Saturday, June 06, 2009

A Couple of Answers

This weekend I am going to discuss a couple of topics. The first deals with some trading issues raised by an email from a subscriber to one of the alerts and the second with a suggestion by a blog contributor that I provide some information about the differences between my two books, "Trade Your Way to Wealth" and "Smart Investors Money Machine". I'll provide the information about the books toward the end of the article.

This past week, on one of my subscription services, I sent an alert indicating that I was buying shares of a stock that had been trending up and that had just broken above a resistance. The sector was also trending up. The company was reducing debt and the stock had also recently been upgraded to "outperform." Those were salient facts of which I was aware when I bought the stock in my own account. After market hours, the company announced that it would be paying fairly generous dividends on certain classes of preferred shares. The following morning, the stock price fell. I received a couple of emails from subscribers evidencing concern evidently because I had not immediately pulled the plug as the stock began to fall.

One email labeled the trade as stupid because I bought at a high and failed to wait for a dip. Since I am still in the position as I am writing this article, I can't yet agree or disagree as to how bright or stupid it may have been. I do confess, however, that every trade I make isn't great, and I do have losers on occasion. As I write in the next paragraph, both entry and exit strategy for this trade were in place before entry. The facts of the market are that prices do go up and down and can reverse unexpectedly and on a dime. Until a price reverses down, we can't know what the high actually became. In this situation, I did not know that my entry would prove to be at a near term high until it was followed the next morning by a turn down. The entry could only be said to be at or near a high after the price dropped the following day. I should mention that my entry in the stock in the example was nowhere near the high for the year, but was near a recent short term high.

Actually I do like new highs in many situations, but that was not the reason for my entry in this trade. The specific reason for entry in the example was that the price had broken up through a resistance or ceiling. My exit strategy was to sell if and when the stock broke down through the uptrend line since I am aware that often a stock that breaks resistance may take some time to deal with that level. In both entry and exit, the strategy was controlled by a technical discipline -- i.e. enter on the break above resistance, exit on a break down through the trend. As with any strategy, the one I employed in this situation can result in a loss. Some trades lose; it is that simple. The best way I know to trade is to utilize a discipline that is designed to cut losses and let profits run. That was the idea in the example trade. The loss would be cut when the stock no longer remained in the uptrend, but as long as it was trending up, I would not exit in spite of normal fluctuations in price that do occur every day.

One readily apparent reason for the dip in the stock was the after-hours announcement of dividend payments. Whenever dividends are paid, cash is going out of the company and, theoretically, at least, the value of the company is reduced by the amount of the dividends paid. It is not unusual to see a stock price dip on such announcements only to be followed by another upswing. As long as the stock does not violate my pre-determined exit and remains in a trend in the direction I want, I want to avoid pulling the plug out of panic. All too often, it is panic that motivates action with retail traders and it is a significant enemy.

Some important lessons here, I suggest, are that 1) not all trades win; 2) day to day prices fluctuate, often as a result of unpredictable events; 3) one should have an exit strategy in place and stick to it; 4) trading should not be ruled by panic; and, 5) as traders we need to rely on something other than our emotions in pursuing our trading business.

Thanks to the blogger who asked me to explain the differences between my two books. First, I suspect that the new book, "Smart Investors Money Machine", is designed to and probably does have appeal to a broader audience. "Smart Investors Money Machine" is premised upon the idea that most of us have one major source of income -- our job, but that having more income would definitely be helpful. This book details many ways in which we can add additional sources of income to enhance our finances if we only chose to do so. Using examples of young unmarrieds, growing families, and folks near retirement, I show a wide variety of ways in which almost anyone can add more income each month. I discuss a wide array of devices and methods including (but not limited to) things as diverse as dividend capture, bonds, MLPs, writing covered calls on stock you already own, even reverse mortgages and annuities to show how people can add streams of income and I discuss how much (or how little) effort may be necessary to achieve a better quality of financial life. This is a book that can help nearly anyone, no matter how much or how little time they have and no matter how much or little money they have, to add some income to their lives by having money work for them instead of the other way around.

"Trade Your Way to Wealth", on the other hand, is more focused on people who have an interest in trading. In my view, trading should be treated as a business (whether full time or part time) in order to achieve success. "Trade Your Way to Wealth" sets out critical elements of a trader's business plan and takes the reader through a step-by-step process of how to create a personal business that is specific to his requirements. In "Trade Your Way to Wealth", I then set out at least 15 specific stock and option strategies that can help traders achieve large profits with varying levels of risk. Since I have seen so many traders fail to understand and appreciate the risks they are taking, I try to emphasize the risk in each strategy and show specific methods to reduce and, in some situations, even eliminate risk in trading. In addition to explaining the strategies in detail, I discuss the relative rewards each offers in relation to the risk the trader may undertake. This is a book that is meant to help people from novice to relatively experienced add to their trading knowledge.

by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
All Rights Reserved

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To comment on Bill's article click on the "comments" link below.


Anonymous said...

thank you, Bill. An essential element that appeals to me in reading your weekend newsletter is that I can feel your centered stance in your approach to trading. That engenders trust.

As I fine-tune my own stability in trading, I will gain trust in my own decision process. I suspect that any inclination to judge the decision of others will fade.

I subscribe to an option alert service, and indeed I have reacted to my losses in a couple of instances. Who is responsible for my trades? I am, no matter what. I must learn to apply my own knowledge and intuition and take responsibility for the alerts I elect to trade.

Anonymous said...

I had noticed that a lot of your Covered Call recomendations were on stocks that were at, or just slightly below, a new high. Unless I already own the stock or really want to own it, I avoid it.

I think it is risky to open a new position just to grab a few dollars by writing a call on it. I might make 5% on the contract and see the stock drop 6%. However, if it is a stock I've been wanting, or one I already own, I'll write the call even if the stock just hit a new high. If I wanted an income without risk I would go into the morturary business.

Grant Johnston

Bill Kraft, said...

William, I commend you for your sensible approach. As you note, each of us must be responsible for our own trades and our own trades only. Trading can be a difficult business and it is important to understand that each individual trader must make and be responsible for his own decisions even when getting information from services. No service, including mine, should be blindly followed in my view. Thanks for your comments.
Bill Kraft

Bill Kraft, said...

Hi Grant. I don't edit the covered call alert service. That is offered by the publisher, and I have absolutely nothing to do with it nor do I see the alerts on that service so you've got the wrong guy. Incidentally, there is an excellent book co-authored by Larry McMillan on writing covered calls. I think the findings based on the authors' research might genuinely surprise you.
Bill Kraft

Anonymous said...

I was surprised that someone would call your trade "stupid". As you note, there is no way to know (at the point that you were writing) whether the trade will be successful, i.e., profitable.

When you entered the trade, the percentage play was very substantially in your favor. The idea that everything should "favorably align" before taking a position is a point that you make in your book, your private tutoring, and in every presentation you make.

Indeed, it strikes me that a company that announces a dividend payment is a good purchase candidate. Company leaders have considered both the company's fiscal situation and market carefully and have decided that it is in the position to pay dividends. That's good news.

In addition, I am actually surprised that you would receive such a negative comment from anyone who has had any experience whatsoever trading. Does the writer believe that every position is always a winning one for a successful trader?

Your example, and the details about why you purchased your position AND why you continued holding it at the time of writing were -- are -- instructive and useful.

I trust that over time the person who wrote will come to understand that successful traders like you always: A) Consider the percentages; B) Never make a purchase without ensuring that the "percentage play" is substantially in their favor; and C) Don't stay in a trade if it violates their predetermined exit positions, even if that means taking loss.

I hope that the person who complained comes to understand that it's that kind of thinking -- and trading discipline -- that results in long-term success.

~ Nona

Bill Kraft, said...

Thanks, Nona. You have emphasized exactly the points I was trying to convey although, frankly, you did it better than I did.
Bill Kraft