Market Monkey

27th January

"Jesus christ.  This action is crazy."
Not my words - they came from the trader at www.boogster.com/blog.  Like every trader on the planet though, I'm not going to disagree.

The markets have been loony.  You could have made or lost a fortune.  You could have done both.  Me, I made €81 but I'm happy. Firstly, unlike some people, I didn't blow my entire account in a single trade (more of which anon).  Secondly, I made a number of trades, adapted my strategies to cope with the volatility and stuck with my initial plan rather than getting caught up in the heat of it all.  Keep doing that and the money will flow.

Where do you start?  Each day has been more bizarre than the last. Monday was when global markets started crashing.  US markets were closed for Martin Luther King day so I was nowhere near a computer but I nearly fainted when I heard that practically every European and Asian market was down between 5-10%.  Tuesday morning and the Dow was scheduled to gap lower by a mind-blowing 650 points - that's the most it can drop before it becomes 'locked, limit down'.

Panic, baby.

I had to laugh.  I'd contemplated going long at the end of the previous week - buy when there's blood in the streets and all that - but held off.  Anyway, terrifying as it all was, I'd resolved to buy at the open.  I'd been waiting for a capitulation move and this was surely it.

Then the Fed cut rates.  By 0.75%.  The biggest cut since 1984.

That was the end of the planned 'fade the gap' trade (Google that phrase if you don't know it, it's a day-trading strategy worth knowing about).  A bout of short-covering powered the Dow higher in pre-market action.  Flip it, I said, or words to that effect.

The gains were short-lived though.  Trader Mike (www.tradermike.net) was planning to "buy below the pre-market lows...I think we need to flush the trapped longs out before we can go higher."  That seemed smart, so I opted to follow suit.  As it happened, the markets went straight up at the open and that chance never arrived. 

Impatient to trade, I eventually went short once the Dow approached some technical resistance from Friday's session, opting for a wide stop.  My timing was spot on - within twenty minutes the Dow had given up 150 points and I was up €300.  You're da monkey, you're da man - it's always nice to call a top like that.  Unfortunately, I got a bit greedy and decided to hold on rather than cash in.  My lowered stop loss was soon hit for a paltry gain of €56, prompting another bout of 'flip it'.

While Tuesday's action was manic, Wednesday's resembled a full-blown psychosis.  Disappointing iPod sales and lowered guidance from Apple saw the stock tank in after-hours trading, bringing the markets down with it (Apple's guidance is always conservative, so it seemed like an overreaction to me, but that's another story).  Anyway, the Dow opened 250 points lower, recovered all its losses in the first hour, then tanked by 300 points to take out the previous day's low before going on to jump - wait for it - 600 points in late trading.

Flip me.

During all this lunacy I made two day trades.  The first - a short - saw me in trouble within minutes and I came within a couple of ticks of being stopped out for a €250 loss (lucky monkey).  It came back down and I gratefully cashed out for a tiny profit.  The second was a long bet that went nowhere during a quiet period.

With an hour of trading left Mrs Monkey called a halt to proceedings - 'why don't you give it a break, you've been up there all day and you're hardly going to make your fortune in the next thirty minutes.'

Hmmm.  The Dow ramped up 400 points in late trading.  Note to self - never listen to Mrs Monkey's market wisdom.

Going forward?  Another rate cut next week, more volatility and an oversold rally is my guess.  Wednesday's action saw a lot of weak hands get washed out, increasing the chances of an intermediate low. Furthermore, we're at levels that have traditionally marked bear market lows, with just 13% of stocks trading above their 200-day average. Even perma-bear Barry Ritholtz (thebigpicture.typepad.com) is gearing up for a rally, pointing out that this level is "lower than anytime in the 2000-02 bear market" and "lower than anytime in the 1998 and 1994 bear markets...This indicator is saying that sentiment has become excessively negative - considering we are only 3 months off of the all time S&P500 highs".  Ritholtz is "slowly legging in for the trade" and looking for "an 8%,10%,12% bounce".

Whatever happens, traders should be thinking of risk before reward. That should always be the case but especially in such a treacherous market.   A day-trading friend of mine told me that he was up €500 in early trade on Wednesday, down €1500 by midday and up €28 by the closing bell.  "Dude, I'm exhilerated", he screamed at me.  He was a bit too exhilerated for my liking (why was he calling me 'dude'?). You've got to keep your head. 

To illustrate my point, check out the video entitled "The stock market ruined my life" at www.highprobability.blogspot.com. The trader in question took on a mammoth position at the end of the previous week's trading.  The expletive-riddled video shows his reactions as he watches the futures tank at the beginning of this week.  He lost $31,000 - practically his entire account.

Funny thing is, the guy is no fool.  He's not a newbie, he knows his technicals, he knows what he should and shouldn't do.  And yet...

Like I say, you've got to keep the head.  If you don't - well, you're flipped.

Weekly gain/loss: +€81

Overall balance: €19,806

20th January

Well, that was quick.  After a few tentative weeks watching on the sidelines, I finally took a stab at things on Wednesday, going short on a Dow day trade.

I lost.  The sum forsaken - €275 - is not going to keep me awake at night.  There's little dignity in getting stopped out of a trade within five minutes of entry, however.   I didn't even have time to get nervous. 

It was made more irritating by the fact that I'd passed on a couple of decent opportunities earlier in the week.  I contemplated going short near the close of day on Monday.  The Dow had enjoyed a pretty strong day price wise but trading volumes were unimpressive.  Besides, Citigroup was due to report earnings next day and they were sure to be ugly.  One could argue that this was already reflected in market prices - everyone was expecting a multi-billion dollar write-down on account of sub-prime losses - but the market's 200 point rise on Monday made me inclined to think that we might be due another leg down anyway.  In particular, I was expecting that shorts would attempt to test the much-talked of August lows.

As it happened, Citigroup's report was predictably awful - a loss of almost $10 billion and a write-down of over $18 billion (euch).  The Dow quickly gave up the previous day's gains and this silly monkey was left cursing and whining. 

A second shorting opportunity arose later in the day.  Even weak markets rebound at some stage but the Dow's attempt to do so was a pretty sad one.  It settled  into a midday trading range not that far off the morning lows.  The obvious play was to short near the top of the trading range and wait for a break of the bottom of the range. Distractions in the monkey household meant I had to leave my computer for a time, however.  By the time I got back, the market had broken to the downside and although it wasn't a decisive break, it would have been sufficient to carve out some decent profits.

These lost opportunities were preying on my mind on Wednesday. After another ugly morning, the Dow rebounded and I decided to short the bounce, placing my stop above the morning highs.  As I said at the start, it was a brief trade - not even five minutes (a personal record).  Even worse, the market reversed back as soon as it hit my stop.  Bad luck?  Nope.  Sheer amateurism on my part.  Markets love to test obvious price points that will trigger the stops of fellow traders.  Once that occurs, you'll often see a quick reversal of the move.  I should have placed my stop another 10 points or so away - that would have been sufficient.  Instead, I was picked off at the very top of the move.

More to the point, I should have avoided the trade in the first place.  It wasn't a bad place to enter but it wasn't a great entry either.  The wise and patient thing to do would have been to wait for price to come close to the morning highs and get short there.  I considered it but, thinking that the price would probably not get that far anyway, forced an early trade instead.  That would have been an easy and profitable trade.  Traders need to have a little imagination. If you're staring at the screen for an hour or two during a quiet period, it can be easy to think the market is never going to move or that the price will 'never get that far'.  Of course, it does eventually.  Indeed, even if your order never gets filled, so what? You haven't lost any money, which must always be the first priority (unless you're like the person who complained on my blog that I should get trading pronto - "so what if you lose money, at least it will be interesting reading".  I disagree).

The same goes for swing trades.  Wait for a great entry - I've preached it many times.  Put the odds on your side at the very beginning.   

Alternatively, do what I did on Wednesday and land yourself in, at best, a 50-50 trade. 

People think of traders as adrenaline junkies but my guess is that the best guys are the patient ones.  I watched the action for most of Wednesday.  For the most part, it was a choppy and unpredictable session.  On only a couple of occasions did a half-decent opportunity arise.  Other days, you won't even get that.  Again, same goes for swing trades.  You might look at a hundred daily charts and only a couple might offer a decent set-up. 

Certainly, the present market isn't affording me many set-ups, a situation that the blogger at themarketspeculator.blogspot.com can relate to.  "We are in a tough spot with regards to initiating short positions, and I'm in no mood to add longs,", he wrote on Tuesday.  The following day saw similar reflections.  "I am still finding this market tough to trade. I have no problem trading in bear markets, but my issue right now is that we are oversold, but not that oversold. So it's tough to initiate longs or shorts. If I do decide to trade, it will most likely be with an even distribution of longs and shorts".

That's how I feel.  My technical style works well in a range-bound market - buy at support, sell at resistance.  In a down-trending market, I look to get short after a weak bounce to resistance points. At the moment, we're scarcely getting that.  For anyone who got short a couple of weeks ago, this is an easy market.  Finding decent entries at this stage is a tougher proposition, however.

Day trading opportunities are arising so I expect to be a bit busier on that front over the next week or so.  Hopefully, I'll show a bit more cop-on too.

Weekly gain/loss: -€275

Overall balance: €19,725

 

13th January

Let's go kick some market butt.

That's how last week's column ended – a call to arms after months of inactivity, an exhortation to 'show me the money'. Well, I haven't done any kicking – not a single trade and praise be for that.

The market would have kicked my butt, not the other way around. I've been getting everything wrong in 2008, everything. It would have been one losing trade after another.

Unless you've been on another planet, you'll know that markets have been in free-fall recently, with US indices having their worst ever start to a new year. The NASDAQ was particularly brutalised, suffering eight down days in a row before enjoying a late-day rebound on Wednesday. Lousy manufacturing data, a sharp rise in unemployment, the refusal of the whole subprime issue to go away and worries that the already beaten-up financial sector is nowhere near a bottom – it's not been pretty.

As for the 'R' word – recession – many commentators say that the US is already there. Goldman Sachs joined Merrill Lynch in predicting that the US was unlikely to avoid one this year and called for investors to load up on defensive stocks and get out of, amongst others, financials and IT stocks (apparently, the tech sector tends to be the second-worst performing sector in both the six months leading up to a recession and during the initial phase of a recession).

Anyway, I returned to my trading desk last Monday. After catching up on some charts and doing a little market-watching, I couldn't help but notice that I wasn't getting anything right.

Take the NASDAQ 100. After falling precipitously, the index fell to its 200-day average near the end of the previous week. Not once has the Nas closed below this level over the last eighteen months. I'd have been a buyer here – it looked like an obvious place for shorts to take profits and for cautious longs to start nibbling. Instead, it kept falling. Similarly, up-trending Apple fell below its 50-day average (which happened to coincide with obvious technical support near $180) on the same day.

So what, one may say? Can't get them all right surely? True, but these were bread and butter, high-odds plays. This kind of market action (a one-day fall of almost 4% for the tech sector) spooks me. There's an old saying that bull markets have no resistance and bear markets have no support. It's an exaggeration but there's more than a little wisdom there. At the moment, this is still a correction (all the indices have dropped by more than 10%) rather than a bear market (commonly defined as a drop of 20% from peak to trough). The action is awful, however.

So why not get shorting? No way. That train had already left the station. Despite the ugliness, I spent the week looking at the long side. The percentage of stocks trading above their 50-day average had dropped to just 20 – that level nearly always signifies that a snap-back rally is near. The guys at www.indexindicators.com (a site I've recently come across - looks promising) pointed out that a paltry 4% of stocks were trading above their 10-day average. Sentiment surveys were showing that retail investors have become gripped by fear and have reached panic levels suggestive of a bottom. The blogger at www.tradersnarrative.com pointed out some other interesting indicators and concluded that a rally was "just around the corner; time to buy".

Next day saw the market swoon over 300 points in late day trading.

Again, I'd have been pulverised. A late rally finally ensued on Wednesday, which led to the usual 'I knew an oversold upturn was coming, I should have bought'. To be honest, I do think I was a bit chicken here. The bounce occurred as the market hovered around the intra-day low that marked the August bottom – ordinarily, a low-risk place to buy. Still, that kind of thinking would have cost me dearly all week.

So the long plays have not been working out. Incredibly, I've even been getting things wrong from the short side. Take Elan, who I was contemplating shorting near $24. The stock would have blown me away.

Going forward, I'd love to see a capitulation move. That is, a big down day followed by a sharply lower open – that's how near-term bottoms are formed and I'd be a buyer in such circumstances. Up to now, every down day has tended to be followed by a higher open, which just emboldens the bears to get shorting again. Unless the news flow starts to turn positive, however, any such rally is likely to be a dead cat bounce. My guess is that an oversold rally will ensue but shorts will use the bounce to add to positions.

If the desired capitulation scenario does not arise, I might choose to ease my way back into things with a couple of day trades. The volatility is intense at the moment. I've already mentioned the 300 point collapse in the last hour of trading on Tuesday; Wednesday was the opposite, with a 250 point turnaround in the run-up to the trading bell. Juicy stuff.

As for swing trades, smaller positions with wider stops is called for. Unless your entry is absolutely exquisite, that's the only way of profitably trading a volatile market.

One final comment. After pronouncing that I was "itching to trade", I'm a trifle embarrassed to be inactive this week, especially when the market was moving so much. I know other traders can relate to the feeling that they 'should' be trading. Thing is, our only loyalty is to our pockets. We should trade when the opportunity is there, not because we feel we ought to or because the neighbour is making a mint with some wild shorts.

Now, let's go kick some market butt. Please, Mr. Market. Even if it's just a gentle toe poke. Please.

6th January

OK, people.  It's a new year, a fresh start and monkey's ready to rock and roll.  I'm starting the year with a smaller bankroll of 20k.  That means I won't be giving up the day job in 2008 but if I'm good enough - and I believe I am - I'm going to make some pretty decent pocket money.  I'm ready to trade, no, I'm itching to trade.

Despite my self-imposed exile from market trading, my time out has not resulted in any real changes in my outlook.  In fact, I've been damn pleased with my paper trading over the last couple of months and am feeling pretty optimistic about the coming year.  I'm going to experience losing streaks this year - that's a fact of market life and one I can do nothing about. As long as I keep my cool, however, I should come out well ahead.  My only real concern is that a losing streak causes me to trade differently, thereby becoming self-perpetuating.  Some traders get too cocky after a long winning run and blow up through complacency.  Not me.  I trade well when I'm winning.  I'm not afraid to pull the trigger and I take every opportunity that presents itself.  When I'm losing, however, I get jittery and either pass on trades I should have taken, take a smaller position than intended or take my profits too quickly.  That's why I'm hoping for a stress-free January - I need a good start.

The best way of eliminating all that silly emotional stuff is to have a set of rules and to stick to them.  I've said it a thousand times - plan the trade, trade the plan.  My rules?

• A maximum loss of 2% on any one trade.
• Never lift a stop.  Leave that to the tossers.
• Move stop up to breakeven (or nearby) if a position moves in my favour by an amount equal to my initial risk, ie, if I buy a stock at $10 and set my stop at $9, then stop is moved up to breakeven as soon as it hits $11.
• Never take profits until the above stage is reached.  Never mind that guff about how you can never go broke taking a profit - if your losses are always larger than your profits, you'll do just that.
• Scale out of trades.  Take profits in advance of resistance (if long) and support (if short).  Keep a portion of the position open for the occasional home run.
• Don't take a trade if the risk:reward ratio is less than 1:1.  A ratio of 2:1 or better is preferable, although 1:1 is fine if the odds of success are deemed to be high.
• Never double down on a losing trade.
• Never take a position based on technical grounds in advance of earnings or a major upcoming news event.
• Keep a mixture of longs and shorts.  A preponderance of one or the other is fine but be careful not to load the boat too heavily to one side.
• Buy support, sell resistance.  Watch sentiment surveys.  Look at quantitative research.  Ignore the talking heads and all the fundamental guesswork.  Leave the price-sales ratios and balance sheet analysis and all such idle chit-chat to the BROKE-rs and the BANAL-ysts.
• Stop punning.  It distresses readers.
• The trend is your friend but look to go the other way when sentiment reaches an extreme and/or when buying/selling hits levels that traditionally mark short-term reversals.  Only be a contrarian on index trades - individual stocks can go to heaven and beyond or to hell and below.
• If a trade comes close to a stop-out and reverses back up to the breakeven level, count your blessings and get out.
• Follow the rules without question.
• Know when to break the rules.

It was market wizard Ed Seykota who made those last two quips. Occasionally, I will consider doubling down on an index trade (not on a stock trade).  Similarly, there will be index trades where I risk up to 5%.  It might be just once or twice a year but if the situation demands it, you have to be flexible rather than acting like the class swot who's too afraid to give two fingers to the out-of-line teacher.  There will be other deviations, although I don't plan on breaking into 'Born to be Wild' mode - for the most part, I'm going to stick to the rules.

Goals for the year?  Well, I've long been a believer that a good trader can make up to 10% a month.  Compounded, that's close to a quadrupling over the course of a year.  Unfortunately, I've never managed it myself, so perhaps I should revise that belief.  A doubling over the following twelve months is definitely achievable, however, so that's going to be my initial goal. 

The whole question of yearly returns was recently addressed by the blogger at TheMarketSpeculator.blogspot.com. A fine (part-time) trader who details his individual trades, he began with a bankroll of $25,000 in 2006 and has already gone past the $100,000 mark (newbies should note that he has been trading for years - perhaps I shouldn't have used the word 'began').  He's a pretty aggressive trader - more aggressive than me, as he often risks up to 5% on high-flying momentum stocks - but he's disciplined and detached.  Like Monkey, you're not going to catch him breaking out the old Steppenwolf records in the middle of the trading day. 

Anyway, I agree with him that "anything less than 50% (in a year) is not acceptable."  Could he manage that if he was running a billion dollar portfolio?  Of course not.  That's the advantage of being a small retail trader though - we can nip in and out of positions at abandon and not lose a fortune in price slippage.  We should be aiming for those returns.  Otherwise, why bother?

Now, let's go kick some market butt.