Why do I invest my time trading stocks?

I play the stock market because it is fun. This post is the only motivation you will ever need to start trading stocks. Why? because it is a real story of why I do not need to work.

I have always loved the concept of money and markets. I earned a Masters in Economics as I love the idea of  economics as a social science and focused on the history of economic thought. However, I also have made a lot of money in stocks over the years. I lost a lot at the beginning and even today make stupid mistakes. However, over all when other investors, even institutional investors are worrying, I sleep at night. I do not worry about the crisis or the gyrations in the market. Why I have perfected a system that works for me and because I am not a materialist.

I am not greedy (too much so). I live in Krakow, Poland and live a very modest life with my family.  I do not need money to impress people or show up or to fill some void in my life as I believe life as a purpose besides here and now.  I believe that time not money is most valuable. I pursue money because it is like a game for me. It is like chess. Other people watch sports (I do somethings too of course), I play the market and read economics.

Warren Buffet lives a very modest life (the same house he was married in in 1959) and says the only difference between you and me is – I get in the morning to invest because I love it not because I have to. I think he always had that philosophy. He is not one of my personal idols, but I am impressed by his work ethic and is charitable giving.

So alas, I do not need a job. I am an entrepreneur and trade stocks and have not had to work for about seven years, other than teaching and consulting, I do from time to time for fun.

So I trade stocks because it is a bit of an intellectual rush, and makes me money.

Trading genius who did not care about money – I remember reading about a particular genius who never needed to work because whenever he needed money he just spent a little time investing and when he made enough he would go back to his intellectual endeavors.  I was partially inspired by that and thought if he can do it why can not I? I often joke to my wife that when we need more money, do I have her permission to turn up the dials on my money making machine.

I highly recommend if you have any passion for markets and economics and money as an intellectual curiosity, to study and play the market. It is like I have said, it is clean, honest fun the most you can have with your clothes on.

Wall Street

Beautiful old photo of Wall Street from the Gilded Age

Why trade stocks?

Andrew Lo and Craig MacKinlay were two professors in the 1980s who disproved the Efficient Market theory. The efficient market theory states, market players have perfect information and to make anything more than normal economic profits was not possible, at least in the long-run. The conclusion is you cannot beat the market. If the Efficient Market theory was true there is no reason to do anything but to buy the Vanguard 500 index fund and spend your time watching TV after work.

Professors Lo and MacKinlay argued the stock market is not a random walk down wall street. In fact they published a book in 1989 called A Non-Random Walk Down Wall Street. The subsequently backed it up with technical patterns that they found made money more often than not. They studied markets in the 1960s, 70s, 80s and 90s and gave examples, of stock trading patterns that make money. They talked about head and shoulders and triangle tops and bottoms. These patterns consistently made more.

The major take away is you can make money in stocks. You can get rich fast and you can make more money than your day job. Even with a crazy market you can make money.

Of course, it is impossible to predict a price 100% of the time. Even with some quantitative analysis of stock prices, the best you can do is increase your probability of making a profit.

What is the basis of making greater than normal profits in the stock market?

Markets love tends – Not only are trends real but they work. I would add one more thing, there is safety in numbers and time. The more people that are participating in trading in a market or individual stock, the more the stock or market trends in a logical way. Let me give you an example. If there is a stock with only two people trading, then a trend or pattern is harder to find. In fact, there will be no trend. However, with ten people trading there might be some eradicate trend. With ten thousand people trading, you will find a pattern.

Patterns are caused by herd moments. People are pack animals and move and live in herds. We live together and move together. We have leaders and followers and trend setters. Think about society and how it operates.

There is nothing wrong with this. Each of us are leaders and followers in different ways and walks of life. I am a leader in my family, my business, but a follower when it comes to politics. I do not vote for myself. Humans are social and we act in groups with predictable behaviors. When a classical music concert is over the audience claps and then starts to leave. Rituals, patterns and groups movements are everywhere. The stock market is about human groups reacting to market data. Everyone reacts different but there is usually a general trend which can be seen and used.

If you want to get started trading read a few books

There are scores of books and software programs to help you trade stocks. I am a big fan of Stan Weinstein because he is simple and honest in his approach and from his classic book you can build a trading strategy of your own. If you read his book Stan Weinstein Secrets For Profiting in Bull and Bear Markets , you have a jump on 90% of the guys out there. It is simple and old and even a bit outdated but it is a classic and you can use it as a conceptual framework for developing your own trading system.

Most of the other books out there give you people’s personal strategy for trading. I do not think they are are powerful as Stan’s book. But I am open to rebuttals on this point.

For example, Ed Downs wrote a Book 7 chart patterns that consistently make money.

I do not give this book a strong recommendation. It is too short and not enough meat, but nice graphs. It is more of a salesly book for omnitrader software. The good point is it does drive home a good point. a point that I believe in. That is the market is predictable. But I will use this book as an example of what is one the proverbial shelf, even if a mediore one.

The main takeaways from his trading book:

  1. Support and Resistance – breaks cause tend shifts – I basically agree.
  2. Trend Line reversal – breaks cause are buy and sell signals. – I use the 12 month moving average and this is not hocus pocus, it works.
  3. Saucer formation – Smooth transitions that cause buyers to enter. – I look more to the above two points as saucers are often hard to spot and never as they draw them in the book. Even with software there they are hard to find. But some people spend time finding these and do profit.
  4. Fibonacci retracements – Markets adjust in 1/8 this usually at 38%, 50% and 68% – I personally do not use this as it is too much for me but there is some support for this theory.
  5. Price gaps – Found at the beginning, middle and end of a price movements. The most significant are the end and beginning. I think the beginning are the most telling. My opinion is it has mixed agreement with technicians.
  6. Volume climax and trend – Large volumes confirm price movements. My take is it depends, I know Stan is big on this, but I have not used this confirmation vote with as good success.
  7. Consolidations – Each consolidation period will be followed by a movement of equal distance from the last consolidation. – My take is this might be true but, more trading talk. Yes there are consolidation points but the exact length of the next movement is more speculation.

However, even though I pew-po most of the above points as I am not a day trader or short term trader, even if you were armed with basic information like this you could do reasonably well if you studied these patterns.

So read a few books and read them critically and objectively.

What charts do I use?

I use the 12 month moving average on the market as a whole. When there is not clear pattern, then I look at industry patterns or just do the best I can with quantitative value analysis. The current market is really a hard one.

  • If you play around with tend lines like simple moving average (SMA) or the exponential moving average (EMA), you will see that the longer the time frame the more clear the line. In my experience the 12 month moving average is optimal. Longer than that and you will not be as sensitive to the underlying price. Shorter than that and you will have too many false starts and stops for my system.
  • Buy and hold does not work. Just look at a trend on any market. Use the EMA and or the SMA. I have always preferred the SMA but lately I have been playing more with the EMA. You will see if you bought and hold you would have missed every major swing in the market and you would have lost money. For example, from March 2003 to December 2007 you’ll see a very steady upward trend in the 12 month moving average. This trend held despite the peak and valleys in 2006.

Technical analysis is not the only way to trade stocks but it is a start

  • You can make money trading stocks.
  • I prefer simple technical systems over the long-term. I would rather be the world expert or master on one or two technical trading tools than try to learn everyone.
  • Combine trend analysis with quantitative value screens and your own research and feel about a company.
  • Once you have a system you have been trading for a few years, some leverage with LEAPs (long-term equity options which have less time decay) or options or margin will amplify your returns.

This is the way you beat the market. Nothing is guaranteed, however, I believe you can get greater than normal returns. Some people prefer to trade currency or in other markets, I prefer stocks as in doing so I participate in the overall growth of the economy, it is not zero sum.  In conclusion, I love trading stocks because it is fun and makes my money work for me, so I do not have to go to work.