Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...
What I’ve Learned as a Trader This Year
09/06/2010 12:01 am EST
Growing up I had a soccer coach who was highly influential in my development as a person and as a player. While I was a good athlete, I was never the fastest or the most skilled player, but Coach Jacobs made me captain of the team because he felt that other qualities as a person and leader superseded any measure of skill. Before we even touched a soccer ball at our first practice, he preached mental toughness and awareness.
As a native New Yorker who idolized NC State coaching legend Jim Valvano, Coach Jacobs produced a lot of quotable sound bites, but there was one thing he used to say that has always resonated in my head, and one I feel is very applicable to trading: “Things are never as good as they seem or as bad as they seem.”
It is human nature to perceive the extremes in any situation. As a species we are manic, especially when it comes to money. In life, on the soccer field, and in the stock market, it is important to fight that tendency to be overemotional, and instead to remain on an even keel. To achieve optimum results in any setting, you have to be diligent, acutely aware of your surroundings, and posses a basic skill set to take advantage of opportunities.
The Year So Far
At the beginning of 2010, my market mentor Scott Redler announced his predictions for the year ahead. After the unprecedented events of the last two years, the market needed to rest and digest. 2010 would be the year of the active trader, he proclaimed, a year defined by range-bound action. In 2008, traders made money trading the extreme moves of a market in turmoil. In 2009, there was the buying opportunity of a lifetime as the market bottomed and made a fierce snap back with the aid of heavy government intervention. In 2010, the only way to make money and avoid risk would be to take a highly stock-selective, active trading approach to the market.
As someone relatively new to the markets, I especially take Scott’s advice and analysis to heart. It helps that it made perfect sense. In 2010, you will not be able to buy every breakout or sell every breakdown. You will not be able to take a primitive technical approach; you must do your homework, develop a plan, and adjust to the environment around you. Whenever I am on the trading floor or in the T3Live chat room, I hear successful market veterans lamenting the difficult nature of this market. And I certainly understand where they are coming from. Timing trades in a range-bound, news-driven, fundamentally complex market is damn near impossible 95% of the time. I think perhaps, though, my lack of experience as an active trader puts me in a position to more quickly adjust to this “new normal” that Scott always talks about. The “new normal” feels just plain normal to me because it is all I know, and I think that will serve me well now and going into the future.
“Things are never as good as they seem or as bad as they seem.” This market right now is confused, and different market players (or “powers that be,” as I like to call them) are pulling stocks in altogether different directions. Polarization is in vogue in this country today, whether it be in terms of politics, sports, marriages, or opinions about the economy and market.
The chorus of double dippers just doesn’t ever seem to quiet down. There is too much consumer and federal debt. Loose monetary policy and stimulus have compounded our problems. The financial sector remains overleveraged and undercapitalized. Tax revenues are down. Unemployment is through the roof with no end in sight. Trade imbalances are killing the dollar. The aging of the baby boomers will increase Medicare and Social Security costs. The thing is, they are exactly right. There are deep-lying issues in our economy that, in the long run, will ultimately lead to a diminished quality of life in this country.
On the other side are the rascals that are driving this melt up. They, too, have a set of facts to point to, and it just feels like the powers that be ultimately want to take this market higher. The economy is recovering, albeit at a less-than-desirable pace. Today, for instance, the monthly Institute of Supply Managers (ISM) survey revealed a greater-than-expected increase in activity, with managers additionally noting a significant amount of restocking. The most recent corporate earnings season generally exceeded expectations, albeit partly due to cost cutting. Stocks are still trading relatively cheap at these levels. Maybe most importantly of all, the government and Federal Reserve have made it abundantly clear that they will make sure this thing gets better before it gets worse, no matter how far down the road they have to kick the can. In due course, austerity measures will likely be implemented to avoid futures bubbles and calamities, but in the meantime, we seem intent to spend our way out of this mess. While in the longest of runs, everything goes to zero, in my lifetime, the markets are certainly going to blast off from this point sooner or later.
NEXT: Key Takeaway Ideas for Traders|pagebreak|
The crosswinds will continue to blow. In the last 12 months, the market has built and breached nine separate “mini-trends” within the range between 1010 and 1220 in the S&P. Each break has led to a significant “correction,” frustrating traders who are chasing moves and looking for follow through. More recently over the last four months, we have built a tighter range between the 1130 to 1040 level on the S&P. Everyone wants to blame the indecision in the market on light volume; everyone is apparently out at the Hamptons this summer. While volume has been uncharacteristically light, even for the summer months, I think the indecision runs much deeper. After a tumultuous three-year stretch in the economy and the markets, a period of rest is healthy. The bears gorged themselves in 2008 and the bulls devoured cheap stocks in 2009. After a big meal, you don’t immediately go out and run five miles; you sit on the couch and digest.
The mentality of a trader or investor must be fundamentally different when you encounter a manic market like this one. It doesn’t make sense to make the same number of trades every day or to chase scenarios that just do not meet certain strict criterion. Just like an outfielder in baseball, if you are unsure where the ball is going, your first step should always be back. By taking a step back, you are taking heavy risk (the extra base hit) off the table and giving yourself an opportunity to see things more clearly before making your next move. Traders need to spend more time watching, learning, and waiting. But waiting for what?
If you are trading the indices right now, I believe it is a time to be somewhat of a contrarian. “Things are never as good as they seem or as bad as they seem.” Whenever the bears reach a fever pitch (and CNBC even seems willing to admit the outlook is bleak), I start to think, hey, maybe things aren’t as bad as they seem, at least from a purely market perspective. The buyers that have been there during this entire melt up are still there, and the odd report comes out every once in a while that shows real economic growth is occurring. Copper, a strong leading indicator, is bullish right now. Let me look for the right spot to test a reversal in small size. Within each mini-trend or range, only trade the extreme moves, the ones that present an overwhelmingly positive risk/reward parameter. I like to take a slightly longer-term approach to trading, and rather than getting in and out of cash, I take those opportunities to get in and out of hedges.
The real opportunity in this market exists in a stock-specific approach. My approach as a stock picker is simple: I like to identify technically strong stocks with compelling fundamental stories and find opportunities to snap them up as cheaply as possible. Not quite a groundbreaking approach to trading and investing, I know, but simple is good in a complex environment. At the beginning of this year, for example, Scott highlighted several “go-to” stocks, concentrated in tech, which looked poised to outperform. At the top of that list was VMW. While trading at a very high multiple, VMW fit my criteria as a technically herculean stock that is the industry leader in cloud-computing solutions—a paradigm-shifting technology. I have stalked it all year, looking for opportunities to add when others come in to take profits and when the market looks ready to cooperate with a bounce.
My executions are by no means clean and perfect, but as Coach Jacobs taught me, success has more to do with knowledge and awareness than it has to do with skill. I have enjoyed similar success with stalking attractive pullbacks in names like NFLX, RHT, and BIDU, and not so much with SNDK, although I tiered down heavily prior the break of the 40 level. In the coming months, I will be looking for entry signals in names like INTCand MSFT.
The real lesson this year, and especially this summer, has been to take a look around you (both literally and figuratively). Be aware of your surroundings and remain on an even keel. Traders with no appetite for this action have lightened up their size and taken vacations to avoid losing money in an environment that does not suit them. Others have taken note of this manic market environment, scaled down longer-term risk, and made consistent money on short-term reversal set-ups. I have concentrated on narrowing my focus, only considering investments in the most compelling companies with the most compelling charts. Results so far have been mixed, but with good average entry prices, I feel confident that I can hold longs through some ups and downs until the market has finally digested the action of the last few years.
“Things are never as good as they seem or as bad as they seem.” I always repeat this mantra to myself whenever those around me get overly fearful or exuberant. I feel that one of my greatest strengths is that I am circumspect; I remain on an even keel. A soccer coach and a Red Dog have taught me well as an athlete, a trader, and a person.By John Darsie, trader, T3Live.com
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