Mark Minervini's sequel to Trade Like a Stock Market Wizard
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Mark Minervini, Author of Think & Trade Like a Champion.
The sequel to his previous book, and our subsequent review, of Trade Like a Stock Market Wizard.
Mark shot to stardom in the trading community through his success in the US Investing Championship by achieving a 155% return in 12 months.
Arguably the most respected stock trader of the modern era, Mark carries the torch for other legendary traders that have passed before him. Let’s take a look at this sequel for more hidden gems.
Mark says there are two types of trader within all of us, a builder, and a wrecker.
The builder has a disciplined methodical approach, and trusts that results will come with consistency.
Always learning from mistakes and takes encouragement from new information.
Forever optimistic, knowing that through discipline and a continually evolving process good things will come.
The wrecker has a different mindset, always looking for someone to blame if the strategy fails in the short term. Often driven by ego, fixated on results, and never really committing to the process.
Mark however points out that all of us have each of these traits within us, it just depends on which one you choose to feed that determines the trader you will be.
Marks Says:-
“Even a good strategy will do you no good if you feed the wrecking ball”
Adopting the right mindset is highly important if you want to put the following chapters into use.
Mark drives home the importance of embracing the trading process, and points to a study of Violinists by a team of psychologists in Berlin.
They found that there was a direct correlation between the number of hours practiced and the level of ability. Notice here how the professionals and best performers accrued 10,000 hours by the age of twenty, down to teachers at around 4,500 hours.
Mark suggests that to become a great trader you need to put the hours in, specifically aiming at the constant learning, refining and examination of the process.
Mark says;-
“If you put your heart, soul, and mind into something, then why not do everything you can to succeed in a big way”
Once you adopt the right mindset and are willing to put the time and effort into the trading business, you need to create a plan. There are very few successful businesses that do not follow some form of strategy.
Mark says;
“Trading is a serious business with real money on the line. Why would you go into it without a well-thought-out plan of action? Yet, most people do”
Firstly, Mark defines his objective followed by a road map of how to achieve it.
The plan or strategy will be constantly evolving depending on the feedback you get from your data recording and analysis. But from the research and prior back testing, your rules should be objective and fixed until your information tells you otherwise.
You need a buy signal, a mechanism for entering the trade.
You need to establish your position size and consider how long you are willing to have the capital allocated to the position, and over what period of time.
Some form of in-trade risk management needs to be determined should the position turn against you. Where will your stop loss be positioned, will it be a trailing stop? Have the fundamentals changed?
Not forgetting, how will you sell to lock in profits? Will it be a fixed percentage? Will it be a certain chart pattern? All these considerations need to be predetermined in the plan ‘before’ placing a trade.
Once the trade is complete, it needs to be recorded for continual analysis and continual optimisation of the strategy. Once this process is mastered, you can reach your objective and become a king of your trading business.
Throughout the whole process, Mark emphasises the importance of capital preservation.
You must limit your losses on each individual position which will ultimately protect your trading account. If you risk too much on any individual position, you risk losing the game and ultimately your capital.
Having a plan will not only help protect your capital base, but encourage discipline and provide a foundation for continual analysis.
Mark says;
“By defining my parameters ahead of time, I establish a basis for knowing whether my plan is working or not”.
The next part of the video will be focused on Mark’s trading strategy, his theory, and how his super performance created huge profits.
Mark provides an order of importance before entering a trade, first he will define his maximum risk and place a stop loss accordingly.
Next, he looks to protect his bottom line after an initial move by raising the stop loss to break even.
Thereafter he protects his profits by using a trailing stop loss as the price increases.
Notice how each of these priorities are all based on either limiting the loss of the initial capital or limiting the loss of gained capital. The overall priority is therefore protecting capital no matter what stage the trade is in.
Mark says:-
“The moment the price hits the stop-loss, I sell the position without question. Once I’m out of the stock, I can then evaluate the situation with a clear head”
Arguably the most important statistic in trading is the risk reward ratio. Mark says you should always risk less than you expect to gain, and he gives a coin toss example to make the point.
Each coin toss has a 50% chance of either landing on heads or tails, but if someone offered to give you 10 cents for landing on heads and lose 5 cents for landing on tails, how many times would you want to toss the coin? The answer would be as much as you could.
Yet many new traders have the ratio in reverse, they might for example risk 10% to win 5%, and with a 50% strike rate you are destined to lose huge amounts of cash in the long term.
This simulator shows exactly how an account balance would look with this ‘new trader’ ratio.
Let’s call a 10% loss $100 and a 5% win $50, with a 50% strike rate.
If you took a trade every day, after 365 days you would have lost on average $13,000.
But if we flipped the ratio to risk 5%, looking to win 10%, with the same 50% strike rate, we would win on average over $6000 over the same period.
This provides a simple example behind the rationale Mark makes when he says that your reward must outweigh your risk. A rationale that is the foundation of Marks strategy and the reason why risk management is so important.
Mark uses a batting average when he describes the need to build in failure.
If your analysis suggests that you will lose 4 out of 5 swings, you have built in a failure expectation, which is good. However, you must also have an expectation of the return when you have a winning swing. In this example each losing swing has a value of minus 1, but the winning swing has a value of 5. Therefore, despite building in a failure rate of 80% you still have a positive expectation.
A common term used in the trading arena, which this theory also confirms, is to ‘keep your losses small and let your winners run’.
Mark says:-
“Maintain a positive expectancy, and you’re a winner. My results went from average to stellar when I finally made the choice that I was going to make every trade an intelligent risk/reward decision.”
Keeping a track of your progress (or batting average) is extremely important. Mark provides a chart of a typical monthly tracker he uses to keep score.
He records the average gain, the average loss and the strike rate.
The summary for the year provides the overall performance. In this example we can see the strike rate, the average gain and again the average loss. This provides the all-important win to loss ratio.
Mark says;
“Tracking this data will keep you honest and give you a true read on what’s happening within your trading. This is the discipline of champion traders”.
After keeping score and summarising the results, we can then dig deeper into the data to see if there are areas for improvement. For example, a distribution of results can be plotted into a bell curve which Mark provided here.
The goal is that the left-hand side of the curve should be short, with a low number of entries, whereas the right-hand side of the curve should be long with numerous entries. This shows that your strategy is cutting losers short and allowing your winners to run. The optimum approach.
Let’s move on to the strategy Mark uses which he calls the SEPA strategy.
Since 2010 Mark has been teaching his strategy in workshops to people across the globe, and as of May 2020, the United States Investing Championship has 11 of Marks students in the top 20.
There is no coincidence, the results we see here after just 5 months of the year are testament to what Mark teaches.
If I can, I’ll try to get a discounted link to his course and add the link below.
We dedicate the next portion of the video to the core aspects of the SEPA strategy.
Mark says;
“My starting point is always to have the “wind at my back.” That means I only buy stocks that are in long-term uptrends”.
Foundational to Marks approach is to trade with the trend, or as mark puts it ‘catching a wave’ like a surfer. Therefore, going with the tide, not against it. This aspect is crucial to understand before looking at specific buying criteria.
An area we have discussed in various other videos is that of ‘Stage Analysis’. And this is the first technical aspect of a chart Mark looks at.
He will only look for entries in the stage 2 portion of a charts cycle, the green area we see here.
Mark says;-
“During the other three stages (1, 3 and 4), you are either losing money or losing time.”
Mark raised an interesting fact from studies going back 100 years, where more than 95% of the biggest gaining stocks had the majority of their gains whilst in a stage 2 uptrend.
Trading great Paul Tudor Jones reinforces this foundational criterion, and when asked for his most important rule in trading, he said the price must be above the 200 day moving average and the moving average needed to be in an uptrend.
Paul Jones went on to say:-
“The whole trick to investing is: 'How do I keep from losing everything?' If you use the 200-day moving average rule, then you get out. You play defense, and you get out.”
We found some interesting analysis to add merit to the advice of Mark and Paul.
This chart from 1997 to 2018, gives comparison of a simple buy and hold strategy of the S&P 500 index, against a buy and sell moving average strategy using the same index.
The trigger to buy the index was when the price crossed above the 200 day moving average, and the investor switched to cash when the price crossed below the 200 day moving average.
It’s quite remarkable how the periods of drawdown were almost eliminated.
No wonder Mark prioritises this indicator prior to looking for entry points.
To further emphasise the importance, Mark points to Billionaire investor Bill Ackman, who doubled up on Valeant Pharmaceuticals despite the price dropping below the 200 day moving average. From the point it dropped below, the stock fell 92%.
A reminder also that even the most successful investors make mistakes.
Remember, swim with the tide, not against it.
A core concept of Marks strategy is the VCP or Volatility Contraction Pattern.
After a stage 2 uptrend is confirmed he then looks for a period of consolidation.
The chart here taken from the book demonstrates the pattern in action. Notice how the first stage of the pattern has a range in price (or volatility) of 28%, the 2nd stage has volatility of 16% and the final portion has volatility of 6%. This final portion has the tightest price movement and forms a base for an entry, also referred to as the pivot buy point.
The tight areas of consolidation are often accompanied by a decrease in volume.
Such a pattern represents a period of equilibrium where supply of the stock has diminished. Shortly after, the demand outweighs the lack of supply and we see an increase of volume and price.
In this example, the price later increased 465% in just 10 months.
Mark provides another great example, this time showing the chart of Netflix prior to a 525% increase in the following 21 months.
The price broke into a stage 2 uptrend after the 2008 lows, 4 months later it began the VCP pattern. Volume decreased, and after 3 periods of price consolidation the price broke out on high volume.
To conclude the VCP concept, Mark Says;
“Determining a correct VCP is the key to establishing the precise point and time to enter a stock. In virtually all the chart patterns I rely on, I’m looking for volatility to contract from left to right”.
An important aspect often overlooked by traders is that you do not need to swing for the stars to get super performance.
Mark points out that Its not easy swinging for stocks that return 40%, in perhaps 12 months, but it would be far more realistic to find 12 stocks each returning 10%.
The interesting point which adds to this message, is that the compounding of two 40% returns provide an overall return of 96%, whereas the compounding of twelve 10% returns provide a total return of 214%.
In theory it would make sense to swing for the more achievable returns which offer the highest compounded returns.
Marks says;
“Remember the lesson on time value: thanks to the power of compounding, if you can get a small but consistent return and repeat it over and over, it could be far more productive than trying for a bigger return that takes several months or even years to produce”.
Mark refers to this as opportunity cost.
To conclude.
Adopt the right mindset.
Commit the time to continuously improve.
Have a plan and strategy to achieve your objective.
Build in failure.
Keep a log of all your results and aim to win more than you lose by minimising your losses and letting your winners run.
Learn from those that not only teach but have a proven track record.
Trade with the trend, not against it. Look for opportunities in a stage two uptrend only, supported by the 200 day moving average.
Look for periods of price consolidation and reduced volume prior to looking for an entry.
And finally, be realistic with your returns and compound them regularly.
In summary, the book is a must read for any aspiring trader looking to follow in the footsteps of arguably the most highly regarded stock trader in our era. Easily achieving 5 stars.
Thanks for listening.