D2, one and a half trading days, capital: 10 000 USD and looking for people to spit in the wind

I am worried today. I am feeling the typical looser angst of missing out on a rally. But this is one of those things we should resist. The world would be a much better place if we had the equivalent for the AA for people speculating or investing. There's almost as much people wrecking their lives with the stock market than with alcohol, and no AA. Just a large number of expensive books people are peddling to improve trading. The "SPA" (Stock Speculators Anonymous) would do a better job, but "soit" as they say in Belgium, not the subject here and now.

Amazon made a mistake and sent me 2 book express instead of expedited which is rather good news, I'm just afraid the one book I ordered express will be shipped in the slow lane ... I am particularly proud of these two beauties and they are important for the following parts of this journey: Quantitative Trading: How to Build Your Own Algorithmic Trading Business (Wiley Trading) ; The Encyclopedia Of Technical Market Indicators, Second Edition

Obviously, I am taking this blog seriously and I am planning to go through all Julia's recipes, hence the order.

Here's the deal: as everyone agrees that discretionary traders can potentially make larger profits than system/mechanical traders I am very much tempted to go for a hybrid approach. I am tempted to think (might be delusional) that I am an intelligent person with a creative mind, and I should monetize this ability. Very often you see discretionary in opposition to mechanical trading, but I am thinking: as the entire idea is to create a framework/system that relies very much on discipline and good execution and a methodical approach to avoiding losses we can get creative in making money in the first place.

Sidenote: I really have to be disciplined whilst I am writing, because my mind has an outline ready, I have a stock which fits the outline, I am looking at the price whilst typing, real time, and I am realizing that with my paltry 10 000 USD and generous application of margin today's profits could have amounted to (aaarrrggghhhh) 1334 USD. But I am not doing anything until the framework and the system are ok. Yes, it is difficult to stick to the promise I made to myself, but I am very much aware that if I jump on the bandwagon, profits will reverse into losses.

Let's get back to discretionary vs system. If we go for a layered approach we can incorporate a very important point, shift in market "character". You don't trade a rally which is long in its legs the same way as you trade a reversal. So part of the framework should be supple and adaptable, part of it should be rigid and a guardian for sudden investor stupidity.

Before I present you a layered or onion approach (which sounds sexier?) I feel like splashing out on an anecdote. No random anecdote, but a humbling one, an anecdote that makes me wiser now I think of it.
A lot of people trade and look at themselves as the lions or the racehorses of the track, the dragon or the tiger. This might be right if you are working for Deutsche, JPM or GS, but for folk like me and you (rest assured, we are legion) we should see ourselves like hyena's at best (if you are a hedgefund trader your would qualify for this), but I prefer to look at myself as a maggot of the markets. There is the clash of the counterparties, the hyena's play their role, but the maggots live of the little remains, or even, clean the wounds.

Flashback to fall 1999 and a trip to Cambridge with a Swedish investment manager. We went over there, evaluating a company that didn't turn out bad in the end, I think it's branded Jobserve now and is specialised in contractor jobsearch, but back then it was just a me-too-monster thing. We were picked up by a lawyer specialised in IPO's, well that is not correct, we were picked up by his driver, we just saw him for 2 minutes as he was hunting (no no, no weekend) and when I looked at his estate I slapped myself for being such a nitwit and not being able to make "big" money. Victorian mansion (the real thing, no "Mc") surrounded by huge sequoias and roughly a thousand acres of land. Ouch. Maggot.
When the driver dropped us off on the premises of an old filmstudio and we entered the offices we just saw a couple of PC's on picnic tables. They presented us the business idea and the technology they were using, simple Microsoft NT server stuff. It was very difficult to take this serious, and I recommended against putting in any angel investment money. The investment manager decided to "just" invest 250 000 (a lot of seed money for pic-nic table setup). I didn't grasp it. He countered by asking me if my sale of shares in the startup I was managing worked out. How did he know? He was one of the only buying parties in the market. He, and some other institutional investors were "spitting in the wind". But how could you possibly make money "spitting in the wind"? I was truly puzzled, but this was because, obviously, the maggot wasn't getting the big picture. Maggots often don't get the big picture. He explained, and it dawned on me. They had a company roadmap, sold it to a number of institutional investors, and on every milestone, the price went up. This was spitting in the wind. Then, after a lot of spitting, the final milestone was reached, the company became "mature" and some pension fund bought a big stake. But they were buying into a mirage? So these poor pensioners could loose part of their pension money. He just smiled. "Their problem". And don't forget, he was just a crow, not even a hyena. Don't forget: we're just the maggots, because any one of who you had been buying into this flying trashcan just after the IPO (at the beginning of the "roadmap and the "spitting in the wind") could have taken a lot of capital gains, and you might have even thought that you were a dragon and a damn good stock picker. Well, you were just setting yourself up for future failure.

Flash forward to the current market situation. You might have heard of Elliott Wave theory. If you haven't, just google Robert Prechter and you'll get a very decent intro. If you want to read about it, order the basic works of Elliott (Elliott Wave Principle: Key To Market Behavior or even: The Complete Elliott Wave Writings of A. Hamilton Bolton), unfortunatly all compiled by Prechter, but don't be put off by this. Basically, all market advances happen in five waves, three up, two corrective waves. Declines happen in three waves, two declines, one advance. So wave one, three and five are up, four and two are down:

(Courtesy Robert Prechter and co)

The first wave is violent and unexpected. The third wave has got the greatest intrinsic push, breadth, strenght and fundamentals, the fifth wave is the con-man's wave: market participants have learned how things work and there is a lot of spitting against the wind. Furthermore, the market is pushed by it's own momentum and participants are increasingly looking for opportunities of lesser and lesser quality.

I firmly believe (can you get more discretionary than this?) that we are in the last leg of the counter-trend rally starting in march 2009. This means we should be looking for the current flying trashcans ad pick out those with the best potential for added value. We should try to detect where the spitting in the wind is going on and adapt our discretionary layer to it, or build it in the mechanics (there are indicators that can give us a clue on this). Our other layers will be less flexible, resulting in a single body that can be automated and get us ROI without a lot of rework in the future (when the "character" of the market will change).

More on the details tomorrow. It's 23 15 here in Brussels and time to get some sleep.