The Rule of 72

Over the weekend, I read another great book, The Four Pillars of Investing by William Bernstein. I am not going to give a review this time around, but I am going to discuss on one of the concepts mentioned in the book: The Rule of 72. Honestly, it was the first time I knew it and I thought I would like to share it here in my blog.

According to Wikipedia, it is a method for estimating an investment's doubling time. The rule number (e.g., 72) is divided by the interest percentage per period to obtain the approximate number of periods (usually years) required for doubling. Although scientific calculators and spreadsheet programs have functions to find the accurate doubling time, the rules are useful for mental calculations and when only a basic calculator is available.

For example, if you want to know how long it will take to double your money at eight percent interest, divide 8 into 72 and get 9 years. Below is a table to shows how accurate the rule is.

As you can see from the above, the rule is remarkably accurate. So long the interest rate is less than about twenty percent, it is rather reliable formula. At higher rates the error starts to become significant.

You can also run it backwards such that if you want to double your money in six years, just divide 6 into 72 to find that it will require an interest rate of about 12 percent.

Watch this video from Investopedia to understand more about The Rule 72.

Relating 80/20 Rule and 3M (Mind, Money, Method) in Your Trading

I have just finished reading The 4-Hour Workweek, a bestseller book by Tim Ferris. One of his many interesting theories that struck me was the use of the 80/20 rule. This rule, also known as Pareto's Law  is applied in business studies, sales, economy and many other endeavors. Today, I am going to illustrate how the 80-20 rule can help optimize your trading and boost your trading profits.

Pareto's Law can be summarized as follow: 80% of the outputs result fro 20% of the inputs. To put it in different ways, Tim Ferris gives more examples in his book:

1. 80% of the consequences flow from 20% of the causes.
2. 80% of the results come from 20% of the effort and time.
3. 80% of the company profits come from 20% of the products and customers.
4. 80% of all stock market gains are realized by 20% of the investors and 20% of an individual portfolio.

One important thing to note is that the ratio is often skewed even more severely such as 90/10, 95/5, 99/1 are also common, bu the minimum ratio to seek is 80/20.

How this Law is related to trading?

Trading in general consists of the 3M - Mind, Money, Method. Mind is basically how you manage your emotions and understand the psychology of trading. Money is the position sizing system so that you can manage the risk and survive in the trading business. Method is the strategy to buy and sell stocks. 

For most traders out there, there is one thing that matters the most: the trading system. Trading system research and developing new strategies for trading are their main focus, but mostly this is about looking for that holy grail of trading systems. Their argument is that while I do like to apply money management and discipline/psychology, about 80% of what I do is test new trading systems and look for new methods. That leaves 20% for money management and trading psychology & discipline.

The truth is, to make profits in trading, one does not need to have the most accurate system in the world. What is needed is really a good system executed with discipline and using proper money management methods. I strongly believe that trading psychology + money management are the 20% which is responsible for 80% of trading success.

So, to relate the 80/20 rule, I would like to summarize this way..

1. Instead of researching and keep updating/changing your Method (I am not saying it is not important), spend more time in understanding the trading psychology and position sizing.
2. As 80% of your profits are coming from your top 20% trades, focus on the market movement and make sure you do not miss the boat when the market is uptrending.

Happy trading and happy holiday!

Are You Discretionary or Mechanical Trader?

Traders often classify themselves as stock traders, or e-mini traders, or ETF traders, or Forex traders. However, at a more basic level there are really just TWO types of traders – discretionary and mechanical.

The discretionary trader uses his or her experience and judgment to make trading decisions. The discretionary trader will usually have a documented trading plan with rules to guide or bound their trading decisions. But when it comes time to actually pull the trigger on an entry or an exit to a trade, they will evaluate the current market situation and apply the intuition they’ve developed over years of experience.

Conversely, systematic or mechanical traders have a rigid set of rules that precisely dictate their entry point, when they will exit the trade, and the size of the position. Systematic traders do not take into account anything in the market environment that is not explicitly covered in their rules. They take every trade. Period. Intuition, judgment, and experience do not enter into the equation. Systematic traders will also have a documented trading plan, but their rules will be so specific that they can be, and usually have been, programmed and back-tested. (Back-testing is the process of modeling a trading concept in a computer program and testing to see how it performed in past market environments).

I developed trading plan, create a set of rigid trading rules, combine a few technical indicators for my entry and exit strategy. So, yes, I am a mechanical trader. Not being biased, but my arguments are here.

#1. Systematic trading may not be as fun, but it’s much more consistent

#2. Emotion is a demon to trading 

I am not saying that discretionary trading is not as good as mechanical trading, but I was not in luck when I was one. I started my trading days as a discretionary trader, enjoying my time deciding - to buy and sell. However, even though it was exciting, the return was not as good as expected and hence I switched to mechanical trading. I developed codes to give me buy/sell signal and keep testing and updating my codes. In this way, I need to be really disciplined and try not to be affected by emotion.

So which method is best? Which method should you choose? The answer is, of course, that it depends. Discretionary trading has the advantage of tapping the world’s best computer – your brain. But the downside is that the computer supported by our necks is very susceptible to the virus of emotion. Whether you’ve been trading 1 week or multiple decades, emotion is a demon that must always be neutralized.

So what are you?

Stock Trading is Just Like Doing Maths

If you recall your school days, your math teacher often asked you to do math exercise. It was easy to find the answer - flip the book to the last page and you can find the answer. However, by knowing the answer is not enough really. And probably you will not earn full marks for that. In math, workings are required and you need to understand fully to show it in your exam/homework.

Stock trading is just like math!

Most of us know the final answers! But again, knowing the answer is not enough, we need to know the "workings" and the steps to the right answers..

Just think for a while, what are your "steps" (read - system) you have to get your answers (read - profit/wealth)?

Who are Your Shoe Shine Boys?

The story goes like this..

In 1928 in New York City, John D. Rockefeller was having his shoes shined. The shoe shine boy, presumably not knowing who Rockefeller was, started giving him stock tips and financial news of the day. Rockefeller took his shoe shine boy’s advice but not in the way you would expect. He decided that if a shoe shine boy was giving stock tips.. It was time to get out of the market. He did! And it’s the reason his family was able to stave off the Depression, and continued to be one of the richest in our history.

Honestly, I do not give a damn if the story is true or not. But this story really give us a piece of important lesson!

Who is your equivalent shoe shine boy? Is he the taxi driver? Is he your colleague who has shown sudden interest in stocks like never before? The first tip is about increasing your street smarts by surveying the sentiments of the people around you. When many people are optimistic about investing in stocks, it is probably time to get out.

 "Honesty is a very expensive gift, don't expect it from cheap people"

Stick to your trading plan, and be disciplined. Keep it simple.

3 Reasons to Use Moving Average 200 (MA 200) in Your Stock Trading Analysis

Out of a few simple technical indicators I use in my daily stock analysis, Moving Average (MA) 200 is one of the most important.

"The 200 day moving average may be the granddaddy of moving averages. Simply put, a financial instrument that is trading above it is healthy; below it, anemic. The 200 day moving average measures the sentiment of the market on a longer term basis. This is where major players like pension plans and hedge funds need to look in order to move a large amount of stocks. I display it on all my workspaces proudly, formatted in emerald green and real thick so I can't help but notice."

MA 200 lags. This indicator does not predict the direction of the price, but rather the current situation. Coupled with other leading indicators, you analysis could be more complete. Therefore, when you hear "the trend is your friend," technically put it really means that the price over the last 200 days is indicating an upward trend, therefore look for buy opportunities; versus the price is below the last 200 days, therefore look for sell opportunities.

So, in nutshell, what are the uses of MA 200 then?

In my trading analysis, the indicator basically give a good picture on the following.

#1. TREND - check if the price is well below, above or touching the MA? This will show you generally what is the trend of the price movement. This comes useful if you want to find out the performance of the stock in terms of growth.

#2. SLOPE - ask yourself if the slope in steep enough (being up or downtrend), or is it just a neutral slope. Generally, as a trend-following trader, the steep slope is a good chance of continuous up-trending.

#3. CROSSOVER - this is in relation to other short-term MAs I am using. If the price and other short term is well above the MA 200, it is a good chance that the stock is still up-trending. However, if the short term MA (or even the price) starts to crossover MA 200, the trend could change.

Ask "Frugal Filter" Questions Before Buying Things

"If You Buy Things You Do Not Need, You May Soon Have To Sell Things You Need"

Well, this article is not preaching you to be frugal, but to share my "system" wherever I want to buy something. Just recently I started asking myself these questions before buying stuffs, and the effect is actually quite amazing. I am now can decide well if I really need to buy or not. Practice and let me know what you think.

#1. Do I really need this?
#2. Do I have something else of the similar function?
#3. If I really need this, can I get somewhere cheaper (or free!)?
#4. If I cannot get it cheaper or free, how can I get the price down?


These are the questions I would ask myself before deciding to buy something. Here are some examples.

Thinking of buying an Android Tablet.
#1. Do I really need this? Nope! This is a WANT, not a NEED
#2. Do I have something else of the similar function? Yes, my laptop and Nexus 4 are more than sufficient.
Decision - Do not buy

Looking at Digital weighing machine
#1. Do I really need this? Yes! I am too fat.
#2. Do I have something else of the similar function? Nope, my previous weigh is not functional
#3. If I really need this, can I get somewhere cheaper (or free!)? My housemate use to have it and I can use it for free, but not anymore. I think I do not need digital one, the normal weighing scale will do (cheaper).
Decision - Buy cheaper weighing scale

Malcom Gladwell's bestseller book Outliers
#1. Do I really need this? Yup, a lot of friends recommends this book
#2. Do I have something else of the similar function? Not really
#3. If I really need this, can I get somewhere cheaper (or free!)? Yes! I can read it free at library
Decision - Do not buy, instead read it at library and making own notes

Why Market Order Works for Me

I do not really like to trade when a stock moving sideways and I keep telling my wife that I am a trend-following trader (what are you?). I will only buy a stock when there is higher probability that the uptrend is obvious.

You may argue that I may not buy at the bottom, and you are actually right. I do not usually buy at the bottom as I will wait until I am sure that likely bottom has formed (by using my indicators). So when I observe a start of a trend then I PROBABLY have better chance of making money. So I put a BUY order. MARKET ORDER.

So, get in the boat no matter what!

"Your market order is executed at the best price obtainable at the time the order is executed. In other words, with a market order the fact that the order will be filled is all but guaranteed (subject to the availability or liquidity of the stock), but the price at which it will be filled is not."

Sometimes (often) I got slippage. But that's okay as long as you follow the trend. But again, the trend could be a trap, and you end up going down, so remember your cut loss strategy.

So write comment below your preferred order. Market or Limit order?

Test: Trading System A on Indonesia Stocks (2)

Today, I did the usual. After work, I downloaded the EOD for Indonesia market, and check my watchlist. So, as one of my criteria is ratings from analysts, the watchlist may change quite often. And today it changed! One stock is out and a new stock is added in. So what I do is just to change my watchlist in my Amibroker and Android app accordingly.

I run the EOD, and still no buy signal. Patience is golden :)

How to Become a Trader - Van Tharp's Video

Van Tharp is one of my favorite authors of trading books. I have read some of his books and inspired by his theory of business plan for stock trading (or investing). If you have read my post on the business plan template for stock trading or my trading system test, I adopt most of my trading systems and plans from his ideas. I do not really follow all his points, but it was all started from his thoughts and idea. 

Anyway, if you are not convinced about the importance of business plan before you start trading, you may want to watch this short video. Enjoy.

Always Cut Your Losses Short. Always.

I learnt this the hard way really. In my early trading days, I stuck too long in a stock that kept dropping. I had not exit plan, what I had was just hope that the stock will go up. It didn't. Since then, I set my rules right and always cut my losses short.

In my view, there are some important benefits why you should always apply cut loss.

#1. Admit it.. You are Losing the Trades. Move on.

This is about pride, isn't it? When the price keep dropping 5, 10, 15, 20 percent of your buying price, you may have this ego saying, "This can't be right! It will bounce up". The reality is that when what's left is HOPE, you should get out of the market and just admit you lost. Understand the 4 important emotions in trading.

#2. Boost Your Confidence. Really!

I can tell you that  the period when I was seeing my stocks were down 20-40% of the buying price was terrible. Sometimes I asked myself what I went wrong and started to doubt this whole trading thing. So avoid getting this feeling. Cut your losses short. Learn to set you mindset right. I believe this is also important.

#3. By Staying in Losing Trades, You are Losing Opportunity for Other Winners

When you are in the losing stocks too long, you are losing opportunity to move on to other stocks that could be a winner. It is the same principle with my other post on why you should not average down.

"Cutting losses is like having disaster insurance. By shielding your nest egg from devastating trades, you earn the privilege to invest again."

#4. Stocks Always Bounce Back, don't They?

Well, what I can tell you is that, I dare not to predict, and if I am in a position where I am losing my trade below my limit, what I know is that I am risking my capital for further losses and and should get out. Who cares if it will go up tomorrow, next week, or next month or never? Nobody knows really. Stick to your trading system and cut your losses short.

Test: Trading System A on Indonesia Stocks (1)

Hey hey..

I love doing test! This article will be the first of many test-related article you will see in this blog. What I am going to do is to test my trading system (or you can call it business plan) and see if the system will give positive return in the long term. I have experimented many system and this one will be experimented publicly! :)

With this, I am also testing myself (all of you are the judges) if I can follow strictly my rules and system. Please note that the disclaimer page is here and my trading system may work for me but may not for you. Also, I have evolved into a type of trader I am now, and pardon me if you are of different type and find this system does not suit you. :)

Let's start!

Trading System A (yes, you will see I am testing other systems)

#1. MISSION

I created this system so that I will have a POSITIVE return over long period of time (this test will be one year long!). Losing trades is part and parcel of this business, what matters the most is to have a positive return in the end. Note that I categorize this system as a trend following system and hence you will not see many trades in one year.

#2. GOALS

To trade right, strictly following my system and to minimize mistakes.

#3. RULES

My rules are here.

#4. METHOD

Step 1 - Choose the market you would like to trade - Indonesia stocks

Step 2 - Choose a bucket of stocks you would like to watch - I am using online stock screener with fundamental analysis, which mostly include strictly good earning and sales growth. The following are the stocks screened as of today (1 Dec 2013). I will check this everyday as the watchlist can change whenever the criteria changes.

Step 3 - Add the watchlist in your trading software. I am using Amibroker.

Step 4 - Create a program/algorithm that will give me a buy and sell signal. To craft this algorithm, I spent hours/days/weeks to find out what combination of indicators that suits me. This system is for trend following and not very suitable to sideways markets. I have backtested it and give positive return if the signals are religiously followed and no slippage when you put order.


Step 5 -  Everyday, I will download EOD (free) for the Indonesia market (contact me if you want to find out where to get). Upload the EOD to your software (Amibroker) and monitor daily (at most 15 minutes daily) if there are signals for all the stocks in your watchlist. Yup, I am only monitoring my watchlist, ignore the rest.

Step 6 - When signals BUY is given, quickly put an MARKET order, so you won't missed the boat. This is trend following system, so getting the order transacted is more important that what price you are getting. When signals SELL given, I will sell it 2 days after the signal is given.

Step 7 - Exit when there is a SELL signal or cutting loss at 10% drop from buying price

#5. MONEY

My capital allocated for this test is IDR 38,000,000. The size of lots I am buying will follow my position sizing system.

#6. MIND

Psychology/Emotion is not really playing important part here as I am following buy/sell signal. But if you want to know how I manage my trading psychology, you can find my articles on Psychology Trading.

#7. TRADING ROUTINES

Explained in the METHOD part. You can make use of your android smartphone to monitor your watchlist too.

#8. MISTAKES

Not yet committed :)

Wait for further update..