Thursday, June 12, 2008
Stock Market Wizards: Mark Minervini
This book, written by Jack Schwager, is highly recommended. If you haven't read this book before, then, I strongly recommend that you buy a copy, and keep it on your shelves. My copy is a 2001 edition, and like most of my investing and trading books, is dog-eared, highlighted in several colours, under-lined, and noted.
For this article, I won't be doing a typical book review. If you like to see the review of this book, simply google the title of the book, and it should lead you to many links with reviews of the book. Talking to the guys in my chatbox, those who has read it simply loved the book and found it very inspiring. I have yet to met anyone who says the book is simply terrible! (smile)
Basically, the book involves interviewing 15 of the Top Stock Market Traders in America, each with their own unique styles. The Trader that I would like to mention here is Mark Minervini, which is featured from page 169 to 188 (20 pages long). What impresses me about Minervini is his track record, and his approach to trading.
After nearly a decade of market experience and research, Minervini developed his own trading methodology. In mid 1994, he consolidated his various accounts into a single account that was to become his track record. From mid 1994 to end 1999 (5.5 years) - in this consolidated account - Minervini's performance is simply incredible and astounding. His average annual compounded return is a towering 220% per annum! His worst year was 128% gain! During the 5.5 year period (22 quarters), he only have 1 down quarter, which is barely 1% loss.
To put this into perspective, the S&P was around 450 at mid 1994, and grew to around 1440 at end 1999. The equivalent Minervini performance from the same starting base of 450 would see the S&P at the end of 1999 equivalent to 34,400!!! This trashes the market performance in a big way, no matter how you cut it.
Now, what impresses me a lot is how Minervini can have just 1 quarter loss in that 22 quarters. Further how his worst annual gain is only 128%, and averaged 220% per annum. To give you some idea, I'm going to quote a few phrases from this Chapter, together with my interpretation. However, I strongly urge you to buy the book if you haven't yet bought it, and read the relevant Chapter. If you are a beginning trader, I guarantee you, that a careful study of this book will give you insights into the common traits and characteristics of highly successful traders.
The Method / Trade Entry
"The motivation (for Buying a Stock) is always the same. Although I may hold the position much longer, I buy ... because I think it will go up within hours or at most days"
"The starting point is a quantitative screen based on the characteristics of the stocks that witnessed the largest and most rapid price advance ..."
"They tend to be less familiar names ... More than 80% ... are less than 10 years old ... avoid stocks below $12.... typically buys over $20 ..."
"My basic philosophy is: Expose your portfolio to the best stocks the market has to offer, and cut your losses very quickly when you're wrong".
"What surprise most peple is that these stocks typically trade at above-average P/E ... even before they become big winners. Many investors limit their selections to stocks with low P/E ... Unfortunately, avoiding stocks just because of the P/E seems too high will result in missing out on some of the best market moves ..."
"None of this is black box. ... People always want to know what's in my computer model. I think that is the least relevant issue to successful trading. Of course, you need an edge, but there are a thousand ways to get an edge. Some people use strategies that are completely opposite mine, yet we can both be very profitable."
"Developing your own strategy is what is important ... which I have designed to fit my personality. ... Besides, I think most people over-emphasize stock selection."
"I think people spend too much time trying to discover great entry strategies and not enough time on money management."
"Assume you took the Top 200 relative strength stocks, and placed the names on a dart board. Each day, throw 3 darts, and buy. Whenever any stock went down - say 10% from your entry level - sell it instantaneously. I would be willing to bet that you would make money, because you expose yourself to a group of stocks that is likely to contain some big potential winners, while at the same time cutting your losses".
"The initial setup is based on long-term price action. ... confirming fundamental conditions ... finally, determining the entry point is based strictly on the price action. ... the price action to confirm a trade entry is much shorter term that the type of price action initially used to screen for a potential buy candidate ..."
Mistakes, Stop Loss, Money Management
"Containing your losses is 90% of the battle, regardless of the strategy."
"Being wrong is acceptable, but staying wrong is totally unacceptable".
"Being wrong isn't a choice, but staying wrong is".
"To play any game successfully, you have to have some skill, an edge, but beyond that, it's money management."
"The key is managing the downside."
"Good traders manage the downside. They don't worry about the upside".
"You can't get beaten if you have a great defence."
"If a trade doesn't work out quickly, I take a small loss, and I may have to take a small loss many times."
"Previous hands mean nothing. The current hand determines the probabilities".
"Sometimes, when a stock stops you out several times, it sets up a much higher probability trades."
"You need a plan for every contingency. The most important contingency plan is the one that will limit your loss if you are wrong. Beyond that, you need a plan to get back into the trade if you're stopped out. Otherwise, you'll often find yourself getting stopped out of a trade, and then watching the position go up 50% or 100% while you're on the sidelines".
"I would rather get stopped out of a trade 5 times in a row, taking a small loss each time, than take 1 large loss".
"You don't have to make all-or-nothing decisions".
The Mind & Discipline
"I don't give up easily."
"Perhaps the single most important factor was that I had great passion for the game. I think almost anyone can be net profitable ... given enough time and effort ... but to be a great trader, you have to have a passion for it. ... Van Gogh didn't become a great painter because he dreamed one day his paintings would sell for $50 million"
"My goal is to be the BEST trader in the world. If you're the best, you don't have to worry about the money; it comes flying through the window"
"I now fully believe that losing all of your money is one of the best things that can happen to a beginning trader ... Why? ... Because it teaches you to respect the market. It is much better to learn that lesson (that you can lose everything) when you don't have that much money, than to learn the same lesson later on".
"Know when to do nothing. Most people, even with a winning strategy, will not follow it because they lack discipline".
"What differentiates you from majority of traders who are a lot less successful? Discipline. I don't think anyone is more disciplined than I am. When I put on a trade, I have a contingency plan for every possible outcome. I can't think of any circumstance that would be an exception. If there were, I would have a plan for that too." (Seng comment: For us, I think Mar 10, 2008 was a possible example, where right on opening, the market gapped down 50 points, and ended up limit down for the day. Such a rare event I would imagine would have been planned out by Minervini)
"I think paper trading is the worst thing you can do. If you are a beginner, trade an amount small enough so that you can afford to lose it, but large enough so that you will feel the pain if you do... if you go from paper trading to real trading, you're going to make totally different decisions because you're not used to being subjected to emotional pressure ... the most important thing to becoming a good trader is to trade".
The Transformation from Failure to Success
"What counts is NOT how often you are right. But how much profit on your winning trades, versus how much you lose on your losing trades. "
"On average, I am only profitable about 50% of the time, but I make much more when I'm right than I lose when I'm wrong".
"The fruits of your success will be in direct ratio to the honesty and sincerity of your own effort in keeping your own records, doing your own thinking, and reaching your own conclusions ... Take 100% responsibility for your results".
"... analyse all my past trades ... my most important discovery ... I was holding on to my losing positions too long. After seeing the preliminary results, I checked what would happen if I had capped all my losses at 10%. I was shocked ... that simple rule would have increased my profits by 70%! ... Capping my losses at 10% only knocked out a few of my winners ... winning trades usually worked from the onset. I realized it was not only totally unnecessary to go through the pain of holding on to losing positions, but actually detrimental to do so ..."
"... holding on to my losing positions for extended periods ... tying up capital ... the impact ... went beyond the losses themselves ... keeping me from making profits elsewhere ..."
" ... use much wider stops on long-term trades than short-term trades ... much wider stops when market is in the early stages of a bull move, than, late ... the stop loss point ... function of the expected gain".
"... not impose artificial restrictions on upside potential. In 1995, I was up over 100% YTD, which achieved my original goal for the entire year. I was seriously considering booking the year. A friend asked "Why can't you make 200%?". I thought about it ... said to myself he's right. I ended up that year +407%."
Fundamental and Technical Analysis
"Roughly 50/50, but ... I would never bet on my fundamental ideas without some confirming price action ... I might consider buying a stock with apparent negative fundamentals if its relative price performance is in the top 2% of the market."
"The price action may be telling you the stock is discounting a potential change in fundamentals that is not yet evident."
"The combination of strong price action and weak current fundamentals often occurs in turnaround companies or companies with a new technology whose potential is not yet widely understood".
"Each night, I review the charts of around 800 stocks. My first pass is very quick, ... on average, I'll spot 30 to 40 stocks that looks interesting ... I then review these stocks more closely, scrutinizing fundamentals ... select several that might be considered for purchase the next day".
"I always look at a 5 year, 1 year and intraday charts".
"I don't use conventional chart patterns ... Many of the patterns I observed and found useful are more complex variations of the conventional chart patterns. I have a list of patterns that I've named. These patterns repeat over and over ... since 1800s, and they will repeat forever. ... about 20 of these patterns ..."
"I constantly try to figure out how the market can trick or frustrate the majority of investors ... Then, after the majority have been fooled, I get in at what I call the "point of smooth sailing". A so-called "failed signal" can actually be the beginning of a more complex pattern that is far more reliable than the initial signal based on a conventional pattern ..."
"You can't blindly interpret a pattern without considering where it occurs within the larger price picture."
Some Concluding Remarks
One of the dangers of summarizing it this way is that I might not do justice to the full interview, which comprise of questions and answers. I've just picked the bits that appealed to me in the 1 hour writing this article. You really need to read the full 20 pages, to get a better understanding and appreciation of how this guy achieved such a fantastic trading result.
In short, I highly recommend this book to everyone who is serious in their pursuit of better investing and trading results.