Stock Exchange: In Investing and Trading Asking “Why?” Can be a Mistake

Jeff: Taking the lead for the Stock Exchange report is my colleague Todd E. Hurlbut, CMT, Chief Investment Officer at Incline Investment Advisors, LLC. Todd is the creator of the Emerald Bay model featured in this column. He is known as “Trending Todd.” And yes, that is a hint about his trading style.

Summary

Humans have an insatiable desire to know why. Whether curious children (like my 5 and 8-year-old using the “Why” word 50 times a day) or investors trying to understand a market move, we can’t help but want to know why? However, reasons why market moves are happening can be distracting if not counterproductive. Most people think it’s the news that makes the price move. Often the price will move, and journalists must search out the reason to justify or explain the price action. A recent article in MarketWatch Opinion: Turn yourself into a better investor by learning from hedge-fund star Jim Simons’s successes and failures quotes Jim Simons’s early frustrations as a discretionary investor trying to understand the market:

“Simons built an automated trading system because he couldn’t handle the market’s ups and downs. The losses were ‘stomach-wrenching,’ he told a friend amid early losses, when he was trading like most others. ‘There’s no rhyme or reason.’

The Stock Exchange is all about trading. Each week, we do the following:

• Discuss an important issue for traders,
  
• Highlight several technical trading methods, including current ideas,
  
• Feature advise from top traders and writers, and
  
• Provide a few (minority) reactions from fundamental analysts.
  

  We also have some fun. We welcome comments, links and ideas to help us improve this resource for traders. If you have some ideas, please join in!
  

  Review: Good Trade yet you lost money?
  

  Our previous Stock Exchange discussed separating trading process from outcome Good Trade yet you lost money?. Nobody enjoys losing money, but unprofitable trades are an integral part of a robust investment process. We asked readers for their views on this dynamic and received varying responses in terms of the evolution of their individual trading strategies.
  

  This Week:
  

  Separating one’s investment process from the daily barrage of news can be challenging indeed, with networks like CNBC offering excitement to entice you to tune in. The MarketWatch article continues:
  

  “The Renaissance team views the narratives that most investors latch onto to explain price moves as quaint, even dangerous, because they breed misplaced confidence that an investment can be adequately understood and its futures divined. A Renaissance employee once said if it was up to him, stocks would have numbers attached to them, not names, so investors would be less likely to succumb to a story.”
  

  Everyone likes stories and it’s historically how we passed along information and understood the world. I was fortunate to have a highly successful mentor in this business and he had 6 essential rules for successful investing/trading:
  

      Ride Your Winners
  

      Cut Your Losses
  

      Manage Your Risk
  

      Use Stops
  

      Stick to the System
  

      File the News
  

  File the News always stuck with me as it’s one of the most challenging of the 6 essential rules. And by “file the news” he meant into a circular receptacle on the floor. We would often reminisce that “price makes the news” not the other way around.
  

  Jeff: I began in the business working for a team of options market makers.  The most successful did exactly as you are suggesting, Todd.  They did not want to know the news.  They focused on the flow of “paper” and traded accordingly.  The only time they cared about news was when trading was halted with “news pending.”  In those cases I helped with an estimate of where the stock might reopen.

  Expert Picks from The Models
  

  Road Runner: I recently purchased shares of Keysight Technologies Inc. (KEYS) on 11/22.
  

  
  

  TT: Why’d you buy it?
  

  RR: I like to buy attractive momentum stocks in the lower end of a rising channel, as you can see in the following chart.
  

  
  

  TT: It seems like a strong stock testing the lows of a rising channel and trading at a multiyear high price. Attractive stock indeed.
  

  .
  

  RR: That’s correct. There are a few more data points that go into each trade, but essentially, yes–you got it.
  

  TT: Okay, I think this trade has potential. Thanks for sharing. And how about you, Athena–any trades to share this week?
  

  Jeff: Not so fast! I can see that you chart lovers will need some help. Let’s take a look at the fundamentals with the basic chart from FASTgraphs. Earnings growth is fine, but not really enough to support the rising channel. RR may be reaching too hard on this one.
  

  
  

  TT: As we were saying, the price is leading the fundamentals, Jeff. But your comment does illustrate the difference between trading and investing. Athena, any new trades this week?
  

  Athena: I bought shares of WW International Inc (WW) on November 22nd.
  

  
  

  TT: Looks like a sharp rally from a long-term rounding base.
  

  Athena: I look for stocks having strong positive trends and then select only those with the very strongest trends (“king of the hill”), constantly replacing the ones with weaker trends. It should not surprise anyone that I bought WW International Inc. A quick look at the chart should make the strength of the trend obvious. And I generally continue to hold my positions until either the strength of the trend abates or a stock with an even higher trend strength comes along. I don’t have a set “holding period” for a position. I will exit only when either a stronger stock comes along or if market conditions dictate a strong potential for loss – capital preservation remains the key driver in all situations.
  

  
  

  TT: Thanks for sharing. And how about you, Emerald Bay?
  

  Emerald Bay: I bought shares of Brown-Forman Corp (BF.B) on November 20th.
  

  
  

  TT: It looks like these shares have been rising steadily in a tight channel for months before you purchased.
  

  EB: I seek exposure to the highest momentum names in our large cap equity universe, adjusted for volatility. Specifically, I like to base my position sizes on volatility with more capital invested in the less-volatile stocks.
  

  TT: You’ve been doing quite well since purchasing this position and I suspect you’ll hold it until the trend changes. Thank you for sharing.
  

  Conclusion
  

  Successful long-term investing and trading often requires us to ignore the news and instead focus on process and the price action of the instruments in our portfolio. Understanding the reason why a stock is rising or falling can be counterproductive and only obvious after the fact. Yet, my kids still ask why?