Defense Wins
Stockscores.com Perspectives for the week ending October 12, 2008
| Get the StockSchool Pro Free |
DisnatDirect named the number one Canadian brokerage for Traders by Surviscor! Open and Fund a brokerage account with DisnatDirect and receive the StockSchool Pro home study course free, including special Pro level access through the DisnatDirect client website. Offer only available to Canadian residents. For information, click here
|
|
In this week's issue:
This past week saw already significant losses get even more significant as major market indexes dropped around 15%. For many investors, it can take two years to make back the losses of just this one week and I am sure that many of you are feeling great frustration with what is happening. This market is unlike any I have ever seen but I have encountered rough times before and learned from them. I find myself enjoying pretty decent gains this month because I follow some simple rules that ensure I am on the right side of these very pessimistic conditions. This week, I share a list of 10 ideas and rules that I think are particularly applicable to what we see now. If you have been reading this newsletter for some time, nothing here should be new but hopefully it helps everyone find better methods for managing their money.
1. Stocks Can Go Down To Zero - I often hear investors tell me that they bought a stock because it had fallen so far already, it just had to bounce back. After all, stocks can not go down forever. Yes, that is true, stocks can only go down to zero and then they stop, but a stock that does go to zero is eternally gone. Do not buy something because it appears to be on sale, you should only buy something if it is more likely to go up than down.
2. Never Average Down - averaging down is the practice of buying more of a stock you are losing on as the price falls. Investment advisors sometimes refer to this as dollar cost averaging, but basically, it is all about buying more of a stock that has proven your original decision wrong. If you were betting on a horse that was in last place half way down the back straight of the Kentucky Derby, would you go back to the wager window and add more to your bet if you were able to? Of course not! Buying more when you are wrong is no different, so just wait until the market proves you right and average up.
3. Trade With Who Is In Control - next time you are in an airport, hop on one of those moving sidewalks that speeds you to the gate. When you get off, turn around and hop back on but this time, going against the traffic to understand what it is like trying to trade against the momentum of the market. Yes, it is possible but it sure is a lot harder than going with the flow. The market is no different; you will always have an easier time if you select strategies that are appropriate for the market condition. To understand whether the buyers are in control or the sellers, look at a chart of the stock or market index. If the tops are falling, the sellers are in control. If the bottoms are rising, the buyers are in control. So long as you can draw a line on the chart with a ruler, you can do this analysis and save yourself from a lot of difficulty.
4. Don't Apply Logic - many investors make the mistake of using logic to make their trading decisions. The market will do a lot of things that do not make any sense because the market has information that you don't have. A stock that "should" be going higher may not because a large shareholder has learned that there are problems that the general public does not know about. Or perhaps a large shareholder has a liquidity problem and has to sell stock whether they like it or not. You can not argue with what the market does and you will never convince the market that it is wrong. You just have to do what the market tells you to do.
5. Don't Take More Risk Than You Are Comfortable With - the great enemy of every investor is emotion. It makes us break our rules and lose our discipline. We are emotional because we have an attachment to money that we must learn to minimize if we are going to have a chance of beating the market. The first step toward that goal is to find comfort in the risks that you take. If your exposure to financial loss is too great, you will break the rules and forget your discipline because you don't want to feel the pain of the loss. If all you are facing is a manageable amount of discomfort, you are more likely to trade well.
6. Markets Predict, Not React - the market is a leading indicator for the economy; it tends to move at least six months early. This means you can not look at the world around you and use what you see to make trading decisions. Since the market looks ahead, so too must you and think about what will happen in the future instead of what has already happened.
7. Diversification Does Not Mitigate Risk - this market is a perfect example of how you can not diversify away risk. An investor with money in bonds, commodities, industrials, technology and banking is feeling losses in all areas. The best way to manage risk is to limit losses. If the market proves you wrong on a decision, get out and take the small loss. Never let small losses grow in to big ones.
8. The Market Never Lies - all markets express the opinions of those who trade it and the wisdom of the crowd is far smarter than you or I can ever be. If you learn how to read the true message of the market, you can make money by doing what it tells you to do. If, instead, you try to outsmart the market, you will likely get your ego delivered to you in the form of debits to your trading account. Do you think you are smarter than thousands of people?
9. Everyone is Smart in a Bull Market - riding a trend is the best way to make money, but many investors confuse their trend timing with investment intelligence. The truly good traders are those that can beat the market in all market conditions. Don't fall in to a false sense of security if you make money while everything is going up because you are likely to give it all back. For most, profits in the market are just short term loans.
10. Leverage is a Double Edged Sword - all of the problems that we are seeing in the market and the economy right now are because of leverage. Yes, you can improve your return if you borrow money to make money, but always remember that you can also increase the loss potential if the market goes against you. If you use leverage, it is even more important to manage risk and have discipline. If you don't understand the true risk that the leverage of margin, options and other derivatives provide, don't trade them.
Back To Top
I continue to think that the best way to trade this market is to play the bounce back which will eventually come and when it does those who catch it right should enjoy very nice gains. The problem with trying to buy the bounce is that it is a more difficult thing to predict and so the probability of success is less than other strategies.
That means you may not get it right the first time, but because the reward potential is a very nice multiple to the risk, even if you have a few losses on trying to find the bounce, you should do well so long as you have the discipline to take the loss when the market tells you to.
This week, I rant the Dead Cat Bounce strategy to uncover Exchange Traded Funds that have had emotional sell offs, that are far below their downward trend lines, hit a new low on Friday but came back to close strong and above their open. Here are a couple of picks:
Back To Top
1. UYG
This is the second time that I have featured UYG, the first time the trade did not work and it was stopped out. I feature it again because I want to emphasize that we can never predict what will happen, we can only manage risk and how we adapt to what is happening. Friday saw a good comeback from early weakness and this ETF closed up for the day and above its open. If the ETF closes below support at $7.31, cut it loose. However if this trade works, a move back up to $20 is quite possible. That means it has a potential 1 to 5 risk reward ratio and that is what I like most about the trade.
Back To Top
2. T.HXU
The pattern on T.HXU is no different than any of the other Dead Cat Bounce set ups, support at $12, if you get a close below that, dump it.
Back To Top
3. EWG
Since EWG reflects the German market, you may find that it gaps up on the open since the European markets open before this ETF will start trading. Be sure that the risk reward ratio does not get out of range, but with support at $16.70 and likely upside to $25, this one looks worth considering.
Back To Top
References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
Back To Top
|
