In recent weeks, I have received a number of emails from traders who have been suffering a high percentage of losses in their accounts and who wonder what they are doing wrong. In many cases the answer is that they are playing a market that does not exist right now. They have been buying stock only to see it fall in price. While some stocks will inevitably move up in bearish markets, most are going to fall. If we think about it, the markets would not be falling if most of the stocks in the market weren't also falling; that is why the indexes drop -- most of their components are dropping. When we buy stocks in a falling market, we are making a bet on an upturn rather than taking what the markets are willing to give.
I am writing this article on Monday, July 28th and, at the moment, 68% of the S&P 500 stocks are showing losses. If that is the case, why would I want to buy an S&P 500 stock? Isn't that the way to give the other guy the edge? In trading, as in life, there is no foolproof way to predict what will happen tomorrow. We can try to predict the future, and sometimes we will be right, but, truth be told, we have no control over the future. A rising market can turn on a dime as the result of some unexpected, unpredictable event or geo-political event. If we can't predict the future, how can we possibly succeed at trading?
The answer, I believe is to play the hand we are dealt rather than trying to play the hand we hope we may be dealt. In playing the hand we are dealt, we can try to get an edge by observing what the market is actually doing rather than what we think it might do. If, as has been the case, the markets are falling, why not make bearish plays instead of trying to force a play in the opposite direction? I once knew a successful trader who said: "Play it until it breaks." Pretty good advice in my opinion. If the markets are generally bearish, emphasize bearish plays until it turns. If 70% of stocks are going down, consider playing the downside by selling short, buying puts, entering bear call credit spreads, or any other bearish strategy to give yourself the edge by favoring the current direction. Will the market turn? Of course it will, but no one and no system can tell us when. Meanwhile, let's try to take what it is willing to give.
If I am looking for a directional play, I look to see the market direction and then I look at sectors that are moving the same way as the markets and then I look at individual stocks moving in the same direction as the sector. Once some candidates are identified, the next step, for me, is to see where my exit will be in the event I am wrong on the direction so that I can try to exit with as small a loss as possible. If I enter a directional play and it moves my way -- great. I'll just follow my exit strategy for the play and let it run. If it goes the wrong way, my initial exit should get me out with a relatively small loss so I can try again.
by Bill Kraft, Editor
Copyright 2008, Makin' Hay, Inc.
All Rights Reserved
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Please explain more on ..."entering bear call credit spreads, or any other bearish strategy to give yourself the edge by favoring the current direction."... Give examples also please.
“In trading, as in life, there is no foolproof way to predict what will happen tomorrow. We can try to predict the future, and sometimes we will be right, but, truth be told, we have no control over the future. A rising market can turn on a dime. In trading, as in life, there is no foolproof way to predict what will happen tomorrow. We can try to predict the future, and sometimes we will be right, but, truth be told, we have no control over the future. A rising market can turn on a dime”
Is one of the most honest I have ever heard from a professional trader and thank you for infusing a measure of reality an honesty in your newsletter/blog.
As it turns out…your assertion that you can not second guess the market was proved 100% accurate. You mention “I am writing this article on Monday, July 28th and, at the moment, 68% of the S&P 500 stocks are showing losses.” So perhaps the trend is moving down and “why not make bearish plays instead of trying to force a play in the opposite direction.” The following 2 days (Tuesday and Wednesday) the S&P500 moved up by almost 4%. So, I wonder how many short traders ‘betting’ on a market meltdown ended up losing money on Tuesday/Wednesday?
~I am an “Automated Process Investing” investor
Good advice, looking at direction of market, sector and individual stocks. thanks, Ben.
thanks for the info. in your article..playing the market that is at hand ..i believe, at this time we have already bottomed at 1200 on the s and p...there were over 1150 new lows on that day..now i see less than 200..not only that the bullish advisors are at a 5 year low.,as well as bearish advisors at a high level .in addition the short interest ratio is off the charts.. most people are predicting doom and gloom..i see these days as opportunities,if you have some available cash in the xlf..especially because they have been beaten down so much .buy small amounts of quality stocks at a time..there will come the time when a confirmed breakout to the upside will take place on tremendous volume.when the shorts are forced to cover..iam in the bullish camp,as i await..thank you..bob
Well, Martin, a bear call credit spread is a two legged position where the trader sells a lower strike call to bring in income and simultaneously buys a higher strike call with the same expiration for protection. Since the lower strike call will have a higher premium than the higher strike call, the trade is entered with a credit. As long as the stock price is below the strike price of the call that was sold at expiration and no adjustments have been made, the trader gets to keep the whole credit. Adjustments can be complex and are well beyond the scope of the Newsletter. I discuss these spreads in my book Trade Your Way to Wealth, and they will be examined in depth in my next book that is due out next year. A current example is a trade I entered a while back on the Diamonds (DIA) where I sold the Aug 116 calls and bought the Aug 117 calls for a combined credit before commissions of 25 cents a share. That would result in a 33% return on risk as long as I don't have to adjust and the DIA is below 116 at expiration.
Yup, Bess, only to turn back down by week's end. Thanks for your comments.
Bob, I am sure the market will turn bullish some day, and, for me, that will be the return to more bullish plays. So far, it hasn't. If we look at the trends, the major indexes are still downtrending and as while markets are moving down may ultimately lead to great profits, it may also see big losses first. Another saying for buying stock while a market is falling is "trying to catch a falling knife." In my own trading, I try to wait until the market at hand actually becomes bullish before going that way myself. Good trading!
At the office your book Trade Your Way To Wealth is quite popular.
I'm just getting into the 5th chapter and am wondering if when you talk about placing collars with options if it assumes that shares of a given stock are purchased along with the puts and calls?
Absolutely, Guy. When placing collars, I buy the stock, buy the protective puts and sell the calls at the same time to start. I should tell you the premiums discussed on page 88 are in error when I speak about the adjustments on GOOG, but the principles are accurate. I don't know how I messed up, but, again, there was a big profit in that trade and the principles are what is important. Glad the folks at the office are enjoying the book.
Thank you Bill,
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