|
45 Years in Wall Street – A Life Time of Experience
(Part Four)
In this article, Part Four of the series discussing W. D. Gann’s twenty-four never-failing rules, Rules 16 to 19 will be discussed. Gann’s full set of rules can be found in:
Gann, W. D., 45 Years in Wall Street, Lambert-Gann Publishing Co., Pomeroy, WA, 1949.
Rule 16 – Never cancel a stop loss order after you have placed it at the time you made a trade.
W. D. Gann’s extensive experience as a trader is obvious when we examine the wisdom of this short rule. In this rule he instructs us to: - Place a stop-loss order at the time the trade is placed.
- Place the stop-loss order with a broker. It should not be a “mental” stop.
- Never cancel a stop-loss order.
Good trading rules, such as those devised by Mr. Gann more than 50 years ago, take into account the all-important psychological aspects of trading. Placing a stop-loss order with a broker, as opposed to having a “mental stop”, is a good example of this. Not only does the broker execute the order the moment the market trades at the nominated price, but it also eliminates the possibility of the trader saying those fateful words “I’ll just give the trade one more day to come good”.
Rule 17 – Avoid getting in and out of the market too often.
Many amateurs trade for excitement. Professionals, on the other hand, trade with the objective of implementing their proven system to the letter – and enjoying the resulting profits. Entering and exiting the market too often makes trading more exciting for amateurs, but the professionals soon learn to take transaction costs into account.
When traders open a trade, they commit themselves to one “round trip” of transaction costs. These costs are a real cost of trading and can make a significant difference to the profitability of different trading systems. A system with an average trade length of three days will have transaction costs which could be up to twenty times higher, in total, than one with an average trade length of three months.
Medium-term stock market trading systems are generally more profitable than short-term systems due to the lower transaction costs. They are also less stressful to trade, require less work, and allow traders to make their trading decisions in the calm after the market has closed.
Rule 18 – Be just as willing to sell short as you are to buy. Let your object be to keep with the trend and make money.
Short selling is foreign to many traders. Few beginners can understand how one can make money in a falling market, and indeed very few people engage in short selling.
Short selling is unpopular for a number of reasons. These include: - Most traders are conditioned to, and experienced in, trading stocks in a rising market.
- Short selling appears to be unethical, as uninformed people believe that in the stock market, it is the trading equivalent of stealing.
The short selling of stocks did, in fact, become illegal in Australia in 1980. It was reintroduced in the mid-1980s, but with conditions attached.
Professional traders, particularly in the United States, have made considerable sums of money trading the short side of the market, despite the fact that the average American investor also has a clear preference to only trade the long side.
Short selling is a practice that is good for all markets, as it helps to prevent extremes in price movements. If a short seller believes a market is at a top, regardless of whether he or she is correct, and the person sells stocks short, this adds selling pressure to the market, taking some of the ‘heat’ out of the buying frenzy. Similarly, the short seller must buy the stocks back at some point, thus applying buying pressure that will help to prevent excessively low prices. Also, the short seller contributes badly needed liquidity in a bear market.
Traders who are experienced in trading on the long side and who have an adequate amount of trading capital are in the best position to undertake short selling. It is also best undertaken in a sustained bear market.
Chart 1. HIH Insurance – a stock in a sustained bear trend.
Rule 19 – Never buy just because the price of a stock is low or sell short just because the price is high.
One of the most common mistakes made by amateurs is to buy a stock simply because the price of the stock is low. This can be a very expensive mistake, indeed.
There are many reasons why a stock’s price could be low. These include: - The market is a sustained bear market and the prices of the majority of stocks are falling.
- The stock has experienced a normal correction.
- A negative rumour concerning the stock has been circulated.
- One or more of the large funds is unloading the stock.
- The company is in severe financial trouble and may not survive.
Clearly, it is dangerous to buy a stock purely because its price is low – particularly if we do not know why it is low. Even if we do know the real reason that the stock’s price is low, the stock’s price could soon be much lower if the trend is down. Indeed, a stock with a low price could still be an excellent candidate to short sell!
As Edwin Lefevre stated in Reminiscences of a Stock Operator:
“…stocks are never too high to buy or too low to sell. The price, per se, has nothing to do with establishing my line of least resistance.”
(Lefevre, E., Reminiscences of a Stock Operator, Traders Press, Inc., Greenville, S.C., page 122.)
An excellent Australian example of the “buy it because the price is low” phenomenon has occurred with Telstra. As Chart 2 shows, as Telstra’s price fell from its all-time high of $9.20, people have been buying it as it has settled at so-called low prices. On each of these occasions it looked like it had finally bottomed and would soon recover. In fact, it has fallen to less than $4.00, and there is no guarantee that it will not fall more. (Note how well this stock illustrates support and resistance theory.)
Chart 2. Telstra making numerous bottoms that appeared to many to be “the” bottom.
Conclusion
To many, the four rules discussed in this article may seem basic – yet they are rules that many traders break on a regular basis. Sadly for them, failure to adhere to these apparently basic rules has proven to be very expensive for many traders over the years.
aboutneil.php
DISCLAIMER:
Every effort has been made to ensure that the content and conclusions presented in MasterStroke are complete and accurate.
No part of MasterStroke contains trading advice - stated or implied, nor is an invitation to trade. The directors and associates of Market Masters Pty Ltd are NOT licensed trading or investment advisors. Market Masters Pty Ltd is an organization designed to assist traders and investors to become more knowledgeable and independent.
The giving of advice is therefore contrary to the very objectives of Market Masters Pty Ltd.
Traders requiring trading or investment advice should contact a licensed advisor. Stockbrokers and futures brokers are licensed advisors.
Neither Market Masters Pty Ltd, nor anyone else involved in the production of MasterStroke, will be liable for any liability, loss or damage directly or indirectly caused, or believed to be caused, by MasterStroke.
Traders, to be successful, must take full responsibility for their own actions.
With respect to trading results, past performance is not necessarily an indication of future performance.
By maintaining your subscription to MasterStroke, you acknowledge that you understand and accept the contents of this disclaimer.
|
