Dr Alexander Elder is rather famous in the trading scene. I jumped on the rare chance when he came to Singapore to conduct a 2-day seminar (11 and 12 Feb 12). Although it was a paid seminar, I think MacQuarie subsidized quite a bit. Thanks for offsetting the cost and Phillip Capital for putting it together. I have documented the pointers below.
Ocean of ignorance
Dr Elder shared about something he learned in his chemistry class which had no relation to the subject, but it was meaningful enough to stuck in his head till today. His professor said we live in an island of knowledge and surrounded by an ocean of ignorance. As our island of knowledge expands, our boundary of ignorance increases too. The more things we learn, the more things we find that we do not know or understand. There is no way one can totally understand what the market is doing.
Why do people lose money in trading?
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He opined that many people traded out of boredom. A typical trader is a college educated 50 year-old who finds his work boring and mundane. He wish to trade his way out of the current lifestyle. He is trading for fun, and not for money. This is why most people lose, because they are simply engaging in the activity for pleasure. There are 2 objectives in every trade
- To make money
- To become a better trader.
Do not count money
Although one of the objectives is to make money, one should not focus on how much money is made or on the Profit and Loss statement. The analogy given was about the medical doctor who runs a clinic. If you ask him how his business is doing, he would roughly estimate the number of patients he have seen. He is not going to say he had made $x amount of money. Focus on trading quality.
Elephant vs rabbit hunting
Dr Elder described himself as a rabbit hunter – someone who trades in and out within a short period of time, taking smaller profits as compared to someone who trades for a longer time frame. He is not a trend follower. He does not catch big trends like an elephant hunter. He is happy with a rabbit. Dr Elder is not claiming one style is better than the other, but one must find a method that is comfortable to execute. Trading is a personal activity.
Separate the Analyst and the Trader
In big institutions, there are analysts and traders. The analyst will plan trades while the trader will execute them. As an individual, you have to be the analyst and the trader. However, you can only be either one at any one time. Be an analyst outside trading hours and make your plans and decisions without emotions. During market hours, be the trader and execute the trade plans accordingly. The trader must adhere to the trade plan faithfully.
There are 4 styles in trading
- Insider trading
- Fundamental analysis
- Technical analysis
- From the gut
Dr Elder finds that TA suits him the most. Fundamental analysis may take a long time to realize profits. For example, Boeing had orders fully booked for the next 6 years but its stock price still fluctuates day to day. FA cannot determine the waves of optimism and pessimism of the market participants. TA on the other hand is the reflection of psychology of the crowd.
Definition of price – A momentary consensus of value among the crowd of market participants. In particular, Moving Average is the composite snapshots of the market. The slope of MA, distance of price from MA and the area between 2 MAs are important clues to how the market is behaving.
Scientific proof: Price fluctuate above and below value
Dr Elder mentioned that the price has been proven to fluctuate above and below value by Benoit Mandelbrot, who wrote a research paper on cotton prices. He went on to define value, which is the gap between 2 moving averages. Prices tend to move above and below these MAs. And by adding a moving average envelope that encapsulates 95% of prices, the is able to determine manic and panic levels in the market.
His mantra is selling manic (top of MA envelope), buying panic (bottom of MA envelope) and profit take at value (gap between 2 MA).
Strategic and Tactical decision making process
Always look at a bigger time-frame before looking for a trade in a smaller time-frame. For example, if you trade the daily chart, you should look at the weekly chart and make a strategic decision. If the weekly chart suggest a buy, look at the daily chart for buy signals only.
5 bullets in a clip
There are only 5 important data points from the market
- open price
- high price
- low price
- close price
Hence, a trader does not need to use many indicators to reflect these data.
In his book, “Come Into My Trading Room“, he mentioned the 5 tools he used for his charts
- Moving Average
- MACD Histogram
- Force Index.
However, he only showed 1, 2, 4, 5 and moving average envelope on his chart during the seminar.
Force Index – Sharp large negative spike indicates massive dumping. However, it is not meaningful on the positive side. This is because people can stay in greed for a long time but will not stay too long in fear.
On Volume – Stocks must have a minimum 1 million shares transacted per day. As TA is a reflection of mass psychology, when volume is low, there is no mass to begin with. It would be subjected to manipulation easily. Do trade if you would end up claiming 1% of the day’s volume.
Buy new lows and sell new highs (Divergence trades)
Dr Elder finds that divergence trades are the most reliable signals. He has discussed his method in his books – “Trading for a Living” and “Come Into My Trading Room“. I shall illustrate it as simple as I can with the following chart:
The concept is that the bulls and bears are always in conflict. At any one time, one may be stronger than the other. The task is to identify who is becoming weaker and go the other way. Referring to the chart at (1), a low is being established. The price went lower to (2) and broke into a new low. However, the MACD histogram has shown a divergence – (4) is shorter than (3). This shows that the bears are weaker. This is known as bullish divergence. It works for bearish divergence too.
Basically, he is looking to buy into new lows and sell into new highs.
Learn to survive first
As a newbie, the most important thing is learn how to survive. The 2 causes of trader mortality are
- a single disastrous loss
- numerous small losses that add up to disaster
To survive, a trader must apply the 2% and 6% money management rules. Never risk more than 2% of your capital per trade and never risk 6% of your capital for your entire position. In other words, if you risk 2% per trade, you can only get into 3 trades.
Keep a journal
As cliche as it may sound, Dr Elder said the journal is necessary for a trader to improve his skills. He should grade his results in 3 areas.
- Buy Grade (high – buy point) / (high – low). More than 50% is considered a good buy
- Sell Grade (sell – low) / (high – low)
- Trade Grade – how much of the moving envelope range did you capture? 30+% = A. 20-30% = B. 10-20% = C.
I had a great time learning from the guru. Look forward to future classes.