After all the hubbub a while back, I wanted to talk with Teresa directly and make my own determination of her. We had a lengthy conversation and I was impressed with her openness and honesty. We also had a philosophical discussion about R.
Read on for more about how Teresa Lo trades, how she blew up her account in the early years, and the most common mistakes she sees traders making.
StockTickr: How did you get started trading stocks?
Teresa: I started buying mutual funds as a teenager because stocks were fundamentally cheap in the early 1980s. I had money to invest because I was marginally successful at fashion modeling while I was attending university. When I graduated in 1986, I went to work at a local brokerage firm here in Vancouver, which was the premier stock exchange for natural resource exploration stocks in Canada at that time. This is a brokerage town, and all my friends also went into the business because their parents were in the business. I wasn’t burning to be a trader. People went into the investment industry knowing that trading is not the way to riches; corporate finance is the sure way to the big money.
StockTickr: Most traders have a horror story about losing their shirt when they first started trading. What’s yours?
Teresa: One of my friends was a technical analyst. He made a stock recommendation that I took. In no time, it was down 50% and I asked him what the plan was…to which he seemed to have no answer other than to hold on. At that point, I decided it was time to learn about trading. Now, being the mining finance capital, I mainly traded gold stocks, both penny exploration plays and senior gold producers.
A few years later, I learned about the dangers of leverage. I blew out my account not because I was wrong, but because I was levered so high that a small pullback wiped out the equity in my account. If you want to read about it, Art Collins interviewed me for his book, When Supertraders Meet Kryptonite.
The headline for Chapter 5: Teresa Lo is:
“I Prayed for One Thing – That When I Liquidated Everything, I Wouldn’t Owe the Firm Any Money.”
That sort of says it all.
StockTickr: What single lesson did you learn along the way that has helped you the most in your trading?
Teresa: Next to the leverage debacle, the most important thing I learned about was the psychology of the crowd, and by extension, how to anticipate their moves. In his book, Justin Mamis calls it the sentiment cycle. I wrote about this in my blog. The bottom line is that chart patterns form in a certain context, and you need to know what it is.
StockTickr: How important do you believe record keeping is to successful trading?
Teresa: None of the traders at the office did it, and it never occurred to me to do it either. In retrospect, it might have been good practice to do it, and I certainly think it could benefit new traders tremendously. The bulk of my trading is now mechanical, and as such, I have the results at my fingertips and examine the data with Excel.
StockTickr: How could traders improve their trading logs to get more out of them?
Teresa: Discretionary traders should use StockTickr to track their real time or paper trades in order to objectively analyze the results. Once you know that you have an edge, you can trade it unemotionally. It’s important to get away from the emotional need to make the trade in front of you work out by giving it more and more rope.
Trade logs are probably most helpful to those experiencing the emotional roller coaster from watching their account equity fluctuate wildly. My reaction is that this problem is largely an artifact created by using too much leverage rather than bad trading technique. For example, if a trader uses no leverage and bets a certain percent of his account on each trade, poor technique should erode the account over time rather than have huge up and down days. Huge fluctuations are probably an indication that the trader is using too much leverage. StockTickr can help them determine if this is indeed the problem.
StockTickr can be of tremendous help in analyzing stop size. I am utterly convinced that people use stops that are way, way too tight. What they ought to do is reduce position size. “R” must account for the natural range for whatever market and time-frame the trader operates in. “R” should never be calculated by dividing how much the trader can afford to lose by the number of contracts or shares traded.
StockTickr: What’s your exit strategy for winning and losing trades?
It’s the same for both. I have a stop and I use it. The most important part to remember is to actually execute the stop. Just do it.
StockTickr: What 3 books do you recommend traders read?
Teresa: I’ve already mentioned Justin Mamis’ book, The Nature of Risk. A Mathematician Plays The Stock Market by John Allen Paulos is a must read. The Handbook of Parametric and Nonparametric Statistical Procedures by David J. Sheskin is very useful because much of the work in trading has to do with identifying outliers. In my opinion, anyone using indicators really ought to carefully evaluate the theoretical foundation and purpose of the indicators they use and confirm for themselves that the assumptions, construction and application are all valid. Since most indicators only use price, they fall within the realm of univariate time series analysis, a subject that is not that fancy or new.
StockTickr: What is the most common but easily correctable mistake you see traders make?
Teresa: I think the most common problem is also the hardest to correct. For example, everyone starts out envisioning a tight stop, but they only use tight stops when the trade is in the money. When the trade is out of the money, people tend to loosen their stops to give the trade more room to “work out”, often to the point where they just take the stop out all together. They know they shouldn’t do it, but they always do it, and end up taking small profits and huge losses.
The other thing is that people think that they should have a trade on all the time. The time to trade is when there is a setup. Waiting is not easy. The temptation is to get in there and position for a breakout.
StockTickr: What technical indicators could you not live without?
Teresa: I can trade with no indicators, but if I had to watch one, I would use the usual moving averages since I know other market participants set up trades based on certain moving averages.
StockTickr: How do you think the market has changed over the last several years? How have you adapted?
I don’t think the market has changed. It’s always featured periods of high and low volatility. I wrote a blog entry about this.
StockTickr: Do you suggest backtesting and if not, how do you suggest traders instill belief in their system?
Teresa: The term backtesting is quite loaded. Yes, I believe in backtesting, but not of the usual canned technical indicators because there is an assumption there that they work, and therefore, the mission is to find the right combination and permutation through brute force with optimization. I think most people know by now that it doesn’t work like that.
My approach is more along the lines of the scientific method. Observe the phenomenon, make a hypothesis, test, confirm and repeat. There is no optimization. It’s more like simulations. This means each trader needs to watch the market and come up with ideas to test, not just pull canned stuff off the shelf. And that’s only for the buy and sell signals. Next comes position sizing and leverage. These two factors might even be more important. For example, if a trader uses 19:1 leverage — meaning that for every dollar of their own money, they use 19 dollars of margin — a 5% drawndown means your equity is gone and you’re out of the game.
StockTickr: What advice can you offer traders who are just starting out?
Teresa: This is counterintuitive, but I think it might be best to refrain from reading too many books that feature technique. This way, you don’t get too many preconceived ideas. Rather, watch the market for a while and learn to be a sophisticated consumer of performance and efficacy claims. In other words, do your own homework. Learn some statistics. Take a good look under the hood of any indicator you wish to use. Ask yourself, “Why is this supposed to work? Is there a valid theoretical foundation? What is the purpose of this tool?” The focus should not be directed solely to researching buy and sell signals. Position sizing is very important, perhaps even more important than the buy and sell signals.
Those who wish to trade chart patterns have to know that they form within the context of the sentiment cycle.
StockTickr: What do you like best about trading?
Teresa: Trading per se is just another job, and certainly not an easy one. The one good thing about it is that the market offers variety, since no day unfolds like the one before. If you have a lot of intellectual curiosity coupled with attention to detail, it’s like a puzzle that just goes on and on and on. You might get close to perfection, but you will never, ever attain it.
I think this quote from Fischer Black and the Revolutionary Idea of Finance by Perry Mehrling sums it up:
The best problems, like the best toys, are hard to exhaust. You can approach them from a variety of different angles, each new angle making the problem fresh again, and bringing the opportunity to discover something new. Any idea, no matter how crazy seeming, might work and can be worth exploring. Indeed, the harder the problem, the more degrees of freedom one can allow in tackling it. Fischer relished hard problems because he relished that freedom, but in practice he did not try just anything. In his view, if a problem does not yield to known methods, that doesn’t mean we need more sophisticated methods, indeed probably just the opposite. Usually problems are hard not because our technique is deficient but because our understanding is deficient.
StockTickr: Thanks, Teresa!
Teresa: Sure, Dave.
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