Introduction to technical analysis - how to make money

TA1   INTRODUCTION TO TECHNICAL ANALYSIS – HOW TO MAKE MONEY

Logic flow absolutely from TA1 onwards – like a book starting at chapter 1

It is critically important that you differentiate between “managing your investments” and “trading” as these are, in my opinion, totally separate.  You secure your future wealth in your old age by accruing money and correctly managing your investments.  Contrarily, initially and “for as long as you do not have a successful track record”, “Trading” is like going to the Casino and taking a wager on price direction.  i.e. You are taking some of your money, preferably a small percentage of your wealth, and wagering it on the direction of a few selected shares / instruments / asset classes.

INVESTMENT: I postulate that “We spend a lifetime accruing money and almost no time learning how to look after our wealth”.  We glibly claim ignorance and hand over that responsibility to others, few of whom are truly honest & professional and many of whom are outright charlatans.  This is counterintuitive since:-

“We can delegate a task, but we can never delegate responsibility”

i.e. If it all goes wrong we have no recourse and cannot point fingers.  I maintain it is up to us to educate ourselves, at least until we understand investment basics – i.e. the broad investment concepts and strategy.  We can then communicate intelligently with our broker and agree the ideal diversification strategy for the ruling economic situation.  Thereafter, it is up to him to refine it and select the best fund managers.

TRADING: If you wish to become a trader it is useful if you understand the basics of global economics and market fundamentals, as these often highlight future trends.  However, despite that fact, your trading should be based exclusively on technical analysis and not biases that arise from understanding global economics and equity trends.  i.e. You need to maintain a detached objectivity when trading and “not” allow emotions to interfere with your decisions.  In fact, I would go as far as to say

“The less emotion affects your trading decisions, the more successful you will be”.

Everyone trades to make a profit, yet very few people trade profitably.  Those who trade profitably are the people who are disciplined in their approach to “each and every” trade.  Discipline is probably the most important characteristic of a successful trader.  Most people end up losing for the following reasons:

  • Because they do not do their homework, and/or they are not disciplined enough;
  • They got in too late and out too late instead of getting in early and out early;
  • They believe they “know” where the market is going and trade on gut feel – ie. Their ego mind overrules what technical analysis, and/or the market is telling them;
  • They are gamblers and their “fix” is having open trades and being in on the action, so they “look for and see trades” where there are no trades – i.e. Greed overrules common sense. e. Only trade when you see trades;
  • They are greedy and do not know when to take their profits or cut their losses.

Trading success depends on three primary components:

  • Firstly, let’s say 30% of your success lies in managing to side-line your Psychological Idiosyncrasies – which also ties into your discipline;
  • Secondly, let’s say 30% is about learning, developing and managing your technical analysis skills.  This skill is directly proportional to the amount of time you spend looking at and understanding how oscillators move in relation to price and the useful interrelationships between the technical analysis tools;
  • Thirdly, let’s say 30% is about the discipline of managing your Entry Point, Exit Point, Stop Losses and Bet Sizes; and
  • Finally, 10% is about luck as “black swans” like a natural disaster, war or an untimely comment by a politician can “throw” the markets into disarray.

This course is mostly about the second and third aspects, namely Technical Analysis and Placing Trades.  It only provides a brief introduction to the more popular TA tools and Setting Trades, it is incumbent on you to research those you elect to use by reading appropriate books and articles on the web.  The reason for this is that there are multiple books about any aspect I touch on, like Psychology of Trading, Cycles, Elliott Wave Theory, TSAR Lines, Trading Patterns, Candlesticks, Oscillators, Moving Averages, etc.  If you do not read at least on book on each of these topics, you risk inadequate skill, which is not professional and leads to losses.

Technical Analysis is the art of improving your chances of making a profit.  Essentially, the safe money is made when the market is trending and markets only trend 30-35% of the time.  When you start it is easier to risk small amounts to play the trends, therefore you will only be in the markets 20-25% of the time and typically for periods ranging from a few days to a few weeks.  Although there is money to be made in volatile markets, which is usually when trends are ending or there is no trend, we initially leave that “intra-day” to the professionals.  You can graduate into this shorter-term intra-day trading arena as your experience grows and only if you have the time to watch your screen continuously.

There is no such thing as a sure bet.  Fundamentally, trading using technical analysis is the art of using trading signals that have a 70%-80% probability of predicting direction and/or the size of the move.  Couple this probability with incorrect trading analysis, bet sizing, entry and exit points and you understand why, most professionals only have a 35-60% trading success ratio.  More than 66% of professional traders do not outperform the markets, but when they do, they make money because they limit their losses and let their profits run.  We will use this information coupled with an expected 2:1 Reward to Risk ratio to teach you how to make money.

We will talk about a wide variety of topics, including the following:

  • Fundamentals (Top Down approach);
  • Psychology of trading – how to identify your strengths and weaknesses;
  • Technical Analysis tools, including Cycles, Identifying Trends, Elliott Wave Theory, TSAR Lines (Technical Support and Resistance Lines), Charting Patterns, Oscillators, Volume, Candlesticks, Swing Trading;
  • Entry Points, Exit Points, Stop Losses and Bet Sizing;
  • Cutting your losses and letting your profits run.

Research conducted among top traders has shown that no two traders use the same trading strategy, so no one can teach you an exact trading strategy.  Each of you will develop your own trading strategy that suits your personality and style.  This requires an investment in time and costly mistakes.  If you initially spend 3-4 hours per day looking at the charts, reading educational material and developing your understanding of the markets, you can expect to become consistently profitable after 2-3 years.  You may ask why so long if the system works.  The reason is that initially you will make poorer trades because you will have traded too early or too late, set your stops wrong or missed spotting contrary signals.

Below I touch on the three investment approaches, namely:

  • Investment portfolios;
  • Trading Individual Equities; and
  • Pure Trading using leveraging tools like Options, Warrants, Contracts for Difference (CFD’s) or Leveraged Futures Derivatives (Spread Betting).

An understanding of basic economic concepts and technical analysis can assist you in optimising your returns in all three.

Equity portfolios are the place where you store your wealth.  The younger you are, the more aggressive your strategy and the older you are the more conservative.  Equities Portfolios are difficult to manage in that one typically has to invest in sectors that are going up as most funds do not enable you to short markets.  Over time one has to switch funds out of those sectors that are topping out and into those that are bottoming or rising, since no sector or market rises in perpetuity.  Such multi-year cyclical swings are fairly easy to identify with some basic education and tools.  To some extent you can protect your capital against stock market corrections by periodically switching to cash, bonds or contra-cyclical assets or funds (i.e. those that do well when all is unravelling) when it is apparent that the markets are about to correct.  The advantage of funds is that they diversify your participation in any one sector and protect you against individual shares’ miss-management, insolvencies or crashes.  Since they are managed by professional fund managers, you do not need to monitor these on a daily, weekly or even monthly basis – reviewing your strategy once every 6-12 months is sufficient.  However, it is important to identify the “best” fund manager in that sector – eg. The best of say 10 Resources Fund Managers.

Trading Individual Equities is an activity where you take say 10%-20% of your “Wealth Money” and invest it in individual Equities.  However, this is more risky and requires considerable knowledge of the equity being traded.  There is an ever-present risk that the share price will drop due to Natural Crises, Contrarian News, New Legislation, New Competitive Products, Embezzlement, Bad Management, Insolvency etc.  Whereas you can leave the management of Equity Portfolio to the Portfolio Manager for up to a year at a time, with individual shares you need to check on your investment assumptions, the technical performance and the price of each and every share every day – which can be onerous.

Pure Trading on the other hand, is an activity where you take a small percentage (eg. 1-2%) of your Wealth Money and use it to speculate (gamble) for higher gains using leveraged tools.  The reason why I recommend such a small percentage is that in the event you lose it all and still make 9% on the rest of your wealth, your weighted return will be 7-8% after allowing for the loss of 1-2% in your “gambling hobby.  In this arena you should be able to make money with your trading activities, regardless of whether the market is going up or down, once you know what you are doing.  Typical examples of such trading platforms are CFD’s, Options, Warrants and Spread Betting.

The Macro Economic thinking we teach you in this course material will better enable you to identify when to switch funds.  The Technical Analysis tools that we teach you in this course material will better enable you to Trade Individual Equities and/or to Trade Leveraged Derivatives using trading platforms such as CFD’s, Options, Warrants or Spread Betting to elevate your portfolio return.  However, that is usually easier said than done as it takes time to hone your skills.

My advice is if you are going to risk/spend considerable money to make even more money, it is worth investing a small sum in some books and one or two trading courses.  The cost of that investment will be negligible in relation to the investment and especially when measured against the potential profits if you go about it in the right way.

Before you start with the rest of the epistles, engrave on your mind:

Truly successful trading is “ABSOLUTELY DEVOID OF EMOTION” – it has to be driven by a systematic mechanical approach using Trading Analysis Tools, appropriate Bet Sizing and well considered Entry, Exit & Stop Loss levels.

There was an extremely successful Russian trading team, who operated as more or less as follows:

  • One identified the instrument and the entry point;
  • Another decided on the bet size and stop losses;
  • The third managed (raising) the stop losses and decided on the exit point.

The purpose of this approach was to strip out the risk that any one person became attached to any aspect of the trade.  i.e. The objective was to eliminate much of the emotion that traders attach to their trades, such as staying in too long because they want to make even more (greed – I saw a $40 000 profit evaporate for this reason).


Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at EelcoGold.com

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

Top down fundamentals

TA2 – Part 1 Ch1 – Top down fundamentals

Logic flow absolutely from TA1 onwards – this is like a book starting at chapter 1

It is useful to know the fundamentals driving the markets or sectors you are investing in as these can highlight investment opportunities and/or threats.  Fundamentals are the reasons why the economy, the market or the sector is trending up or down.  The reasons may be direct or indirect and may be obvious or obscure.  While I believe that a top down approach commencing with the fundamentals is important to give you insight into the bigger picture, I want to say at the outset that Technical Analysis supersedes Fundamentals and not the other way around.  The shorter your trading time horizon, the less important the fundamentals.

One fundamental that is affecting almost all markets globally is the fact that all countries have adopted fiat currencies and are printing money hand over fist, in a veritable currency war, to preserve their relative export competitiveness by way of competitive devaluations.  This manipulation and debasing of all currencies has caused certain imbalances that have a bearing on the long term competitiveness of certain countries and the validity of their “so called” market returns.  Understanding the nuances and intricacies of the Fiat Currency house of cards and its effect on the Deflation, Inflation, Hyperinflation and Stagflation debate is almost critical at this juncture as it highlights opportunities/threats.  More about this in the next chapter.

Another fundamental that is affecting almost all markets is the awakening of the BRIC countries (Brazil, Russia, India, China – should include Malaysia, Indonesia, Thailand, Philippines, etc).  This awakening is being accelerated by the internet that allows access to almost any information, products, prospective customers etc.  These countries have become the manufacturing engine of the world as they have access to labour at a fraction of the cost of the West.   Furthermore, the rise in their living standard over the next 20 years will almost quadruple the demand for most resources worldwide.  As a direct result, the West is becoming more service oriented and socialist while the East is becoming more manufacturing oriented and capitalist, which is causing a global power shift from the West to the East.

Looking at trading, all markets are to a greater or lesser extent dependent on each other, so seemingly unrelated markets can give signals that move in sync or that are contra cyclical.  Bottom line, if you view the world in 4 generational economic cycles, we are now only moving into the “Winter” (bottom right) of the long cycle as illustrated by the following familiar diagram from Ian Brown’s report on www.Gold-Eagle.com.  If you look at Autumn, you will see it exactly characterised the period from 1981 to 2005 when they were talking of the Goldilocks economy.  However, in the “Winter” falling inflation/deflation may be replaced by inflation coupled with falling “Real Values” of assets & currencies as the money being printed is excessively inflationary and we will probably have hyperinflation with negative economic growth sometime in the near future.  Hyperinflation is equally as destructive to wealth when measured in “Real Terms” as deflation is.  Equally, the suggestion that one should invest in Bonds will have to be treated with caution as it is more likely that we will see a collapse of the bond market due to the collapse in the “Real” value of “Fiat” currencies and the corresponding increase in rates.  I think the investment of choice will be precious metals followed by Resources & Commodities (due to Chinese demand).  These amendments in interpretation arise due to the fact that we now have Fiat Currencies and not Gold Standard Currencies.

In essence, the global economic climate and trends have a bearing on your investment strategies.  Much of this can be observed and concluded through logical thinking.   So for example:

  • If the global economy is in decline, that could have a negative or a positive impact on the shares you want to trade eg. if the motor industry is in decline that will have a negative demand on platinum used in catalytic converters;
  • If the Dollar is getting weaker, the rest of the world is prepared to pay the same for commodities in their currency so the Dollar prices of those that are quoted in Dollars tend to rise.  Equally, a fall in the Dollar is good news for USA Companies that export and/or derive a lot of income from abroad as their profits will soar and, contrarily, it is bad for those who import.  Similarly moves in bond prices often precede moves in equities and a move in Gold shares often precedes a move in the Gold price.  This is why I look at the Dollar, Bonds and Gold equities for trend changes and signals that are predictive and may help me better trade Gold, Silver and the DOW Jones as moves in the first three often lead the latter three by as much as 1-3 days;
  • Equally, you should follow the money.  When the Dollar is getting weaker, it means people are getting out of Dollars and you need to ask “where is that money going”, to which the answer will probably be into Bonds or Equities.  If people are getting out of Equities, they will usually flee to the security of Cash or Bonds or, in true crises, into Gold and other precious metals.  When bond markets offer negative real returns, Gold and Silver come into their own;
  • In South Africa a sudden move in the Rand will frequently precede a sudden move in Gold Shares by 10-15 minutes and a fall in the Equities in the USA will usually precede a fall in Equities in South Africa, the East & then the EU;
  • People always need food and clothes.  When markets crash, unemployment and interest rates rise, that means tough times are ahead and this is frequently a precursor to the fact that those discounters selling lower priced products will prosper whereas those chains selling upmarket products will suffer;
  • A more extreme example is that news of a shortage of Rare Earth Metals will affect Manufacturers of Electric Cars, Computers, Cell Phones etc, who cannot function without these essential raw materials;

Understanding basic economic concepts, basic investment trends, cycles and interrelationships makes it less likely that you will be caught on the wrong side of the trading fence.

Unfortunately, the markets are an intricate web of almost infinite interdependencies and interrelationships, which makes it hard to exactly predict/understand all movements.  However, with time you do start to see the broader picture, and this is what you are after.


Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at EelcoGold.com

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

Understanding Inflation and Interest Rates

TA3 – Part 1 Ch 2 – UNDERSTANDING INFLATION AND INTEREST RATES

A bit of a chicken and egg story?

Logic flow absolutely from TA1 onwards – this is like a book starting at chapter 1

There is much debate about whether rising inflation precipitates rising interest rates or rising interest rates precipitate rising inflation, due to the fact that both are probably true.  However, regardless of which is true, “in the longer term”, there is a strong correlation between Interest Rates and Inflation, or, visa-versa, between Inflation and Interest rates.  It is certainly true that rising inflation is always accompanied by rising interest rates because investors’ after-tax returns need to exceed inflation.  It is equally true that the declining rates of the period from 1980 to 2007 were accompanied by declining inflation and that the super low rates of the period from 2007 to 2017 were accompanied by super low inflation/deflation.  NB! We are not talking short term fluctuations.

RE:- INTEREST RATES:  Essentially Investment Funds and/or Wealthy Investors lend Governments money in return for a loan certificate known as a Bond, that pays a “yield” on their investment known as the coupon interest rate.  Historically, this yield determined what the markets were prepared to pay for these Bonds and that, in turn, set the tone for the interest rates used by Banks, etc.  Such Government Bonds are/were always seen as “Risk Free” investments on the assumption that Governments cannot go bankrupt.  This was true when countries were on the Gold Standard, but this is no longer true as all currencies are now Fiat and that has facilitated rampant deficit spending and the unsustainable parabolic spiralling of national debt.  Consequently, literally hundreds of emerging countries have gone bankrupt in the past century.  More important, no Fiat Currency has ever prevailed longer than 100 years and all currencies are currently Fiat, therefore, we could conclude that the USA, EU, China, Japan and UK’s Fiat days are numbered.   i.e. The countries will survive, but they will be eventually no longer be able to service their debt, where-after they will effectively be bankrupt as they will default on their debt repayments, at which point their currencies will tank/collapse.

Before we proceed, it is useful to know that investors are constantly switching between “lower risk / lower return” Government Bonds/Treasuries/Gilts and “higher risk / higher return” Stocks/Shares/Equities, and it is this “risk management” activity that traditionally sets interest rates.  i.e. Historically, all market interest rates were derived from this “free market” trade in Government Bonds (NB! we are not talking about Corporate Bonds) and these “Risk Free Interest Rates” were the market’s “Risk Pricing Mechanism”.  It is further important to understand that the Bond Prices and their respective Bond Yields are inversely correlated.  This is because rates fall when investors are aggressively buying Bonds, during a flight out of more risky Equities into the safety of less risky Bonds.  Contrarily, rates rise when investors are aggressively selling bonds in a search for higher returns in Equities.

This is best illustrated by way of a slightly oversimplified example – oversimplified because time makes the pro-rata calculations illustrated below more complicated.

A Government issues Bonds with a face value of say $1 000, with a coupon rate of say 10% per annum over say 10 years, where-after the Government pays back the money to the investor.  However, a few days later, there is a market crash or global crisis and investors want to get out of their temporarily/potentially more risky Equities into the safety of Bonds.  This drives down the demand for and prices of Equities and drives up the demand for and prices of Bonds as the Bond Sellers want to hang onto their safe investments and the Bond buyers want to buy these “now safe” investments.  Let us suggest that the Sellers hold out until the Buyers are prepared to pay $2 000 for that Bond, which has a face value of $1 000.  However, that $1 000 Bond still pays only 10% or $100 per annum interest.  Implicitly therefore, the $1 000 Bond is now only yielding 5% for the new owner who paid $2 000 for it.  In this way we see that as the Bond price rises, the coupon rate falls and visa-versa.  This perfectly illustrates how the interest rates set by the Bond markets reflect Risk.

Earlier I suggested that “Historically, interest rates were the “Risk Pricing Mechanism” of the markets”.  However, during the past few decades, Governments have engaged in an orgy of Deficit spending and Rising Sovereign Debt.  Subsequently Central Banks started issuing new money to buy their own Governments Bonds, mainly to suppress interest rates as they could not afford the future debt service costs that would be associated with higher rates.   In most countries, interest rates are now artificially low, and, in many countries, interest rates are now negative, which means you pay the bank to hold your money.  These super low rates have caused pensioners, pension and investment funds to take imprudent risks in a search for yield (higher returns).  Consequently, equities are no longer correctly priced as the “invisible hand of the free markets” is no longer setting interest rates and this means that the market’s mechanism to evaluate risk based on the prevailing interest rates is now broken.  Bottom line, this makes it harder for investors to “read” the risks embodied in the markets.

Next it is useful to know that both inflation and interest rates are cyclical.  Typically Interest Rates rise for 15-30 years and then fall for 30-40 years.  The following US 10 Year rates chart illustrates the recent 36 year decline from 1980 into Early 2016

Based on the above chart, we can see that interest rates have broken above the red resistance line.  However, it could take a few years before rates really start rising.  At the time of writing, mid 2019, it was more likely that Equities would experience a major correction and that the flight to the safety of bonds would drive rates far lower.

Bearing in mind that low interest rates wreak havoc with pensioners’ and pension funds’ returns, as they both rely considerably on interest bearing investments to provide a “conservative” safe return on their investments, this is not sustainable in the long term.  Their return on interest after bank charges and taxes is certainly lower than inflation, which means investors are becoming poorer, not richer and pensioners are not able to make end meet.

RE:- INFLATION:  When interest rates bottom and a new trend of rising interest rates manifests, which will almost certainly happen in the next few years, this will almost certainly herald a rise in both commodities and inflation.  More important, a persistent rise in interest rates will cause the current 37+ year Bull Market in Bonds to end, where-after there will be a protracted Bear Market in Bonds (rising interest rates).  Equally important, rising rates will cause Equity Markets to retreat/collapse, which we explain in the next chapter.  In addition, consumption will fall dramatically, as consumers who had no incentive to save during this period of super low rates and were encouraged to buy on credit to the point where private credit card debt is at record highs, will either no longer be able to service their debt, or they will be incentivised to save.  Finally, a protracted rise in rates will cause the housing market to stall or collapse as people will find it increasingly difficult to service their mortgages.  Bottom line, any protracted rise in rates from these super low levels will have a dramatic negative impact on most markets.

Nicholas Taleb wrote a book called Anti-Fragile, in which he postulates that the strong get stronger during times of crisis.  i.e. It is up to you to see how you can avoid losses during, or even benefit from these crises, if and when they arise.

I would also like to mention at this point, that Gold only truly rises during periods of “Negative Real Returns”, which usually happens when interest rates are less than inflation and equities are offering low or negative returns.  However, Gold also rises during protracted periods of global crisis or protracted periods of war on a massive/global scale.  At such times, Gold, Silver (poor man’s Gold) and Platinum tend to be an alternative “flight to safety / value” destination.  Furthermore, what usually happens when inflation/rates rise, it first manifests in rising commodity prices – i.e. Commodity prices rise before wages or the prices of the products made from those commodities rise.

While the above can be defined as “fundamental considerations, understanding this sort of thing can help you anticipate emerging trading opportunities.


Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at https://eelcogold.com/

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

How interest rates determine share prices

TA4 – Part 1 Ch3 – How interest rates determine share prices – OR

How share prices are set using interest rates

Logic flow absolutely from TA1 onwards – this is like a book starting at chapter 1

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Whenever one invests, one looks for the best average return, bearing in mind that one should never put all one’s eggs in one basket – i.e. your investment must be diversified (more about that in a later chapter).  Within that “diversification” constraint, investors are always switching investments from one investment category to the next, to maximise their returns.  The bulk of one’s investments usually lie in the two biggest investment categories, which are “lower risk/lower return” Bonds/Treasuries/Gilts and “higher risk/higher return” Stocks/Shares/Equities.  The best way to illustrate how the price of any Share is determined is by way of example.

The Market’s benchmark for risk is 10-year Government Bonds (Treasuries), which are deemed “RISK FREE”, based on the assumption that that Government cannot go bankrupt.  Let us imagine that these Bonds yield 10% at a time when inflation is say 7% – i.e. the after-tax return is likely to be at or just above the inflation rate.  At the same time, let us say that Retail shares are providing a 13% return.  Implicitly therefore, the Retail sector is trading at an average risk premium of 3% (13%-10%) over those “risk free” Government Bonds, which means investors are prepared to buy those shares provided they get an additional 3% for the risk associated with those Equities.  However, if one looks at the individual shares in that sector, some may be trading at a lower risk premium of say 2.5%, while others may be trading at a higher risk premium of say 3.5%.  Implicitly the difference between the risk premium of the latter share at 3.5% and the sector at 3%, namely 0.5%, is the Beta of that share (which can be calculated using log trends).  i.e. The market calculates the Levered or Unlevered Beta for each company’s shares and adds that to, or subtracts that from, the sector’s risk premium to determine the price at which that share should be trading.

Now it is critically important to understand that any change in interest rates or, more important, the “Risk Free Rate” heralds an almost immediate change in each and every equity as the return provided by that Equity is either enhanced or diminished as follows:

Let us say that we have a share that is trading at a price of $100 and is yielding earnings of $13.50 per share (the above mentioned risk free rate of 10% + sector’s 3% + Beta of 0.5%).  Suddenly, as suggested in the previous chapter, the risk free rate falls from 10% to 5% almost overnight, because investors want to get out of Equities and into Bonds (an extreme case just to keep the example simple).  At this point it is important to remember that interest rates can move rapidly, share prices can fall rapidly, but that companies’ earnings do not change rapidly.  Therefore, after the markets have corrected, all shares are repriced and the above share’s value would rise.  The calculation is as follows:  That share still provides a return of $13.50 per $100 share.  However, the market now dictates that the Risk free rate is 5%, which means the adjusted return expected from that share would be 5% + 3% + 0.5%, for an overall return of 8.5%.  Therefore, we divide the $13.50 by 0.085 (8.5%) for a revised share price of $158.83.  Again, it is important to note that as soon as Equities are in favour again, Bonds are progressively less in favour and this process starts to reverse.

Contrarily, if the Risk Free Rate were to double, the price of the share would drop considerably.  i.e. The market now dictates that the Risk free rate is 20%, which means the adjusted return expected from that share would be 20% + 3% + 0.5%, for an overall return of 23.5%, so we divide the $13.50 by 0.235 (23.5%) for a revised share price of $57.45.  NB! These two examples are in principle correct, but simplistic as the action is more complex because risk premiums change and changes in interest rates affect companies’ earnings.

Therefore, you can now understand why falling rates push equity markets up, whereas rising rates push equity markets down.  It is worth remembering the chart shown in the previous chapter which implies that this era of super low rates is unsustainable in the long term and that is will have a dramatic “negative” impact on equity markets at some point in the future.


Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at https://eelcogold.com/

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

Risk and Diversification

TA5 – Part 1 Ch4 – RISK AND DIVERSIFICATION  

Logic flow absolutely from TA1 onwards – this is like a book starting at chapter 1

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Every investor is faced with the traditional trade-off between Risk and Return.  The older you are the more risk averse and the younger you are the more risk inclined.  Equally, the wealthier you are, the greater your freedom to take on risk and the poorer you are, the lower your freedom to take on Risk.  Regardless, risk should always be managed by not putting all your eggs in one basket.  This is done by diversifying your investments across a number of asset classes.  Traditionally, the trade-off was as shown below in the first slide.

These were two brilliant slides presented by Chris Hart – RSA Economist

A) Normal investment environment – normal strategies below

B) Revised investment environment on next page. However, the above traditional approach has been undermined (turned on its head) by Central Banks / Governments printing money in excess to the point of no return “A-la-Zim”, deficit spending with escalating Sovereign debt and conspiring to keep interest rates artificially low.   The artificially low interest rates have, in turn, compelled fund managers and investors to engage in a search for yield which has distorted all markets – Reasons:

  • Avoid cash – Interest pays a low return after tax and certainly less than inflation (and progressively Fiat money will become worthless);
  • Lower portfolio weighting of Bonds – again, a low return after tax and mostly less than inflation (longer-term prospect that the eventual inevitable rise in rates will cause bonds, the traditional risk-free investment, to fall dramatically or collapse);
  • Low rates make property a no brainer as these make bonds affordable – certainly better than Cash and Bonds which return nothing after inflation. Prospect of rising rates makes property value escalation unlikely, however, Property is certainly better than seeing your investment tank – i.e. losing your money;
  • In the absence of adequate returns in the Money and Bond Markets, the money has to go somewhere. Therefore, for the time being in a Fiat environment where investors are engaged in a search for yield, Equities could do well, despite the fact that equities do not perform well during periods of rising rates;

C) My more extreme view?

  • However, as outlined before, this is a temporary unsustainable anomaly, so what do you do when the “proverbial” hits the fan – avoid third party risk – favour tangibles; and
  • I am of the opinion that one should invest in commodity equities, new technology equities and definitely all equities should be biased in favour of paying dividends.

However, in the short term, as the markets are peaking and ready to crash, it is prudent to sell equities and get into both Cash and Bonds.  Cash does not devalue overnight or over weeks, and Bonds do well during a crash as they are the traditional preferred destination in the event of a flight to safety when markets tank.  Gold/Silver are the ultimate flight to safety destination.

Regardless, this summarises the current situation and does not address the essence of the topic.

The essence of the topic is that Diversification is essential to manage risk.  Eg. Historically, every portfolio had say 20% invested in Bonds and 10% invested in Gold & Gold Equities to hedge against stock market crashes, global crises like War, etc.  The implication was that if Equities crashed, gains in Bonds and Gold would partly offset that fall in the value of your Equities.

However, today an entire generation of brokers have mostly known rising markets and never really experienced extreme recessions or global crises like depressions.  Furthermore, the markets were bailed out during the 1987 and 2002/3 crashes and the one major crisis in 2007, so they believe the “Fed Put” will always be there to protect the markets from crashes.  In addition, they have become addicted to the carry trade, comprising borrowing at super low interest rates to invest for greater returns and hedging by way of derivatives to protect these leveraged investments.  They have even started using leveraged derivatives to make money.  Accordingly, their perception of risk has been moderated and “Diversification” has now been redefined as Diversification across a lot of Equity sectors and some Bonds, not across the wider range of Asset Classes, because they feel they are protected by way of massive hedges.  However, this is risky as any crash can pull all Equities down across the board and collapse the margin debt and derivatives pyramids – a-la Lehman in 2007/8.  Therefore, strictly speaking Diversification should be across all asset classes listed in the above diagrams with shifts between these classes from those that are overbought to those that are oversold.  Truly wealthy people also diversify across countries and continents.

The important issue is that when there is a truly global market crash / crisis, it will be worse than usual, because of the unwinding of the huge leverage embodied in the Hedging, Derivatives and Margin debt arenas.  There are those who say it is a zero-sum game in that there is a winner for every loser, but the point is that the winner will not be paid and the loser will go belly up, like Lehman brothers did.

From a trading perspective, all this is useful to understand as monitoring the proclivity of the markets for Derivatives and Margin debt are useful.  Below is one of many charts that provide warnings of an overbought market, “not” guarantees that it will crash.  Such charts make you cautions about taking too many long positions and, if you do, I suggest your stops to the downside should be small.

From an investment perspective – Now is the time to be in Cash, Bonds and Tangibles, not in Equities.  Gold and Silver are the ultimate currency hedge, so I would have up to 20% of your wealth in physical precious metals, preferably held by yourself and not an investment bank, as they cheat.  However, half in PM equities and half in physical will also do.

SEE CHART THAT INDICATES MARKETS ARE OVERBOUGHT, YET, DESPITE THIS INDICATION THAT A CRASH IS IMMINENT, IT IS MY OPINION THAT THE MARKETS CAN CONTINUE EVEN HIGHER – HOWEVER, IF THEY DO, IMAGINE THE MAGNITUDE OF THE CRASH WHEN IT DOES COME – GREAT EQUITY SHORTING OPPORTUNITY??

Charts reflecting Margin Debt

https://www.advisorperspectives.com/dshort/updates/2017/03/29/a-look-at-nyse-margin-debt-and-the-market


Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at https://eelcogold.com/

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

The Psychology of Trading

TA6 – Part 1 Ch 5 THE PSYCHOLOGY OF TRADING

Please do not underestimate the importance of this section.

Logic flow absolutely from TA1 onwards – this is like a book starting at chapter 1

Trading is all about discipline and the “thing” that gets in the way of discipline is your personality.  We are inclined to “believe we know” and go with that belief instead of going with the evidence at hand.  Some typical faults would include the following:

  • We are inclined to open the platform and panic/look for a trade because we have nothing going, whereas you have to learn to accept that there are often times when the market is too volatile to trade or there are no good trades;
  • We are inclined to “see” and open a supposedly good trade eg. I think this market is going up, without first going back to basics and applying proper analysis to verify if it is a good trade.  I often looked at the markets for a moment and thought I saw a no brainer and that was always a mistake, so I later learned to always take the time to look at all the time spans and related instruments patiently before going ahead;
  • We are inclined to try to catch the bus after it has left the terminus – we see the market moving up rapidly and think I had better enter this trade before I lose out, which is frequently bad news as volatility usually takes you out;
  • We are inclined to trade badly when we have been burned a few times as we get too cautious and enter trades too late;
  • We are reluctant to enter a trade until it is too late;
  • We are reluctant to exit a trade until it is too late;
  • We move our stop, increasing the margin at risk instead of taking the loss;
  • We exit prematurely.

I am not about to analyse your profile or teach you about your profile, as I do not know you and I am not a trained Psychologist or Psychoanalyst, but I want to stress that you “SHOULD” read at least 1 book about The Psychology of Trading before you commence trading.  Understanding the way in which your ego is going to bias your trading comprises at least 30% of your successful trading strategy.  Merely being aware of the importance of the element of psychology helps, as you will keep asking yourself what you are doing wrong and gradually see a pattern that can be corrected by introducing a discipline.

This is one of the reasons why we start with simulated trading or small trades, until we have accumulated a lot of empirical evidence about those of our biases that contributed to our loosing trades.  We then develop counters to prevent ourselves from making those mistakes in the future and, in so doing, we progressively become more dispassionate, analytical, professional and consistent about the business of making profitable trades.  This period typically takes “at least” 1-2 years, depending on the amount of time you invest, before you learn to put aside emotion and trade purely based on the technical facts presented by your analysis.

Greed and fear make it very difficult to trade since they are always present.  There were trio of Russians who were very successful traders as they found a way of eliminating the biases of greed and fear from their trading decisions.  Their recipe was that the one determined the entry points and stop losses another determined the bet sizes and yet another established the exit points and he could not see if and how much they were in profit.  One almost needs another person who moves the stop loss up with every higher low (more about this later), but this could be done by the first person.  That way greed and fear could not enter the equation.  What we need to do is remove Greed and Fear from our emotions and trade purely on the Technical signals.  We need to establish trading habits/routines/disciplines that are mechanical and stick to those.

I frequently had trades that were wonderfully in profit, but I “felt” it would go higher or I “wanted” a greater profit and that is not the way to decide whether or not you stay in the trade.  Mostly I lost with these.  I then became super cautious.  I used to see them in profit and sell far too early.  Again, the emotional decision.  There is one advantage to the latter trade and that is if you can consistently be in profit and selling too early, you can make lots of small profits.  However, being consistently in profit initially is the tricky challenge.

It is also important to keep a log of all your trades, bet sizes, entry and exit points, and, most important, your state of mind/decisions, preferably in tabular form.  The reason for this is you can pick up patterns relating to both winning and losing trades.  It also helps you keep track of your total profits/losses.


Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at https://eelcogold.com/

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

The impact of Announcements and Crises on profitable trading

TA7 – Part 1 Ch 6 – The impact of Announcements and Crises on profitable trading

Logic flow absolutely from TA1 onwards – this is like a book starting at chapter 1

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One should always guard against events that may cause the markets to rise or fall at any moment, some of which can be anticipated and others not.  Any share, sector or stock market can be hit “at any moment” by an utterance from a politician, such as we frequently saw with Donald Trump, or a crisis, such as we saw with 9/11.  Furthermore, releases of official statistics such as GDP growth or Unemployment figures can cause markets to rise of fall in an instant.  The release of the Brexit referendum results caused an instant reaction in the markets, causing the pound to fall out of bed within seconds and minutes.  Even a technological breakthrough, can have a positive or a negative effect albeit more gradual.  For the most part, many of the above events merely cause a “knee jerk” blip effect on the charts, often only for a few minutes, hours or at most a few days.  However, each of these will either take out your stop losses, causing a loss or yield a sudden unexpected profit which should be reaped quickly.  Bottom line, the markets are mostly going where they are going as the more durable foreseeable risks have already been priced in.  Below we see that the markets were already correcting in 2000 and the spike down in 2001due to 9/11 was merely an anomaly in an already declining market.

Those knee jerk reactions to things like political utterances or terrorist attacks, that have a temporary effect, should be ignored.  Naturally it is mostly impossible to anticipate the occurrence of these eventualities.  Contrarily, technological shocks can have a dramatic effect as many technological breakthroughs are disruptive – think of how quickly Nokia and Ericsson were dethroned.  When one is trading individual shares, they can be more susceptible to such shocks than a sector and the market as a whole is often more protected.  Let us look at a few examples to illustrate these allegations:

  • A company share could be badly hit by fraud or allegations thereof, whereas the impact on the sector will depend on the company’s relative size in relation to that sector.  The total equity market on the other hand may barely be affected.  The rock fall in the Chilean Mine disaster led to the permanent closure of the mine, but did not affect global mining shares or stock markets;
  • An industry sector could be badly hit by some government announcement threatening nationalisation or new regulations revoking mineral rights, as happened in Venezuela, Zimbabwe and South Africa.  Odds are that the total equity market will only be marginally affected depending on the relative size of that sector in relation to the total market.  Frequently these announcements lead to sector corrections, international disinvestment and condemnation, where-after they are shelved as they were for short term local political gain;
  • A stock market may be affected by a government announcement relating to changes in interest rate policies, tax rates, etc, or by monthly releases relating to unemployment, inflation, money supply growth etc.  The 911 terror attack caused US Markets to collapse and the rest of the world markets followed suit and that effect lasted for many many months.  Similarly, the sudden announcement of a war between say Israel and Iran would have a negative impact on most markets, but the duration, cost and economic impact of that war would be quickly discounted and the markets could recover in weeks.

Recent examples are as follows:

  • The Japanese Earth Quake cause the US markets to decline immediately, but within 24 hours the markets had recovered, since that part of Japan only accounts for less than 1% of global GDP;
  • The Silver Market corrected 35% when the Comex unexpectedly raised the margin requirements by 85% to dampen speculation.  However, this market commenced its recovery within a week as the regulation did not affect investment or industrial demand for the physical metal;
  • The food riots in Mediterranean countries caused a more gradual and prolonged effect as they were indicative of a global impoverishment of the masses due to food inflation that would in time affect all markets as their disposable income was diminished.

Now that we have addressed this, let us look at the permanence of these reactions.  Firstly it should be noted that the markets are the ultimate discounting mechanism.  Therefore, the impact arising from say monthly economic releases is usually very temporary as the odds are that market had actually anticipated the increase or decrease in unemployment, inflation etc.  This means that if you suddenly see the markets drop following some economic release, odds are that the market will recover within a few hours or a day at most.  The impact of embezzlement of company funds on the other hand could have a medium term affect on the share price, which would last until the offender was replaced and the normal profitability was re-established.  Changes like Nationalisation on the other hand would have a much longer term effect on the sector share prices.  The global increase in monetisation, which effectively commenced in 1971 and really accelerated in the last decades has resulted in a 10 year rise in commodity prices and a flight to the Real Value of Gold.

So now we need to look at the way these outside influences have a bearing on traders.  Effectively the amount of time you spend behind your computer dictates the type of instruments you trade, namely high volume or low volume instruments, and the time span of your trades, namely Intra Day, Daily or Weekly.  The reasons for this are as follows:

  • The impact of these unexpected announcements on shares and/or markets is usually immediate, so when they occur you want to be in a position to get out immediately without incurring extraordinary losses. This can be done by closing the trade if you are constantly able to watch your screen or by activating a “Guaranteed Stop” if you are not.  However guaranteed stops are only available for extremely high volume Global Markets, which is why I only focus on these.   Therefore, the rule is that it is easier to get out of high volume markets and harder to get out of low volume markets.  If an announcement of fraud causes a single share of a company with low trade volumes to drop, there may not be any buyers when you try to sell so the price could collapse and you could be left with a massive loss.  On the other hand, in the case of a high volume instrument there will almost always be a buyer when you want to sell unless there truly is a global stock market collapse and you can guard against this eventuality by instituting guaranteed stop losses;
  • High volume globally traded instruments such as Gold, Silver, Oil, Treasury Bonds, Major Currencies and major stock market indices like the FTSE, DOW and S&P are less likely to be hard hit by unexpected announcements. This is because most announcements only affect individual shares or sectors;  Therefore you are partly insulated against many risks that could cause you losses otherwise;
  • If you are trading in your spare time to make some extra money, that usually means you can only check your screen before and after work or every couple of days. Therefore, you have to focus on trades that run for a longer time span, as the odds are that you will not be behind your screen at the time critical moves take place.  Trading intra-day is also more for the professional than the amateur.  It is so tricky that trainee professionals are not allowed to hold open positions while they go out for lunch – that tells you something.

Effectively the less time you are able to spend behind your computer the longer the trading window you are looking at, as you must be in a position to respond to these outside influences.  The three options are as follows:

  1. You are very inexperienced and/or you can only look at your computer once every day or once every few days, then you should look at trades that last from 3-5 days to 3-5 weeks or longer;
  2. You are inexperienced but can check your trades a number of times per day, you can look at trading intraday with a time span of 3-8 hours up to 1-5 days or longer.  However, you need to be sharp and things can go wrong while you are not watching your screen;
  3. You are a professional trader and you are watching your screen 24/7, which means that you can actively trade intra-day on the 5 minute or longer time frames.

If you are new to the trading game, my advice is stick to high volume frequently traded markets like Gold, Silver, Oil, the DOW, S&P and major currencies like the Dollar, Euro, Pound and Yen.  The reason for this is that those markets are more analytically predictable as they are less likely to be affected by minor issues.  Effectively there are three trading horizons

Sophisticated traders who sit in front of their computer screens all day and are in constant contact with the markets, will get out at the drop of a hat – Buy on the rumour, sell on the news”.   This is why having the bulk of your wealth invested in funds is important, since those “fund manager” guys are getting out of losing trades long before you even knew there was a problem.

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Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at https://eelcogold.com/

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

Trading Maxims

TA8 – Part 1 Ch7 Trading Maxims

Logic flow absolutely from TA1 onwards – this is like a book starting at chapter 1

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TRADING MAXIMS

There are numerous trading maxims that you will read in articles or hear from experienced traders.  They have become popular sayings because they are mostly true.  Here are some worth mentioning.

The Trend is your Friend

On a macro scale, you get bull markets and bear markets and in between you the markets are trading sideways as they are consolidating, bottoming or topping out.   The best illustration of a bull and a bear market was found in one of Jack Chan’s reports on www.Gold-Eagle.com

The Graph below shows a bull market with the blue lines trending up.  Rising tops and rising bottoms.  You get in early and ride the corrections (bucking horse) to the top or you buy every time a correction is completed

The Graph below shows a bear market with the blue lines trending down.

After every bull or bear market, you get periods when the market is correcting or consolidating (moving sideways).  It is very difficult to trade during consolidation periods since the markets are often volatile and unpredictable with huge swings either way.  Therefore, the best time to make money is when you play the trend – go long when markets are rising and go short when markets are falling.  In the above charts, you would buy the dips or sell the peaks until that strategy no longer works.

On the abovementioned Macro scale, you get generational Bull and Bear markets that run for periods of 10-20 years and scaling down, you get runs that last years, months, weeks, days, hours or minutes.  Regardless of the time frame, markets move up and down with corrections and consolidations as shown above.  The shorter the time scale the greater the amount of skill required to trade and the greater the amount of time that needs to be committed.  Trainee Professional traders are not even allowed to hold positions open while they go out to lunch.

The market can stay irrational longer than you can stay solvent

Another way of saying this is markets will always do “what” they are supposed to do but they will never do it “when” they are supposed to do it.  Therefore, you may believe the markets are topping and due to crash and keep shorting those markets, but they could continue up for years before crashing and in the mean time you will have lost money because you did not want to give up on the idea that the crash was imminent.  A perfect example is the US stock markets from 2008 to 2017.  The markets kept rising despite terrible market fundamentals and an endless stream of negative economic news.  Essentially the markets were rising on a sea of liquidity being created by the Federal Reserve and aggressive buying of equities by the Fed and its agents (shareholder banks).  Therefore, betting the markets were going down you were in fact betting against the power of the Fed/Central Banks and their ability to manipulate the markets.   The important thing to remember here is not to have an opinion but rather to trade based on technical signals.  You still need to know the fundamentals – the markets are structurally unsound – as this will mean you are prepared to get out when the market does turn, and you will have managed your stop losses correctly.

Buy the rumour, sell the news – or, contrarily, in a bear market sell the rumour, buy the news

By the time the news is public knowledge, the market will already have discounted it in the price of the shares or markets and the opportunity to profit from it will be gone.  A broader variety of this is when everyone is piling in, be ready to get out as their irrational exuberance is pushing the markets beyond the point where they offer fair value.  They say when Waiters and Bellhops are telling you to buy a share or what shares to buy, it is time to get out as “rational” buying is no longer present – i.e. irrational buying is driving the markets up.

Bottom pickers become cotton pickers – or, in a bear market, the reverse is true

The problem with bottom pickers is that they are convinced this is the bottom of the bear market, so they go long, then the market resumes its bear trend and they pick another bottom and another and another, losing money every time.  The problem with this is that they are allowing emotion ruled their trading activity.     Since the same rules apply to bull markets as to bear markets, we include those who sell exactly at the top as they inevitably get it wrong.  At this stage, I must stress that you can pick bottoms of corrections in bull markets using Elliott Wave Theory etc. & vis-versa for with tops in bear markets and that that can be very profitable.  However, the management of your money on margin and your stop-losses becomes critical.

Most amateur traders lose money because they get in when the market is near the top and get out when the market is near the bottom; i.e. they wait too long before acting.  More specifically, when the share/sector has been rising consistently, they are unsure if the rise will be sustained and wait for evidence until they inevitably get in near the top when the bull run is old news.  Equally, they miss the peak as they think the reversal is a correction and that the market is going higher after the correction and when the market keeps going down, they are too tardy to sell.  The trick is to buy just after the bottom and sell just before or after the top.  For this you need technical analysis and good stop loss management.  Many investors do well by buying in just before the bottom and selling just before the top, but this is only practical if you are buying the actual asset and not when you are trading – in my opinion.

Nothing works consistently

There is no trader in the world who succeeds with all his trades.  Therefore, you must be prepared to lose and lose often before you can win.  It is also true that none of the trading tools is infallible and most of the rules and patterns are only right about 70%-80% of the time.  They just enable you to improve the probability that you will get it right.  As one trader says at the bottom of every report on www.Gold–Eagle.com,  “Technical analysis is a windsock, not an exact science”.  Now you may say 75% to 80% means I am going to be right more often than I am wrong.  However, many of the trades you may be right, but you will lose money because your stop loss is not positioned incorrectly and then the market volatility will take you out before it commences in the direction of your trade.  This is why you need to spend TIME.  Time looking, time analyzing, time reading and time doing simulated trades until you start honing your skills to determine the correct entry, “stop loss” and exit points – which can and mostly should be done in advance.

Cut your losses and let your profits run

Most professional traders only make profits on say 30% of their trades.  The important thing is to limit you losses and let your profits run.  So if you have made a mistake, do not hang in and hope that someday the share will recover because you are afraid to admit that you were wrong.  Rather cut your losses.  Contrarily, when you have a good trade, do not be afraid to let your profits run.  You can continually raise your stop loss, but do not close a trade that is showing good profits because you are greedy.

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Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at https://eelcogold.com/

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

Trading Style

TA9 – Part 1 Ch8 Trading Style

Logic flow absolutely from TA1 onwards – this is like a book starting at chapter 1

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TRADING STYLE

They have compared the trading styles of numerous of the most successful traders in the world, and no two follow the same approach.  Therefore, you need to develop your own.

The essence of learning is that we gather a lot of information from discussions, courses, reading etc., but that knowledge only comes to us after we have put “it” into practice and experienced the truth or untruth of “it”.  This is why it is important that you cannot learn the information in this course, countless books and articles parrot fashion, as these reflect someone’s opinion so there will be contradictions.  Each of us notices different things and interprets information differently – a bit like everyone takes home something different from a seminar or a movie.  Equally, each of us has a different risk reward profile and will feel comfortable about a trade at a different point.  Therefore, it is a given that each of us has a unique trading style and that is why it is critical that you develop “your own” style.  I can introduce you to all the tools, but you need to learn to identify patterns on your own and this only happens when you have watched the markets to the point of distraction.  i.e. Initially, you will spend more time being totally preoccupied with this and later you will naturally find a more balanced approach.  However, this initial pre-occupation phase, which lasts a year or two, is almost mandatory as it gives you a “feel” for the markets, their price action and the matching action the trading tools reveal, all of which is essential for successful trading.  More important, it gives you a feel for how the “Technical Analysis” tools you use behave and their nuances/idiosyncrasies.  With your newfound hobby and knowledge, you will be looking for Buy and Sell signals.  Many of these signals are revealed by repetitive patterns of popular trading tools that predict probable subsequent bullish or bearish price action.  There are books that will give you the probabilities of breakouts for each tool and this gives us a warm fuzzy feeling that we are reducing the risk that we will lose.  However, whereas you should know these “patterns” and their positive probabilities (which are a given else we would not be using them), you need to “see” these patterns evolve and develop your own intuitive understanding of the outcome.  Gradually you will become more comfortable with some and you will develop your own combination of those tools that make sense to you.  Without this, you will never be comfortable about your trades or become truly good.

I subscribe to the top down approach, which includes the following:

  • Start with the Fundamentals.  What signals are the global economy, allied industries and the sector giving, that justify a position – long or short.  Foremost amongst these is interest rates, since these impact on almost every asset class;
  • Then look at tools like Cycles and Elliott Wave Theory, divergences etc. that tell you whether the share or market in question is in a bull or bear market, bottoming or topping out, correcting or consolidating;
  • Then look at the TSAR lines (Technical Support and Resistance), Chart Patterns etc. to determine entry points and targets (market moves);
  • Then look at bet sizing, entry points, stop losses and exit points;
  • Then look at the Oscillators and Candlesticks etc., in numerous time frames, to time your entry.

However, as mentioned before, the shorter your trading time the less relevant the fundamentals and the more important the technical aspects.  Many feel you should never consider the fundamentals and you should only use the latter TA tools.  However, I disagree.

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Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at https://eelcogold.com/

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

Trading Horizon

TA10 – Part 1 Ch9 Trading Horizon

Logic flow absolutely from TA1 onwards – this is like a book starting at chapter 1

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TRADING HORIZON

Essentially this decision is made for you by the time you have available to trade and by your level of expertise.  The longer your trading time frame, the less time it takes to monitor your trade, the less expertise you need and the greater the percentage/amount of money you have to risk.  The shorter your trading time frame, the more time you need to be monitoring your trades, the more expertise you need and the smaller the amount/percentage of money you have to risk.   The fact that you may be totally absorbed in your new hobby for the first year does not mean that you will be able to devote hours a day to your trading in the long term, so do not bluff yourself time wise.  The fact that you make a few successful trades and become cocky does not mean that you will remain successful, it takes years for you to reach a stage where you are reliably/consistently making money.  Hopefully this course will reduce your initial losses and shorten this initiation period.

Therefore, you have three choices:

  • You engage in longer term trades, lasting days, weeks or even months.  This requires time to determine your entry point and to monitor your trade in the early days until it is established and profitable.  If you have a day job, this is more likely to be where you are going to end up;
  • You engage in medium term trades lasting 1-5 days.  This requires more time as you need to be able to monitor your trade frequently intraday;
  • You engage in intraday trading.  This requires you to watch your monitor almost continually and you need considerable expertise.  Trainee professional traders are not even allowed to keep a position open over lunch.  Only when you start trading will you see how quickly the markets can move against you.  I once had an intraday position open and my laptop was open on the passenger seat next to me.  I was filling up with gas when my trade suddenly moved from a R5 000 loss to a R20 000 profit in the space of one minute.  With a sense of satisfaction I turned to the attendant to sign my garage card slip and when I turned back to my computer my trade was closed for a R10 000 loss.  While this is extreme, it illustrates how quickly these things can happen.

All that said, the basic principles used for all three are the same, except that you may spend more time looking at oscillators and candlesticks if you are an intraday trader.

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Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at https://eelcogold.com/

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

Selecting a trading platform

TA11 Part 1 Selecting a trading platform  

Logic flow absolutely from TA1 onwards – this is like a book starting at chapter 1

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SELECTING A TRADING PLATFORM/COUNTRY AND INSTRUMENTS

There are a plethora of trading platforms that allow you countless options:

  • You can trade actual shares.  Typically, you have to put all the money down and your profit or loss is proportional to the amount that the price has risen or fallen.  Eg you buy a share for $100, you sell at $110 and you make $10 or 10% profit, less trading charges of 1%-3%;
  • You can trade options or warrants where you put down a portion of the money and any gain or loss is large in relation to the money you put at risk.  Eg you pay $10 for an option to buy a share for $100 at a future date and you sell it when the price is $110 (at any time).  However, your $10 gain translates into a 100% profit on your initial outlay, less the finance charges on the $90 loaned by the platform;
  • You can trade CFD’s (Contracts for Difference) or Single Stock Futures, which also provide leverage but also incur finance charges, which means the time you hold the position is an important factor;
  • Finally, you can trade Futures Derivatives using a Spread Betting Platform.  Derivatives “derive their price from an underlying asset” i.e. this means that you are not buying an asset.  Essentially this is a casino where you bet against another on the direction of movement of the price of the underlying asset.  This usually gives you the greatest leverage and you mostly incur no finance charges for that leverage i.e. $10 will probably make you $50 or $100 in the above analogy.  This is my trading platform of choice.  It should be noted that I talk here of profits, but the losses are merely the inverse situation i.e. the higher your leverage, the higher your potential loss (although you can specifically limit the extent of your loss with a Stop Loss and often a guaranteed Stop Loss.   The advantage is you know what your maximum loss is but your profit is not capped.  I typically engage in trades where I risk say R20k and can make say R200k, but every time I am wrong, I lose R20k.  This is not a problem, if you make R200k and then loose R20k 2 or 3 times, then make R200k and lose R20k 2 or 3 times.

I think it is worth mentioning here that in this internet era, the platform does not have to be in your country of residence – i.e. You can trade on one platform in the RSA, another in London and another in Luxembourg – etc.

It is important to note that when you are investing in equities, precious metals shares, property, etc. you put down all the cash and any correction is merely a reduction of your investments/wealth and that loss may be recouped if/when the asset price increases again.  On the other hand, with leveraged instruments you put down a fraction of the total investment on margin and you can lose the total margin if you get stopped out, but you can make disproportionately big gains when you win.  This means that if put down say a 1% margin or R2 000 for the equivalent of a R20 000+ investment, a 1% decrease in the value of the asset will wipe out your margin and you will lose all the money put on margin, but you can equally easily make R4 000 or more in a very short time if the share goes up a bit.  The advantage is that you are investing small amounts for huge leverage and huge profits, or you are investing small amounts frequently and on balance earn medium profits more frequently – provided you trade profitably on balance.  The leverage offered differs from instrument to instrument and from platform to platform and from product to product.

Insofar as selecting the instruments, shares, indices or commodities you wish to trade, my advice is as follows.  It takes a huge amount of time to monitor one instrument properly, especially initially when you are a novice and are struggling to remember/interpret all the “Technical Analysis” tools/techniques, how to apply them etc. – and there will initially be say 10 tools that you monitor until you eventually settle on say 5 or 6.  Furthermore, for every instrument you trade, you probably need to monitor at least another two for “complementary or contra-cyclical” signals.  Therefore, I recommend you start with only a few.  Eg. I read daily market analysis publication, watch Bloomberg for contextual news, monitor the Dollar Index, Sovereign Bond interest rates, various currencies, Gold, Silver, the DOW and S&P, but I only trade Gold, Silver and the DOW.  My reasoning is I rather know a few instruments really well, rather than a lot only fairly well.  Therefore, I analyse a range of instruments as follows;

  • Currently Gold and Silver are in a Generational Bull market, which means they are trending up in the long term – it seems that the bottom of the correction from 2011 to 2016 is in and that the next major up-leg has started, which should last many years;
  • The Dollar is mostly contra-cyclical to Gold and Silver, so monitoring the Dollar often gives me additional information and/or frequently “advance” signals about the possible/probable direction Gold and Silver will move – i.e. If the Dollar looks like it is going to drop, it is likely that Gold (and Silver) is going to rise and visa-versa.   This helps me manage how close my stops must be, or even when to get out of Gold/Silver;
  • I also watch the Commitment of Traders (COT) charts, since these are great for watching if the smart money is long or short and when the “bets” that Gold (or Silver) is going down are extremely high, it is almost certain that a correction is coming soon and visa-versa.  This helps me manage how close my stops must be, or even when to get out of Gold/Silver;
  • Treasury Bonds yields are an important indicator of probable deflation when rates are below inflation, or inflation rates are rising fast.  Gold and Silver normally rise in the face of super low interest rates (deflation), i.e. negative real returns when bonds yield less than inflation.  However, they will also rise in the face of rapidly rising bond yields as this often implies Inflation / Currency debasement, i.e. when interest rates lower than inflation.  Currently (early 2017), yields appear to be rising, bonds are yielding negative Real returns and the bond markets appear to be on the brink of collapse, which could herald a flight to value – all of which are good for Gold and Silver;
  • The DOW and S&P are currently floating higher on a sea of money and/or currency devaluation, in the face of a plethora of negative economic factors.  In my opinion, the situation is unsustainable in the long term and any crash will herald the withdrawal of money from the equity markets and a flight into the safety of Gold and Silver.  Equity markets yielded negative Real returns for the years from 2000 to 2011+ – which was good for Gold and Silver.  HOWEVER, Initially, when markets commence a significant correction/crash, they often sell gold to get the cash to cover margin losses, which means gold will first dip and then only rise later;

Next, you need to select highly liquid instruments – i.e. those that are heavily traded (preferably globally), as they have the lowest buy/sell spread and they have the lowest risk that you will not be able to get out if the market reverses rapidly (more about that later).  This is another reason why I have selected Gold, Silver and the DOW/S&P as my preferred trades.  Bonds, Major Currencies, Oil, Copper, etc are also heavily traded globally so they have low spreads.  Furthermore, guaranteed stops are only available for instruments that are highly liquid/heavily traded;

NB! As mentioned before, I cannot stress that it is important to analyse instruments that are complementary or contra-cyclical.

EXAMPLE! If you want to trade Platinum Equities, you have to also look at the Motor Industry as the bulk of Platinum is used in the Motor Industry.  You also have to look at the Rand/Dollar exchange rate, since that has a meaningful impact on the profitability of the Platinum Mines.  Equally, you will have to look at the Main Equity Markets as any crash, correction, recession or depression has a markedly negative effect on the Motor Industry.  Finally, you are going to have to monitor Russia, since they have huge platinum reserves that are just not being released into the market at present.  Therefore, if you are a long, or medium, term trader, you will most probably end up analysing at least two to four times as many instruments as you are trading, and this all takes time.  The shorter your trading horizon, the less important it is to look at other instruments.

ANOTHER EXAMPLE – I do not trade say Sasol share, but if I did, I would look at the Rand/Dollar and Oil charts for advance signals, since Sasol scores if the Rand weakens and/or if Oil rises.  However, any dip in the economy or motor sales may also affect oil.  What I am saying is that one should frequently be looking at multiple charts for every single instrument you trade, which requires a lot of work and time.

Note – If the stock markets correct, almost all equities will correct.  There are many reasons for this, namely unsophisticated sellers sell all, many funds sell to increase liquidity, commodities etc decline as demand for commodities, durables and semi-durables will decline if the economy slows etc.  Contrarily, there are always certain investments that are contra-cyclical.  For example, a hedge fund that shorts equities will go up when equities correct, if equities correct bonds usually go up as rates increase and there is a flight to the relative safety of bonds, if the Dollar goes down dollar traded commodities go up etc.

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Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at https://eelcogold.com/

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

Determining how much money to set aside for trading

TA12 Part 1 Ch11 DETERMINING HOW MUCH MONEY TO SET ASIDE FOR TRADING

Logic flow absolutely from TA1 onwards – this is like a book starting at chapter 1

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DETERMINING HOW MUCH MONEY TO ANNEX  FOR TRADING

Remember, trading is not how you build your wealth – unless you are particularly good or lucky.  Essentially you are taking a small portion of your wealth and “playing” with it in the hope that you can make a considerable amount of money.  Very few people manage to do so well that their trading profits significantly contribute to or exceed their wealth.

Therefore, it is up to you how aggressive you want to be.  Stock market trading is risky since individual shares can go bankrupt, but it is less risky than trading systems that use leverage.  Remember leveraged trading is as addictive as gambling and you can end up throwing good money after bad – and in that way you could lose it all – winners know when to stop.  I was 55 when I started trading so I could not afford to be too aggressive.   Accordingly, I elected to use 1% of my total wealth to start trading – let’s call that the Kitty.  My reasoning was as follows:- My total wealth portfolio grows at say 10% p.a. so if I lose 1% in any one year, my return will only be 9% that year.  Fortunately, I trebled my money with my first few trades, so then I had casino money to play with.  I say fortunately, because after doing really well trade after trade, I lost it all my gains and my seed capital in the next year – it went to my head, I thought I was good, and I became reckless.  I then stopped for a year to regroup and resumed with 1% of my wealth.  I have subsequently become more experienced, more methodical and I subsequently grew this money 15 fold in two years.  Therefore, my advice to you is to use no more than 1%-2% of your wealth for your trading Kitty.

Start by using the simulated money and trading platform that companies offer as this is a way to learn without losing money.  However, when you lose simulated money it does not hurt, so the lessons may be lost.  Regardless, it does teach you how the system works.  Thereafter, start small with money you can afford to lose and if you manage to grow that great, if not, you can always decide if it is prudent to put more in next year.  Therefore, starting with the greater of say R10 000 or 1% of your wealth is probably prudent, especially if you use the simulated trading facility for a few months before commencing with your real money.

Regarding bet sizing, it is prudent to bet no more than 2%-5% of the above monies per trade, so you have a lot of “chances” and can afford to lose often initially.  At first, you may lose more than you make, but eventually you want to make more than you lose – more about this later.  Normally there is a 2:1 risk reward ratio that implies you should say risk R1 000 and hope to make a profit of R2 000 – or better.  If this succeeds, your next two losses are covered.  Once the trade is profitable and one received further confirmations that the trade is correct, one can pyramid, which means you add further bets to any particular trade to grow your total position.

Remember, any trading is a risk, since you buy thinking the price will go up and the man on the other side of your trade, who sold or shorted the market, thinks it is going down – and visa-versa.

Remember too, that gambling is addictive and leveraged trading can become addictive, so when you have lost your initial capital, stop trading for a year to regroup.

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Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at https://eelcogold.com/

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

Overall approach

TA13 Part 1 Ch 12 – Overall approach

Logic flow absolutely from TA1 onwards – this is like a book starting at chapter 1

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OVERALL APPROACH AT INCEPTION

You need to spend a lot of time looking at the charts, analyzing them, learning to use one Technical Analysis Tool (TA tool) at a time.  This is truly important as you want to get to the stage where you intuitively notice signals when looking at any Tool.  If you try to learn multiple TA tools at the same time, you will end up seriously confused.  You need to focus on one TA tool at a time, applied to multiple instruments in multiple time frames, for at least a week or two before moving on to the next one.  You must get to the point where they talk to you – i.e. you intuitively know what they are going to do next.  Then you use the one you have mastered, together with the new one.  Try say 10 oscillators/tools before you select those you prefer.

As mentioned before, you should also understand how each oscillator is calculated and then try to tell what the oscillator would be telling you based on price action alone, without seeing the oscillator itself.  That is when you truly understand and get a “feel” for the oscillator.

You need to watch Bloomberg for hours a day, month in month out, to get a sense of how markets react to news.  This is less necessary if you are an intra-day trader, but more necessary the longer your time frame.  You need to watch economic indicator releases, political rhetoric, etc. and the way the markets react to these to get a sense of just how volatile and fickle the markets are.

When you start, use the simulated trading facility provided by your platform or create your own, where you have a book to keep track of trades and play with imaginary money.  Once you have identified a trading opportunity, trade, but do not look for trading opportunities as a desperate man will always find one but it will not be good i.e. one of the greatest skills is to know when to stay out of the market.  At one stage I was looking for a trade every time I opened my computer – especially if I did not have an open trade – and that was when I started to lose consistently and took a year break.

Remember, emotion has no place in trading.  Successful trading is always the product of a cold clinical analysis, a mechanical process, which can eventually be called your system.

Be aware that it will take a year or two before you know what you are doing.  This is not something you become good at in a few days or weeks.  If you do, become extra cautious, because it was probably luck, which makes you cocky, and that is when you lose money – as was my experience.

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Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at https://eelcogold.com/

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

Eelco Lodewijks

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