Trading can be a very lonely game. As self investors we tend to internalise our feelings and emotions without sitting back and assessing where, we’re really at.

Recently I was fortunate to be interviewed on JSE Direct – a South African radio program hosted by well respected South African media analyst Simon Brown.

Simon’s interview drove me to divulge what I believe to be the key trait of a successful trader.

This interview is purely educational and I would encourage you to take notes and listen to the recording a second time. I believe the content will help improve the way you look at the market.

Click here to listen to Gary Stone on JSE Direct
13 minutes 16 seconds

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For the first (oops, second) time in our history, we have a hung parliament.

Under a parliamentary system of government, a hung parliament occurs when no political party has an absolute majority of seats. Resolving a hung parliament will usually result in a minority government forming a coalition, with independents or other smaller parties to give it enough seats to gain ‘control’. This can be an unstable option as many vested interests can come to the fore. The other option is a fresh election.

Whatever happens, market participants (traders and investors) tend to consider these as periods of great uncertainty. In the initial stages following the election this revolves around who will actually govern the country, who will lead and how, and which policies will be implemented. If a minority government forms there will be concerns about vested interests and the roles and responsibilities of the independents and the smaller parties involved. All of this tends to have a de-stabilising effect on both the economy and the share market. Markets dislike uncertainty and this will be reflected in share prices in the short term.

If a minority government is formed, investor concerns will turn to policy implementation and direction. Will the minority government be able to pass new ideas and bills through the parliament? Or will it be continually hand-cuffed in its decision making by the simple fact that without a majority it cannot obtain a result in the parliament as members jostle for position and to protect their interests and those of their constituents? One party simply cannot pass any laws without the support of the other or others. It is a tricky and delicate situation that can result in a period of in-effective governance if such a situation arises.

What does it mean for investors?

Well, as we all know humans in general don’t like uncertainty and because humans constitute ‘the market’, it follows that the share market also doesn’t enjoy uncertainty. A hung parliament could result in a prolonged period of sideways price action if no definite action can be taken by the minority government. Will there be a resources tax? Will spending increase? Will tax changes eventuate? The unknown answers to these and a multitude of other questions could potentially have a negative impact on the market for some time to come. In the end all of this is ‘noise’.

During times like these, those without a strict set of processes and rules to follow may well find share investing and trading tough going. The market may play many tricks on these investors in the months ahead, as they try to predict what effect the noise will have. In the meantime, those of us using a mechanical approach will continue to follow the rules and processes of the system, ignoring the market ‘noise’ and progressing on our journey.

It will be interesting to watch how it all unfolds and to be able to look back in the years ahead and reflect on the fact that we have been a part of an historical event in Australia’s parliamentary history.

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Carrying on from last week’s journal post “Who’s to blame?”, I will now discuss shifting our thought process to make change.

To improve your responses you can do one of two things:

1. Change your perception of the outcome to see it as positive or at least as not causing pain.
2. Change the process to make the outcome positive.

This takes effort on the normal person’s part. It is far easier to blame someone else or just get angry. The more we blame the less responsibility we take for outcomes in our life. The less responsibility we take, the lower the chance of changing our perception of the outcomes or the outcomes themselves. Meaning, we don’t grow and improve.

This cycle of blame is very damaging for performance in anything that we do in life, especially trading. “I was too busy today to check my open positions,” is a blaming justification.

The first step is to take responsibility for all the outcomes in your life. No doubt you have heard the cliché definition of insanity, but it is well worth repeating here: ‘Doing the same thing over and over again and expecting a different result.’

When you take responsibility, you create conflict which needs to be resolved in your subconscious. The conflict can either be resolved by opting out of the action that causes the hurt–that is, giving up–or by changing.  Changing requires commitment, desire, discipline and effort.

The second step is to create a process to resolve the conflict until it goes away and is not perceived as potentially or actually causing emotional hurt. If you don’t create this process, the conflict will still be resolved by the old technique, relying on your hurt avoidance mechanisms which will avoid, hesitate, deny, rationalise, justify etc. And the cycle of blame will start all over again—you won’t take responsibility; you will continue losing; and you will blame it on someone else.

It doesn’t really matter what happens, its how we take it that counts. Most of the time there are variables at play in our lives that we have absolutely no control over and never will which will cause perceived and real negative outcomes. We can control how we react to these outcomes but we can not control the variables and outcomes themselves.

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As human’s we’ve been programmed by society to not accept the following situations on an event by event basis:

• being proven wrong or not being right,
• losing,
• not belonging or missing out.

This starts at a very early age as our subconscious is bombarded by experiences and words all indicating that these situations are not good. Anything that is perceived as being not good for us causes us to experience emotional hurt. These experiences include not being invited to a party by a school friend which results in the hurt of not belonging to a school peer group; or your football team losing a match; or losing an argument with a friend.

As our subconscious gets more and more accepting of the belief that when any of these three experiences occur they are unacceptable, an increasing level of emotional hurt is experienced when any one of them actually does occur.

Whenever our senses perceive that one of these aspects may be about to occur, our hard-wired association mechanisms in our subconscious brain trigger an autonomic hurt avoidance mechanism. This could be avoidance, rationalisation, justification, hesitation, delay, procrastination, fear, uncertainty or doubt.

If the event physically occurs because it was for some reason that is unavoidable, the autonomic hurt avoidance mechanisms still go to work but as a different emotional response which could be rationalisation, justification, anger, frustration, blame, denial, “passing the buck”, lying, ignoring or betrayal.

One of the most common responses if the event couldn’t be physically avoided is for our subconscious to try to break any connection between us and the event in order to avoid the hurt of being proven wrong, not belonging, missing out or losing. This can be done by blaming something or somebody else. Doing so transfers the ‘being wrong’ to another so that at the end of the day, you can say to yourself ‘I wasn’t wrong’. And therefore if ‘I wasn’t wrong’, then the emotional hurt associated with the event is avoided. Your emotional hurt avoidance mechanism in your subconscious has done its job.

The problem with this is that once the blame is transferred, it is now perceived to be okay for the event to have had the outcome it did. So you do not need to do anything to improve or change yourself—because it wasn’t you who did anything wrong! You’re off the hook! It was the third party that was to blame.

The more you find a reason to justify that it was ‘out of my control’ to explain the occurrence of something negative in your life, the more you enforce and strengthen the process that could potentially cause the negative outcome to occur again because you are not doing something to improve the situation. Yet another paradox!

Another common response to an outcome that causes emotional hurt is to feel angry. It has now been proven scientifically that anger makes you stupid. When we get angry our logical brain power is diminished because the subconscious autonomically secretes chemicals into our bodies that shuts down our logical computing brain and puts us into the fight or flight mode of operation. We have absolutely no control over our brain’s response to getting angry but we do have control over entering into a state of anger in the first place.

The same would apply for each of the emotional responses of revenge, frustration, betrayal, denial or fear. Obviously, such responses are not good because they prevent you from embarking on a process of dealing with the mental error and hence improving yourself and also set you up with the incorrect mental state for the next opportunity to execute. That execution could be a golf shot or a tennis shot, a relationship interaction with another human being or a trade in the financial markets. They all interact. Getting angry at others or on the golf course with yourself will creep into your trading. Blaming a friend or colleague for a negative outcome in your life will set you up to blaming the market (or some other 3rd party) for a losing trade.

Next week I will discuss shifting our thought process in “Who’s to blame” – Part 2.

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Having discussed the need to ensure your cash is secure, and that you are satisfied with the way your cash is held by your stock broker, this week I will take a look at how your shares are ‘held’ by your broker. I will also briefly cover what happens in the CFD and FX markets.

Ownership of shares.

Of equal importance to the question of where your cash is held, is where and by whom your shares are held. This can be in one of two ways:-

1. Registered Shares on a sub-register that are CHESS Sponsored with a client HIN, or Issuer Sponsored with an SRN

A full description of CHESS Sponsored with a Holder Identification Number (HIN) and Issuer Sponsored with a Securityholder Reference Number (SRN) is provided at this link on the ASX website:

http://www.asx.net.au/products/shares/how/chess_benefits.htm

You own ‘Registered Shares’ when your name, or your entity’s name, is recorded on the share registry of the listed company in which you have invested. Registered Shares give you legal ownership of the shares and the rights associated with being a share holder of an ASX listed company.

Of the online brokers who facilitate trading ‘exchange traded’ Registered Shares on the ASX and whom are ASX Participating brokers, Commsec, E*TRADE, Westpac, NAB and Macquarie Bank are probably the most well known. This system is not unique to Australia as international exchanges do offer an ‘exchange traded’ registry based system. The majority of full-service brokers are also ASX participating brokers.

2. Shares that do not have a HIN or SRN in your trading entity’s name

It is possible to ‘hold’ shares that may not be held with a HIN or SRN in your name. The unknown in such a case is who the ultimate legal owner of the share assets really is. This may depend on confidential contractual agreements between any and all parties involved in brokers’ transaction processes.

Investors need to be aware that the broker-related risks involved with holding shares that are not CHESS Sponsored with a HIN or Issuer Sponsored with an SRN are greater than if the holdings do have a HIN or SRN in the name of your trading entity.

The broker-related risks could be spread across multiple third party organisations with which the broker needs to have a relationship to facilitate the trading of the instruments that they offer. In the case of holding a share that does not have a HIN or SRN in your name, you could be exposed to the risk of other organisations failing with which you have no direct relationship. You will probably not know or be aware of these complex relationships until such time as they unwind, as has been the case with several brokers since the GFC.

What happens to shares in the event of a default by the broker?

In the case of Registered Shares, the owner on the share registry for a particular listed company has legal ownership of Registered Shares. As such neither the broker nor any associated third party with which the broker may have a contractual relationship has any legal or beneficial right to the registered shares if your broker goes into liquidation, unless you have pledged these through a ‘lien’ or ‘charge’ to a margin lender.

If shares are not registered on a listed company’s share registry with a HIN or SRN, then these shares can potentially be viewed as the assets of the defaulting broker and may be used by liquidators to settle outstanding creditors of the defaulted broker. As a potential unsecured creditor you could be amongst the last to be paid.

CFDs, futures and FX

Those that wish to trade CFDs, futures or FX must be aware of the risks associated with trading such instruments by making themselves acutely aware of the information described in the respective brokers’ PDS documentation. Be aware that all potential risks cannot be totally eliminated and that the degrees of risk can vary from one broker to the next.

As I have publicly stated in the past, investors who would like to trade leverage should invest a maximum of 15-20% of their total market related capital into any leveraged strategy but preferably less, and more like 10%.
Strategy aside, similar principles in relation to limiting capital to user-defined percentage levels should also be applied to depositing investing capital with a provider that facilitates the trading of shares that do NOT have a HIN or SRN.

Conclusion

It is the responsibility of each investor to understand the risks associated with choosing the broker that they wish to transact with. However, different brokers offer different lists of instruments that can be traded and hence the investor needs to match their risk profile to the benefits and the potential broker-related risks of any broking solution that they may consider using.

From our research it was clear that the most secure manner for investors simply trading unleveraged stocks through their self managed super fund, or any other entity, is to do so through a broker that offers the trading of Registered Shares with a linked CMA or CMT for the unallocated cash. Even so, risks, as minor as they may seem to be, still exist during the clearing process or with the Australian bank defaulting.

Those trading CFDs and other synthetic instruments should consider choosing an online broker that you have thoroughly researched. Ask the necessary questions about their product disclosure statements (PDS) and how secure your assets will be when deposited with them, particularly in the event of their default. If you don’t get the answers you’re looking for then keep looking for another firm to deal with.

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The recent collapse of brokerage firm Sonray Capital Markets raises a number of issues and questions that are important to all investors – not only those trading Australian shares and CFDs, but traders in all markets and all instruments. Reports from the appointed administrators suggest that SONRAY has lost around $46 million of client’s funds out of a total of around $76 million through a combination of illegal and inappropriate trading activities and poor business management. Apparently, client’s funds were being used to fund the illegal trading activities being carried out by SONRAY. It is suggested that a trader or traders within the SONRAY organisation had access to client funds and used this money to fund the illegal trading activities and prop up the business. These trades have gone horribly wrong leaving clients facing losses of their trading capital and perhaps even shares they believed they owned, through no fault or action of their doing. These clients may well be asking how was this allowed to happen and what are the regulators intending to do to prevent this occurring again?

Cash at risk

Many of the Sonray clients may well have believed that their Funds were held safely in ‘a client segregated account’ that was separate from the brokers ‘house’ account. This appears to not be the case. This may well raise a number of questions, including:-

1. Why and how was access gained to this pool of client’s funds?
2. Who has access to this pool of client’s funds?
3. Are client’s funds really as ‘safe’ as we would like to think?

I’m sure you can think of many more.

After researching the security of cash injected into accounts for trading we found that there is no alternative more secure than having your capital deposited in an Australian bank account, whether linked to your online broker or not. Many Australian brokers provide their clients with CMA (Cash Management Account) or CMT (Cash Management Trust) accounts which are typically linked to client online trading accounts or are the linked account to the online broker. Accounts under $1 million are also secured under the Australian Government’s Financial Claims Scheme (FSC).

In the case of Sonray, it has been reported that client cash, that is the deposited monies in their online trading accounts that were not invested in shares, is allegedly not secured and therefore is at risk of being used by the appointed liquidators to pay outstanding creditors. This remains to be confirmed by the currently ongoing Sonray liquidation process. I’d urge investors to familiarise themselves with the Sonray situation, and to thoroughly research your current broker to determine if they deposits monies in a similar way to the method that Sonray did or in a more secure manner that cannot be used to pay creditors in the event of a broker default.

If an ASX broker provides an online linked CMA or CMT account with an Australian Bank in the client’s name, the clients’ funds are protected in the event of a default by the broking arm of the business. This means that your funds are held at the bank in your name and not within the brokerage firm. In the event that the broker was to default, your cash would be secure within the banking structure. The risk is significantly reduced but it is not eliminated.

If a broker deposits their client’s funds into any other account other than an account with a recognised Australian bank in the client’s name then the client’s cash that is not invested in the market may be at risk of being used by the broker in the event that the broker defaults or a client of the broker defaults with a large loss. This is a general statement as the level of risk varies depending on the details provided in the broker’s PDS and any back-to-back contractual agreements that the broker may have in place with third parties.

I urge you to thoroughly research and understand the way your broker holds your funds so that you are fully aware of any extra layer of risk that you may be exposed to in the markets. This starts with your brokers Product Discloser Statements. You should start by reading your brokers Product Discloser Statement in detail and assess what are the potential risks you are exposed to. Don’t treat your broker Product Discloser Statements or your broker client agreement forms the same as you would treat your general banking or general insurance Product Discloser Statements. Be diligent and ask your broker specific questions that concern you and your money.

As traders and active investors we CHOOSE to participate in the financial markets. We know and understand individual trade risk, we understand market risk, and we also need to understand the potential for broker default risk as the Sonray example shows. This is a layer of risk over which we have little if any control when things go wrong. We can take steps to limit this risk but we must still be aware that it can occur.

We also need to be aware of the fact that ‘cheap’ brokerage is not always the ‘best’. Whilst at first blush it may appear that a brokerage rate of $10 per trade is cheaper than $25 per trade, this is of little consequence if our trading capital disappears into a black hole if our cheap broker defaults and collapses, and leaves us thousands of dollars worse off. As always, do your research, know your risks, and understand fully the whole environment in which you are trading.

Next week I will discuss how shares are ‘held’ and what happens when trading other instruments such as futures and FX.

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A better way to think about bear markets

The beauty of long bear and sideways market periods is that they are almost always followed by long rising market periods. The majority of the time, the longer and stronger the bear market, the longer and stronger the bull market that follows. This is how consistently successful traders think. Winning, whether it be in the markets or elsewhere, is a state of mind, as is losing. Winners see down market periods as impending opportunity. Losers put a significant amount of focus on the monetary drawdown that they suffer during down market periods and are blinded to the imminent opportunity. Often they withdraw their funds and miss the complete upturn performance when the market takes off again.

So, look upon a bear market as an opportunity—the opportunity for the market to catch its breath and to set up for the next rising market. See the lead up period to the next rising market as the period in which trades will be signalled that will take your portfolio out of drawdown and recapture what may have been lost during the drawdown period.

The mechanical methodologies that I have traded and continue to research show that every drawdown period has been followed by a new equity peak, thereby making a new equity peak a high probability outcome. By thinking from the market’s perspective, you think in probabilities, which means that you think in terms of your edge and the drawdown trading statistics will revert to the mean of the long term researched statistics of the edge. Then you should be able to consistently execute the processes of your edge without reservation or hesitation, believing that anything can happen and that you do not need to know when the next bear market will be or how long it will last.

Summary

Is this the only way to train yourself to become a successful trader?

Probably not.

But it is a high percentage approach that, if completed, will result in a high success rate of people who complete it because people change who they are. You become a trader rather than a market observer, a chart reader or just an analyst. Broking firms employ chart readers and analysts who are very good at their job, but they are not traders—there is a massive difference between the two.

If you want to join the discretionary ranks from the very beginning, in an attempt to become a successful trader without using a mechanical system to assist with retraining your mind, you may come out the other end as a successful trader but the probabilities are much lower and the failure rate is much higher.

Those who embark on the discretionary pathway do so mostly because they are ignorant of another way and don’t understand how their mind works or they have a large ego that urges them to take the most difficult pathway. Their big ego will take care of the outcome all on its own.

Life is a percentage game as are all sports and games that human beings play. Follow the high percentage route and resist the high ego route. Play the par five like a par five and you will, over a large sample, have a better average score than the big ego hitter that tries to play the par five like a par four and birdie it every time.

But at the end of the day, your subconscious is not tested until you play the game with your money.

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Thinking about the markets from the market’s perspective can remove fear from the equation by creating a belief that down markets are a necessary part of market behaviour in the future and just as tradable as low market risk periods.

If you think from the paradigm of your business, your job objectives or from your societal perspectives, you will have a core belief that all down markets are bad. Imagine if employers were paid an inconsistent amount of salary every month and some months you even had to pay some in! People in that situation would not be motivated employees—but they might be better traders, as they would be trained to endure drawdown. “Winners are grinners”, the saying goes. Have you met a winner who has not been a loser at some stage—even though they rarely talk about losses? Losing teaches you how to win. Losing puts winning into context, just as pain puts pleasure in to context; hate puts love into context and hot puts cold into context.

Imagine if people went to the football looking forward to their team losing!!! Reading this statement will seem foreign because people have a core belief that the reason they go to the football is to enjoy the feeling of being there for a win. Of course, this sets people up for feeling the total opposite if their team loses. Win and you feel happy. Lose and you feel unhappy ! What did you do? Nothing. The team did it all!! The outcome of an event over which you have absolutely no control has defined how you feel. If you changed your paradigm to that of being at the football to appreciate the high level of skill by both teams, witnessing a close contest, soaking up the atmosphere and being amongst the buzz, then perhaps you could be happy, regardless of the outcome. This is a simple example showing that how we think can define how we feel. The same event takes place; the only change is how we perceive the event.

Remember what we said about thinking from the market’s perspective? You think in terms of probabilities by thinking in terms of the probabilities of your edge. This becomes the focus, not how much money you have in your account. That is, you detach from the money and attach to the process to execute your edge. Achieve your edge and the money will flow. Focus on execution to achieve your edge and your account will take care of itself. Knowing that you have an edge researched in the market environment with a positive mathematical expectation means that you are thinking in probabilities. Then, you can simply focus on the process of execution.

Thinking this way can define away and eliminate:
• The fear of losing
• Feeling despair, frustration and anger during drawdown periods
• Living with ongoing fear of the prolonged bear market

It is our responsibility to ensure that we are in the best frame of mind to execute the next trade.

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Research shows that the average down market lasts three to four months. However, it is not the short-lived down market periods that active investors should worry about, but the occasional longer and sustained down market periods, such as the one we are now experiencing. All ‘long’ strategies, whether they are Buy & Hold or more active, will go into drawdown during sustained bear market periods. The perennial active and passive investment dilemma is that nobody really knows when the prolonged bear period will occur or how long it will last. However most investors live in fear of such a situation and it is this fear that causes investors to become inconsistent in their actions during the down period and the ensuing positive market periods.

Why is there fear of such market periods? Because people fear losing. Is it a comfortable feeling living in fear of such market periods? Probably not. Would investment life be more liberating if such fears could be overcome? Probably so.

So how can we overcome the fear of losing? If this fear can be mastered, active investment will become much simpler and more enjoyable.

Most try to handle it by looking for a reason for their loss, hence analysing charts and indicators. However there will always be loss trades. So fear is impossible to analyse away unless a perfect solution can be found in which there is never any loss or drawdown. Such analysis is an infinite task that has a limitless path. If it is impossible to achieve a lossless environment through analysis in order to overcome the fear of loss, then another way has to be found to overcome the fear.

You can achieve this by changing the way you think about the market, by learning to think from the market’s perspective as we have said before. Why do we need to think from the market’s perspective? Because understanding why and how the market moves makes us empathetic with the market, we become one with the market’s movements, we become an insider looking out rather than being an outsider looking in. Markets do move up and down, not just up. An obvious statement we could assume. So why do people have an eternal expectation of upward movement only and become despondent when downward price movement prevails?

Another way to think about the market is to accept that down periods are good for the market because they allow the market to catch its breath. Down periods provide the setup for new upward moves. Up periods, which bring profits, follow down periods. This is the law of polarity—everything has an equal but opposite polarity: there are ups and there are downs, there is hot and there is cold, there is good and there is bad, there is outside and there is inside, there is long and there is short, hate and love, pain and pleasure, win and loss, bitter and sweet, good shots and bad shots, etc. As an imperfect growing human being, in every endeavour we will experience positive and negative outcomes. This is the law of polarity.

In the context of the market down periods causes drawdown in portfolios and generate loss trades. All of these movements are a necessary part of the anatomy of the market. We must encourage ourselves to accept down markets rather than feel fear, despair, frustration and anger. We must learn to accept drawdown in our portfolios as a necessary occurrence of active investment. Whilst still tough, this is easier when using a proven system with a positive expectancy.

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This week I have moved away from psychology training as I feel that it is important to add my commentary on the current market conditions.

I’m not one to normally predict the direction of the market. To be honest I don’t get caught up in the economic noise or the negative press articles on the economy or market factors but I must say I can see this current market moving even lower, purely using technical analysis. Actually, I think we need to condition ourselves to this fact and that the bear market may be around for a while yet. This may help many traders and investors align their expectations to their trading plan.

Recently I reflected my thoughts in the Share Wealth Systems Active Investor eNewsletter and clearly stated that, “if the Friday 25 June low does not hold this week then the ALL-ORDS must find support around the 4325 level or it could fall to 4200 (there is weak support around 4275 where the trend line is drawn). If 4200 does not hold then the next target is around the 3954 – 3961 level which is some way below where the ALL-ORDS is now”.

With the All Ords closing at 4324, I beleive this market does not have to move much further for it to go much, much lower. If the price action at 4200 does not hold this market could move a further 200 plus points down in the blink of an eye.

Whilst I am sharing my thoughts and technical analysis experiences, most of you would know that I am a pure advocate for mechanical trading. I would always much rather react to the market than attempt to predict it. Attempting to predict what the market will do next is a sure fire way to lose both money and face! That being said, a disciplined application of technical analysis can provide some valuable insights into market trends and internal market structure.

The SPA3 system I designed and released 12 years ago triggered a short or hedge signal only yesterday. Whilst the last hedge trade our customers made back in May was a profit trade, the previous three previous trades before this were loss trades. Rather than questioning our rules and making changes based on a small sample we follow our predetermined trading plan. It now remains to be seen where the market goes. Perhaps it can hold support around these current levels, but if it doesn’t, then the technical indicators appear to be pointing to further price falls. As always, now is the time to be disciplined and consistent in the application of our trading plans and trading rules so we are able to once again take advantage of suitable market conditions when they do re-appear.

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