The biggest secret to successful trading

The biggest secret to successful trading is …

Trading Discipline

Emotions are probably the biggest obstacle any trader has to overcome. Many traders become losers because they can’t follow a plan. They see a couple of losses, get excited, abandoned the plan and start to take wild shots at the market.

Traders who develop a sound set of trading rules that match their financial situation with their objectives, and then stick with those rules, increase their chances of becoming big winners. Trading discipline can be more important than your trading system.

Discipline means you must become mechanical in making trades when certain price actions occur. You must shut off your emotions, and not accept one trading signal over another. Disciplined traders let profits run and keep losses short by following rigid guidelines.

Again, discipline does not mean you will have perfect results. If you’ve select a diversified portfolio, you know that you can expect losses in some markets. Yet, discipline forces you to trade the whole portfolio and keep you from second guessing your system. If you have a training system that’s proven successful, discipline may be the only thing you need to get profitable returns.

Note these concepts all work together - you can’t have the right trading system and no discipline, you can’t select the right trade without the right system, you can’t diversify without having adequate capital, etc. If you adhere strictly to all of these rules of money management, trading may not be as glamorous as you probably thought it would be.

However, by using sound money management techniques, you spread out your risk and take a conservative approach aimed at getting 25-50% returns on your investments, year in and year out. That’s a good return on investment in anybody’s book, and that’s the approach any new trader should take towards markets.

Adam Hewison

President, INO.com

Co-creator, MarketClub

*Courtesy of Trader's Blog

Positioning portfolios for a possible rally

Commentary: ETFs to help prepare for a short-term, cyclical bull market

HOUSTON (MarketWatch) -- Given the somber assessment of the global economy so prevalent in the news today, it is reasonable to assume equity markets will struggle for some time.

But while stocks remain in a bear market that began March 2000, investors shouldn't ignore the potential for a substantial rally in a short-term, cyclical bull market.

Ned Davis Research looked at 18 previous bear markets and found that the average cyclical bull market within the bear has seen the Dow Jones Industrial Average rise 64% over 508 days. The conclusion is that massive rallies have occurred during severe bear markets, including some of the worst contractions in history in the 1930s and 1970s.

In recent weeks, we've noted several positive developments that make us more optimistic on equity performance during the first half of 2009. First, investors put $23 billion into equity mutual funds in December after taking out a record $320 billion from all funds in 2008. That suggests forced selling is beginning to abate.

Some of the record cash that's now on the sidelines, earning less than 1%, eventually gets allocated to equities. Second, the CBOE Volatility Index

has dropped 50% from its November high. That indicates investor psychology, while still fearful, has greatly improved.

Third, early signs have emerged that the tremendous stimulus provided by the Federal Reserve and U.S. government are helping to stabilize credit markets. Finally, many of the classic signs of market bottoms occurred last fall, suggesting that the lows of October and November could hold for near term.

Assuming November equity market lows hold, stocks could be set for a rally over the next several months as investors begin to feel confident that the massive economic stimulus package to be enacted by Congress will result in a second-half recovery.

How should investors position portfolios to take advantage of an equity market rally? We think there are three exchange-traded funds that, when included within a diversified portfolio of asset classes, should allow investors to participate in a market recovery.

Exchange-traded funds offer an efficient, low-cost method of easily investing in specific investment opportunities. SPDR Trust Series 1 seeks to replicate the performance of the large capitalization sector of the U.S. equity market represented by the S&P 500 Index.

This ETF has a very low expense ratio of 0.095 percent. Studies have shown that the majority of actively managed mutual funds in the large capitalization sector fail to outperform the S&P 500 after fees and expenses.

The reason is that this sector of the market is highly efficient, which makes it very difficult for stock pickers to consistently have an edge. As a result, we recommend that investors index much of the large capitalization allocation in their stock portfolio via an investment in SPY.

Small capitalization stocks also should be part of a portfolio positioned for a market recovery. The iShares Russell 2000 Index Fund seeks investment results that correspond to the performance of the Russell 2000 index of U.S. small capitalization stocks.

Small-cap stocks no longer sell at a valuation premium to large cap stocks and a transition to small cap leadership could develop in the coming months. In addition, increasing investor confidence in an economic recovery would likely favor the shares of small cap companies.

One last recommendation is that investors maintain a modest investment in emerging markets. The iShares MSCI Emerging Markets Index seeks to replicate the performance of a diversified index of emerging market equities. Emerging markets were hit particularly hard in 2008 as commodity prices plunged, exports to developed markets slowed and the U.S. dollar strengthened.

However, the long-term trend of emerging market-led growth likely remains intact. Looking at past emerging market corrections, much of the losses were retraced quickly during a recovery.

In addition, the massive stimulus in the U.S. and other countries, particularly in China, is likely to spark inflation in the years ahead, benefiting emerging markets. Finally, an international equity allocation still makes sense as a currency hedge against the potential devaluation of the U.S. dollar.

James Shelton is chief investment officer at Kanaly Trust in Houston.

*Courtesy of MarketWatch

When the next bull market is coming

Commentary: Charts show it could show up again in late 2010

NEW YORK (MarketWatch) -- They say that bottoms in the market are events while tops are processes. That means it takes time for the many parts of the stock market to roll over following a bull market, but they all travel together as bears bottom.

While I agree that cyclical bull and bear markets follow that rule, I have a hard time believing that a secular bear market -- in other words the real deal bear market -- is going to turn on a dime. This is something to which technical and fundamental analysts can agree.

So, while I do think the bear is over and a transition period is underway, I have pushed my expectations for the next bull market out to next year. Based on simple chart reading, it was not a difficult conclusion to reach.

Many analysts make comparisons to bear markets past. And while we can glean insights as to the psychology of the market at those times, we can be assured that no two bear markets end the same way. They all begin differently and for different fundamental reasons, too. But both tops and bottoms all have technical elements that do repeat.

Therefore, while we cannot match them up point for point, we can use previous bear market bottoms as rough guides to how the current one will form.

I have approached this analysis from two angles. The first is simply matching up the trends of the past two bear markets, and remarkably they are parallel. The massive twin 2000 and 2007 peaks in the Standard & Poor's 500 and sizes of the subsequent declines are certainly similar.

Using just this basic analysis of comparing the two trends, and then adding in support and resistance seen on both the 2002-2003 and 2008-present trading ranges, the time frame for declaring a healthy bull market is sometime in late 2010 (see Chart 1).

That is the point in time where the current trading range top runs into the trendline drawn from the 2007 peak. It is obviously a very simple analysis and does not really differentiate the speed of the two bear markets. But it does give us a framework for just how much work the market needs to do to heal itself.

Chart 1

There is more to be found in the 2002-2003 bottoming process and it relates back to the concept of gradual change in trend rather than a simple reversal.

Theoretically, the final big push down to bear market low territory occurs with panic. Prices move very quickly and internal measures such as market breadth and momentum swell to very high bearish levels.

Such a move is unsustainable for long and the market corrects higher before attempting its next push down to lower lows. What we observe is that the decline has a shallower trend and internals that are not quite as bad as the previous decline. This process can repeat a few more times before all is said and done.

The next chart shows the Dow Jones Industrial Average six years ago with each of the final declines highlighted in red (see Chart 2). This makes it very clear that a transition was occurring as the balance of power in the market shifted.

Chart 2

While not exactly the same in terms of elapsed time, the current bottoming process exhibits the same gradual change in trend slope (see Chart 3). It started with the crash-like drop last October to a January decline that was much more normal in speed (whatever normal really means in the market).

Chart 3

Because the current bear market was so much worse in terms of overall speed, decline the healing process should take longer. I would expect more than one more tradable rally and decline cycle within the basing pattern before the target breakout date of September 2010.

This is far from a forecast but rather it is a framework. It keeps us in trading range mode for the foreseeable future and that means if you are going to play you need trading range strategies. Buy low, sell high.

It should be many months before we can switch to trending market strategies of buying breakouts. It also tells us when we can switch from being traders to being investors again.

Michael Kahn writes the Getting Technical column for Barron's Online, which analyzes sectors and markets twice a week. www.barrons.com. Read his blog at www.QuickTakesPro.com/blog

*Courtesy of MarketWatch

DowJones 60m.chart (05.02.2009)