Trading research involves a lot of time spent trying to find and evaluate new or interesting techniques and approaches.

Everyone has their own filters that need to be gotten past before a golden nugget is deemed to have been uncovered. These filters get more sophisticated, targeted and refined as experience is gained.

Often times new connections can be made with something that was discarded a long time ago.

The Goji method which I came across not too long ago on the babypips forum places a lot of emphasis on only trading during the opening of a session when liquidity and volatility are generally high.

From the murky depths of my memory rose the ACD method put forward by Mark Fisher in The Logical Trader.

The ACD method is not a trading strategy in its own right, more of a framework upon which you can add your own rules.

It’s core tenant is that the opening range is statistically significant. The easiest way to demonstrate how this is used is with a quick example.

Let’s say we use the opening 15 minutes of the London session on EUR/USD. The high and low prices achieved during those 15 minutes form the opening range.

The A high is calculated as being a certain number of pips above the opening range, and an A low is calculated the same number of pips below the range bottom.

The exact calculation of the number of pips is not stated in the book, but Mark Fisher in presentations has often used Average True Range (ATR) calculations as part of the process.

One common calculation is to use 10% of the 10 day ATR. You can quite happily change either of those figures to suit, such as using a 30 day ATR instead.

So with a 10% of ATR(10) calculated it is possible to plot where the A high and A low are.

If price moves up to the A high (or down to the A low) and stays there for a period of time exceeding at least half of the opening range time, then an A high (or A low) is said to be active. This signals directionality in the market and then feeds into other rules you might have whereupon you would only take long trades if the A high is triggered, or shorts if it is the A low triggered.

The stop loss placement for any such trade would be the opposite side of the opening range (labelled the B point).

Only one A point can be triggered per session. Thus if an A high is active then the A low is no longer a possibility. They are effectively like OCO (One Cancels Other) price points.

One an A point has been activated, it is possible to calculate the C point.

The C point is placed on the opposite side of the opening range to that of the active A point.

The distance of the C point from the opening rage is another magic number which is often seen as 15% of the ATR for forex pairs. If an A is active above the opening range then a C point is calculated and placed below the opening range.

If price retraces back through the opening range and continues through it, the C point will become active once price touches it. Once point C is touched, only short entries should be considered and traded depending on what other rules you have in place.

Point D is the opposite side of the opening range, exactly how point B is for when A is active, and is used as a maximum stop loss point for any trades taken once C is active.

There are layers of other stuff added on top of this framework, from pivot points to considering what happened exactly 30 days ago, but you’ll have to read the book to see what they offer.

Just remembering about the calculation and placement was enough to draw me back to investigating it once more.

The time element, waiting for price to hold a certain level at point A before confirmation is given, is especially interesting. Time considerations are preying on my mind much more.

There’s always the fun question of what exactly is the opening time period for a 24/5 global currency market. Mark Fisher is perfectly happy to use the opening time for the local currency. For example, trading EUR/USD or GBP/USD you are probably best off using the opening of the London session. For AUD/USD or USD/JPY use the Asian session’s open.

There seems to have definitely been a statistical edge in using the opening range on energy markets 10, 15 or 20 years ago like Mark Fisher used to trade his way to success.

Futures markets are basically 24/5 nowadays, just like the currency markets and I think it is only natural to assume that the statistical significance of the opening of the local markets has to have diminished somewhat.

I’m intrigued by his assertion in Outliers that reaching the pinnacle in a given field often has more to do with hard work, practice and environmental factors than it does necessarily with innate talent. Van Tharp provides a great summary of this portion of the book and its accompanying examples in a Tharp’s Thoughts Weekly Newsletter from last month, so I won’t repeat all that.

A more indepth look at this topic is covered in Geoff Colvin’s Talent Is Overrated which I’m now interested in reading. Seems like Colvin turned his original Fortune article (which I even ran across back in 2006) into a fully fledged book (although there also now seems to be a more expanded up-to-date article).

Ten thousand hours seems to be the magic amount of practice needed to become highly proficient at something. So I’ve been trying to guesstimate how much time I’ve spent trading to date. My interest in trading blossomed in the middle of 2002. Let’s say it’s been six and a half years, or around 338 weeks.

There have been occasions when I’ve put insane amounts of time into this pursuit; other times when I’ve taken a break for weeks at a time. It has primarily been a part time endeavour, so I’m going to ballpark it and say that I’ve dedicated around 15 hours a week to trading.

Fifteen hours a week for 338 weeks means that I’ve put in just over 5000 hours of practice.

Hmmmm. Half way there!

I also just want to highlight one part of Blink, Malcolm Gladwell’s previous book, as it contains a section that directly mentions traders.

It turns out that traders (or at least the floor traders used in the research) make excellent military commanders. Their ability to make rapid decisions using limited information on the trading floor turns out to be remarkably similar to the conditions that a military commander faces in the heat of battle.

I found the parallels to be striking, especially after have so recently read Sun Tzu’s The Art of War and the application of its principles in fti’s thread of Forex Factory.

I have a copy of Rob Booker’s Adventures of a Currency Trader book, as well as two copies of Rob’s ‘Don’t be a stunt monkey’ CD.

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The reason for this delay is probably pretty self-evident from the title of the book. It is purely focused on successful stock market traders while I only trade the currency markets. At the end of the day though, a good trader is a good trader. The choice of markets that a trader focuses on is purely one of the many preferences that are often aligned with the trader’s personality. This means that there are still plenty of golden nuggets to be learnt from traders that ply their skills in a market that is different than the one that I focus on.

There is an eclectic mix of equity traders interviewed in Stock Market Wizards; ranging from the purely quantitative style employed by David Shaw to the intuitive, gut feel used by Steve Cohen.

Any time that I read a book of trader interviews I will often find that I resonate with certain traders while the style used by others leaves me cold. I certainly resonated with the gut feel, almost wildly discretionary approach used by Steve Cohen. This gut feel can often be gained through experience, although some people have it through innate talent. When using such a discretionary approach it is vital that your trading style matches your personality. I feel that is certainly true in my case. I have found a way to approach the currency markets that suits me. I do not find myself fighting my own trading system or second guessing the trading rules I have in place. Instead I am able to exert my energies into diligently following my trading plan. An important component of any discretionary approach is risk control and money management. Often times this means knowing when you are wrong so that you can exit unfavourable trades. Knowing when you are wrong is going to be different for each trader but often consists of either price action moving in the wrong direction, a time stop whereby if a move in your desired direction has not happened within a certain timeframe you exit the trade, or the underlying rationale for why you placed the trade no longer holds true.

Two of the more prominent observations made by Jack Schwager about all the traders interviewed in this book is their unceasing discipline in following their trading plan and the confidence that they have in themselves. Do you gain confidence after being successful for a certain length of time, or do you need to be confident to see that success come true? It’s almost a chicken or the egg dilemma. Which came first? From my point of view you need to have the confidence first. There are many things that you can be confident in that can help you on your way to consistent, profitable success. It’s almost like breaking down the whole trading challenge into simpler, baby steps. You can have an overriding confidence in your ability to see the challenge through. You can be confident that you’ll commit to learning and educating yourself at a steady pace for the foreseeable future. You can be confident in really learning who you are so that you can determine what sort of trading style will best fit you. Your confidence and success in completing these piecemeal tasks on the road to becoming a successful trader will increase the confidence that you have in your overarching goal of being a consistently profitable, standalone trader.

The interview with Ahmet Okumus also resonated with me. Ahmet Okumus is very much a dhandho investor; he buys value stocks. His approach means that he continues to hold trades that are in the red as long as the fundamentals for that trade remain in place. Okumus even details how he held trades open through a 50% unrealised loss drawdown as he was confident in his reasoning for putting on the trades.

Jack Schwager comments on how this approach seems to fly in the face of commonly spouted trading wisdom of cutting your losses short. How can Okumus be so successful when he does the exact opposite of what so many other great traders advise?

The apparent paradox is only illusionary. The cut your losses short mantra is effectively just a method of money management and risk control. While all successful traders must incorporate risk control into their trading strategy there are many different way to implement it. Okumus incorporates his risk control through the rigorous selection process that he goes through in picking out which stocks to buy. By doing this he is extremely confident in what he buys and knows if an adverse price moment in a stock he owns violates the rationale that was used to purchase that stock. Okumus’ selectiveness in what stocks he buys is his central means of discipline. He would rather keep his trading capital in cash rather than risk it on an opportunity that does not meet his highly selective criteria.

When I highlight some of the trader interviews and how they seemed to resonate more with me I am acutely aware that this resonance is the confirmatory bias at work. I am gravitating towards things that I already believe in to be true. In essence I’m looking to validate my current beliefs through information and comments that back up those beliefs.

Knowing this I also have to consciously step outside my box and be open to completely contradictory information or viewpoints. I have to be open to continually questioning what I currently hold to be true. If I come across a belief or assumption I hold that does not stand up to scrutiny given new information then I have to have no qualms in replacing that belief with a new one that more closely conforms to the new data available.

Who I am today as a trader is different than who I was twelve months ago. The same will be true this time next year; some beliefs that I have about the market, my trading style, the world around me or even myself will have been superseded by new, better, more informed beliefs.

This constant striving for betterment is another constant seen amongst all the traders interviewed in Stock Market Wizards. Many of the traders detail personality flaws that they had to correct before they saw consistent success. One prime example of this that was quite common was relying too much on the opinions of others. It was only when the traders made a commitment to solely relying on their own judgements and decisions did they experience the sort of success that they knew they were capable of.

I can understand why this book is generally thought to be slightly inferior to the first two Market Wizard books. I think this can be mainly attributed to the narrower scope of focusing on stock market traders, especially at a time when just about anyone could make money trading stocks. The main interviews were conducted in 1999 when the tech mania and internet bubble were in full swing. Follow up interviews for the paperback edition of the book look at how well the various traders have weathered the bear market that unfolded from 2000 to 2002.

Some of the interviews seem slightly shorter than those that appeared in the prior books and many don’t see to contain the wisdom and insight that existed in those prior tomes. The proprietary nature of the trading systems employed by some traders, such as David Shaw, and their complete refusal to talk about them in any depth meant that some of the interviews will have very little benefit to anyone who reads them. It almost seemed like they were happy enough to be included in the book for the fame value but their inclusion rings kind of hollow since they don’t provide enough insight into their methodology and approach to be looked at as someone worth emulating. It is almost as if they were slightly defensive in nature. Becoming a market wizard means opening yourself up to close scrutiny for ever more.

Even with these caveats, Stock Market Wizards can be a useful motivational tool. When reading interviews with successful traders you are reminded that it is possible for you to be a successful trader too. Key ingredients to making it are supreme confidence, hard work and discipline.

For Mohnish Pabrai, the author of The Dhandho Investor, value investing is that method. I read this book on the recommendation of a colleague who was just getting started in the world of stocks. I am not a stock trader and have no real inclination to become one in the near future. So why did I decide to read the book anyway?

I have heard about value investing from many different quarters over the past few years. It has peaked my interest enough that I felt it might be worthwhile to know a little bit more about the world of value investing. After all, one of its biggest proponents is Warren Buffett, so there must be something to it!

Mohnish Pabrai is very much a Buffett follower, not in the sense that he copies Buffett trades, but that he follows rather closely the methods and practices that Warren Buffett uses in making his trading decisions.

Value investing is an approach where you attempt to identify securities whose shares appear undervalued as compared to your understanding of the fundamentals for that company. You are not necessarily looking to find a company for a bargain price, rather you are looking to buy into a company that is outstanding at a sensible price.

Pabrai often uses the following coin toss phrase throughout the book to describe the types of investments that he looks to make: “Heads, I win; tails, I don’t loss much!”

One of the main tenants of most stock investors is that diversification is key. This means that you buy stock in many different companies that are unrelated so that you do not expose yourself to risk in any one company or market sector.

Value investors shun this approach. Instead they look to find a few companies that are worth putting their money into. The book details how the Kelly Formula is often used to determine how much of your trading capital is to be used on any given trade or investment.

Pabrai seems to keep things even simpler. He just allocates 10% of his trading capital to any given investment that he is going to make. This obviously means that he is only ever interested in holding shares in a maximum of ten companies at any one time.

Investments are made irregularly and only after thoroughly researching the company in question and the market sector in which it belongs. A thorough understanding of the company and its fundamentals needs to be pieced together before the trade is placed.

The investment approach can be succinctly summed up as using few bets, big bets, infrequent bets.

When it comes to exiting from trading bets placed, an obvious profit target is reached when the stock price is no longer considered to be undervalued.

If the stock price goes against you then Mohnish Pabrai generally advocates holding onto that position as long as the fundamentals are sound and continue to point to the stock being undervalued. Only if the fundamentals turn against you should you consider exiting the trade for a loss. Pabrai recounts several trades he made that initially went against him, some for quite a long time, but he held onto to them as the fundamentals remained sound and he wanted to give the company time to realise their potential.

There is one other scenario that can force the exit of an existing trade and that is uncovering another value investment opportunity that offers substantially more reward and/or less risk than what is currently being held.

Like any trading or investment approach, if you want to be successful you need to put in the time and work to reap the rewards. Pabrai does an excellent job of detailing the research and legwork that he put into many of his investments.

I found the description of how Pabrai set up his investment fund to be fascinating. Once again he has followed Warren Buffett’s example in how he sets his fee structure. Instead of the 2/20 fee that most hedge funds use (where there is an annual 2% fee on the total trading capital being invested, along with a 20% fee on any monthly profits), Pabrai charges an annual fee of 25% on returns made that exceed 6%.

I like this approach as it eliminates the monthly volatility that can exist in returns. The 6% threshold is chosen to alleviate worries from investors that their potential profits will be eaten alive by fees if the fund does not make much during the year. The 6% level assures the investor that they will hopefully sees returns at least equivalent to risk-free investments such as treasury bonds which generally sees annual returns in the 4-6% range.

This fee structure also gives a nice incentive to the fund to generate the best return possible as they will receive a higher cut of the profits the better they do. There is no safety net equivalent to the 2% annual fee charged by most regular hedge funds. The fund manager must generate at least 6% in annual profits before they will see any income from fees.

Let’s look at a few quick examples of how this fee structure works. If the annual return is 10%, then the fee paid is (10 – 6) x 0.25 = 1%. If the annual return is instead 20% then the fee works out to be (20 – 6) x 0.25 = 3.5%.

This fee structure is extremely competitive when compared to regular hedge fund fees as well as mutual fund fees. Mohnish Pabrai sees it as a vital competitive advantage his Pabrai Investment Funds have over other managed funds.

The success of Pabrai Investment Funds means that its annual shareholder’s meeting is even turning into something similar to the Oracle of Omaha’s annual Berkshire Hathaway gathering.

There is also an interview with Mohnish Pabrai on The Motley Fool from earlier this year where he details how the assets under management for the fund have grown from $1 million at its inception in 1999, to over $400 million this year. The second part of the interview is here.

The Dhandho Investor clearly details the steps that Pabrai has taken to achieve value investing success. It is an enjoyable book to read, even for someone like myself who is not actively looking to get into value investing. It contains plenty of interesting stories and anecdotes that help to illustrate the concepts that are being showcased. Mohnish Pabrai shows that you don’t have to reinvest the wheel to find investment success. In many ways, Pabrai has just cloned the methods and strategies of Warren Buffett, making sure that they mesh with his personality and investment outlook.

If I ever have an inkling to do some stock investing then I shall certainly be returning to this book for help and guidance.