A few Non-Decision Strategies

May 23, 2007: 8:31 PM CST

If you are fed up with trying to guess the direction of the market and being wrong, try experimenting with these trading ideas:

  • Place stops on alternate sides of technical decision nodes

By this, I mean find a spot where the market reaches a known barrier and forces itself into the difference between two outcomes.

Place a buy stop slightly above the barrier and a sell short stop slightly below the barrier.

This occurs when the market touches a well-traveled (or well-established) trendline. Either price will penetrate it and continue further, or reverse off it and validate the trendline further. Either way, the market is unlikely to stay stagnant at that zone because so many trades are watching it.

What makes this strategy work is that people with positions are forced to take an action, either by their stops being triggered, or fresh entries being triggered. The cumulative effect often serves to trigger a ‘snowball rolling’ phenomenon where price will move stably in one direction, although the direction of penetration is often unknowable until the ‘snowball’ actually is in motion.

Rather than establish a position at the top of the mountain, relax and place entries on ‘both sides’ of the mountain so that you’re (almost) guaranteed to capture a small portion of the move.

By the way, exit stops would be the other side of the technical boundary should your entry be triggered. Profit targets will be set by your risk-tolerance (aggressive = large target and conservative = small target).

  • Use option spread strategies in an observed uptrend

By this, I mean find uptrending stocks and then wait for a pull-back (or not even wait for it if you are aggressive) and then sell a put either at the current strike or slightly below the current strike (reduced premium) and then hedge by buying the next lower put (if the stock is in an uptrend).

This is known as a “bull put” spread and is a credit spread. This allows you to collect the entire option premium when two of the three possibilities occur:

  1. The stock continues to rise in its established uptrend (you collect full premium)
  2. The stock pauses and consolidates (you still collect your full premium)
  3. (BONUS) The stock retraces (declines) a bit but not enough to cancel the premium you collected

What this means is that (technically) you could be wrong about your decision and still collect the full option premium!

Let’s say a stock is rising and is currently at $53. You sell a put option at $50 and buy a put option at $47.50 or $45 (this acts as a hedge). As long as the stock DOES NOT decline (or close) below $50 (actually, $50 minus the premium you collected) then you will collect the full premium. The stock could actually decline $3 and prove your initial thought wrong, but you still make money.

Obviously, you’ll make money if the stock closes at $53 (flatlines) or rises to $55. I am assuming you hold the spread until expiration Friday (Saturday).

I will let you ponder your thoughts on these strategies before going deeper.

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Being Right vs Making Money – A Quick Thought

May 22, 2007: 7:31 PM CST

I have read many times how it is more important to make money in the market rather than be right-on with your opinion of price action or market direction.

How many times have you excitedly told your friends or family what the market was going to do the next day? Or what direction a particular stock was going to go?

When you were right, didn’t it feel wonderful!? You’re finally getting it and people are respecting you and asking you for advice. So, naturally, your ego is gratified and people ask you more questions about the market. It feels wonderful.

But there’s a dramatic difference between calling the market and profiting from the market (taking money out of a trade).

Is it possible to be wrong and make money? Absolutely!

Is it possible to be right and lose money? You bet! I’ve done both many times. I suspect you have too.

What happens when your stock-picking (or market discerning) skills actually CAUSE you to lose money?

When you tie yourself down to an opinion, you introduce an element to your trading that is often deadly: The Need to be Right (or Directional Attachment)

As humans, we are conditioned that being right is better than being wrong, and our psychology/emotions are set-up to reinforce this condition. If your trading becomes structured or founded on being right all the time, you set yourself up for eventual total failure. You cannot be right all the time and sustain a career in trading – the earlier you realize this, the better off you’ll be.

There are many ways to make money in trading that do not involve calling a direction in a stock or the market at all. In fact, many traders who are successful have developed strategies that take advantage of these opportunities or conditions. Hedging is a great example of ‘directionless’ or ‘opinionless’ trading. Certain types of spreading strategies classify as directionless (whether with futures or options).

I will be discussing strategies soon that capitalize on this concept of making money rather than being right. Feel free to post your ideas or thoughts/experiences.

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30 Year Bond Price Breakdown

May 22, 2007: 6:01 PM CST

Recent price action confirms a downward break of consolidating trendlines on the 30 Year Bond futures (USM07), combined with a New Momentum Low, forecasting lower bond prices to come (and also higher bond yields).

Both outcomes (lower bond prices and subsequent higher yields) often isn’t the best scenario for the stock market, yet we’ll see if current action continues.

30-year-bond.jpg

(TradeStation)

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Swing Charts and Quirky GOOG Chart

May 21, 2007: 10:16 PM CST

Attached is the most recent “swing” charts and market-structure charts for the major indexes and also the quirky action I observed in Google today.

First, as a teaser, here is the Google Action (15m bars):

goog-quirk-may-21.jpg

Notice how price quickly rallied from $467 up to $480 before falling right back to $470. For pure day traders, this was heaven (provided you were on the right side – most likely not both ways) and for swing traders, this nailed both short stops and profit (long) stops most likely. Otherwise, it was just quirky!

Now for the index charts (weekly):

dow-may-21.jpg

nas-may-21.jpg

spx-may-21.jpg

On the Dow and the S&P 500, we are making (obvious) new price highs and new momentum highs, yet we are trading at the upper end of the Keltner Channel (which is indicative of strong trends).

The Nasdaq is making new price highs, but not new momentum highs which serves merely as a warning/caution (and no reason to short).

Notice the steepness of the angles (changes in angular momentum) of the S&P and the Dow. This recent upswing was far stronger (and quicker in duration) than the previous upswing.

The angular momentum in the Dow is particularly alarming – it’s as if we’ve reached new highs at break-neck speed and wonder where fresh buying power will arise to drive to newer highs.

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Link: MoneyCentral – Current Environment

May 20, 2007: 11:58 AM CST

Bill Fleckenstein recently published two bearish articles both on the US and Global economy.

Here are a few quotes I wanted to highlight:

From Ignoring the Lessons of 1929:

The economic and financial landscape of 2007 bears striking similarities to 1929. …business began deteriorating in the spring of 1929, though the partying in stocks lasted until the fall.

Meantime, the stock market is powered by gargantuan speculative forces. With every day and week that passes, speculation becomes that much more intense.

The deteriorating economy is a process that has a long way to go, even though Wall Street tries to throw a party every day that bad news does not absolutely pummel it into submission. No amount of hedge-fund and LBO speculation is going to make the average consumer whole again. Thus, I continue to see no way forward other than a recession and, at some point, a dislocation in the stock market.

From Bad News:  The Bubble is World-Wide:

Money printing by virtually every central bank on the planet has created a synchronized global boom, gobs of speculation and complete disregard for risk. This will make the downturn uglier.

(Due to Leveraged Buy-out Mania) companies that are doing poorly have seen their stock prices improve, relative to better-managed companies, because they’re more likely to be acquired.

In the perverse way of markets, folks will probably only worry about economic weakness after enough debt has been piled on corporate balance sheets to make the downturn even uglier than it would have been otherwise.

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