Saturday, August 09, 2008

Standing Aside is a Strategy

Over the past several months, I have received a number of emails and heard from many traders how hard they consider the markets have been to trade. In talking to others, I have heard many sad tales about significant losses. In a sense, these complaints echo those I heard when the markets turned south in 2000. I always try to ask these folks what they are doing in the markets and the answer most often is that they are buying stock or taking bullish positions. The problem, of course, is that the markets have been decidedly bearish in general and unless a trader was focusing on oil and energy, the chances for success weren't very good. Markets are going down because most of the stocks in that market are going down so why be surprised that we lose if we are playing against the market?

I am convinced that most people are bullish by nature or training. The consensus, wrong though it may be, seems to be that we need to buy stock or directional options to make money in the markets. I once knew a man who literally made millions in a few short years trading the markets only to lose it all when the tech bubble burst. Of course, there were many reasons why he went broke including failure to manage money and failure to discipline his trading, but most importantly, he refused to do anything but continue to make bullish plays as the market turned more and more bearish.

It is fine to be bullish, but my suggestion is that if you are bullish by nature and only like to make bullish plays, then stand aside when the market turns bearish. Going to cash and just watching when a market is bearish is a lot better than watching our assets melt away as we try to pick the bottom.

There are many ways to make money in bearish and sideways markets. I discuss several of those ways in my book, "Trade Your Way to Wealth". In Appendix D to that book, for example, I specifically set out bearish and neutral strategies along with the bullish and describe things like their relative risk, capital required, time likely to be in the position, potential rewards, etc. However, just because those strategies are available doesn't mean everyone knows them or knows how to use them. If you are among those whose bent is bullish and who neither knows nor cares to use bearish strategies, the best strategy is probably to stand aside until the bull returns.

Awaiting the return of the bull requires patience and many would-be traders are very impatient to say the least. Patience, though, is a great asset for a trader. Rather than rushing in to catch the falling knife as so many do, how about waiting until a bullish move is confirmed and then invest. That certainly seems better to me than watching the portfolio race toward zero.

As the paid subscribers are aware, I have been addressing the bearishness for months now, and, in the bullish services have sent out many fewer alerts than when the markets were moving up. My efforts for the bullish services have been to try to find the occasional position that looks like it has reversed up and get in with a reasonably tight stop in case I am wrong on the direction. In general, though, I have spent much more time "standing aside" than I normally would in a bullish market. During the same period, the Option Trader service has had more trades simply because of the ability to make bearish and neutral trades.

The markets or a stock can only go one of three ways -- up, down, or sideways -- and there are strategies for each, but we have one other option available when we are unconvinced about direction or just uncomfortable with a market; we can stand aside and wait until we find the conditions we like. It may take time and require patience, but it is better than the alternative.

by Bill Kraft, Editor
Copyright 2008, Makin' Hay, Inc.
All Rights Reserved

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Unknown said...

Bill, great article. I allways look forward to your weekly e-mails. Very informative and I like the way that you think;tons of knowledge with a heavy dose of common since.
I'm just getting my feet wet as an option trader. My plan is to develop my skills well enough to do it full time. The markets are my passion in life and I realy have a burning desire to devote all of energy toward it.
Thank you,
Brian Hunt

Anonymous said...

I don't know how you describe bullish, but if you mean the vehicle you are trading is set to go up, by looking at its chart, then buying a put is a bullish play. The charts on options look just like charts on stocks, and up means up. So all you bulls out there, keep being bullish, just buy puts!!! Go long the put, not long the stock.

Anonymous said...

You are so right, Bill. I have suffered losses in this "oil up-everything else down" seesaw. in spite of working really hard at it. I use the double inverse ETF's a lot, but they move so violently that I sometimes can't move fast enough.
Got caught with some Friday! With my timing, I'll go all cash and miss the recovery! Fortunately, I have money with a market neutral hedge fund that has manuevered its way thu
this market very nicely, but the mere term "hedge fund" makes most of us bite our nails, so I don't have everything there.

Anonymous said...

Thanks for confirming what I have slowly come to understand. Little guys like me who were taught the market is for long term investors(I have been in the "market" for 15 years) have lost our shirt. I needed to hear your "standding aside" info much earlier. Thanks for carring. Didn't realize anyone did anymore.

Unknown said...

Good article and responses here, especially "anonymous @ 2:49" who suggested being bullish on puts. There are perma-bulls and perma-bears, but I think that we need to maintain a detached view that does not care. I heard a caller on the radio the other day say that he only made money by going short, so he was losing money during this rally. I wanted to call in and suggest that he should short the inverse ETFs. Maybe the biggest key is money management as Bill mentioned. Make sure that each position fits and has a purpose in your portfolio and that it is properly sized so that no one loss will do great harm to your capital. I tend to hedge with options any trades (long or short) that I hold overnight, as anything can happen. The tools available now are wonderful for smaller investors like us.

Bill Kraft, said...

Thanks, Brian. Trading became my passion fairly late in life, but it has been very rewarding. It can be simple, but it definitely isn't easy. As you are no doubt finding out, it requires great commitment to discipline and study.
Good trading.
Bill Kraft

Bill Kraft, said...

Anonymous, buying puts is definitely NOT bullish. Bullish means the markets and/or stocks are going up. When one buys a put, he is looking for the market to go down. Put owners make money when the stock moves down, not up. We buy puts when things look bearish.
Bill Kraft

Bill Kraft, said...

Thanks, Anonymous, I'm glad the "standing aside" article helped light a light.
Bill Kraft

Bill Kraft, said...

Those are some important thoughts and considerations. Thanks, Tim.
Bill Kraft

Anonymous said...

As always Bill, great article and I echo Brian’s message; “I always look forward to your weekly e-mails. Very informative…”

I think the reason many traders consistently take a bullish position is because they are using an investor’s mindset to do trading. Let me explain what I mean. Looking at the long-term performance of the markets it’s easy to see why everyone should be bullish (for the long term). Perfect attitude for a long-term buy and hold investor…not so much for a short-term “swing” or “position” trader!

When folks are trading and taking short term positions, they should definitely be using strategies that will match up with the current trend of the markets. Most recently, as you state Bill, this has been down. And bearish strategies (buying puts, selling calls, shorting shares, buying ‘ultra short’ ETFs) would be the prudent way to go…or is it?

Last week the markets did an amazing thing, they continued a short-term trend of higher highs and higher lows (many would claim this is a very bullish pattern). If you look at an S&P 500 chart, you will see that on July 15 marked a POTENTIAL market “reversal.” And since then, the bellwether 500 index has moved up 6.7%. Here is the dilemma: have the markets really reversed? Or is this just a “suckers rally” in a longer term bear market?

Using a bearish strategy now could burn a lot of traders. Then again, people may get into the fray on the bullish side just to see the markets turn down again.

There is no easy ‘foolproof’ technique to second guess the markets direction this is why I use an automated process investing approach that allows me to mitigate risk and avoid the whipsaw effects of such a volatile and unpredictable market.

Christopher Cerda
Retail Investor and “Serious Money Investing” Author

jerry said...

Just got done reading your book "Trade your way to wealth" for the 2nd time. Although I already have 2 different online discount broker accounts, you mention in your book your Discount broker which pretty much does it all. Would you let us know which Online discount broker you use? Thanks

Bill Kraft, said...

Jerry, it would be inappropriate for me to recommend a broker so please do not take the fact that I use OptionsXpress as my online broker as a recommendation. Everyone should investigate their potential broker themselves to make sure the broker offers the services the client wants at a price that is acceptable. OptionsXpress does not have the cheapest commissions, for example, but their service has been quite good for me. Thanks for writing.
Bill Kraft