Part B – Surviving and Prospering
Neil A Costa
The trading and investment industry is made up of, on the whole, fine honest and ethical people. As with any industry, however, there are those who try to prey on people using get-rich-quick marketing and sales tactics.
It is the aim of this article to examine some of the tactics that are used to separate decent budding analysts, traders and investors from their money. Awareness is the key to surviving and prospering in the Temple of Boom.
Black Box Computer Programs
The modern Temple of Boom has automated gurus. These are called black box computer programs (or the black box component of grey box computer programs). These programs are termed ‘black box’ as you are never told what generates the buy, sell and hold signals displayed by the software.
The main reason usually given for the secrecy is that the software is supposedly “far too profitable” to make public the basis of the system. The real reason is often that the system is embarrassingly simple, using simple oscillator or moving average crossovers, and thus would not justify the huge price charged. Another, more worrying reason, is that the system may have been curve fitted for a particular market.
A system that has been curve fitted for a particular market over a period of time will look immensely profitable. The problem is that the more a system has been curve fitted, the less likely it is to achieve similar results in the future. Good trading systems should give reasonably consistent results when used to trade liquid markets.
Unscrupulous system designers can take a particular market and have a computer randomly test, for example, the profitability of moving average crossovers until a combination is discovered which gives spectacular returns. Few traders understand the checks and balances that are incorporated into professional trading system design. Most assume that such spectacular past performance will continue in the future.
Black box computer systems usually sell for many thousands of dollars, and the people marketing such systems often use a range of high pressure tactics to convince trading novices that they can, indeed, get rich quick. These tactics include:
“You Must Buy Now, or You Will Miss Out On…”
One tactic used is to offer some seemingly major incentive that will result in the prospective client buying the software sooner, rather than later. Unethical sales people do not want to give clients time to carry out consumer checks.
Giving people an incentive to buy sooner, rather than later, is an ethical marketing tactic – however you should become suspicious if the time period is too short (a few days) or if the ‘value’ of the incentive to buy now, is overly generous. A too generous incentive would suggest that the product is overpriced.
The $x,000 Guarantee
From time to time software will be sold which appears to have a guarantee whereby the purchaser need only pay half of the cost up front, and the balance only after he or she has made a specified (usually large) sum of money trading with the software.
It rarely occurs to the purchaser that the real cost of the software is the amount he or she paid up front, and that the idea of paying the balance is really just a marketing gimmick.
The System Makes Huge Returns
Many black box systems are marketed on the basis of the huge returns that they will supposedly make the purchaser. These returns are often based on hypothetical results.
- The system has been curve fitted. Ask the question “is the system consistently profitable on a range of markets and time frames?”
- The effects of large numbers of people taking the same trade. Some markets are relatively illiquid and so a large number of people buying or selling simultaneously could adversely affect the buy and sell prices. Assume that the system has many traders. Can the daily volume handle a large, and increasing, number of traders?
- The system’s vital statistics, tested over at least 30 completed trades, may have one or more major flaws:
- What is the size of the average winning trade and the average losing trade? These are the only two statistics that some people examine – these two, on their own, are of little value.
- What is the size of the average trade (total profit minus total loss, the difference divided by the number of trades). By how much does this fall when transaction costs are deducted?
- What is the percentage of winning trades? The system can still be profitable if this is below 50 percent, if the size of the average winning trade is greater than the size of the average losing trade.
- Peak to trough drawdowns – by what percentage would your trading account have fallen after the system’s worst losing streak?
- What is the largest number of losing trades in a row (regardless of the amount of the losses)? This raises a key psychological issue about black box systems – just how many times will you be prepared to lose money, on consecutive trades, when you have no idea why the system is making the losses? For most people, the limit is three consecutive losses. This is possibly the main reason why some people do not make money trading such a system. Every system will have three losing trades in a row if you trade it for long enough!
- What is the influence of the most profitable trade(s)? A system which gave a ‘short sell’ signal at the time of the 1987 stock market crash could look extremely profitable on paper, yet be a losing system if that one spectacular trade were removed from the test results.)
- What is the average length of a trade?
- There are other more complex statistics that are used to evaluate trading systems. There is not much point in worrying about these other measures if you do not get satisfactory results from the above measures.
- How disciplined the trader is. A trader who does not have sufficient discipline to trade a system according to its signals cannot blame the system for his or her poor trading results.
Why Do You Sell the System – Why Not Just Trade It?
If a black box system is marketed on the basis of its immense profitability, ask the question “If your system is so immensely profitable, why are you earning your living by being a commission sales person? Why don’t you just trade the system and make your fortune the easy way?” If the answer is “because I like to help people”, confirm that the person does, in fact, have a halo.
Is It Worth Such a High Price?
The sellers of high-priced black box trading systems usually ‘justify’ the price in terms of the system’s huge profit potential and/or because of the data and training that is included in the price. Ask the vendor to send you a copy of the system’s track record. Also, ask for a breakdown of the cost of what you are buying, and any ongoing costs. You may find that you are paying many times the going rate for data, for example.
I Ran the Usual Consumer Checks and They Came Up With Nothing
Good – it is wise to check with State and Territory consumer affairs departments, and with the U.S. Securities and Exchange Commission (SEC), but the fact that these organizations have not received any complaints is not sufficient justification, on its own, to buy the product.
The Person Selling the System is a Member of the Market Technicians Association
If the promoter of the system claims to be a member of the Market Technicians Association, ask long-standing and respected Market Technicians Association members if they have heard of the person. If they have not, his or her membership could be simply an attempt to buy some credibility.
All temples have their high priests, and the temple of boom is no exception. The high priests of the Temple of Boom are the forecasters. These are men and women who can forecast market movements – for a price. Forecasters sell their forecasts for large sums of money, and/or conduct high price courses where they reveal their secret methods.
Why can forecasters attract such high fees? They can do so because of successful forecast(s) that they have made in the past.
It is not uncommon to hear of forecasters who claim an 80 percent or even 90 percent forecasting accuracy. Just what does this mean? They will rarely tell you! The public assumes that these people can predict the date, and possibly the price, of eight or nine out of the next ten major tops and bottoms for a given market.
If people are prepared to make such claims in marketing materials, they should be able to clearly define what they mean by the forecasting accuracy figures they claim, and produce an independently audited track record. If they will not do this, think twice about paying for the forecast, or for the secret to conducting such forecasts.
I believe that the most effective consumer check is to talk to someone you know and trust, and who is in a position to comment on the value for money that you are likely to receive. There is little point in asking an unknown vendor for the names of clients because, at best, you will receive the contact details of a satisfied client and at worst, you will find yourself talking to someone who receives a secret commission for convincing you to purchase the product.
Educational Courses and Seminars
When it comes to trading and investment, reinventing the wheel can be very expensive – both in terms of trading losses, and in terms of opportunity costs. High quality courses and seminars, conducted by experienced, reputable people, can help analysts and traders save time and money.
There are excellent courses and seminars available to assist technical analysts and traders. These range from a comprehensive coverage of technical analysis in general, such as the highly respected courses conducted by the Securities Institute of Australia, to seminars on specific topics such as ‘The Fundamentals of Candlestick Charting’.
Again, the best way to ascertain if a course or seminar could be of value to you is to ask people you know and trust. Online Forums , Forums (such as Market Technicians Association meetings) are a good place to meet people who do not have a vested interest and ask them about courses, seminars, or any technical analysis, trading or investment product or service you are thinking of purchasing.
In 1919, the late Charles Ponzi created what is often referred to as the ‘granddaddy of investment scams’. He offered investors what appeared to be the perfect investment. Charles Ponzi was the original high priest of the Temple of Boom.
Ponzi floated a company called the Securities Exchange Company. This name was conveniently close to the name of the United States regulatory body, the Securities and Exchange Commission.
Ponzi’s scheme was to issue promissory notes paying 50 percent interest in 90 days. To help silence the sceptics, he repaid the notes after only 45 days. The scheme was sustainable as long as Ponzi could use the money being paid for promissory notes on one day, to cover the current interest bill and repayments due the next day.
Ponzi made US$15 million in 18 months. He died in jail.
A similar scheme operated in Australia in the 1990s. It offered investors 50 percent interest, while paying its agents a 50 percent commission. The scheme owed more than AUD$150 million. ASIC – Australian Securities and Investments Commission closed it down in 1998.
Many variations on the Ponzi Scheme exist. A common one involves people buying a kit, making copies of it, and then selling the copies to 10 others. These people then repeat the process. Such schemes are illegal in Australia if they do not sell a real product.
The Advisory Newsletter Scam
In 1993 a United States newsletter publisher advised his 100,000 subscribers about his monthly market timing model. He proudly announced that it had turned US$10,000 into US$39 million in just 11 years. This represented a return of 100 percent per annum.
Does this sound too good to be true? It was – he had made up the figures.
The Great Forecasting Scam
Imagine receiving a letter claiming that gold will undergo a big price rise – and it subsequently did. You then receive a similar letter saying that platinum will have a big, highly profitable fall – and it subsequently did. The author of the letter would no doubt have your undivided attention after three correct, and potentially enormously profitable, forecasts.
After you have received three successful forecasts, you are then asked to pay, say, $1,000 for a newsletter subscription so you can continue to receive such forecasts. Alternatively, you could be offered the opportunity to send $50,000 so that your money could be traded for you using the forecasts.
What the victims of this scam do not understand is how the ‘forecasts’ were made:
- Gold: Letters were sent to 100,000 people on a ‘suckers’ list – a mailing list of people who have responded to scams in the past.
- 50,000 of these people were sent a letter saying that gold would have a big rise.
- The other 50,000 of these people were told that gold would have a big fall.
- Platinum: Letters were sent to the 50,000 people who received the correct prediction about the next move in gold prices.
- 25,000 were sent a letter saying that platinum will have a big rise.
- The other 25,000 were sent a letter saying that platinum will have a big fall.
… and so on.
The Boiler Room
A boiler room scam involves the con artist telephoning you and encouraging you to buy a particular stock that is about to have a huge price rise. The stock is usually listed on a stock exchange in another country. The con artist offers to send you a free newsletter and to establish an account for you with his or her broker.
What they do not tell you is that they have already purchased large quantities of the stock and are now using aggressive marketing tactics to get others to buy the stock and thus push the stock’s price up. They then sell the stock at an inflated price to the last group of buyers.
Market manipulation of this kind is illegal in most countries. When I received my telephone call, it was supposedly from Spain. Most originate from Hong Kong, Singapore or the Philippines. I may have been a little more polite if I had not been telephoned at 2.00am!
You may ask, “Why did they telephone you?” The answer is that over the last 20 years I have purchased more than $100,000 worth of technical analysis/trading/investment books, courses and newsletters. Some less-than-ethical vendors hire or sell their mailing lists of people who have already indicated an interest in trading or investment, to con artists.
Today many con artists use the Internet to market their latest scam. This is because they can email literally hundreds of thousands of people for next to no cost, in an instant.
Be very careful when you request financial newsletters by email. If you are asked: “would you like to receive similar information from other suppliers” always say “no” or you are giving them permission to bombard you without mercy. Do not assume that you can ‘unsubscribe’, as doing this confirms that your email address is a current and valid address. You will be unsubscribed from that publication, but then sent many new publications, in accordance with your initial request.
If you wish to receive such information from unknown sources, use a free email account. Then, if the account gets out of control, you can simply note the publications you want to continue to receive, let the account expire, and open a new account.
If the person who owns the email list has a good reputation, ensure that he or she states that his or her email address list is never sold, hired or lent to anyone else.
Examples of emails that one receives include:
“Do you have a Yen to be a millionaire? 100% in less than 90 days! Unique strategy trading the international currency markets… Example: A $5,000 investment in the yen vs the dollar, properly positioned on 08/18/99 could have returned $15,184.45 on 09/19/99.” This email had an email address in China.
Some of the email promises make Ponzi look mean!
Internet Chat Sites and Bulletin Boards
Internet chat sites and bulletin boards are free, and very popular. Unfortunately, many messages are not what they appear to be.
People post messages under a range of assumed names, using free email addresses. They can be:
- Paid promoters of a particular stock, system or tip sheet.
- Someone paid to make negative remarks about a company, product or individual.
- Someone who gives the impression that he or she is highly successful, when the opposite is true. These empty vessels usually make the most sound!
Professional traders and investors do not take such sites seriously.
I define a ‘tip sheet’ as a publication that gives buy, sell and hold recommendations. There is a wide range of tip sheets available today. Some have long established reputations; others have only recently surfaced.
Before paying money for a tip sheet, there are some basic questions that you should answer:
- Why do I really want to trade? If the only reason is to make good, consistent trading profits, consider investing your money in a well-known fund with a good track record. You should only consider trading for yourself if you believe that you can achieve a return that is consistently higher than the average fund’s return.
- If you are going to follow a tip sheet, the tipster must have a track record over several years that is superior to that of an average fund. You will, however, learn very little by mindlessly following someone else’s recommendations.
If you are determined to follow the recommendations of little-known tipsters:
- Satisfy yourself that their track record is good. Nothing succeeds like success, so it is in their interests to publish their full track record on the Internet for everyone to see.
- Paper trade the tips for at least 30 trades. Make sure that you take into account the full transaction costs that will apply – particularly for shorter-term trading.
- If, after paper trading the tips, you feel comfortable with trading this way, and if the tips have proven to be profitable, consider trading the tips. You must follow all of the tips if you are to give it a fair trial.
- Continue to increase your technical analysis and trading knowledge. If you are going to trade, why not make it a goal to learn to make your own trading decisions – after all, that is what the tipster did!
Tactics Used in the Temple of Boom
A shonky operator will often attempt to:
- Establish a ‘Mr Nice Guy’ image.
- Play on your vulnerability – your greed, insecurity, curiosity, or desire to succeed.
- Play on your self-interest and ignorance.
- Imply that he or she is acting with the backing of a government or a reputable organization.
- Utter words which are carefully scripted.
- Rely heavily on statistics, quotations, testimonials, ‘success’ stories and endorsements.
- Make you want to join an exclusive group. “Everyone’s doing it.”
- Make the outlay sound incredibly small compared with the likely enormous rewards.
- Make you want to act with a sense of urgency (the fear of missing out).
- Use buzzwords such as ‘strictly limited’, ‘best in the world’, ‘low risk’, ‘government endorsed’, ‘secret’, ‘free’, ‘guaranteed’…
So How Can You Survive and Prosper in the Temple of Boom?
- Know precisely with whom you are dealing.
- Have information sent to a post office box if you have never heard of the individual or the company.
- Search the SEC, ASIC – Australian Securities and Investments Commission database.
- Check with your local consumer affairs department.
- Increase your consumer awareness.
The large number of serious inquiries was of great concern.
ASIC – Australian Securities and Investments Commission publishes ‘The Gull Awards’ which it states are “true stories of money, deceit and gullibility”. Some classics include the sale of land on Mars, but for “cash only”, and the extraction of pure water from hogs effluent (a good reason for drinking beer).
- One of the best checks is a referral from a trusted friend. Treat referrals from unknown vendors with caution.
- Give preference to companies or individuals who offer a money-back guarantee. Few would offer a genuine guarantee if they did not have total confidence in their product or service.
- If in doubt, do not act. The pressure placed on you to buy is usually in direct proportion to the degree of shonkiness.
- If it sounds too good to be true, it probably is.
Trading and investing using technical analysis can be very rewarding and satisfying undertakings. As with most undertakings, the keys to success are gained through education, experience and of most importance, taking responsibility for one’s own actions.
One key to prospering in the Temple of Boom is to avoid making major, avoidable mistakes. Increased awareness is an inexpensive and very effective way of doing this.