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A Trader’s Guide to Surviving the Stock Market

December 2, 2015
Karl Drobnic

I’ve traded stocks for forty years from various countries around the world.  The stock exchange in Addis Ababa was a chalk board in a local bank, open a couple hours on weekdays.  Spokane was dedicated to penny mining stocks. I traded currencies sitting atop burlap sacks of wheat in Kabul’s old granary.  Now we’ve got super-fast online algos and battalions of talking heads promoting their own interests.  But no matter.  Some things I’ve learned cut through the hype.  I hope they help you if trades are going wrong.

1. A trade is neither right nor wrong.  A trade can only be profitable or not profitable.

  • a) Profitable is good.
    b) Unprofitable is bad. Do something!

2. Therapy for traders on a losing streak:

  • a) Brag about your losers, not your winners. Tell everybody about losses. Get on the phone! Tweet!
    b) For a losing trade the only thing to brag about is how small you kept the loss, how quickly you stopped the bleeding.
    c) Your Ego must understand that you’re going to tell everybody about every loss.
    d) Bragging about losers will develop an inner voice urging you to get out. It will replace the voice keeping you in losing trades.

3. The market is uncaring. If you hang on to losing trades, telling
yourself “I’m right, I know I’m right”, the market will grind your
trading stake down to zero.

4. Every trade has two aspects, time and market direction.

  • a) for every trade, know your time frame.
    b) for every time frame, determine market direction.
    c) enter the trade near the beginning of the time frame with
    the market going in the direction of your trade.
    d) you can now monitor your trade in terms of time and
    market direction.
    e) at the end of the time frame, recalculate. Are your assumptions still correct? What’s your new time frame? Why are you still in the trade?
    f) if the market direction changes, why are you still in the
    trade? Why didn’t you set a stop? Are you looking
    for a loss to brag about? Return to #2.

5. As an individual trader, you’re competing against guys with PhD.s in
math and physics, against algos and super-fast computers, against ruthless pit
traders who have the advantage of being on the floor.

  • a) The PhD.s are smarter than you.
    b) The pit traders are genetically superior – short
    attention spans quickly alert to new stimuli, the
    master hunters of pre-historic times.
    c) Your computer is no match for the competing computers.
    d) Always know where the escape hatch is for each and
    every trade. How fast can you get through it? Practice!

6. If you start believing that you have some special insight into the
market, that you’ve “cracked the code”, discovered “the natural order of
the market”, that the market will go where you say, then put your money in T-Bills and take a long vacation. Motorcyclists who stay afraid of their machines die of old age. Those who think they’re Evel Knieval die terrible deaths. Know your machine before you drive it, and stay alert. Freight trains do come roaring across unmarked crossings.

7. The market is a mechanism for transferring wealth. It does so by
causing pain. Great wealth transfers in times of great pain. Losses are
a way of causing pain. Card sharks operate by letting the sucker win big
in the early going. But by the end of the game, the card sharks have all
the sucker’s money, his clothes, his house, and the sucker’s gratitude
for letting him get away from the table with his life. If you’re making
bigger and bigger trades, think about the sucker who ended up betting it
all exactly at the time the sharks held all the winning cards. Trading
is a business. You go to work in the morning, go home at night, and earn
a paycheck at the end of the week. Keep the size of your trades
reasonable. The sharks can’t take what’s not on the table.

8. Once in a while a sure thing comes along. It’s a good day to skip
trading and take a walk on the beach.

9. As options expiration approaches, the Grand Croupier will sweep the table in all directions. You’re not the croupier. In the last week, never keep an expiring short position that’s within reach of the croupier’s stick. Time and an approaching expiration let the croupier take control of an open short. It’s asking for great pain.

10. Getting market direction right is only the first step of a trade.
Selecting the best trade (trading strategy) is the next step. For
example, is it better to go long a put (it will decay against you)?… or
to enter a call spread for a credit (it will decay for you)? The answer
depends on market conditions. Money management is the 3rd step. Your
goal is to make a profit, not show the world. Your profit/loss statement
will accurately reflect your trading at the end of every day. Read it
carefully. Understand its message.

These are a few thoughts that I’ve found helpful. I hope they help you, too. Please feel free to share them.  Wishing you peace, prosperity and good trading – Karl.

After the market closes, I hope you’ll relax with a copy of my novel, “A Lesion of Dissent”. It’s available on both Amazon.com and Smashwords.com at the links below.

Same great novel, your choice of either original art cover


Carla Grissmann, Sri Lanka, Colombo, Karl Drobnic, Khyber, Afghanistan <== Cover, Amazon.com Edition, click cover to buy

Author Karl Drobnic

Cover, Smashwords Edition- “Annette Monclere at Cabaret Khartoum” click cover to buy

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49 Comments
  1. Hi Karl,
    This article is timely to share with investors the correct mindset in making right decisions at the right time in their investment endeavors .

    Am reposting it in Singapore Update.

  2. Carl Kickham permalink

    Good insights with clever delivery.

  3. I know this is good, sound advice. The only problem is I have NO idea (absolutely no clue) how to begin trading or get into the market <– is that the right word? Or what to do once I get there… Ugh. If only you walked around with me day in and day out teaching me the ropes… But good read, nonetheless.

  4. I suggest you read Lowell Miller’s book “Single Best Investment” and be very conservative. There are dozens of ways to separate you from your money, and Wall St. has figured out all of them. Nobody but you has your best interests at heart.

  5. Neal Salah permalink

    Karl, I think your post is very off point and I would disagree with the perception and perspective it is written in

    • Neal, Disagreements make markets. There are many trading systems and methods, and those that I respect the most include close attention to risk and to limiting losses. Wishing you good trading and a prosperous year.

  6. Neal Salah permalink

    Ever thought about donating your moustache for scientific purposes?

  7. Neal Salah permalink

    Do you feel that Deustche Bank will collapse, or do you think that German government will bail them out?? I read they have 70 trillion in credit swap exposure?????

    • I expect a government bailout, but I won’t try trade DB unless I can find a way to hedge out the risk. I’d take a look around $7 or so. If there is a bailout, then there is a good chance that some kind of long term warrant will be issued, and that could create a hedging opportunity. I checked the put options for signs that bears are piling in to conduct a bear raid, but saw very little activity. During 2008-2009, abnormal put activity in bank stocks was a pretty good indicator that the shares were about to get slammed, driving the puts into the money.

  8. Mike Gofron permalink

    Karl,

    Love the stache! Did you grow it for Movember or are you a traditional card carrying member of the prestigious stache society?

    What are your thoughts on the derivative risk consolidated in BOA, Citi, Chase and Goldman? The OCC’s latest report shows them owning more than 95% of that space.

    Cheers,
    The Gof

  9. Mike Gofron permalink

    Thoughts/insight on my question Karl?

    Thanks,
    The Gof

  10. Hi The Gof,

    I’ve had the stache since 1971, so I guess that makes me a card-carrying member. It covers my dueling scar.

    I only own the bank shares in hedged positions. If banks break the economy again, I’ll pick through the bonds, as I did in 2009. I’m still making a pretty penny off having bought high quality corporates at big discounts, but the ones I bought in 2009 will have all matured in a couple more years. Good trading.

  11. Joe Farrel permalink

    Karl

    How concerned are you about banks doing a bail in next time a crisis takes place??? Do you have a nickname for you mustache??

    • Joe, I spend much of my time reducing risk, so I’m always concerned. Things are far too complex, and markets today move too swiftly to put significant amounts of money in the market without paying attention to protection… and no, I don’t have a nickname for my mustache. Thanks for stopping by, and good trading.

  12. Vic Plastiak permalink

    What’s with all the mustache references? I would concur however, your mustachio is favoloso Karl! Definitely worthy of a nickname in my opinion. Perhaps even a penned op-ed series all his own. It could be like “the dueling Karl’s”. Think about it.

    I have a follow-up question to Joe Farrels. I appreciate your risk tolerance and strategy to reduce risk on a constant basis, so this question is a bit more squishy. Do you feel any different about the risk of bail-ins or other perceptually radical measures at this time in comparison to past years? Where does your concern rank on a imminence scale? 10 being most imminent. For reference, would you also provide a baseline “concern imminence rating?”

    If you nickname that fabstache, perhaps this could be his first entry into the blogosphere!

    Thanks for all you do Karl – appreciate the insight!

    Best,
    Vic

    • Thanks for the follow-up question, Vic. It has made me think about my approach, and re-examination is almost always a good thing. Firstly, I would not try to position ahead of the situation. There is far too much that is not transparent, and therefore requiring guesses. Guesses multiply mistakes and amplify gains, but to get the gains, you have to right. There are far more guesses that can be incorrect than can be correct.

      That said, these situations are interesting since they create misunderstanding, and misunderstanding is usually discounted. So waiting until the misunderstanding and discounting emerge gives a line of sight on what can correct in your favor. As an example, I have been following the AMBAC situation for two years, and I believe that the market misunderstands, and therefore overly discounts, its exposure to Puerto Rico bonds. The company has (two companies actually – the Segregated Account in Wisconsin, and the rest) reserved adequate funds for losses, is opportunistically buying in debt that it has insured, and has (according to sr. mngmnt) two years to go to get past a period of potential large defaults. It then has many years of when it can use its emerging underlying earnings power to make substantial profits. It is also collecting on fraud suits against the big mortgage banks, which is not reflected in its figures until a settlement is reached. So there is a line of sight, and a leveraged way to position using the warrants, which mature in 2023 at $16.67 strike. By shorting calls against the warrants, I expect to have built a zero cost base warrant position by 2018, the line of sight date where AMBC should be beyond the current misunderstood balance sheet problems.

      So while I have not directly answered your questions, I am not comfortable trying to position in front of an event that is opaque and subject to so much political whim. If it happens, it will create rubble, and in the rubble will be some opportunities. Good trading – Karl.

      PS: I don’t understand the mustache stuff either, but it’s a fun distraction and makes me laugh. Great idea…a blog.

  13. Mike Gofron permalink

    Whether the Fed raises rates in June, Sept or even early 2016, what effect will a 1/4% rate hike actually have on equity markets? 1/4, 1/2, or even 1%; are they not merely statistical bumps in the road? Do you provide any mustache consulting on a side note????

    • A rate bump does matter, but in opaque ways that are hard to predict. Assume a carry trade in which Japanese yen are borrowed and invested. Try to follow the (opaque) bouncing ball: A Japanese manufacturer has a factory in Mexico. It sells its product to Argentina. Argentina pays in dollars which become Mexican pesos. The profit goes to dollars to be sent to Japan where it becomes yen. In the midst of this, the Fed bumps rates, which impacts the original carry trade. Now multiply by all the global market trade going on across multiple countries – containers of shoes transported by Maersk from Sri Lanka to Nigeria, etc., etc. World trade has to adjust to any bump in Fed rates because the dollar is the reserve currency. So the impact on the US stock market comes from changes in currency relationships, commodity prices, developing world economies, settlements and other opaque events. Things have to adjust, and the Jan.-Feb market swoon is, in my opinion, a result of vast global adjustments to the Fed’s rate hike.

      (Unfortunately, mustache-consulting is regulated by the FDA, which cites the potential for mustaches to be contagious, somewhat like ebola and bird-flu. So far, the CNN reporters have refused to grill the presidential candidates on their platform positions on the issues involved: public health vs. first amendment rights to free speech and does a mustache impede free speech?; does the right to bear arms extend to the lip or does it stop at the rotator cuff? etc.)

  14. Adam Cabrera permalink

    Are you at all tempted to short JGB? I was lucky to short 1 mini (in Singapore) at an all time high and more a bit below, as rates turned up over the last month in US, EU, Japan. But my conviction is not high, thus smallish size in this lethargic market. Does your mustache sing any songs??? if so can I request Frank Sinatra??

    Thanks!

    • Adam, I don’t understand Japan’s economics well enough to step into that trade. I know that there are a lot of crony fixes to keep a good face on things, and that keeps me out. Good luck on your trade.

      (Alas, the mustache was denied membership in ASCAP, and cannot perform publicly.)

  15. Sean Gallick permalink

    With so many cross currents there have been few meaningful correlations.

    Do you think the recent inverse correlation between US Tr 10yr yield and gold price is noise and will be short-lived, or the market will continue to sell gold as increasing yield is available in US Tr?

    Do you ever put bow ties in your mustache on festive holidays?

    • Sean, Most of my attempts to develop a gold trading plan have ended poorly. Success has been mostly in times of developing financial crises, such as the 2007-2009 home and bank meltdown, and in the hyper-inflation of the late 1970s. In such times, the gold price is driven by emotional forces. A correlation between gold and interest rates is most likely also subject to where the carry trade is, and only the big investment banks can really trade there. I used to trade Canadian gold miners using their warrants to hedge with regular success, but if there was a big move in the currencies, my positions would implode.

      (The mustaches are taking your bow tie suggestion under advisement, with the goal of wangling an invitation to next year’s Victoria Secrets’ gala. Keep your eyes on the audience and you just might see me there.)

  16. George Persekian permalink

    Watching the market shrug off HPQ results, and turn green this morning, strikes me as somewhere between remarkable and scary. Do you think HP’s results are as company specific as the market suggests, or is the markets just too juiced on steroids to care?

    • George: HPQ competes in product areas that are mature, and where competitors are strong, basically “tooth and nail” fighting for sales. Anything HPQ does, somebody else can quickly compete. So there’s not a lot of expectation for HP to do a lot, and hence muted market reaction. Compare that to CRM’s report of giant $ sales to new customers and assertions that it is taking clients from Oracle, which creates exciting cross-currents. HPQ’s long established base of customers among big companies gives it a revenue base that protects downside, but since it’s 3D printers are not wowing the market (yet, at least), there is no upside “wow” in the current report. The market’s fast money has more volatile names to whip up and down. Thanks for stopping by. Good trading!

  17. Mike Gofron permalink

    Thoughts on going long the euro here at sub 1.12? Sentiment is so bearish….can’t find anyone who loves it. Does your mustache know any card tricks???

  18. Stan Druckenmiller, who has a terrific record on currency movements, laid out a long term case for Euro/Dollar parity a couple months ago. He allowed for a lot of back and forth movement, but said he was actively positioning for a move to parity. He is also prepared to change his opinion overnight, but I haven’t heard of him doing so. Being on the opposite side of a Druckenmiller trade is not where I normally want to be.

    (The mustache appreciates card tricks, and has stopped by the Magic Improv on occasion, but finds that the slick coating on cards causes frequent dropping of the aces it has tried to conceal up its sleeves. One such incident led to dueling scar it conceals.)

  19. Adam Cabrera permalink

    What’s your current feeling about gold? Do you think it’s still headed lower or trying to make some sort of bottom? Seems like the miners have been way oversold and may be set up for a decent rally once gold stabilizes. Who wears the mustache better, you or Mike Ditka????

  20. I think negative interest rates in Europe could be a boost for gold. If it costs large depositors to hold cash, then owning gold is a good alternative to cash. There are other alternatives, too, such as paying taxes in advance. So I don’t think negative rates are going to spur a big rally, but they may create some demand. If negative rates cause a big stock sell-off, then I’d watch gold closely for a breakout and run. A look at a long-term chart of gold vs. S&P shows that gold is turning up in 2016, so some technicals vs. the S&P are falling into place for a run.

    (Mike Ditka, of course. Everything he does, he does with authority – and he’s got the championship rings to prove it.)

  21. Jim Masura permalink

    Since the CPI is flawed, what inflation gauge do you like?? Would you ever consider posting a youtube video with your mustache lip syncing to the famous song from Top Gun??

    • Jim, what really counts to me are the differences between CD rates, 10-yr Treasury, investment grade muni bonds in my state, and investment grade corporates. I’ve been keeping my duration at 10 years or less these last several years. Inflation at the personal level is different at different stages of life, and reflects the goods and services that are important to an individual at different ages – college expenses, insurance expenses, mortgage expenses, health expenses, etc. I now resent the Fed’s effort to drive savers into risky assets, but at an earlier stage of my life, would have taken full advantage of low interest rates.

      (The mustache is a bumbling idiot when it comes to YouTube, and is still grappling with how to turn on the camera. It did so, once by accident, but recoiled in total shock at the face that appeared on the computer screen and required several sessions of treatment for post-traumatic-mustache-syndrome.)

  22. Brandon Abate permalink

    Do you think where there is smoke there is fire, when it comes to rumors about an ABX/NEM merger?? Do you ever save the crumbs from the mustache and make a special pie out of it???

    • I did read some speculation about an ABX merger a few weeks ago. I would get interested after such a merger is announced if an arb opportunity developed. I think it is a good time for gold miners to seek deals since so many central banks are attempting to boost inflation. So there are bellows puffing the smoke; whether fire breaks out…I’ll wait and see.

      (The mustache is committed to composting and recycling, and treks crumbs to the compost bin regularly. Donations to SAVE THE EARTHWORMS, COMPOST OFTEN are accepted in cash with the promise that the brown paper delivery bag will be recycled.)

  23. Sean permalink

    Karl, would it be possible to talk over the phone. My number is 602 377 9290. Want to go over a public speaking opportunity/paid opp at the university I teach at

  24. Fred Brandt permalink

    Karl – what’s your take on Buffet loading up on Apple? Will the move keep the doctor away? Or will too much of anything turn into it’s opposite and end up putting Berkshire investors in the ER?

    Does the mustache agree with you on this? Or does he have another angle to evaluate?

    Thanks!
    Fred Brandt

  25. Fred – I think Buffet sees Apple as a “razor and razor blade” company. Once people buy the iPhone, they come back for recurring purchases and upgrades. Apple gains customers for life. Just as Coke is mildly addicting, so is social media. I’m sure he also likes the cash hoard that Apple has squirreled away. Regards, Karl

  26. Marchello "Total Package" Manzuk permalink

    On inflation, the Fed has an upcoming problem (not a new revelation here, I know). Services inflation has been obvious in CPI but masked within the PCE inflation gauge due to the different mix in the components. Well, inflation in the former is now more showing up in the latter. Core PCE rose 1.7% y/o/y, two tenths more than expected and at the fastest pace since December 2012. Yes, about a 3 yr high in PCE core inflation, the preferred measure of the Fed and while we hear everyday talk from Fed officials about worries about low inflation.Deflation remains solely in the goods and commodities space but as we continue to recycle out the sharp drop in energy prices, headline PCE rose 1.3% y/o/y, about double the .7% pace in December and the most since October 2014.

    Does the mustachio think we are actually living through stagflation?

    The TP

    • Marchello "Total Package" Manzuk permalink

      I’m not being impatient.

      Yes, I am!

      The suspense is killing me… where are you Mustachio Fabuloso????

      The TP

    • Marchello – The mustaches lived through the stagflation of the 70s, and this is nowhere close. That was an extremely frustrating time to be in the markets. I see the current situation as a transition from Fed policy to government fiscal policy as the main driver of the economy. In such a transition there are opportunities, and heightened chances of failure. Yesterday I was very busy adjusting hedged positions to changes in delta in CRM and PXD options. Both have been good arbitrage stocks lately, reflecting ping-ponging views on the economy. I am more committed than ever to strictly controlling risk. I had a medium term hedge in PBYI go to the brink this morning, but was pleased to see my downside protection hold serve while price cratered. So this is an intense time to be hedged to high-beta. Everything’s adjusted now — until next week. Best regards, “Total Package”,,and good trading!

  27. Marchello "Total Package" Manzuk permalink

    Just checking back in Karl – hope everything is okay.

    Keep the stache safe!

    The TP

  28. John "Top Gun" Genarrow permalink

    Pretty stunning…with only a handful of stocks holding this market up Stockman thinks we are getting close to a major correction, from ZeroHedge:

    To use a storm metaphor, I have never been in the eye of a hurricane. But I do reside only a few blocks from Wall Street. And I can feel the financial barometric pressure plummeting by the hour.

    In fact, others than the five FAANG stocks (Facebook, Amazon, Apple, Netflix and Goggle), the market has been silently collapsing since March 1st.

    That’s right. During the last 70 days, the FAANGs have gained $260 billion in value, while the other 495 companies in the S&P 500 have lost an identical amount. And on that utterly unmistakable pattern history is absolutely clear.

    In fact, the market cap of the S&P 500 has risen from $19.5 trillion to $21.3 trillion during the last 29 months. But just five NASDAQ stocks (“Big 5”) consisting of Microsoft plus the FAANGs (less Netflix) account for 56% of that $1.8 trillion gain.

    Stated differently, the combined market cap of the NASDAQ “Big 5” has soared from $1.9 trillion to nearly $3 trillion since early 2015, or by 55%. That compares to just a 4.5% gain in the aggregate market cap of the the other 495 S&P 500 stocks during that period.

    That’s a radical narrowing of the market if there ever was one. It’s also evidence that they eye of a financial hurricane now sits dead atop the canyons of Wall Street.

    When the market narrows to a handful of momo names, its all over but the shouting. Like the case of the Nifty Fifty back in the early 1970s, a crash is just around the corner.

    In short, these five giant companies essentially account for the last spasm of a monumental financial bubble that has been building for nearly three decades.

    This has been an incredible narrowing – none of which I’ve seen before. What say you Karl? Seen anything like this? How does The Stache see events playing out?

  29. Top Gun: I’ve been selling calls and buying puts on anything that is not nailed down. I’ve raised cash levels to highest since 2009. If it looks like we’ll have a change to Pence as President, I want to be ready with dry powder. The current situation may well end in a “I Quit” tweet. Maybe this will all blow over, but your points about the market narrowing are spot on. I’ve seen this movie before. Narrow stock leadership in a new high market is very dangerous.

  30. Adam Podkowa permalink

    Fascinating discussion here. Couple follow up thoughts. Why does apple market cap keep growing when it seems like it is a one trick pony now? Secondly, I enjoyed the post from too guns. Does having a mustache allow you to be more effectviecwoth buying puts and calls?

  31. Darryl "BBD" Kucharski permalink

    Hmmmm… very interesting perspectives (Top Guns, Karl). In my experience, this stuff typically appears more imminent than it actualizes. This moment in time may be different though. Feels that way anyway. Could we be at an inflection point? What do you think Karl?

    Also, do you really believe Pence becomes President? Isn’t this all just political theater? I mean, of course half of Americans want Trump impeached. The half that voted for Shillary. this isn’t groundbreaking is it? n my mind it’s just a product of social media and mainstream news driving a narrative. This isn’t even really news IMO.

    Love to hear what the Stache thinks on both topics (potential inflection point, political theater).

    Thanks,
    BBD

  32. Political theater: Paul Ryan has been gutted by the White House. He will turn on Trump the moment he sees the wounds bleeding. Pence is a person Ryan can work with. So it’s in Ryan’s interests to force the change. As for Trump, his way out in the past has been to put his loser projects into bankruptcy (and stiff investors). He has a history of walking away. So, yes, I think a change at the top is a real possibility. If Wall St. thinks Pence will be President, it will rally high and hard. With Pence, the Ryan/McConnell agendas will happen – tax reform, deregulation, etc. I want to be ready for that. Watch for the Democrats to challenge the Jaworski rule that deals with indicting a sitting President. That was only an opinion issued in the time of another crisis. Jaworski probably doesn’t have force of law behind it, only tradition. That is a way for Ryan to get Pence into the WH without getting his hands dirty. He just sits back and lets the Democrats push indictment and doesn’t have to sign on to impeachment. Pretty cynical, I admit, but we’re talking about DC politicians.

    Market breaking: I agree that what is seemingly imminent often takes a long time to actualize. I recall when Intel, Sun Micro, etc led a narrow market higher and higher. It seemed like forever. So I’m not shorting. I’m taking out insurance with long-dated puts, and using calls spreads to pay for it. I’m comfortable with high cash levels, which I’ve put into short-term, high quality corporate bonds ladders. As they mature, I can reassess.

  33. APPLE market cap: I-phones are as addicting as cigarettes. Most days I walk through a university campus on my way to the gym. It is amazing to watch the present-day undergrads come out of their classrooms and hit the streets. They’ve been away from their I-phones for an hour, and they are walking head-down, eyes glued to the screens, stepping in front of cars at crosswalks, not talking to anyone (even though they’re walking in a group), completely captured by smart-phone addiction. Smart-phones are not a choice for them, they’re an addiction and they are constantly in need of a fix. Apple is the new Philip Morris.

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