You don’t need to know everything

Monday, 11 November 2019
Melbourne, Australia
By Murray Dawes

  • Markets
  • Gold Pullback Worth Buying

We are all forced to make decisions in the market without perfect information. You and I are not insiders in every company that we invest in. Therefore, we know less than others, but we still need to make decisions regardless.

Some try to overcome this unlevel playing field by researching endlessly, hoping that the more work they put in, the closer they will get to knowing all they need to know to make money.

But you could read every piece of research released by investment banks and still be no closer to making money consistently in the markets. Information overload is the enemy of efficient decision making when trading.

There will always be uncertainty. It doesn’t matter how much conviction you have when entering a stock. Stuff happens. Sales fall unexpectedly. Currencies rise or fall, affecting profits. Competitors release better, alternative products. Your months of researching a stock means very little if the whole market plummets soon after you enter the stock.

There is nothing more honest than the state of your P+L. It gives you a running commentary on your decision making. It’s no use jumping up and down and saying it’s unfair or that the market is rigged, or the algorithms have it in for you.

Misery loves company. I read comments every day on Hot Copper from stock investors commiserating with each other when they have all lost money. Blaming this or that for their misfortune. Pointing the finger at management for not keeping them informed. Screaming at the level of insider trading when a stock plummets just before a capital raising is announced.

But at the end of the day the buck stops with the investor. Every decision they have made up to that point has led to the current state of their P+L.

Markets

US markets continue to rally on the back of thawing US–China relations. The S&P 500 closed the week at a new all-time record of 3,093, up 1% over the week.

Gold suffered a sell-off over the week falling 4% to US$1,458.

West Texas Intermediate crude oil jumped 2.3% to $57.34 last week but has opened Monday on a soft note trading at $56.81. Brent Crude is trading at $62.51.

European stocks are tracking US stocks higher but remain below all-time highs set early last year. The German Dax was up 2% last week to 13,228. The UK’s FTSE was up less than a percent to 7,359.

Japan’s Nikkei 225 was up 2.3% last week to 23,391.

In Australia, the S&P/ASX 200 underperformed US markets, jumping less than a percent last week to 6,724, but it has started the week with a bang up over 0.5% in early afternoon trading.

The Aussie dollar is worth 68.50 US cents.

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The fact is, the market isn’t a level playing field. The investors pointing out the mysterious selling that so often precedes a capital raising are right (Strike Energy Ltd [ASX:STX] plummeting from 30.5 cents to 22 cents in two days just before a capital raising was announced is a good recent example). If you think someone is going to ride in on a white horse to save you once something unfair happens, you’re sadly mistaken.

You can complain to ASIC all you like, but they haven’t got the ability to stop all the insider trading that goes on.

When you sit back and look at the odds stacked against the retail investor when entering the stock market, you would be forgiven for telling them to run a mile in the opposite direction.

Yes, the odds are stacked against you. There are plenty of people who know a whole lot more than you about the companies you invest in. You will be the last to know when the situation changes.

I could boil all of this down to one statement.

You don’t know the future.

Accept it. Plan for it. Every decision you make should have that fact at its core.

Once you fully accept that you don’t know the future, the questions you ask of the market start to change.

Rather than counting the dollars you are going to make as a result of your incredible analysis, you are focused on the spot where you will be proven wrong. Rather than doubling the size of your positions because you had five winners in a row, you stick to your trading plan because you don’t know what comes next. Instead of holding on to your whole position once prices hit your initial target because you see dollar signs flashing, you take some profit and thank your lucky stars you managed to lower your risk.

The only way you can know what insiders are up to is to look at the price of the stock. That’s because everyone must meet at the current bid and offer. If there is bad news in the wings the price will usually reflect that fact well before the announcement is released. 

My interest in technical analysis is based on seeing it as a way of monitoring insider behaviour. I’d prefer to trust the bearishness of a chart that shows prices breaking below major support than relying on management telling me everything is fine.

Technical analysis also helps to create structure for decision making. Saying that you think a stock is worth ‘X’ which is above the current price ‘Y’ isn’t all that helpful. Where are you proven wrong? When it goes to zero? What if the price hasn’t moved in five years? Do you hold on?

Humans love structure and we are usually very good at providing it. Road rules tell us when to start, stop and give way. Without them no one would get anywhere.

But the markets have no road rules. You must make up your own. There is literally no structure at all. You could sell your house and put all your money on a penny dreadful. No one is there with a red stop sign.

When faced with a sea of grey you have to create some black and white otherwise you will end up chasing your tail. The grey will remain. You still won’t know what the future holds. But you will at least have a flashlight while you navigate the maze.

Technical analysis is a roadmap of investor behaviour. A map of human emotion. Tapping into the flow of price action involves understanding where short and long term traders have their stop-losses. You gain an insight into where the market is in and out of balance.

You don’t need to know whether your company’s widget is going to take the world by storm. You just need to know that you have a higher than X% chance of reaching your initial target before you are stopped out.

Once you have reached your initial target and lowered your risk, your job is done. Allow the future to unfold in all its unknown glory and try not to interfere.

Simplify everything down to what you know and what you don’t know. When you do that you quickly realise the list of things you categorically know without a shadow of a doubt is slim.

Instead of throwing your hands up in the air and saying that it’s too hard, it is possible to beat the market despite not knowing what’s coming around the corner. The path to consistent returns trading the markets isn’t through knowing everything. It’s based on knowing that you know very little and creating a trading strategy that accepts that fact.

I release a weekly video on Monday’s where I show you the nuts and bolts of my trading strategy (minus a few key ingredients). If you tune into that each week, you will learn a lot about creating a trading strategy that uses mean reversion to get into positions where you will either breakeven or make money. My latest instalment on the pullback in gold prices is below.

If you are interested in checking out my trading service, you can do so by going here.

Gold Pullback Worth Buying

[Gold prices are selling off. Should you cut and run, get short or add to positions? Click on the picture to find out.]

Gold prices have come under pressure with news that the US and China are slowly working towards a trade deal. Who knows if one will ever eventuate, but for now the market thinks they’re getting close.

That has caused an unwind of safe haven bets on gold.

But when you consider the fact that gold prices have also been rallying because central banks around the world have been cutting interest rates, it is a fair bet that gold prices will end up meeting strong buying pressure and the uptrend should resume.

But where are the key support levels below the gold price and how do you know when you should start buying gold and gold stocks again?

That’s where technical analysis comes in.

The last wave higher in gold was a very strong one. Prices rallied US$400 or 35% from August 2018 to September 2019. It is no surprise that we are seeing a consolidation period after such a strong rally.

By analysing the last wave higher, we can pinpoint key areas where a reversal should occur. We can also look at past price action to find areas of key support and resistance. As an uptrend develops key areas of resistance will often become key areas of support as the rally develops.

Another important aspect of any analysis is to work out where we will be proven wrong. The fact is that prices will be big picture bullish while they remain above the low of the last wave higher. That price is all the way down at US$1,160.

So if you are long gold and gold stocks there is no need to panic until you see prices heading below there.

It means you may have to withstand some difficult periods if prices do sell-off sharply towards that area, but you don’t want to be shaken out of positions like everyone else if the big picture remains bullish.

Regards,

Murray Dawes,
Editor, Alpha Wave Trader