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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