take a small hit, they nurture their losing position on the hopes of it recovering. That happens rarely, but far more often the bad trade turns into a giant loss. In some cases, it becomes a blow out disaster that ends the trader’s career.

Any trader that wants to let a winning trade can and should do so, but they must establish a new exit rule for that position. I never like to give back more than 25% of a gain in these circumstances. You can alternatively use a shorter moving average as your exit signal.

My rules:

1. Make sure you understand what your holding period is before you establish any position.

2. Traders should NEVER let any losing trade turn into an investment.

3. Strong investments should be given the benefit of the doubt, rather than taking the quick profit.

4. Winning trades should be allowed to run, but require a new exit strategy.

These are fairly basic but oft overlooked ideas. Understand them or create your own, but please don’t just wing it. That’s a real formula for disaster.



Expect to Be Wrong in the Stock Market (The

Category: Apprenticed Investor, Investing, Markets, Rules, Technical Analysis, Trading

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

24 Responses to “Trading vs Investing (and Today’s Bounce)”

  1. Sechel says:

    Barry, Are you not at all concerrned by the lack of volume?


    BR: Funny, I wrote John earlier asking him for a better version of that CS chart.
    Mary Ann Bartels of Merrill had an excellent analysis (here)

    She was referencing Volume as a structural issue; today’s discussion is about recent market action. The volume on Monday’s sell off was light; Tuesday’s was heavy.

  2. CANDollar says:

    Sell into the bounce?
    Resistance at 1389?
    Strong resistance at 1420?

  3. NoKidding says:

    Problem is, the gains on recent bounces keep turning up between the close and the open. You have to place your morning bet last night to make it pay.

  4. dead hobo says:

    Agree with what you said, but more is needed.

    Holding periods are a function of your overall objective. Young and middle aged people will almost always have different objectives than old farts like me. (I’m really not that old but circumstances have given me similar objectives a tad earlier than nature and economics might have otherwise intended.)

    I’m simply interested in making money, as in adding cash to the pile. My holding period will never be what it was when I was 35 because I need the cash in a safe and growing pile , not the promise of an important stock, maybe, in a few years. I can afford some risk, and, because I think I’m smarter and more educated than the average bear (as in Yogi), I will accept short term risk when big moves look probable.

    I’ll usually walk away better off than I was before the trade, but not as good as if I waited a little longer. But I’ll have cash I didn’t have and make much more than the riskless return. The concept of ‘leaving cash on the table’ by exiting early is naive if applied to all.

    Plus, there’s no reason why someone who sells early can’t buy back in if it looks like the sale was premature. A giant foot doesn’t come down from the sky and squish you into a pancake if you buy back a little later. You might even get in at a better price. At worst, you lost a few percent. Or, you might end up avoiding a Netflix type of thing and sell at an envious point that was nowhere near the top.

  5. adid says:

    Sell the bounce today, cover below 1350 ES. Then sell again above 1370 ES next week.

  6. dead hobo says:

    1 pretty good trading rule for if it’s OK to come out and play …

    If ZH reads like a news site, cash out, hide under the desk, and roll into a ball.

    If ZH turns up the crazy, green light for putting cash out

    If ZH shrills up the crazy … plan to make a lot going long.

    Sorry, ZH, love your site but can’t accept it at face value.

  7. CANDollar says:

    I understand the need to let winners run but I look at it from the perspective of risk free return and risk management – anticipate regret. If the stock has a total return that exceeds the risk free return by a certain benchmark then one minimizes regret.

  8. pintelho says:

    heh…I sold some of my stock options in my company and missed another $5 (and who knows how much more)…I keep saying “nobody ever went broke taking a profit”

    In fairness to myself I have been waiting 4 years to sell those puppies…and I did need the money for a renovation…although with those extra $5 in movement I could have paid for more of the reno.

    It is what it is.

  9. Mark Down says:

    My Rules:

    (“You sound bearish today and bullish yesterday”)

    5. Slap down a million and I’ll tell you the real story.


    BR: Yes, I hide so much and hardly reveal ANYTHING in these pages, 21,899 posts later.

  10. RW says:

    The volume on the Dow Jones U.S. Total Stock Market Index (full-cap, basically the old Wilshire 5000) was light on Tuesday (632,684,600), somewhat heavier on Monday (946,911,200) and the previous Friday (918,804,600), but nothing out of the ordinary.

    The heavier volume for the S&P500 on Tuesday may reflect tactical unwinding of positions that weren’t panning out; e.g., overweighting big cap names in the expectation of slow global growth and more Fed easing.

    It’s been a long time since I disliked a market more than this one but that may be recency bias talking.

  11. Conan says:

    Excellent observation and guide lines. My research and past eperience the hard way has demonstrated the same. The only major differences are:

    1) I trade in typically weeks to months so somewhat shorter time frame unleess it is an exceptionally strong trend.

    2) Letting profits run was my original hypothisis, however it generated more even results if I set a risk reward ration of 2:1 or 3:1. So up front I know what my stop will be and what my gain is projected to be. The rest is testing probabilites as to the ratio of wins vs losses using your logic to go long or short. This gives you a perspecitve on how efficient your prosess is, i.e. if you stop out too much you won’t make any money. This, in my opinion was the falicy of a large number of small losses to be made up by a small number of big gains. You need to also keep an eye on the efficiency of your logic as to what is your win loss ratio or percentage. If too high, you need to refine you method and to be realist if to low you probaly over optimized and need to review your testing.

    Thanks for the intellectual stimulation as I enjoy ready your blog for the wide variety of view points.

  12. ZedLoch says:

    “The key to understanding these are your holding periods and timelines. ”

    Indeed. So say my timeline is on the month-year scale.

    I was lucky to get in a few good names late last year. There are a few more I have been looking at, but just looking for the next trough before taking the leap.

    What should I look for? A P/E I am comfortable with?

  13. ashpelham2 says:

    Great rules for trading, as always. Thanks for throwing that information in there to hopefully make us all better. One more thing I’d like to add, which is a bit more specific, has to do with earnings season and company guidance: Struggling with this of late because companies are choosing to far underestimate, then when they beat expectations, expecting a bounce in stock price.

    How do we manage the sandbagging going on with earnings guidance now?

  14. Bill Wilson says:

    I think you have to base your trading rules on your own phycology or tendancies. You have to know yourself. That sounds corny, but I think it’s true.

    Some of the other commenters on this site like to average into positions. They’re probably a lot smarter and richer than I am, so I don’t think it’s wrong to “average in”, but I don’t like to do it. I’d rather take a position with a stop. If I get stopped I can always find a new entry point. I find that taking my chips off the table allows me to think more rationally rather than emotionaly.

    I think the idea of getting a better price than you got before can be a trap. You bought at $10 and now it’s $9. Now it’s $5, and now it’s $0.01. You have to have a place to take losses no matter what.

    I also think that the one advantage that a small fish like myself has over big money investors like Warren Buffet is that I take positions quickly and cut loses quickly.

  15. [...] On the importance of establishing time frames in trading and investing.  (Big Picture) [...]

  16. Iamthe50percent says:

    I bought BP for the dividend (investment). Then came the Gulf disaster. At the bottom, I considered taking my loss, but instead doubled down. I use the gambling term because it was a pure gamble. One that paid off. Recently, BP started falling again. I sold out for a 2% overall gain (not counting dividends). 2008 made me extremely gun shy as I listened to advisers advising to hold while I watched my 401K descend from $350K to $181K. Never again.

  17. bear_in_mind says:

    Thanks for sharing — makes perfect sense!

    Also agree with DeadHobo’s point that one can fairly easily and painlessly re-enter a winning position after uncertainty clears (mindful of the IRS’s ‘wash sale’ rules, of course).


    BR: Its hard to do in real life.

    You buy something at 15, it goes to 42, rolls over to 32 (Stopped out), than breaks above 42 again.

    Do you rebuy it there?

    (PS: THats Apple circa 2004)

  18. mikeinconyers says:

    I think Bill Wilson is right on about our tendencies. I find it very hard to sell into a falling market, so I take some profits on the way up and buy om the way down. I do let my winners run, but I agonize greatly in doing so.

  19. 4whatitsworth says:

    Thanks I needed some of that.. Especially “You need big winners to offset a lot of little losers, and small winners don’t help.” And “I never like to give back more than 25% of a gain”

    That said the idea that “you can’t go broke taking a profit” is wrong freaks me out. Not sure selling a little early is a terrible thing as long as you are not “Playing the squiggles”.

  20. Robert M says:

    You mentioned yesterday’s volume was high. How are you receiving accurate figures for volume given black boxes and other distortions. Two, when i commented last week I found these old measures not being as reliable given black boxes. I think this fact is very disturbing in that you can’t find any real measure of shorts. That is why I believe the market fell so hard(over 1%), finally, there were no bids. If this keeps holding true I believe the facts are entertaining the idea of the late 60′s early 70′s bear market where essentially nothing happened except you came in and periodically the market just collapsed stopped and a week later the same.

  21. Jeff Miller says:

    Excellent article! Great distinction and helpful rules.

  22. dead hobo says:

    BR replied to someone:

    BR: Its hard to do in real life. You buy something at 15, it goes to 42, rolls over to 32 (Stopped out), than breaks above 42 again. Do you rebuy it there? (PS: THats Apple circa 2004)

    I think you would apply the same logic you used to buy any share. You buy if it looks good based on your understanding of the environment at that moment. Agree it’s hard to buy back in, although my reticence in the past was heavily influenced by adverse family influences which no longer exist.

    What’s really hard is explaining to some smartass why you sold and want to buy back. Since a lot of wall street trading and management is influenced by master of the universe imagery that likes to look more infallible than the Pope, sell and buy back implies uncertainty. Masters of the universe will claim they ooze certainty and claim to look much cooler to the unwashed who still believe in wall street superstar mythology.

  23. [...] I was familiar with. Perhaps that was the basis of this week’s time frame discussion of Trading vs Investing. Understanding the very  l o n g  term is an important concept, in terms of getting what the long [...]

  24. [...] a concept I was familiar with. Perhaps that was the basis of this week’s time frame discussion of Trading vs Investing. Understanding the very  l o n g  term is an important concept, in terms of getting what the long [...]