Comment on News Reactions

May 25, 2007: 9:04 AM CST

Investors certainly are skittish lately.  One of the biggest drags on the economy – many economists say – is the declining housing market and its effects on the American consumer.

With stock prices still advancing, bad economic news has had little effect on the general market, at least not to the extent expected.

We recently learned that new home sales surged the greatest percent in 14 years, indicating that the housing market may actually be stronger than expected, potentially removing this ‘drag’ on the economy and the consumer.  When the report was released, what did the market do?

The market sold-off dramatically after the initial report was digested.  What reason did the pundits give for this sell-off?  Many said that the fact that the economy is doing better than expected means the Federal Reserve will no longer consider lowering rates to ease the economy.

It was another classic “Good news is bad news” or “expect the unexpected” scneario that is so common to traders in the market.  Great news causes harsh sell-offs and dismal news causes rallies.  The reason is often attributed to interest rates, yet various forces (including stop-orders and nervous investors) help fuel the price movements.

Always keep both eyes open and question everything and remember that there is only one truth:  price.

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Trading for the Directionally Challenged

May 24, 2007: 7:18 PM CST

As mentioned in previous posts, you don’t have to be right to make money. In fact, the need to be right can actually cost you money!

If you find yourself frustrated by incorrectly guessing the market or a stock’s direction, give up!  No, I don’t mean quit trading.  Try a different strategy.  Stop trying to guess.

Look back over your past trading results and identify how much work goes into selecting trade candidates and managing them with good money management.  Money management is key to successful investment and trading, almost independent of your trade entry strategies.

Why not simplify the process by diversifying into some non-directional strategies?  There are various books – especially on options – that discuss non-directional options strategies such as the spread techniques, the condor, and the butterfly.

I don’t plan to discuss those here, but merely draw your attention to the fact that they do exist and some traders make their entire livelihood by using these strategies month in and month out while maintaining a day job – you can too.

You don’t have to trade every day and you don’t have to be right to earn a comfortable return on your investment or trading capital.  In trading, work smarter with less risk than harder with more risk.  Achieve your goals slowly, rather than seeking to make 100% your first year (or some other insane figure).

Seek spots where the market MUST do one of two actions and see if establishing a position at that zone or level would be appropriate for a trade.   The goal of course is to maximize price movement in the minimal amount of time with money at risk.  Realize that large moves originate out of low-volatility conditions, and often confound the majority (which, perversely, is what sustains many trends at their birth).

Play around and discover new techniques and observations and make them your own.  Chances are you will have more success with an idea or concept that you understand vs one you read in a singular book or heard at a conference/seminar.  Studying the market is a personal endeavor and taps all your skills and experiences.

Set achievable goals, monitor your progress, and trade for experience – not for money.  Also, stop trying to control the market.  You only have control over yourself.

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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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