It’s now been two weeks since SPA3 generated a Low Market Risk signal on the Australian market . For users of the SPA3 system this indicates they can increase their position sizing for new buy signals on individual stocks. However, there are absolutely no guarantees that the market will remain low risk, and may indeed even turn high risk again very quickly as we saw in September of 2008. Then, a low risk market indicator was provided by SPA3 on August 29 2008 and was quickly followed by a high risk market indicator just 18 days later!

Figure 1. ALL ORDS

There are some differences between September 2008 and now. Back then, market volatility as measured by the Average True Range (ATR) was rising sharply, and share prices were trading in huge intraday ranges. Now, the ATR has contracted and appears to be, like the market itself, in a period of consolidation. Periods of lower volatility will always pre-cede periods of higher volatility. There is no correlation between volatility and future price moves, other than a suggestion that prices will break out of congestion and low volatility, and move relatively quickly either up or down. This can be seen in Figure 2 below. During winter 2008 the volatility contracted or ‘washed out’ prior to the low market risk indicator in September. The market then imploded sharply and suddenly in the following months and as prices tumbled the volatility exploded. As the market has consolidated into a trading range over the past 4 months, volatility has consolidated as well.

Figure 2. XJO with ATRVE

It is now that active investors need to deploy their trading strategy, and be prepared mentally and emotionally for the future moves of the market. If the market remains low risk and emerges from this current period of consolidation into a medium term uptrend then profits from long side trades will be generated. If the market breaks lower from this period of consolidation, then decisive action will need to be taken as and when the sell signals are given and if a high market risk signal appears. Those using a hedging strategy (SPA3 customers) will then cover or hedge their long positions and portfolio’s using their hedging tool of choice – either the SPI Futures contract or an Index CFD.

It is during these times that our patience, discipline, trading rules and self belief systems are fully tested by the market. Those that are prepared, have a well documented trading plan, and are able to take decisive action, will be able to participate in the market. They will be thinking in terms of probabilities and overall returns, rather than focusing on the results of each and every trade as it unfolds as either a winner or a loser. Having researched and understood their system fully they will execute trades according to the rules of the system, using its unambiguous entry and exit signals to mechanically execute trades in the market. They will also have prepared themselves mentally, knowing that there are a range of outcomes that could occur, and have readied themselves to take the necessary action required based on this range of outcomes.

Where the market goes from here is open to speculation and great debate. There are some predicting that the lows are in place, the worst is behind us, and that markets will soon begin to reflect this change in investor and trader sentiment and begin a slow and cautious recovery. There are others predicting the sky is about to fall, that the worst is yet to come, and equity prices are yet to capitulate. Regardless of all this ‘noise’ and chatter, it is our job to simply react to the signals of our trading system, and to avoid the mistake of trying to predict and forecast what the market will do. As individual investors, the market is bigger than, and independent of, all of us. Collectively it represents the opinions and actions of hundreds of thousands of decisions each and every day. It is impossible to know the outcome of all of these. Far better to have a well researched system, clear rules for entry and exit, a clear mind, and the ability to think and act in terms of market probabilities and outcomes, than to attempt to survive randomly selecting ‘one-off’ trades.

If you would like a demonstration of SPA3 simply register your details at the following link.

The trading errors I mentioned last week are all the manifestation of poor trading psychology. After making such errors, a trader with this poor trading psychology would typically blame a third party for their trading errors. This may be their broker, a newsletter, the market, their software, their job because they were to busy at the time, their rules, the internet, their computer, and a variety of other poor excuses. They will not take responsibility for their poor trading, choosing instead to justify the loss or distorting why they had the loss. Because they believe it was not their fault and it was therefore out of their control, their view is they need take no further action to improve for the next time this occurs.

Our innate emotional pain avoidance mechanisms cause us to focus too much on individual events and the outcome of each individual event. These events in the market are individual trades. This intense focus on each trade causes undue significance to be put on the outcome of each trade because it’s measured in terms of whether we were right or wrong, succeeded or failed, won or lost to an ‘opponent’ - being the market or some other market participant.

The resulting emotional pain from being proven wrong invokes our defense mechanisms. These include the negative emotions of self criticism, justification, rationalisation, hate or revenge. These will:

• Obstruct our ability to follow rules that might cause a similar occurrence of emotional pain,
• Cause us to make excuses and point blame for the outcome to someone else which means that we need not look to ourselves to improve,
• Make us view the pain deliverer as the opponent that we need to conquer and take out revenge on,
• Blind us to objectively see any other information that might cause the emotional pain to return,
• Cause us to see information that might prevent the emotional pain occurring again.

This causes traders to analyse their edge, that is, analyse their entry and exit signals generated by their methodology. They look at reams of further information outside of their researched edge such as other technical indicators, company information, newsletters, and chat forums seeking non painful information that might justify them not doing the signaled trade or remaining in the trade to exit in an attempt to avoid potential emotional pain.

This further analysis, if driven by revenge, makes the market your enemy or opponent thereby preventing the trader being in sync or empathetic with the markets as it moves to communicate opportunities to the trader in the form of their edge’s entry and exit signals.

The process through which you energise new trading beliefs is called auto-suggestion. Napoleon Hill used this term in his book “Think And Grow Rich” published in 1937. Modern terminology might call it self-talk conducted aloud or affirmation.

The way that new beliefs become energised is by repeating aloud a set of trading truths to yourself every time that you engage the market. At the same time, you carry out certain actions that re-enforce your new beliefs. Every time that you carry out actions which re-enforce your new beliefs you energise the new beliefs and de-energise your old trading beliefs. Every time you carry out actions, make statements or think thoughts aligned with your old pain avoidance trading beliefs you de-energise your new trading beliefs and energise and re-enforce your old beliefs.

We cannot realistically expect perfection. Therefore we must accept that loss trades will occur and are a natural part of engaging the market. This means that we win less than 100% of the time. When we accept in trading that winning 55% of the time is a high winning rate and that 40% can actually be sufficient to outperform the market, we start on the road to re-training our minds.

It is at this stage that we can start thinking in terms of probabilities rather than certainties. When we start thinking in terms of probabilities we start realising that each trade has an uncertain outcome over which we have no control but that can result in large portfolio profits. This is the stage that we start overcoming the stock picking mindset and start thinking in terms of equity curve and accept the drawdown and loss trades are part of the game. We no longer put undue significance on individual trades. We simply follow our trading rules which provide us with our edge in the market.

Our aim, therefore, is not perfection or being right or avoiding being wrong or avoiding missing out. Our aim is to be consistent.

So what are the new beliefs that we must energise to operate in a consistent manner in the market?

Your new thinking patterns can be the Five Fundamental Truths that are found on page 121 in Mark Douglas’s book “Trading in the Zone”. Your actions must subscribe to Mark Douglas’s Seven Principles of Consistency found on page 185 of the same book. If you haven’t read “Trading in the Zone” it is a must for your education. Unfortunately we are bound by copyright not to reproduce these in this text.

The Five Fundamental Truths should be repeated aloud, thereby using auto-suggestion, each time you engage the market until they have become your new energised beliefs. These beliefs will become your new paradigm for trading which will overcome the trading errors discussed in last week’s blog.

Each time you conduct actions according to the Seven Principles of Consistency you will be re-enforcing your new trading paradigm - that of a consistently successful trader. You will now be empathetic and in sync with the market, not it’s opponent, as it communicates opportunities to you through your trading methodology’s edge.

When you start reducing trading errors and they eventually cease, you will have re-trained your mind for ongoing successful active investment. Pain avoidance will no longer be your automatic motivator when engaging the market.

Achieve flawless mechanical trading and you will be ready to move onto discretionary trading using your intuition and empathetic feel for the market. But you may find that profit wise you need never take this step.

It is strongly recommended that you study Mark Douglas’s work “Trading in the Zone” which describes the above discussion in far greater detail. SPA3 compliments Mark Douglas’s message (and vice versa) and provides you with a mechanical methodology to complete his trading exercise in the final chapter of his book.

Do this and start overcoming:
• your fears,
• your doubts,
• uncertainty,
• unrealistic expectations,
• emotional pain,
• inconsistency,
• subjectivity,
• market noise,
• your biases.

Become an overcomer!

Achieve:
• trust,
• surrender by following, rather than trying to control by leading,
• neutrality,
• consistency,
• confidence,
• commitment,
• processes focus,
• objectivity.

This week I have extracted a section from the SPA3 reference manual which focuses on building the critical skills to re-train your mind for better Active Investment. Many of you will be able to relate to the thoughts and feelings derived from the market at a theoretical level but may not know how to actually address these issues and implement the necessary changes. This journal entry will be posted across two issues due to the content and the need for you to fully comprehend the processes involved. I trust that you will enjoy it.

Being aware of how you need to think and feel and how you “should” act is simple and logical enough in theory. Actually practicing it in the heat of market conditions is very difficult to accomplish for the great majority of active investors. Understanding why it is difficult requires some knowledge of how your mind works. Changing the way you think to that of a consistently successful trader requires effort and hard work. In fact, it requires that you re-train your mind to think in terms of how the market conducts itself rather than the way you are currently trained to think – which is in terms of how your world around your chosen lifestyle and profession operates with you as the central focus

We all have belief systems that have become hard wired into our psyche over time. Our beliefs are developed over time and programmed into our subconscious minds through our past and ongoing experiences, thoughts, actions, emotions, sayings and inputs from what we see, hear, touch, taste and smell.

Our beliefs automatically and constantly do our bidding for us. They determine our perceptions and interpretations. They create our expectations, dictate our behavior, our talk and our actions and shape our feelings and emotions. You are a walking, talking, acting, thinking and feeling mirror of your beliefs. Hence your actions in the market are a mirror of your beliefs; in short, you trade your beliefs.

To be successful in the market over the long term you need to add new beliefs into your subconscious mind, beliefs that automatically determine your perceptions, expectations, behavior and emotions with respect to engaging the markets. You also need to “turn off” beliefs that can potentially sabotage your endeavors in the market.

The wonderful thing about the human mind is that we all have the mechanisms within us to change our beliefs. It is just a matter of having the willingness, desire and purpose to put in the effort to change by stepping into a process that is different to what you currently do. Putting in no effort and expecting a different outcome is senseless.

This means that you need to:

• acknowledge that some of your existing beliefs do not suit engaging the market in an ongoing profitable manner,

• commit to change some of your existing beliefs, and

• energise new beliefs specifically designed for engaging the market.

Being aware of these three aspects and actually doing them are two very different things. It is not until you have re-trained your mind to think like a consistently successful trader that you will be able to consistently engage the market in an ongoing and profitable way.

You have to transition from knowing what to do, to doing what you know.

To achieve this you have to understand that your fear of experiencing a loss trade is driven by an automatic pain avoidance mechanism that is programmed into your subconscious mind. We are programmed to avoid physical and emotional pain. This is not how we choose to be – it is how we are because it is hard wired into our very being.

In the markets emotional pain results from loss trades, missing out on trades that you know you should have taken or from leaving profit in a trade. These equate at our subconscious level to being proven wrong, failing, not belonging, missing out, making a mistake, being found lacking, not being good enough or losing to an opponent, all causing emotional pain to some degree.

Our pain avoidance mechanism that automatically kicks in before doing the trade is to not do the trade for fear of experiencing the emotional pain that is automatically associated with losing trades.

Once a loss trade occurs and emotional pain results, the following mechanisms kick in after the event in an attempt to avoid or obliterate the emotional pain: denial, justification, rationalisation, ignoring, hating, revenge, self-criticism, distortion and exclusion.

You will never be able to totally turn off your automatic emotional pain avoidance mechanisms in your subconscious mind. You can de-energise them with respect to trading and energise new trading beliefs which will become your new subconscious trading paradigm.

You do this by redefining to your subconscious what events do and do not cause emotional pain to you.

Until you have gone through this de-energising and re-energising process you will continue to make trading errors in the market such as:

• freezing on entering trades
• chasing trades after the entry signal
• doing other trades that do not meet your rules
• exiting trades before the exit signal
• not exiting a trade when your exit rules are met
• putting to much capital into certain trades at certain times
• putting too little capital into certain trades
• having too much capital in the markets according to your Trading Plan
• having too little capital in the markets according to your Trading Plan

This extract is taken from the SPA3 “Reference Manual”. Share Wealth Systems is passionate about helping active investors transition from knowing what to do to doing what they know. We do this through providing mechanical trading processes that emanate from the market rather than processes than emanate from the human mind which is mostly dysfunctional with respect to making timing decisions in the market.

If you would like to view the services that Share Wealth Systems offers you can click the link below.

Next week we will continue looking at Re-Training the Mind for Active Investment and discuss simple, practical keys to change.

One of the major lessons we can take from the 2008 bear market is the need to take responsibility for the management of our money, investments and general financial well-being. The issue with bull markets, and extended ones in particular, is that they breed complacency. Investors become complacent in their approach to the markets and a level of irresponsibility begins to creep into their trading and investing decisions. Mistakes are covered up by bull markets. Shares that have a correction or pull back in price are lifted again by the market as “the rising tide lifts all boats”. As euphoria spreads due to making big profits stops are ignored, position sizing models go out the window, and bigger and bigger risks are taken as traders and investors clamber to make money from the rising market. As prices are pushed higher and higher on a seemingly never ending upward price thrust many of the basic tenents of investing are ignored or forgotten and leverage balloons as more people assume a riskless mindset. Many traders begin taking ‘hot tips’ from friends, contacts, brokers and anyone with an opinion on the market. Worse still, many people abdicate responsibility for their decisions and place their trust in any number of so-called experts or professional money managers. A few examples were detailed in last week's blog.

These ‘experts’ have a fundamentally flawed belief that equity prices will continue to rise, and that investors need to remain fully invested at all times. This premis is based on historical performance of an equity index such as the All Ordinaries, and various charts are produced to show how equities “always’ rise over the long term. The problem is that the stocks that comprise the basket represented by the index will change over the years. So, whilst the index may appear to rise consistently, many of the stocks within the index will be removed as they drop out of the index for a variety of reasons, including insolvency. ABC Learning, Centro Properties and Allco Finance were all constituents of the ASX200 Index and were replaced by other relatively stronger stocks. Indices therefore have a “survivor bias”, unlike your portfolio.

These “experts” also engage in the age old fallacy of averaging down – buying more as prices fall. I have lost count of the newsletters, broker reports, TV shows and fund manager reports I have seen over the past 12 months advising people to invest as the prices for shares were in a severe downtrend. Why invest capital in a stock that is trending down? Examples include ABC Learning, Babcock and Brown, Allco, MFS and Centro Properties, Lehman Bros to name but a few. The outcomes of many of these ‘recommendations’ speak for themselves. Many of these recommendations stem from sources that have a vested interest in you continuing to buy – stock brokers whose sole job is to encourage you to buy in order for them to generate an income from the brokerage earned on your transactions. Does the outcome of the trade really matter to them ? Do they really care about you and your investments? Whilst a handful may, the vast majority are simply sales people generating commissions from your business.

Likewise, the majority of financial planners generate their income from commissions and fees received from selling managed funds. They are more than happy to encourage you to continue to invest as prices crash because their income comes from the sale of the fund and regular ongoing contributions to the funds. It is not linked to the performance of the fund. They too tout the line that shares will always outperform other investments over the long term. Problem is, how long? And when they stop outperforming , what risk management strategy do they have to protect profits and capital?

The simple way to avoid these mistakes is to take responsibility for your trading and investing decisions and become proactive and decisive in the management of your investments. It can be done. There has been a huge movement in the USA over the last 12 months towards investors managing their own capital. Many of our clients, by acquiring the necessary skills and following their trading plans, and mechanically and unemotionally executing ALL the buy and sell orders generated from the SPA3 system are able to consistently outperform both the All Ordinaries Index and the majority of fund managers.

They have clear cut and unambiguous entry, exit and money management rules that allow them to achieve this. Not only that, but they have peace of mind knowing that they are managing their money in a structured and rigorous manner. They are not subject to outside influences in their decision making processes. Better still, the decisions they make aren’t based on the need to generate a sales or fee related income stream - decisions are based on price action in the market. They are truly independent and mechanical in their approach to the market. By following the rules that they have established they are able to implement their trading and investing strategies with clarity, commitment and confidence.

The point of this week's posting is to educate investors that there is another way. The marketing approach of the large institutions will always allow them to generate business, at your expense. My question to you is if you haven’t already started learning about Active Investment and taking active responsibility for managing your investments, when will you? The fact is that what might initially seem like a lot of hard work may actually cost you 100’s of 1000’s of dollars over your investing lifetime through non action, and through abdicating responsibility to the so-called ‘experts’. When you 'get it' there really is far less time and effort spent on managing your own portfolios than you would expect.

In a future posting we will talk about performance research undertaken by John C Bogle and Charles D Ellis on American mutual funds over 25 years from 1980 to 2005 . The outcomes may astound you.

If you would like to see either SPA3 or SPA3CFD in action, you can register for an online demonstration at the link below.