"Dear Ann Landers"

I received an email from a fellow participant on KaChing.com. The trader was seeking advice on how to become a better trader. This entry will have an "Ann Landers" feel to it. For visitors who are not on this SEC-registered soon-to-combine-fantasy-with-reality community, here is my post about all that.

Note that what was missing from my entry is how KaChing has changed my mindset and attitude. It has, in effect, and so far, made me a more focused investor.

I'm a newbie on Kaching and am eager to learn a lot more about trading. I've reset my portfolio a few times in the past two months (my first two) because I got cocky after a first month of 40% and lost basically all my gains and then some by betting the farm and getting it wrong. In hindsight, I think it's likely my 40% gain was just as lucky as my 50% fall. But I want to move beyond luck and start trading skillfully. I'm a bright guy but don't really know the best place to learn. I'm intrigued by Elliott Wave theory but some of the arguments against it make sense to me as well. I don't know much about technical analysis but am also interested to learn more. At root, I'm a fundamentals guy, but I've been burned both ways using fundamentals: some companies that seem to be financial nightmares (low cash, high debt, declining sales, high p/s, high peg, low roi, low roe, etc.) just keep going up while others that seem so sound and promising just plummet. I've fallen victim to the value trap as well. Other times, I've been right but not patient enough...I short at 20, it rises to 24, I take the loss and then it drops to 15 the next week. :)

The best success I seem to be having at present is riding momentum and getting out quickly. Yesterday and this morning I saw the severe uptick in C and BAC and figured the fundamentals haven't changed and they're basically insolvent so they HAVE to come down. I waited for the ticker to start dropping, shorted them heavily and made a killing before getting out. Now I see they're up nicely since then...and I don't understand why.

Anyhow, I write to you in admiration of your slow, steady gains, similar to those I see in Daniel Carroll's portfolio. I'd like to learn how to gain slowly and steadily and would love to ask you for a recommendation for how I might learn more. I'm curious how you pick stocks (technical, fundamental, value?) Any books or sites you'd recommend? Any advise would be much appreciated.

Thanks, [User's Name - protected for anonymity]

You are probably frustrated, both your inconsistency in trading and in trying to make sense in the market. You will be surprised to learn that YOU ARE NOT ALONE.

In fact, I created two groups on KaChing. One is called “Beginner's Guide to kaChing Trading“ (75 members). It serves to give back to the group, and to find users like you. That’s right. I’m looking out for newbies because you may have some fresh insight to bring to people like me. I often get direct questions or posts from the beginner’s group from users who express the same frustration.

The path to trading success was recently dominated by lucky traders (look up the tech bubble, 1999-2000). Trading based on fundamentals is almost irrelevant right now, but I believe that this phenomenon is temporary. It turns out that investors who want to “study” fundamentals will need to understand government policy. The Fed and the central banks around the world are applying Keynesian economic theory on a problem that requires more thought and foresight. I won’t get into the details of what solution will work, but I still agree that some kind of monetary policy is needed to save key institutions like AIG. Just last week, Citigroup and Bank of America were trading like insolvent banks. Even though they are technically insolvent, so are the global banks. This week, the CEO’s for both companies said they generated profits in January and February!

Why do I yammer on about economics (the economics text books were top sellers on Amazon recently, by the way!)? You are trying to rationalize the market when traditional accounting and fundamental laws do not apply….insolvent banks aren’t technically insolvent if there is someone ready to save them at all costs. It is my belief that fundamental analysis will not apply to as large a degree as you would want. Until the banking system is fixed (it will take longer than people realize) lending won’t resume to normal levels. Earnings will shrink for companies because of this, and such things as P/E will not be a reliable measure for security analysis.

Still, there are other figures you will need to look at for a company before you buy them. For example, I would suggest you look at debt/equity, book value excluding goodwill, and cash flow.

I won’t lie. This will take a lot of work.

This was why I created “Intelligent Investing” on kaChing. It’s now 180 members strong.
This is a second group I created to share ideas on security analysis.

In terms of your trading, it sounds to me that you are chasing trends, applying various trading “methods” to them to rationalize your positions, only to then get “faked” by the market. You are also day-trading. There are quite a number of day traders on this site, but it was one of the founders/owners of kaChing who posted numerous times that statistically, day traders end up losing in the long run, and that investors with a longer term horizon will last.

Pure technical traders ignore fundamentals. They look at charts alone and ignore fundamentals. The fact you look at them is contradictory to your desire to trade on fundamentals.

I employ technical analysis to a small degree in stock market analysis. I use the basics of this using such things as MACD, moving averages, support and resistance. Again, some swear that technical analysis means nothing, but if the market is efficient (“Efficient Market Theory”) then at the very least, the charts will tell me such things as where things might trade to or whether trends are forming. If everyone else is using charting to trade, then one needs to add this tool to stock market analysis. Note that charting analysis is the weakest form of support for this theory.

You should check out the book "A Random Walk down Wall Street" by Burton G. Malkiel. He discusses Efficient Market Theory. On p.174 the author states that:

Even the legendary Benjamin Graham, heralded as the father of fundamental security analysis, reluctantly came to the conclusion that fundamental security analysis could no longer be counted on to produce superior investment returns.
...the situation has changed...
...investors would be better off in an index fund rather than investing in an actively managed equity mutual fund...

It is my intent to last in both the virtual and real trading world. I have grown a following and I hope that some of those followers will eventually invest in me. That is, the followers will tie a portion of their assets to mirror my investment positions on the site. My advice to you is to keep doing what you are doing: invest in yourself (learn), and then invest in the market. Keep making mistakes. Learn. Reset (after all it is just play money). You will know you reached the next level when you become less emotionally attached to the market and see things for what they are from an objective level.

(Yada yada yada on the usual disclaimers: trade at your own peril, take responsibility and ownership on your own actions...)