Thursday, March 31, 2016

Abnormal Returns "Blogger Wisdom" Series: Investing Roundtable

Tadas Viskanta at Abnormal Returns is running his annual "Blogger Wisdom" post series, and a select group of finance bloggers have come to the table to discuss the hot topics and trends in finance and investing. 

I'm pleased to say that Finance Trends is included in AR's investing roundtable, so this week you'll find me addressing a variety of themes that are a bit out of my comfort zone. Check out this recent finance blogger wisdom post on the rise of index investing or today's update on (the lack of) women in finance and trading for some prime examples. 

Update: Highlighting some under the radar trading websites and books in the final part of AR's "Blogger Wisdom" series.

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Special thanks to Tadas and Abnormal Returns for their long-standing support of Finance Trends and the wider financial blogosphere over the past 11 years. Check out the latest Blogger Wisdom series and bookmark AR, if you haven't done so already.

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Tuesday, March 22, 2016

Your Job As a Trader: Manage Your Equity Curve

You can't bet if you lose all your chips, as the saying goes. 

Since our goal as traders and investors is to grow our capital over time (more chips in the pile), I'd like to share a great quote with you that really captures the essence of trading. 

As star hedge fund manager, Steve Clark said in Hedge Fund Market Wizards:

"Your job as a trader is to make the line of your equity curve go from bottom left to top right. That's it. Don't get hung up on other supposed "mandates". Protect your capital and the direction of that equity line."

Market Wizards author, Jack Schwager wrote that he highlighted Steve Clark for his "remarkable performance consistency". Reading those lines again today, I've come to a deeper understanding of how Clark achieved that level of consistency. He was focused on his one true mandate: protecting his capital so that he could continue growing it over time.

Your Job as a Trader Equity Curve Steve Clark, Market Wizards quote

If you allow losses to grow, if you suffer huge drawdowns in individual trades, or add to losing positions in a desperate attempt to prove you are "right" and the market is wrong, you will surely suffer at some point. It is increasingly difficult to get back to your starting point after enduring large losses (simple mathematics), never mind growing your wealth.

This is a subject I've discussed many times with my friend and fellow trader, Olivier Tischendorf, who often speaks to the value of charting his equity curve. Here's what he recently told me: 

"When my equity curve is in sync with market action and meets my expectations, I increase my exposure. I press my bets. When my equity curve does not move higher 'as it should', I heed the warning signals and decrease my exposure."

In other words, "when in doubt, stay out." When you are in sync with the market, you have the best opportunity to grow your capital. When you are out of sync with the markets, or conditions are simply too dangerous or unfavorable for your style, it's imperative to cut back your trading and tightly limit your losses. This is how we keep the line of our equity curve moving up and to the right. After all, isn't that the main thing we are trying to achieve?

Related posts:

1. Lessons from Hedge Fund Market Wizards: Steve Clark.

2. How to Pull the Trigger on Your Trading Ideas.

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Thursday, March 17, 2016

Valeant (VRX) Update: Stunning Losses for Stubborn Investors

Valeant Pharmaceuticals (VRX) is now big headline news, as the stock's downward slide continues to punish investors, big and small. 

Hedge fund manager, Bill Ackman of Pershing Square was reported to have lost $1 billion in a single day due to VRX's latest plunge. Institutional ownership of Valeant's stock was very widespread. As mentioned in our last post, a huge number of hedge funds and mutual funds owned big positions in VRX. Smaller investors may also be feeling the hit in their personal investment accounts or in their pension funds' returns.   

Let's not focus too much on the investors who were unfortunate enough to get burned in this stock crash. The media and the investing world are already having a field day with this debacle. Instead, let's take a fresh look at the chart to better understand why so many savvy investors were hurt in this decline.

As you can see in this updated daily chart (click to enlarge), VRX had been showing signs of distribution (professional selling) for weeks heading into the fall of 2015. 

Valeant VRX stock chart decline crash

After breaking down through its 200 day moving average (the red line), the stock moved sideways for a time before plunging through the $150 level. Here's where the decline really accelerated and volume ramped up. 

Towards the end of 2015, we saw a nice rebound in VRX and a bit of chatter about how "everything would be fine" and "here is a smart place for big investors to average down and buy more", etc. Well, as recent events have shown us, that is not exactly how things played out for the investors who stubbornly held on to their bullish "thesis" for VRX.

At the start of this week, VRX was trading near $68. By Tuesday, the stock had plunged by over 50% to close at $33.49. As of today's close, VRX is trading at $29.65, 60% lower from our previous Valeant (VRX) update at the end of February. 

If you didn't read my last post on VRX, go back and check out the closing section, "How to avoid disastrous stock declines". If you know someone who is stubbornly holding on to major losses in their portfolio or trading account, share the article with them. While nothing is foolproof in investing, these simple ideas may help you pare or avoid the disastrous losses that can ruin any investor, big or small.  

“The most important rule of trading is to play great defense, not great offense. Every day I assume every position I have is wrong. I know where my stop risk points are going to be. If they are going against me, then I have a game plan for getting out." - Paul Tudor Jones, via Darvas Trader.

Related posts:

1. What I Learned Losing a Million Dollars.

2. Marty Schwartz Shares Trading, Life Wisdom.

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Monday, February 29, 2016

Valeant Pharmaceuticals (VRX): The Downtrend Continues

Valeant Pharmaceuticals stock (VRX) continued its slide, as news of an SEC investigation fueled additional selling on Monday. The embattled drug company's stock has been trending lower for several months now.

VRX ended the day down 18% on volume of 27 million shares, triple its recent average daily volume. After a huge run up from 2009 to mid-2015, VRX began showing signs of topping and distribution (selling by major holders) in the fall of 2015. The stock is down 35% year-to-date in 2016 and down 67% over the past year (Finviz stats, click chart below). 

Let's take a look at the charts and examine the troubled stock's downtrend, and the huge uptrend that preceded it. I'll also offer some ideas on how to avoid major stock declines (or at least limit your losses in such instances).

Below, the multi-year consolidation pattern that launched VRX's 2010-2015 advance. The stock would climb from $23 to over $250 in that 5-year period.

VRX monthly stock chart

While VRX started off 2015 on a very strong note (+39% YTD at this time last year), the stock topped in late summer above $250 and began to sell off in late September and October 2015. By late October, the selloff had consumed all of VRX's gains since September 2013. Two years of gains were wiped out in 2 months.

Looking back at VRX's decline from October 2015, I shared the following chart on Twitter. You can see the stock's slide began with a sharp drop in August 2015 that tested its 200 day moving average. VRX then broke through its 200 day MA on significant volume in late September 2015. By late October, the stock was down 50% from its September levels.

Here's the latest price chart of VRX with updated annotations. An attempted rebound in late 2015 turned into a long sideways move, with a recent selloff to new 3-year lows. As of today, VRX is down 75% from its 2015 high.

VRX Valeant Pharma daily price stock chart annotations

Some major hedge funds and mutual funds have taken quite a hit from VRX's plunge. Among them, Bill Ackman's Pershing Square Capital, John Paulson's Paulson & Co., Brahman Capital, Sequoia Fund, and Nehal Chopra's Tiger Ratan (Chopra is one of Julian Robertson's younger "Tiger Cubs"). In fact, VRX was one of the most widely owned stocks in the hedge fund community in 2015, and as Bloomberg pointed out, many got burned.

Now what does that mean for those of us who are small investors and independent traders, rather than hedge fund billionaires? We are (mostly) looking after our own money, so ultimately we are responsible for our results and the preservation of our capital. How do we prevent ourselves from being burned in such a downtrend? 

How to avoid disastrous stock declines (a few thoughts and ideas):

1. Avoid falling in love with a company or its stock. The emotional attachment will cloud your judgement and prevent you from making sound decisions in the market. The "pet stock" phenomenon occurs more often than you may think. See my recent Tesla post for more on this.

2. Are you a long-term fundamental investor or a price-based trader? Know your methodology and your reason for getting into a trade or a particular investment. As the saying goes, it's often easier to buy a stock than to know when to sell it. It's even more difficult to exit a losing position when you begin shifting strategies late in the game. The recent market decline has turned many once-confident "bargain hunters" into panicked sellers.

3. Use a simple moving average to guide your selling decisions. For example (and this is a rough guide, not a foolproof method), you may decide to sell once your stock closes below its 200 day moving average. Or you may decide to sell when the stock breaches a prior support level. Stocks go through a life cycle of boom and bust (see Stan Weinstein's stage analysis). You want to ride the uptrends and, ideally, sell near tops or in the early stages of a downtrend. If you can clearly differentiate between the accumulation and distribution phases of a stock's life cycle, it will help guide your buy and sell decisions.

4. If trading off charts isn't your thing, at least limit your losses to 10% or 15%. Predetermined loss limits can help you take the emotion out of selling. Smaller losses make it easier to get back in the game. Large losses require huge, ever-increasing gains to make it back to your break-even point.

5. Don't add to your losing trades in an effort to "average down" at a lower price. While you may see many big-name investors do just that, remember that they are often playing with other people's money (or taking big risks with their own capital). This is a strategy that can lead to ruin, especially when an investor becomes convinced that their favorite stock is now "cheap" or has been unjustly punished by the market. Remember, "cheap" can get much cheaper than you imagined. Billionaires can usually regroup after a $100 million mistake. What will happen to you if you lose $100 thousand? 

6. Study charts of stocks that had similar boom and bust cycles. Many leading stocks have been pummeled in bear markets or lost most of their value once their high-growth phase petered out. If you study enough of these charts, you'll begin to see warning signs that may help you avoid future declines. William O'Neil's books are a great resource in this area.

Related articles and posts:

1. Tesla Shares Slide to New Low: TSLA Chart Review.

2. Paul Tudor Jones on Trading and Risk Management.

3. Round Trip Stocks: Momentum Booms and Busts.

4. Crash at ASPS and OCN: Early Warning Signs. 

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