The Myth
Wall Street is a myth. On the surface, the daily fluctuation of the stock prices creates endless opportunities to profit from. Once you dip your toe into the market, you start to realize Wall Street is such a merciless beast that squeezing some profits out of it represents a daunting task. Among all investors, only a tiny percentage makes money consistently over the long run.
In the May 2004 paper entitled "Do Individual day traders make money? Evidence from Taiwan", UC Berkley professor Terrance Odean assesses the success of day traders in the Taiwan stock market using detailed individual trading records, they found that individual investors account for majority of day trading activities and over 80% of day traders lose money after transaction costs.
In a study by Wall Street Journal published in 1987 that between 75% and 95% of all commodity investors lose money. A few savvy traders make good money from the vast majority of less sophisticated players.
It is a fact that mutual funds managed by professional money managers, on average, do not beat indexed funds. In one of the best selling books ever about investing, "A Random Walk Down Wall Street", the author, a Princeton professor hypothesized that "a blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by experts." In 1988, The Wall Street Journal, picked up on the popularity and novelty of the idea and ran the experiment of pitting monkeys (blindfolded journalists) against professionals. The rules got changed continuously as experiment upon experiment was run. When the 100th contest ended, the Wall Street Journal presented the results. The professionals won 61 of the 100 contests against the Dart throwers. Though the professionals won, this slim margin was quite embarrassing for these supposed experts. What was worse was that the pro's only beat the Dow Jones Industrial Average in 51 of the 100 experiments. In theory, by just investing in the Dow, you could do just as well as following expert advice.
Nevertheless, Wall Street provides enormous money making opportunities. Selected few savvy investors, money managers, individual investors have amassed enormous wealth over time. What makes them stand out?
What differentiates pros from the amateurs, winner from the losers in Wall Street? Are there common traits exist in all those legendary investors? As an individual investor, is there any system we can leverage to profit from?
The Market
Efficient market theory stops its usefulness at the wall of the ivory tower. Under the theory, there are no trending stocks, market timing is impossible. The market reaches instant equilibrium as soon as the new information is disclosed. The hypothesis maintains that it is impossible to use technical, fundamental or expectational analysis to beat the market.
Efficient market theory only holds if the market participants are perfectly informed, emotionless robots. As was aptly stated by William O'Neil in Jack Schwager's book, Market Wizards, "The stock market is neither efficient nor random. It is not efficient because there are too many poorly conceived opinions; it is not random because strong investor emotions can create trends." It is this inefficiency and trending which create enormous opportunity to profit from.
The most fascinating thing about the stock market is that what works in the stock market is contrary to human nature. Greed and fear take over the consciousness of the majority investors when real money is on the table. Typical investors nearly all sell at the end of the bear market, and buy near the end of the bull market. The interesting phenomena you can observe for years is that when all Joes on the street, all Jacks in the internet discussion board are making money and starting to boast how fast they can make money by buying out-of-money near-term options; how proud they are on their own proprietary trading systems; how smart they are by doubling their dollars by buying the over the counter pink stocks etc. You know the bull market is getting close to the end and all Joes and Jacks are destined to lose all.
The game of Wall Street is more of a psychological than a game of odds and economic know-how. To me, the game is 70% of psychology, 20% of statistics and 10% of economics.
The investors
There is a single Warrent Buffet.
There are couple Peter Lynch(es).
There are couple George Soros(es).
There are couple James Simons(es).
There are couple Ken Heebner(s).
There are couple David Booth(es) who made himself known after donating $300-million gift to the University of Chicago's business school.
There are a massive number of underperforming mutual fund, hedge fund, pension fund money managers, who make their living by managing others' money.
Then we have the sea of small fishes and shrimps, the individual investors, who come to Wall Street with only one purpose, to make money. Over the century of stock market history, a few individual investors, WHO PLAYED THEIR OWN MONEY with lone hands, stood out the market tests with enormous success. The classic examples are Jesse Livermore, Nicholas Darvas, and William O'Neil.
As an individual investor, who should we follow? Or should we invent a system of our own? Well, it is true all road leads to Rome, majority are filled with traps and landmines. There are a few standing out ones which are clearly more superior than the rests.
As an individual investor, what advantage or disadvantage do you have comparing to top notch Wall Street institutions?
In light of the common mistakes of typical investors and clear disadvantage of the fundamental research over the big Wall Street money house, we need to adopt a trading system which can clearly put the winning odds in your hands.
The strategy
In the most general sense, trading success requires 3 basic components: an effective trade selection process, risk control, and discipline to adhere to the first two items.
Over the span of a hundred years of stock market history, stock market spends more than twice as much time in bull market as in bear market. Since 1854, an average business cycle lasted 53 months. The average bull market was 35 months and the average bear market was 18 months. Between 1945 and 1991, the average bull market was 50 months and the average bear market was 11 months. In each bull cycle, normally there are several innovative market sectors and industries to lead the market higher. Top companies within the leading industries with superior fundamentals (big EPS and sales growth, superior products) will SIGNIFICANTLY beat the market (e.g. comparing to SP500). In the following bear cycle, market normally corrects with much bigger volatility, some of the former leading stocks get sold hard and forever finish their bull run. Market goes through changes of leadership until next bull market starts. This phenomena can be best seen in the dot-com bubble of 2000.
To leverage this historically repeating pattern, a trading system can be designed to ride each bull phase buying top leading stocks in leading industries to maximize the profits and move to cash heavy in bear market to preserve capital. To play the market cycle by cycle, by compounding, you can amass enormous wealth.
This is what CANSLIM does. CANSLIM is the trade mark of IBD.
In the nutshell, CANSLIM strategy can be summarized in the following:
Wall Street is a myth. On the surface, the daily fluctuation of the stock prices creates endless opportunities to profit from. Once you dip your toe into the market, you start to realize Wall Street is such a merciless beast that squeezing some profits out of it represents a daunting task. Among all investors, only a tiny percentage makes money consistently over the long run.
In the May 2004 paper entitled "Do Individual day traders make money? Evidence from Taiwan", UC Berkley professor Terrance Odean assesses the success of day traders in the Taiwan stock market using detailed individual trading records, they found that individual investors account for majority of day trading activities and over 80% of day traders lose money after transaction costs.
In a study by Wall Street Journal published in 1987 that between 75% and 95% of all commodity investors lose money. A few savvy traders make good money from the vast majority of less sophisticated players.
It is a fact that mutual funds managed by professional money managers, on average, do not beat indexed funds. In one of the best selling books ever about investing, "A Random Walk Down Wall Street", the author, a Princeton professor hypothesized that "a blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by experts." In 1988, The Wall Street Journal, picked up on the popularity and novelty of the idea and ran the experiment of pitting monkeys (blindfolded journalists) against professionals. The rules got changed continuously as experiment upon experiment was run. When the 100th contest ended, the Wall Street Journal presented the results. The professionals won 61 of the 100 contests against the Dart throwers. Though the professionals won, this slim margin was quite embarrassing for these supposed experts. What was worse was that the pro's only beat the Dow Jones Industrial Average in 51 of the 100 experiments. In theory, by just investing in the Dow, you could do just as well as following expert advice.
Nevertheless, Wall Street provides enormous money making opportunities. Selected few savvy investors, money managers, individual investors have amassed enormous wealth over time. What makes them stand out?
What differentiates pros from the amateurs, winner from the losers in Wall Street? Are there common traits exist in all those legendary investors? As an individual investor, is there any system we can leverage to profit from?
The Market
Efficient market theory stops its usefulness at the wall of the ivory tower. Under the theory, there are no trending stocks, market timing is impossible. The market reaches instant equilibrium as soon as the new information is disclosed. The hypothesis maintains that it is impossible to use technical, fundamental or expectational analysis to beat the market.
Efficient market theory only holds if the market participants are perfectly informed, emotionless robots. As was aptly stated by William O'Neil in Jack Schwager's book, Market Wizards, "The stock market is neither efficient nor random. It is not efficient because there are too many poorly conceived opinions; it is not random because strong investor emotions can create trends." It is this inefficiency and trending which create enormous opportunity to profit from.
The most fascinating thing about the stock market is that what works in the stock market is contrary to human nature. Greed and fear take over the consciousness of the majority investors when real money is on the table. Typical investors nearly all sell at the end of the bear market, and buy near the end of the bull market. The interesting phenomena you can observe for years is that when all Joes on the street, all Jacks in the internet discussion board are making money and starting to boast how fast they can make money by buying out-of-money near-term options; how proud they are on their own proprietary trading systems; how smart they are by doubling their dollars by buying the over the counter pink stocks etc. You know the bull market is getting close to the end and all Joes and Jacks are destined to lose all.
The game of Wall Street is more of a psychological than a game of odds and economic know-how. To me, the game is 70% of psychology, 20% of statistics and 10% of economics.
The investors
There is a single Warrent Buffet.
There are couple Peter Lynch(es).
There are couple George Soros(es).
There are couple James Simons(es).
There are couple Ken Heebner(s).
There are couple David Booth(es) who made himself known after donating $300-million gift to the University of Chicago's business school.
There are a massive number of underperforming mutual fund, hedge fund, pension fund money managers, who make their living by managing others' money.
Then we have the sea of small fishes and shrimps, the individual investors, who come to Wall Street with only one purpose, to make money. Over the century of stock market history, a few individual investors, WHO PLAYED THEIR OWN MONEY with lone hands, stood out the market tests with enormous success. The classic examples are Jesse Livermore, Nicholas Darvas, and William O'Neil.
As an individual investor, who should we follow? Or should we invent a system of our own? Well, it is true all road leads to Rome, majority are filled with traps and landmines. There are a few standing out ones which are clearly more superior than the rests.
As an individual investor, what advantage or disadvantage do you have comparing to top notch Wall Street institutions?
- Small investors have no edge or advantage when it comes to fundamental research.
- Big institutions and funds will almost always have superior information.
- Small investors have the advantage of being flexible and quick moving.
- If a small investor is disciplined, he or she can use charts and superior money management to follow the smart money into the best stocks and generate superior gains.
In light of the common mistakes of typical investors and clear disadvantage of the fundamental research over the big Wall Street money house, we need to adopt a trading system which can clearly put the winning odds in your hands.
The strategy
In the most general sense, trading success requires 3 basic components: an effective trade selection process, risk control, and discipline to adhere to the first two items.
Over the span of a hundred years of stock market history, stock market spends more than twice as much time in bull market as in bear market. Since 1854, an average business cycle lasted 53 months. The average bull market was 35 months and the average bear market was 18 months. Between 1945 and 1991, the average bull market was 50 months and the average bear market was 11 months. In each bull cycle, normally there are several innovative market sectors and industries to lead the market higher. Top companies within the leading industries with superior fundamentals (big EPS and sales growth, superior products) will SIGNIFICANTLY beat the market (e.g. comparing to SP500). In the following bear cycle, market normally corrects with much bigger volatility, some of the former leading stocks get sold hard and forever finish their bull run. Market goes through changes of leadership until next bull market starts. This phenomena can be best seen in the dot-com bubble of 2000.
To leverage this historically repeating pattern, a trading system can be designed to ride each bull phase buying top leading stocks in leading industries to maximize the profits and move to cash heavy in bear market to preserve capital. To play the market cycle by cycle, by compounding, you can amass enormous wealth.
This is what CANSLIM does. CANSLIM is the trade mark of IBD.
In the nutshell, CANSLIM strategy can be summarized in the following:
- Once market comes out of a bear market, buy top leading stocks (companies with superior earning growth) within top leading industry (the sectors with top relative performance leading the entire market higher), which break out of sound consolidation bases on brisk heavy volume.
- Hanging on to leading stocks as long as the fundamentals and chart patterns continue in favor of higher price and market remains healthy. Pyramid on the way up.
- Sell when stocks enter classic topping patterns, e.g. climax run, or high volume breach of important moving averages, or showing signs of heavy institution distributions.
- During bear markets, keep heavy in cash.
I use CANSLIM system with some added momentum strategy of my own.
Once you have a winning system, as if you know you are the casino owner, not a gambler by playing it again and again, the rest of game requires your discipline and consciousness of the mind. You need to sell into strength when you see euphoria of averages Joes in discussion room; You need to refrain from buying and sit with your capital when market offers you no opportunities; You need to act decisively and pounce once the opportunity is upon you; You need to cold bloodly sell your losers and patiently wait your winners to perform.
Once you have a winning system, as if you know you are the casino owner, not a gambler by playing it again and again, the rest of game requires your discipline and consciousness of the mind. You need to sell into strength when you see euphoria of averages Joes in discussion room; You need to refrain from buying and sit with your capital when market offers you no opportunities; You need to act decisively and pounce once the opportunity is upon you; You need to cold bloodly sell your losers and patiently wait your winners to perform.
The flair
"NOTHING IS MORE DIFFICULT, I truly believe, than consistently and fairly profiting in Wall Street." said Gerald Loeb in his first chapter of the book "The Battle of Investment Survival".
He continued, "Knowledge born from actual experience is the answer to why one profits; lack of it is the reason one loses. Knowledge means informaiton and the ability to interpret it marketwise. But, in addition, making money in the market demands a lot of "genius" or "flair". No amount of study or practice make one successful in the handling of capital if one really is not cut out for it."
The end
The purpose of the blog is two fold: It creates a place holder to collectively store my thoughts, observations and studies of the market. Secondly, this is my second Ph.D. thesis. If my first Ph.D. thesis led me to understand the science and engineering, the second will lead me to understand sociology, economics and best of all, human nature.
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