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I’ve been reading the draft volumes of one of my favourite economists, Deirdre McCloskey. She is writing a four-volume tome on bourgeois virtues (basically middle class, commercial, merchant virtues). McCloskey attributes the industrial revolution – and the amazing economic growth it spawned – to business life of the bourgeoisie suddenly becoming respectable in the 1800s.

The basis of the bourgeois life is innovation. McCloskey’s work makes a lot of reference to Joseph Schumpeter, the Austrian-born economist. Schumpeter theorized that the entrepreneur is the central player in capitalist economies; their innovations drive relentless growth and also create the business cycle.

Schumpeter coined the well-known phrase ‘creative destruction’: entrepreneurs innovate and create new products and enterprises. That spawns imitators and eventually booms. The destruction comes both when the boom busts, but also the destructive impact of innovation on existing businesses.

What has this got to do with trading?

It got me thinking that aggressive-growth/momentum traders are essentially riders of the gales of creative destruction.

The goal is to seek out innovation; to buy entrepreneurial companies that are growing rapidly and changing people’s lives; companies that have created innovative new products and services. Google is a prime example; it is creating new products, but they are also destroying old ones like newspapers.

We can identify the innovators by accelerating growth in earnings and sales. Genuinely successful innovators are producing sales and are not just speculative like most biotechs, tech companies and mining explorers. The fact that something big is happening shows up in their …

Driehaus Capital Management has released interesting research showing the rally since March has been led by beaten-down stocks with poor earnings growth and technicals.

As a result Driehaus’ strategy of focusing on companies with strong earnings growth and strong technical action has meant its funds have lagged indices since the rally began.

“Whether these strong performing stocks were re-priced upward to reflect reduced probabilities of bankruptcy or appreciated because they were trading at levels beneath their intrinsic values, it is not uncharacteristic for our strategies to underperform in this type of environment,” Driehaus said.

It helps explain why many aggressive/growth momentum investors can’t find as many opportunities as they’d like, which is proving extremely frustrating. Particulalry, as Driehaus says, there are “many reasons to be incrementally more positive on equities”.

It’s interesting to note that Driehaus isn’t changing their strategy, but will ride it out:

“Though frustrating, this is not the first period where our investment approach has been “out of favor.” Through experience we have learned that the best approach to take in such periods is to continue to implement our investment philosophy and to resist the temptation to chase returns by investing in weak fundamental companies and stocks with unattractive technical charts.”

It’s good to know I’m not the only one frustrated by this environment.

Dr Brett Steenbarger has a nice – and as he pointed out important – post on how traders learn and process information.

While many people assume trading is about getting rich/making money, which it no doubt can be, if approached correctly, it’s one of the best tools for self development.

I’ve been a reporter, columnist, jackaroo, cleaner, dish washer, student, publisher, editor, etc. But nothing (apart from having a child perhaps) has forced me to face up to who I am – my strengths and weaknesses – like engaging with markets have.

I like trading to be a lonely activity; just me against the market. I make all the decisions and take full responsibility for mistakes etc. In that way I also get direct feedback on me. There’s no one else to blame!

Trading does two things: firstly, gives you feedback on yourself, both positive and negative. If negative, you obviously then have the option of changing yourself.

The tricky thing I’ve found is that most of the negative feedback doesn’t mean you should change yourself, but that you should accept who you really are.

Learning style is part of getting to know yourself better; and perhaps accepting that you actually may not be who you think you are, or who you think you want to be, because of parental expectations, or teaching by a guru, etc.

As Dr Brett says, traders get into trouble when there is a mismatch between how they approach the market and how they optimally process information.

I grew up …

One of the most important things in trading is to understand your time frame. How long do you plan to hold stocks for?

If you don’t have a clear understanding of what you hope to achieve in terms of holding periods, it’s easy to get knocked off course by ever-shifting markets.

One of Ed Seykota’s trading rules is to “keep your mind and spirit clear”. Having clear time frames is an important element of this.

The problem is that when it comes to momentum/aggressive-growth/CANSLIM trading, many time frames work. You can day-trade breakouts, hold them for a few days, shoot for 25 per cent profits over a couple of months, or try and ride the entire trend.

Some people have the ability to shift between timeframes; for example, swing trading bear market rallies, then holding longer during bull markets.

Unfortunately, I’m no good at doing that.

My time fame is long-term. When I buy a stock, I plan to hold it until the trend finishes. That often means holding it for a year or longer.

Why do I do that?

Firstly, it’s largely to do with my personality. I’m probably a more considered person. I’d prefer to make one good decision and let it play out over a longer period, than make a series of short-term decisions.

I’ve tried making short-term decisions. A part of me is jealous that I can’t be a more action-oriented short-term trader. The frustrating thing is that I can see short-term opportunities, but I can’t take them.

When I try to …

In the last post I spoke about waiting for stocks with momentum.

Green Mountain Coffee Roasters (GMCR), which is in the news at the moment after a big earnings result, is a classic example of what I was talking about.

While I don’t trade the US market, I still analyse it because it is usually correlated closely with the Australian market. (Though at the moment the US markets are outperforming the Aussies and seem to be throwing up much better momentum opportunities)

GMCR came up on my US momentum screen, but I first noticed it because it was Driehaus Capital’s Small Cap Growth Fund’s biggest holding. As mentioned, looking at what the best performing aggressive-growth stocks own is a good screen.

Looking at the chart above, by February/March, GMCR had put in a big 100%-plus move since October last year — a period of around six months.

This is where people find momentum trading difficult. Looking at the chart at the start of March, it’s natural to think - ‘how on earth could this go up any more?’

But it’s probably only then that I would get interested because the 50-week moving average is starting to tick up, which can be seen in the weekly chart below. The stock was also close to its 52-week high of $45.

It had all the classic tells of a momentum stock: a huge prior move over …

When the market has made a big move I find it can be easy to lose focus on your strategy. There seem to be opportunities everywhere. I mean look at those stocks reversing their big falls, micro-caps are hot, speculative miners are moving again.

In situations like this it’s probably good to remind yourself of your edge every now and then. In my case it’s momentum – buying stocks that are already moving strongly.

As I’ve written before, momentum is an anomaly in the stock market that doesn’t conform to the Efficient Markets Hypothesis – ie it’s possible to beat the market buying momentum stocks. What’s more, despite it being well known, it doesn’t seem to have been arbitraged away.

So I’m chasing momentum.

Obviously momentum primarily refers to price: stocks prices that have been going up tend to keep going up. But do we buy stocks that have been going up after a day, a week, a month, three months?

Most research suggests that momentum is only significant based on gains over the past 6 to 12 months; ie stocks with big gains over the past 6-months or year or will tend to persist in going up.

This explains why many of the best aggressive-growth traders aren’t afraid to buy stocks that have made big moves.

In my review of my last bull market performance, I mentioned that many – if not most – of my most profitable trades were stocks that had already made gains of 100 …

I try to jog at least three or four times a week. Each time I run I notice my energy moves in cycles. I oscillate between high-energy surges to low-energy, painful dips where your mind and body scream to stop. Bizarrely, the worst dips are actually at the start of my run.

For a while I tried to “muscle through” the dips; ie I’d tell myself to be strong and adopt an aggressive posture. But in the last few weeks I tried something new: I’d just try and relax when I experienced a dip.

An interesting thing happened: the dips still happen, but they don’t last as long; I also seem to explode out of them when they end. There are other benefits: I can run longer and faster and my running style overall is more fluid and relaxed. It’s clear now that I was wasting an enormous amount of energy fighting the normal rhythms of jogging.

THE POWER OF FULL ENGAGEMENT

Recently I’ve been thinking a lot about cycles, their benefits and how to handle them. One of the reasons is that I’m re-reading The Power of Full Engagement, an ebook I downloaded years ago by performance psychologist Jim Loehr.

The book has a simple thesis: we need to focus on managing our energy; not our time. Energy – physical, emotional, mental and spiritual – is used optimally in waves or cycles, with energy expenditure balanced with periods of rest or energy renewal. “We are oscillatory beings,” he says.

That may seem …

Last post I said the S&P500 isn’t in an uptrend yet.

But yesterday the NASDAQ officially made a higher higher: it closed at 1670.4 points, above the previous significant high of 1665.6 points, as you can see on the daily chart below (click on thumbnail).

Below we can see it from a longer-term perspective on a weekly chart.

What does this mean? It gives an indication of the strength of this rally and the healing being done in the market. My concern is that the NASDAQ’s uptrend isn’t being confirmed by the S&P500, though that may change. Also, as we can see in the chart below, volume has been light.

As I’ve mentioned before, a suitable strategy at this stage may be to take, if you can find them, limited stakes in aggressive-growth stocks that meet criteria including explosive or accelerating earnings and that are hitting or close to hitting new highs.

One of my old maths teachers used to scream at us to “draw the flamin thing” when we were stuck at a problem; I assume it was in geometry or something. But it also applies to charts and market analysis.

As I said in yesterday’s post, one of the signals we’re in a bull market is when we begin making higher highs and lower lows. I’ve found that ‘drawing the flamin thing’ on weekly charts helps to get a good perspective on where the market’s at.

Looking at the chart above (click on thumbnail), it’s clear we’re some way from an uptrend — and therefore new bull market — with the S&P500.

The last two posts have talked about the nature of the current rally and whether we’re at the start of a new bull market, or whether it’s just another bear-market rally.

The question remains: how do we know if we’re in a new bull market?

It’s pretty simple: when both short-term and long-term market indicators are bullish.

Short term indicators might include: the market trading above its 50-day moving average, gains in the market on strong volume, and the daily and weekly MACD indicators in buy mode.

Long-term indicators might include: the monthly MACD in buy mode, the market trading above its 50-week moving average, new 52-week highs higher than 52-week lows, and the market in an uptrend; ie making higher highs and lower lows on a weekly chart.

The problem is there is often considerable time between when the market rallies, which makes the short-term indicators bullish, and when the long-term indicators turn bullish.

By definition both bear market rallies and the start of the bull market begin with the short-term indicators turning bullish, like they are now.

So what do we do? Do we wait for the long-term indicators to turn bullish before buying? That is certainly a valid option. The risk is you give up early gains of bull moves; the reward is that you avoid being sucked into lots of bear market rallies.

Another option is to phase into the market. An example might include:

1. Increase market exposure to 15 per cent to 30 per cent when the market:

- Makes a strong …