Trading Rules

Don't Overallocate. Excessive overallocation(heretofore known as Jakob allocation after the infamous EMLX hoaxster with the EMLX SS margin call) eventually leads to capital destruction which will cut a trader's career short and send them back to get a real job. This is especially important for the short seller, who usually trades the more volatile hyped up stocks which are capable of doubling or tripling from the initial entry point. Just one incident like the ADSP rise that happened during 11/26/99 will be a greedy short seller's undoing. Allocating properly prevents one from getting emotionally tied to just one position. Short selling is inherently a riskier proposition from a margin call standpoint. Going out on margin to short sell securities adds more risk than going out on margin to go long. When stocks rise, the short seller not only has to deal with his equity declining, the value of his securities which are short rise causing the equity requirement to increase in the process. When stocks fall, the long trader loses equity but the equity requirement also shrinks due to the value of the secruities declining, thus easing the pain and making it easier to stay above the margin requirements. To add insult to injury, most brokerages have higher margin requirements for short positions compared to long positions. So what is the right level of allocation? In general, depending on what your trading size is, one should never exceed 25% of your trading capital on any one position, and preferably should not exceed 15% unless you have a heavenly short with the stars aligned perfectly.

Go after the little ones. Its easier to slay a baby pig rather than a gator. In almost all cases, if there are a few stocks in a certain industry which looks to be filled with hype and overvaluation, its generally best to go after the little one. They tend to fall the fastest and the most. For example, if you wanted to get short etailers, ETYS and VUSA would have been a much better short than AMZN. Stocks with strong institutional followings which have feasible business models with tremendous overvaluation and strong charts should generally be avoided on the short side. Stocks like JNPR, ARBA, and VRSN fit this profile. These stocks likely won't die and go back to reasonable valuations unless we get into a bear market. In addition, these gators follow broader market action too closely, which isn't exactly what you want in a short.

Think both long term and short term. There are numerous opportunities out there in the market, some which are short term in nature and others which are long term. Being able to capture both types of opportunities is important for both diversification purposes and to fully utilize one's capital. There are usually not enough short term trading opportunities to fully allocate oneself without overallocating in any one position. Thus, one needs to capitalize on the long-term downtrends or uptrends by keeping long-term GT0(Good to Zero) short positions and/or promising long positions(hard to find, IMO). Thus, when the markets are diving, the long-term GT0 positions start paying off when there aren't many short-term shorts popping up. And when the markets have casino fever, the short term opportunities arise to make up for any temporary rises in the GT0 positions. This balance also keeps one from holding too much cash for lack of short term trading opportunities. Its always good to at least remain somewhat (dis)invested in the market.

Familiarize yourself with the Wall Street analyst game. There are certain analysts and firms which are known for outright hype and insanity. Kaufman Bros' Vik Grover comes to mind, the guy who pushed junk like EGLO in January. The more ridiculous the price target, the more likely the analyst is a hypester. Henry Blodget's AMZN pump and subsequent dump is typical on Wall Street. And then there are the outright whores who are trying to win investment banking services with bullish calls on various pathetic companies. And numerous upgrades and reiterations of a company are a sure sign that either a secondary is near or insider dumping will soon commence in the stock. In fact, its best to fade most of the analyst drivel, doing the opposite of what they recommend, which means you will get a lot of short opportunities on artificial pumps coming out the horses' mouths.

Be on the lookout for stock patterns. Recognizing patterns in the stock market is one of the keys to trading. In fact, that's how I got started in my trading career. It was by realizing that stocks that had the highest percentage gains in one day tended to lose much of their gain in subsequent days. This still applies to a certain extent today, of course with the exception of buyouts, mergers, etc. Fading big afterhour stock rises is another pattern which was quite valuable in the early months of 2000. Patterns come and go, but if you keep a memory bank of what's happened in the past, mass psychology has a tendency to repeat itself, providing good trading opportunities.

More Trading Rules to follow as they come up in my head.

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