What are the components of a good trading system?
Does nobody know?
Do a search to find the topic. I think it's been extensively covered before.Originally Posted by Jesse Livermore
Try Tech's thread, among others, this is a good start although it may not make sense at first: http://www.aussiestockforums.com/for...read.php?t=605Originally Posted by DTM
My posts are not recommendations (even when I rave about something). Always rely on your own research & judgement.
Positive expectancy is defined as how much money, on average, we can expect to make for every dollar we risk.
The formula is;
E(R) = (PW x AW) – (PL x AL)
E(R): Expectancy/ or Expected Return
PW: Probability of winning
AW: Average win
PL: Probability of losing
AL: Average loss
Positive Expectancy: is a positive “E(R)”
I FOUND THIS ON THE NET.
by Nigel Littlewood
Trading and Investment is the greatest metaphor for success (along with sailing boat racing) I know, like most endeavours, it requires us to behave in such a way that we don't "feel" normal about. Successful investment is a function of the discipline required to initially develop a workable system and then adhere to it. That is how you beat the crowd by not doing what everyone else is doing ... or at least not doing it "the way" they are doing It. As Rene says "when every body likes something, I don't".
The vital ingredients are:
(1) a system or set of rules which have been tested and work and
(2) the discipline to stick with your system. This is harder than it sounds.
Rene Rivkin has devoted an enormous part of his considerable intellect for over thirty years to fine tuning his investment philosophy.
I will endeavour to outline this system for you rule by rule with my own expanded descriptions and examples for each one. The initial rules are global and have cross market relevance. As we progress the rules will become more specific to the stock market and perhaps only apply to certain times or specific situations. The stock market is a game of odds, a good system is designed to sway the odds in your favour.
REMEMBER A BAD OPERATOR WILL LOSE MONEY WITH A GOOD SYSTEM THEREFORE YOUR DISCIPLINE AND THEREFORE IMPLEMENTATION IS AS IMPORTANT AS YOUR SYSTEM.
1. Risk Management
EXAMINE THE DOWNSIDE FIRST!
As Rene says "missing money making opportunity is not a crime (especially if you learn from it) but loosing money is a crime". That is why this rule is at the top of the list. Poor risk management is the most common error investors and traders make.
Always look at an investment's potential down-side before the upside. It is only after accepting the potential down-side that you should go ahead with any investment.
Your capital is your single most important asset. Don't throw it away, Warren Buffett customised the old saying.. "a fool and their money will soon be separated", with "a fool and their money were lucky to get together in the first place"
One of the most common rules talked about in investing and most difficult to adhere to is RUN PROFITS, CUT LOSSES
The most common mistake made by traders and investors is to run losses and cut profits. People do this because they find it hard to accept the pain of taking a loss. The fear of this pain firstly; stops operators taking losses and wearing the pain and secondly; make people take profits too early because, again, they are afraid the position will reverse on them and they will have to feel more pain. Therefore the natural instinct of avoiding pain is actually counter productive and needs to be controlled. Not many people can do this well which is why most people lose and a few win.
People often don't realise why they do things. How often have I heard traders say to me " I new at the time I should have done that but didn't". People are emotional animals and even worse, usually don't realise how affected their decision making is, by these emotions.
Sailors have a saying "whoever makes the fewest mistakes will win" this saying is also appropriate to investing.
SO TO SUM UP; HAVE A RISK MANAGEMENT STRATEGY. IT HAS TO BE CUSTOMISED TO SUIT YOU TO 1) KEEP YOU HAPPY (AN INVESTMENT THAT DOES NOT LET YOU SLEEP IS USELESS. 2) PROTECT YOUR CAPITAL
2. All booms must bust .....
There are many telltale signs that a market is experiencing a boom ... such as taxi drivers giving you tips .... markets making front page news, markets disregarding bad news and as we saw in this boom; markets going up more than the earnings of the underlying companies making up those markets. Identifying a boom is not that hard if you are unsure, ask a seasoned market participant.
By no means should you never participate in a boom. But it will bust!, therefore your position (s) should reflect this expectation. Generally you may choose to invest in specific situations but keep most of your powder dry for the impending and inevitable reversal. Of course the derivative markets of today provide an easy market in which to buy insurance.
A few simple rules for Boom Times:
1) Don't gear up.
2) Don't take tips.
3) Be extra careful of new floats.
4) Keep plenty of powder dry.
5) Be prepared for the inevitable reversal.
3. The Trend is your Friend
Many good traders lose money trying to "pick reversals" or "bottom fish". Trends generally go further than they should and live longer than they should ... this is how human psychology behaves. A trend or movement is started by one group in a community and as each different segment picks up on a movement it gains momentum until the slow to adapt (or dumb money as I call it) chine in toward the end of the trend. People feel confident following, it makes them feel safe.
There are two points to remember here -
1) don't stand in front of an expressway
2) and it is "impossible" to pick exactly when a trend will end.
All good traders I have spoken to or read about make the bulk of their profits by trend following, not by picking reversals.
A trend should be largely supported by fundamentals. If a market starts to move and the fundamentals are not present to support a rising (or falling) market then leave it alone. Of course often the fundamentals may support the first part of a trend but usually the market sentiment will drive the trend further than it should have travelled.
On the other hand if we are expecting a market to start a move .... wait for it to begin then buy (or sell) it. The part of the move you miss should not be significant in the big trend.
Next, getting out .... not always easy and opinions differ but generally when the "boom" or "doom" signs are there, be prepared for the trend to end. Most good investors suggest waiting till the market tops and then sell it as it falls(or vice versa). This is sound advice until you see a market start to show crazy boom signs .... then it is not so easy ( to exit as the market turns)as markets can fall so fast you won't be able to get out (October 1987). Obviously in situations like these you would be better to have sold out when you identified the boom and decided stocks were very expensive. This would have left you in a strong position to buy after the fall.
Remember usually about 70% of a markets trend is covered in the final 30% of its life, therefore exiting too early can be very painful. A staggered or gradual selling strategy is best, so lock in profits (as markets boom) and ride out as much of the trend as possible with decreasing risk (exposure). As the old favourite saying goes, "you never go broke taking a profit."
4. Don't take tips
Almost always free advice is worth what you pay for it. Have you ever noticed how many tips there are flying around on stocks when markets are in their mature boom phase? These "tips" are usually designed to create an opportunity for the tipsters to sell their own shares.
Taking tips should be part of what not to do in your system. Sometimes people find it hard to adhere to this rule.
5. Some basic rules when examining an equity investment
Don't buy management (Directors) with poor track records. They are unlikely to perform well this time.
Leopards don't change their spots.
Rene doesn't like companies with low net asset backing. Generally, if a company has no or few assets ( buildings, land cash) when business turns down or the stock market turns bearish.. then these low asset stocks are the first to fall out of favour and the hardest hit.
eg Skilled Engineering - this year as business got tougher (as it always does), it fell, with no NTA to support the share price, it fell from a high of $4.65 to a low of $1.22 in 13 months. Now that is a big fall in anyone’s' language. If Skilled Engineering had a solid NTA per share of say $2.50, "the break up value" of the company would most likely have supported the shares around that level.
5c) Don't buy "ifs"
The Rivkin investment philosophy is fundamentally "value based". This basically means that the track record of the company behind the shares is of good sound fundamental value. Sounds simple doesn't it but there are many times when the value created by the stock market is totally out of tune with the company itself. There are stocks in every market that depend on "something" to happen to firstly justify current capitalisation and secondly to make shares go up.
This year two large companies CCL BHP both found themselves priced in such a way that they had to deliver a host of prerequisites, simply to justify the values the market had put on them.
When this situation occurs the share price is reflecting so much optimism that the odds are on the share price falling. This can be because of the company making mistakes (BHP) or occurrences outside of the companies control, causing a change in the operational environment (CCL).
This situation of "ifs" is most commonly seen in high tech and concept stocks.
Companies like Orbital Engine, Private Blood or Sausage Software this year, all had market capitalisations that assumed great things were going to happen (usually quickly) to these companies. As most of you should know to assume great things are going to happen (especially quickly) is a recipe for disaster.
This scenario generally results in a falling share price.
Now don't miss understand what we are saying .... sometimes these shares will go up and some people will make money ... sometimes these companies can actually become "proper" companies with profits, products and assets (such as Microsoft) but these successes are few and far between.
What we are saying is the Rivkin philosophy suggests we leave these "blue sky" stories alone. The risk is not worth it.
What we are looking for is companies that are cheap on the basis of their past and present performance not some possible future performance.
Equity investment opportunities
1) Fallen Blue Chips
One of Rene's favourite investment opportunities is provided when a solid blue chip company experiences a problem, resulting in the stock market completely rejecting the stock.
As we saw with Westpac, in the early 90s when Kerry Packer bought in, sentiment was so bearish that the market was not valuing the company in a rational way. This irrational sentiment is what often provides the likes of Kerry Packer, Rene
Rivkin and Sir Ron Brierley opportunities to profit in the market (Remember Kerry selling Channel Nine to Alan Bond in the 80's for about a billion dollars and then getting back for less than half that).
2) Examine takeover situations
More often than not the first takeover bid will not be the last, therefore buying after the first shot is fired is often a good low risk trading opportunity.
The fundamentals should be assessed though as to whether it is worth a trade.
Some of the variables to consider are:
Is it a friendly bid or not.
What are the historical multiples at which the bid is priced at.
How big are the two players involved, and are there others players who are likely to be affected.
Examine the track record of the major players to see if that gives any indication as to how the battle might develop.
Consider the market generally, the cost of debt/equity, the general record of recent takeovers, etc.
All of these issues may give you an indication as to how the bid will go, if you feel there is a good chance of a further bid and you can buy shares above the bid, then you know what your downside is and may then consider the potential upside.
A derivative of the takeover play is simply to buy shares after a takeover below the takeover price, knowing exactly what you will get with almost no risk (with a free option of a potentially higher bid) may not sound all that exciting but when you calculate your annual return .... often the trade can be rather attractive especially when money on deposit is earning a very low interest rate. Many takeover bids today seem to have a fully franked dividend attached so this can add to the return.
Why do people sell below the takeover price? Impatience or requirements for the funds immediately, are the two most common reasons.
This type of trade is often called an arbitrage i.e. buying from one person and locking in a sell to another at basically the same time.
3) Where to get further ideas for basic analysis.
So.. once we have an idea of the sort of investment we are looking for we need to find it.
Where to get ideas from .... what Rene looks for in the market are limits or clues that a stock is misprised by the market. There are many ways that these clues can be found. Some of our favourites are (I must add that the following are reasons to take a closer look at a company not reason enough alone to just buy or sell something):
1. Substantial Shareholding Announcements:
These notices are required to be lodged with the ASX if a shareholder buys more than 5% of a listed company or changes a shareholding that is already over 5%.
This information is published daily in the AFR (Australian Financial Review) and is also available from the ASX.
This source of information has led to many successful Rivkin trades, including Gibson Chemicals ( that ended up being taken over) this year.
2. New Highs and New Lows:
When a stock hits an all time high for the first time in a while it is likely the stock will continue its trend and vice versa.
Therefore, as we saw with Morgan’s earlier this year the stock hit all time highs consistently for over a month.
These "rolling year records" are also published in the AFR daily. Again a great indicator of potential action and a signal to investigate further.
3. Short term "one off occurrences"
A situation that leads to a weak price in an otherwise solid company can be a great trading or investment opportunity.
Two examples this year were ICI and Fosters. These are good companies that suffered short term weakness when it was announced that there were big lines of stock becoming available on the market. The weakness was only temporary and those who bought during this weakness did well. The Rene Rivkin Report suggested buying both stocks during weakness.
Investigating a stock:
Some places where information can be sourced in order to learn more about a company;
1. Broker research
2. Company Reports
3. ASX company announcements
4. Press analysis
5. Company Reports of major competitors.
6. In the field research. Such as going to look at the company and its products.
Some specific strategies for long term investors.
Basically holding shares in good companies over the long run is a low risk - high return investment strategy. As can be seen from long term charts the market ultimately go up. There have been periods when the broader indices don't go up over periods of more than five years .... so long term means long term.
For this sort of investment strategy a number of issues are important.
Owning different companies in different sectors of the economy will reduce risk by limited the impact of negative occurrences in specific companies or industries.
Just ask Graeme Hart!!!!
2. Watch your stocks.
Burns Philip used to be a blue chip company stock. The company forfeited this status long before the turmoil that has resulted in the stock falling by 90% this year. The decision should have been made earlier on that the company was no longer of blue chip quality and no longer therefore belonged in a long term portfolio (Rene made this view quite clear in the report earlier this year).
3. DRP (explanation)
If you don't require the dividend income a DRP (Dividend Rivkinvestment Plan) can be utilised to firstly continue to grow a portfolio as well as benefiting from receiving shares at a discount to market prices.
4. IPO's (Initial Public Offerings or Floats)
Floats can be a great opportunity to buy good companies at cheap prices as Australia has experienced with GIO, Commonwealth Bank and Telstra. Of course not all floats are winners. When the market is booming, floats become more prolific and the quality generally falls when the market is low then floats must be more competitively priced to attract capital. One advantage of a float is the availability of a prospectus which should have enough information to assess its suitability to you.
A LONG TERM STRATEGY
This is one of investments most neglected strategies. Basically it goes like this .... allocate a certain amount (eg. 10%) of your disposable income and invest it in long term growth securities.
The benefits are threefold.
1) Forced Saving
The standard and strict allocation of 10% (for example) of income will eliminate the often difficult (for many) practice of saving to buy or invest.
You will be amazed that by taking the money out of your income before you receive it ..... your lifestyle will not be affected ..... you will automatically adapt to the lower disposable income. If you don't believe me try it for 3 months.
2) Dollar Cost Averaging
By buying the same amount in dollar terms of a security each month you actually (without realising) are benefiting by the volatility of a market. This happens because you buy more shares when prices fall and fewer shares when prices rise. This results in you averaging down and therefore reducing your average entry cost.
For example if you were buying $100 worth of one stock per month.
Month 1: share price $1.00 bt 100 shares
Month 2: share price $2.00 bt 50 shares
Month 3: share price $0.50 bt 200 shares
At the end of 3 months the average monthly price of the stock is $1.16 but you own 350 shares at an average price of .86 cents. That is dollar cost averaging.
3) Another often used buy not fully appreciated investment benefit is "compound interest". A very powerful tool in the investment process which basically is the process of earning interest on your re-invested interest. Over the long term compound interest will create good growth even for modest amounts of capital.
As an example $1000 per month invested for 10 years at an annual rate of 10% ( the long term stock market return) will grow to $204,850 over 20 years to $759,360.
Over twenty years you have more than tripled your capital.
As you can see a person who gets into the habit of investing a part of their income over the long run will benefit enormously. Using advice such as Rene Rivkin's (or any other market guru you can get access to) it is also very possible to improve that annual return above 10%, that makes a significant difference to the long term performance.
Last edited by RichKid; 26th-April-2005 at 09:24 AM. Reason: formatting
There is a lot of good stuff written above.
But in answer to the question of what are the attributes of a good system the above is similar to placing someone at the controls of a jumbo and saying here it is/here is the manual---go fly it.
I really think that most dont understand what to expect when trading a method or system.
There is this hazy recognition that its a plan which needs to be stuck to.
But often attached to that is the thought that to miss a trade could spell disaster (as an example of one misconception).
A system or a trading methodology SHOULD place you in a position where its implementation places you in a position similar to a bookie.
Youll win(Some big----- some small) and youll lose (All small----NEVER big) and at the end of the week/month/year youll make X% profit through your trading method.
You see even with a system you wont know which trade will be that one that you can let your profits run---and run---and run.
It will be a loser or a string of losers.
What you will know with a carefully tested system is that if you follow your rules you can EXPECT to return REWARDS greater than that RISKED.
Trading a system is NOT about being RIGHT its about being profitable,simply its a business plan.
WHAT ARE THE COMPONENTS OF A GOOD SYSTEM?
(1) An entry (and it doesnt matter what it is!---how its found or calculated)
(2) A stop (it does matter where its placed and how it affects your method)
(3) An Exit (This matters as well as it must allow a trade to gain profit)
Finally a positive expectancy---a reward that exceeds risk.
The only other thing to remember is to work on a method which suits your trading style and budget.
I dont have the time or inclination to sit in front of a screen looking to take lots af small gains in an effort to reap larger overall gains.
Prefer to be able to almost set and forget so I trade LONG TERM.
This means at times the market will not be the place to be SHORT TERM but my method will tell me when to be involved and when not.
Hope this is of help.
I was wondering if anyone has heard of and /or has any comments re
"the sharemarket college" and its product (system)??
Get hold of a couple of profitable "graduates" who can verify SUSTAINED results.
Ask for a guarentee from the educator.
Most systems results are based on hindsite systems testing.
Few are or have been verified trading forward in a real life situation,bonafide live trading results arent available,I only know of a few.
Many more again are based upon Leveraged instruments mainly CFD's to make a return.--20% equates to 2% return trading CFD's at 10 x leverage.
Drawdown of 12% equates to 120% (or your broke) trading CFD's x 10times leverage.
There are no Quick roads to trading success but plenty of highways to ruin.