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This was the quiz:
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Here is a little quiz. Its mainly for the benefit of less experienced
traders on this list. Since I devised this quiz myself, its not too
difficult ;-) By the way, this is how many people trade and make simple
mistakes.
For purposes of this quiz, we will assume that the last bar (today)
displayed in a chart is bar 1, the one before that (yesterday's) is bar 2,
the one before that is bar 3, and so on.
There are 3 traders - A, B and C. They all have day jobs and when they come
back home from work, they download the latest data and then look at the
daily charts of their stock holdings on their computers (in Metastock!)
Based on this, they then go to their brokers' websites and place appropriate
orders. e.g. based on the chart, they update their sell-stop price daily.
Lets say all 3 have a long position in a particular stock which has been
climbing steadily. They have only one sell condition - namely, sell when the
stock makes a 20-day low. This is what they do:
Trader A - he chooses the low price of bar 20 (latest bar is bar 1, one
before is bar 2...see above) and selects that as his sell-stop
Trader B - he chooses the low price of bar 19 for his sell-stop
Trader C - he chooses the low price of bar 18 for his sell-stop
Which trader is right? Remember, the sell condition is "sell when the stock
makes a 20-day low". Answer tomorrow.
Shashi
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The correct answer is - Trader B.
On the next trading day, a new bar will be added to the right of the chart
and this will be bar 1. What was bar 18 will be bar 19, old bar 19 will be
new bar 20, and old bar 20 will be new bar 21. So when the stock trades
below Trader's B price intra-day, it is making a 20-day low and that is a
valid sell signal.
Trader A fails to realize this simple fact so his sell stop actually becomes
a 21-day low rather than a 20-day low. He broke his own simple trading rule.
Trader C does understand the implication of adding the next bar but he has
made another mistake. He is calculating a 20-day low while using only 19
days (bars) in his calculations. Unless the stock falls to zero, it is
virtually impossible to tell if its making a 20-day low simply because he
hasn't included 20 bars in his calculations. He has also broken his simple
trading rule.
Lesson: Most traders look at end-of-day data and then plan their trades in
real-time. Some of them undoubtedly forget the implications of adding a new
bar to the data and by doing so they make inadvertent mistakes. Once a new
bar gets added to the right side of the chart, virtually everything that is
based on periodicity gets recalculated. Thus the value of a 10-day
low/20-day low, etc. will change. Also, virtually all indicators - 10 day
Stochastic, 14 day RSI, etc. - change, too, and newbies are prone to forget
this. Similarly, when you do a system test based on end-of-day data and
pretend to enter/exit a trade on the same day that a signal is generated,
you must realize you cannot do that in real life - the earliest you can
enter is either at the open the next day (sometimes even that proves
difficult, but that's another story), for stocks, or at the close, for
mutual funds. But by then, the value of any indicator you have chosen (your
"holy grail") has also changed in value!
Simple mistakes, compounded over a trading lifetime, can easily translate to
(hundreds of) thousands of $$ of lost profits/losses.
Shashi
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Do some people "really" understand numbers and percentages? Heard this on
CNBC some time ago:
A caller has called in with a question for a "market guru".
Caller: You recommended _____ stock some months ago. It fell 90% from your
buy price, but in the recent Nasdaq rally, it has doubled in price. What
should I do?
Guru: Well, the stock was down 90% and has then gone up 100% (you said it
doubled), so you are up 10%! (Looks around and puffs out his chest) See, the
market is down so much but that stock has already given you a 10% gain! You
should listen to me!
Caller: You are right! I have made a profit!! But my brokerage statement
shows a loss. I will call my broker to complain - their computers have it
all wrong! Thank you!
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Well, I don't claim to be a rocket scientist or a Ph.D. in Mathematics, but
it seems to me:
Stock bought at, say, 100
Down 90% = 100 - 90% = 10
Up 100% (it "doubled") = 10 + 100% = 20.
Loss at present = 100-20/100 = 80%!!!!!!!!!
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Shashi
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