Monday, May 11th, 2009
Knowing your time frame
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 take short-term opportunities, I just get confused. I lose my analytical clarity, or as Ed Seykota might say, “my mind and spirit become cluttered”.
I need to be detached from the action.
The best illustration of this was when Nicholas Darvas had success trading the market by receiving short telegrams around the world with nothing else but price movements. He reasoned that if he traded more often and got closer to the market he’d be even more successful.
Darvas started trading from a Wall Street broker’s office. But rather than make a killing, he totally lost his ability to see the market clearly. The numbers and movement stopped making sense. He lost his cold, analytical, detached view and started trading like a drunken sailor and lost a big chunk of cash.
Longer-term trading is also more cost effective. Costs often make the difference between beating the market or not. In Australia, if you hold for more than a year, your capital gains tax rate is halved. I spend little on broker’s fees and don’t need expensive trading software.
I also usually get extra returns from dividends, which does make a difference to the bottom line.
Being a longer-term trader has strategy implications. To hold a winning stock you need to know three things are in your favour, which gives you confidence to hold on.
The first is momentum; the stock has been going up and is likely to continue in that direction. The second is the company’s fundamentals indicate it is doing well; the third is the condition of the market. As Jesse Livermore said “general conditions” were his best ally.
As I’ve mentioned before, I can hold a stock that goes up 20 or 30 per cent and watch most of those profits disappear on a retracement and not sell out. Because I know things are in my favour.
It means that when conditions are sub-optimal, I have to let opportunities go.
Bear market rallies are sub-optimal. They fail to meet the three conditions above: they’re led by stocks reversing downtrends; fundamentals of these stocks are often weak (they’ve been plummeting for a reason); and the market is not strong.
Watching opportunities go can be frustrating, but until conditions are right, and the right stocks are setting up, I can’t take positions and have the faith to be able to ride them to the max.
I can only do this by knowing, understanding – and having faith in – my timeframe.
Colin Nicholson has one of the best illustrations of timeframes I’ve read. Based on his definitions, I’d fall into the active investor camp.
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