Market Monkey

24th February

Well, that's a bit better.

The market continued its recent directionless chop but unlike last week, I managed to find an edge amongst the noise and make a few quid for myself.

The last few weeks have been frustrating and this week began in a similar vein.  The more nerdy among you might recall me making reference in the past to 'fading the gap'.  It's a high-odds day trading strategy in which you take a position at the open in the opposite direction to which the market is scheduled to open.  If the Dow, for example, is scheduled to open 100 points lower, you buy at the open and consider closing the position once the gap is filled - that is, once it rises 100 points or to where the market closed the previous day.  If the market opens 100 points higher, you do the opposite.

Markets were closed in the US on Monday and opened significantly higher (150 points or so) on Tuesday morning.  Why?  That was hard to figure out, with news of increased write-downs among European banks, oil climbing towards the $100 barrier and Wal-Mart issuing conservative guidance for the year ahead.  Now, most of you know that I'm not big on interpreting news flow.  After all, bulls often use good news to close their positions and bears behave similarly ('sell the news' and all that).  As traders find themselves trapped in a losing position, that move often gathers momentum, puzzling newbie observers who can't understand why a market is behaving so weirdly. 

Anyway, like I say, I've never been big on trading the news.  In this case, however, it was hard to think that the gap up would hold. The tone in the market has been weak for quite some time.  To sustain the move, some kind of catalyst was needed.  It wasn't there, so I was hoping to get short at the opening bell.  Unfortunately, I missed it, arriving at my screen some fifteen minutes late (don't ask).  By then, the market had slipped a little and I opted to pass on the trade.  That was a mistake - the opening losses were minor and the gap fade was still an option, but I'm a devil for getting in at as favourable a price as possible.  A late slump saw the market give up all its gains and then some, a 200 point turnaround.  Cue usual bout of cursing and ullagoning.

Next day, same trade.  This time, markets were poised to open 80 points lower or so (around 12,250).  Despite yesterday's bearishness, I was looking to get long.  Gaps of 100 points or less have a strong history of filling.  Besides, I'd come across some statistical analysis that morning that showed that longs had a slight edge over the following few days.

So I bought the Dow at €3 per point and enjoyed a stress-free trade, with the position never going more than twenty points against me. After an hour or so, I tightened up my initial stop to just below the morning lows.  By now, my max loss was just €90 or so, so I wasn't exactly breaking sweat.  A couple of hours of tedious range action ensued before a decent break-out finally occurred.  I'd initially planned on taking partial profits once the gap was filled but opted to let it run, trailing my stop under a short-term moving average.  It motored another 50 points or so above my initial target before eventually dipping a little.  My stop management ensured that partial profits were taken not far off the intermediate top.  Full marks, Mr. Monkey.

Thereafter, the plan was simple.  Hope for continued short-covering to push the market higher into the close, where I would hopefully take further profits and allow the remainder to run into a multi-day trade. I left my stop around the break-even mark until the Dow went beyond 12,400.  Then, I tightened it to below 12,340 (obvious intra-day support).  Release of the minutes of the last Fed meeting saw the market go bananas for a bit.  If you're not paying attention, the manic action looks indecipherable.  I came within ten ticks or so of being stopped out on a couple of occasions before the buying resumed. Coincidence?  Luck?  Not on your Nelly.  Even amidst the brief Fed-induced insanity, traders had their eye on the aforementioned support level.  Praise the Lord for technical analysis.

We had lift-off soon after, with the Dow hitting 12,470.  I was up well over €500 at this stage and sitting pretty.  It slipped from there and I took another partial minutes before the closing bell (12,411). I'm holding on to a third of my original position.  I'm not feeling bullish in any sense - there's no obvious directional bias at the moment - but I might get a few quid more out of this trade.  Sometimes, a good day-trade can become a spectacular swing trade.  I'm not envisaging that but no harm giving the trade a chance.

So that's that - the anatomy of a pretty sweet and professional day trade.  Any errors?  Just one.  Instead of buying at the open, I set a limit order to get in at a slightly better price.  Like I said earlier, I'm a devil for it.  My order was filled but it might not have been and I'd have been left cursing a second missed opportunity.  I really shouldn't quibble over a few ticks like that.  Apart from that though, it was perfectly-managed. 

I was impatient to make a few quid after a poor start to 2008 and am glad I waited for the right trade to come along rather than forcing my way into a low-probability position.  Similarly, I'm glad that I took the trade - I'm the first to admit that losses can make a chicken out of me.  By the time you guys get to read this, I hope to have made a couple of more trades and got back into the black.  We'll see.

Weekly gain/loss: +€465
Overall balance: €19,336

17th February

It's been choppy and directionless in the market of late.  I'm never in the mood for trading in the immediate aftermath of a few losses but I couldn't find anything worth dabbling in over the last week or so anyway.  It's been a bit of a snooze-fest, especially in comparison to the wildness of January. 

After four days of chopping around in a relatively narrow range, news that Warren Buffett offered to reinsure $800 billion in municipal debt risk from the top three bond insurers saw the markets break out on Tuesday.  It wasn't the most convincing of moves, however, with the indices giving up much of their gains as the day wore on and the NASDAQ actually closing lower.  Decent retail data on Wednesday saw a second and more successful push from the bulls, with the Dow gaining 180 points and the NASDAQ surging by 2.5%. 

Hip hip hooray?  Hardly.  Trading volumes haven't been inspiring and the indices are basically back to the level they were at four weeks ago.  I'm looking to get short at an appropriate juncture, probably around 12,750 for the Dow.  That marks the early February high and its 50-day average is not far ahead.  With the Fed cuts out of the way and this week's signing into law of a $168 billion stimulus package, it's hard to see a catalyst that will spring the markets decisively forward from here.  If something major does emerge, then I'll stand out of the way and let the bulls do their stuff.  At the moment though, the short side is looking more attractive for a short-term trade.

It bears repeating that a trader's first duty is to ensure that he minimises his losses.  Even from a day trading perspective, I couldn't find anything over the last week that offered better than 50:50 odds. Sometimes you play the game, sometimes you don't.  It would have been silly to be playing over the last week, so I didn't.  The number of blow-ups I've been reading about recently heightens my appreciation of the need to keep your discipline in the markets.  A few weeks ago, I mentioned the blogger at www.highprobability.blogspot.com who blew almost all of his $40,000 account on a suicidal trade just before the markets were massacred on Blue Monday.  He's taken down the expletive-riddled video he posted of his reaction.  Last I heard, the video had been downloaded over 350,000 times so his decision to remove it is a little late.

The 'high probability' guy, ironically, is a pretty knowledgeable trader who brought his account from $7,000 to $40,000 over the previous year or so through intra-day futures trading.  Obviously that level of return isn't sustainable and indicates that he was taking on undue risk but still, the guy's not a silly newbie.  If you want to hear of a newbie disaster, check out boltar1.blogspot.com. This guy only began trading recently - he hadn't a clue, to be honest. That didn't stop him from hatching an absurdly ambitious plan - to take his savings of $72,000, get a loan of $170,000 against his house and transform it into $1,000,000 over the following four years. 

Using the leverage available to him, he bought 2,440 Apple shares at $172 before the recent MacWorld conference (he obviously wanted to make the million as quickly as possible).  The stock tanked after MacWorld but he refused to take the loss.  Since then, Apple has been butchered after reporting disappointing earnings and currently sits at $130.  He hasn't posted since mid-January, despite the hundreds of comments left on his blog so it's fair to assume that he lost $100,000 or so and is likely to lose his house.

Pitiful, as is the situation reported by the trader at www.dehtrader.com. This guy is more experienced but he's hopelessly in-disciplined.  He lifts his stops, doubles down on losing trades, trades on emotion  - he does just about everything wrong, despite the fact that he knows better.  As the market bottomed in mid-January, Dehtrader joined the above blogging colleagues and got hammered to the tune of $62,146.88. "I sold all my swings today, they just kept getting worse. I also cleared out my long term account...Knowing my luck, I am pretty sure I marked the exact bottom. I am 100% flat now and learned my lesson.  I lost way more than I can afford at this time. My dream to do this crap fulltime just went down the toilet."

He's still trading and has been doing quite well of late, in fact. With his cavalier approach to risk, however, it's only a matter of time before the next bruising.

Most recently, the trader at www.boogster.net/blog blew up.  He hasn't revealed the sum but has said that it "was the lowest that I've felt in my trading 'career' to date" and has compared it to a past options trade where he lost over $34,000.  Boogster has actually been profitable over the last few years but he's prone to making the occasional lunatic trade.  On this occasion, he bought the Dow at 11,909 and was looking to sell at 11,960. That would have been a maximum profit of $250, a modest day trade.  The market proceeded to drop 300 points in no time at all.  Chances are that Boogster doubled down on multiple occasions and got in completely over his head. 

Contrast the above insanity with the disciplined approach taken by someone like tradermike.net, who takes a number of days off in advance of market-moving events that might upset his technical approach, or Brett Steenbarger at traderfeed.blogspot.com, who waits for everything to line up in his favour before pulling the trigger. 

Think of risk before reward.  That's what the Trader Mike's and the Steenbarger's do and that's why they're still playing the game. 

Weekly gain/loss:No change
Overall balance: €18,871

10th February

This week's lesson; how to clutch defeat from the jaws of victory by acting like a scared rabbit.

After losing almost a grand this week, I'm not a happy monkey.  I was underwater on my Elan short from the very beginning.  I was hoping to get out at break-even if the stock dipped but it never came close. I got stopped out on Monday as the stock easily breached $26.

I mentioned last week that I was looking to short Caterpillar. Unfortunately, I did just that and got stopped out for a 500 loss just fifty-two minutes later (yes, I timed it).  Next time I see a caterpillar, I'm going to stamp on the damn thing.  Butterflies too.

There's nothing I would change about the above trades.  Both of them were good set-ups.  Doubtless, some people will say that I should have opted for looser stops (Caterpillar came back to my entry point over the following days and Elan dipped slightly also).  I don't buy that at all.  Both stops were placed above notable resistance points. Secondly, if you opt for really wide stops, you destroy your risk:reward ratio.

If you make a mistake, you console yourself with the thought that you will do things differently next time.  You learn.  Here, I did everything right and yet I was down almost a grand in just a few days. That stinks.

Of course, that's trading.  Two consecutive losses - big deal.  It's all part of the game.   Unfortunately, human nature dictates that we all become more risk-averse after losing a few quid.  Another two losing trades would bring my new year losses to over €2,000.  I didn't fancy that so I wimped out for the remainder of the week.

That was dumb.  I mentioned last week that the Dow "looked shortable on further rises to resistance (12,750)".  It was a clear resistance point and, considering that the index had risen by 10% in little over a week and no obvious catalyst (eg. rate cuts) lay ahead, an obvious place to get short.  What happened?  The Dow made it to 12,767 before cratering almost 600 points over the following days.  It would have brought spectacular profits.

I didn't completely chicken out on this no-brainer trade, placing an order to go short at around 12,770 only to miss out by just a couple of ticks.  Unlucky?  Brutally so, but I should have made absolutely sure of an entry.  I've no doubt that my earlier losses caused me to place my limit order that bit further away.  Besides, it was a small order anyway - not even half the size I'd have taken on a normal day.

The rest of the week brought similar fare.  I would see a half-decent opportunity and pass on it.  Invariably, the curses would start flowing as the trade proceeded as I initially expected, only without this silly monkey on board.  The more opportunities I missed, the more reluctant to trade I became (you're left with an irrational Murphy's Law-type feeling that when you finally do take the plunge, the market will suddenly turn unpredictable on you). 

To be honest, watching the Dow this week made me feel like a bloody clairvoyant.  On Wednesday, for example, the Dow opened higher before dropping 100 points.  It then rose by 130 points before plunging another 200 points in the final hours of trade.  It might all sound chaotic but I foresaw all three movements (that is, short at the open, long near the morning bottom and short again near the daily high). Space forbids me from going into the reasons why; suffice to say, it could have been a very profitable day.

To sum up, it could and should have been a very profitable week. The opposite occurred because I allowed a couple of losses to unduly influence me. 

None of this is new.  In my first column of 2008, I wrote that "my only real concern is that a losing streak causes me to trade differently, thereby becoming self-perpetuating...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."

Déja vu.

It's not just me, you know.  I remember reading of an experiment whereby participants were given the option to bet $1 on a coin toss at the beginning of a twenty-round game.  You gained $2.50 if you won the toss and lost just $1 if you lost the toss.  Wimps were given the choice of not playing and keeping the money.

Any eejit would know that the obvious move would have been to play every round.  Instead, people grew more cautious as time passed, especially after rounds where they lost money.  I remember thinking, 'what a bunch of saps'.  Of course, the same impulse sabotaged my trading this week and has done so on countless other occasions.  Humans are hard-wired to guard against losses.  Most people, if offered a single coin toss whereby you gain 200 if you win and lose 100 if you're wrong, decline the offer (try this out on friends if you don't believe me).  Why?  Because the 100 loss is felt more acutely than the 200 gain.  It's a survival instinct that served us well back in cave men days but a lot less so today.

I find all this behavioural stuff fascinating and have read about it in some detail - there are few psychological sins that I'm not aware of.  What amazes me is how little difference this knowledge makes. Sure, it helps to be aware but most of the time, we'll obey our gut and make the same mistake over and over again.

That's trading.  In fact, that's life.

Weekly gain/loss:-€791
Overall balance: €18,871

3rd February

Another week, another rate cut.  Helicopter Ben Bernanke gave the market what it had been crying out for by cutting another 0.5% off interest rates on Wednesday and holding out the promise of further cuts.  No surprise there - while some saw a more meagre 0.25% in the pipeline, most traders had already priced in a half point cut.

The fact that it wasn't a surprise didn't stop the market from going bananas, with the Dow running up by 250 points in the hour after the announcement before giving almost all of it back in late trade.  Fed day follows a familiar pattern every time.  The hours leading up to the announcement are mind-numbingly boring, with stocks crawling around in a 'I'm too petrified to move' fashion.  Then, at 7.15 Irish time, all hell invariably breaks loose, with wild swings in either directions. It doesn't matter if the announcement is a predictable one - the market always goes nuts anyway.

The best option for indices traders is to ensure that you've got no position coming into the announcement.  It's all too easy to get stopped out as the market lurches around.  Sure, anyone who was long going into Wednesday should have done fine, as the market immediately took off and gave traders enough time to take profits.  On other occasions, however, the action is positively manic and a triggering of one's stop loss is almost guaranteed.  Even worse, one is likely to get stopped out at a lousy price.  For most of Wednesday, for example, Dow futures traded in a tight 12,420-12,460 range.  On an ordinary day, a trader who is short would place his stop just above the 12,460 level. As soon as theannouncement was made, however, futures shot up to 12,535.  Chances are that one would have been stopped out at an absolutely awful price.

Anyway, the euphoric reaction was short-lived, especially after Standard & Poors said that the carnage in the mortgage market was likely to result in total losses of $265 billion for financial institutions.

I'm relieved that the whole 'Waiting for Fedot' thing is over.  I was loath to open positions based on technical grounds when such a massive market-moving event lay just ahead.  It made sense to let Bernanke to do his thing and allow the market settle down.  The fact that we're in the middle of earnings season makes the situation worse for a trader like myself - I'm continually coming across technical set-ups only to discover that the stock is reporting earnings the next day.

That said, I did manage to open my first swing trade of the year by going short Elan.  Elan tends to plough its own furrow and I was confident that any Fed decision wouldn't impact the stock too much. The stock has been in a broad trading range since last October, going back and forth between $21 and $25 without ever showing much conviction that it wanted to break out in either direction.  I shorted on Wednesday with the stock trading around $24.75, placing my stop just above $26.  The little pup powered straight past me, hitting $25.50 within 30 minutes or so.  It's never nice to be down 300 euro or so in such as short time but the stock did provide some minor comfort by slipping back to the 25 area later in the day.

Anyway, while I'm down a few quid at the moment, I'm in no rush to close out the trade.  The stock has raced ahead since hitting a low of $21.30 last week and should see some profit-taking at this juncture. If I lose, well, so be it.  Sometimes you lose money by taking a trade you should have passed on but this isn't one of them.  These trading range plays tend to be pretty reliable ones so you've got to take them as they come.

By the time this column has been published, I'm also likely to have shorted Caterpillar.  After bottoming near $60 recently, the stock has rebounded up to its 50-day average near $70.  I'm looking to short on a break of Wednesday's low (around $68), with my stop going above that day's high (and the aforementioned average) above $70.  The stock reported earnings last week so at least that's out of the way.

I'm also looking at Research in Motion (RIMM), both from the long and the short side.  I know that sounds a bit peculiar but I'd be tempted to short if it got near resistance at $100 and long if it came down to its 200-day average around $84.  Ideally, I should have gone long last week after it tested that same average for the first time in eighteen months.  The first test of such affairs tends to be a successful one and the stock predictably bounced.  However, I only noticed it after the event.  That kind of sloppiness isn't good enough.  It can be a pain in the butt ploughing through chart after chart but it has to be done if you want to find the low-risk set-ups. Anyway, it's probably quite obvious that I don't have the same faith in the new RIMM set-ups as I do in the Caterpillar one so I may yet pass on it.  We'll see.

Whatever happens, I don't want to be lumbered with a bunch of short positions and yet that's all I seem to be noticing.  Both the Dow and the S&P look shortable on further rises to resistance (at 12,750 and 1400 respectively, although I would pick one or the other ).  I'll have to locate some decent long set-ups to balance things out a little.  That's not just for the sake of prudence - I'm not particularly bearish in general.  Last week's bottom looks like a significant one to me and I don't envisage it being tested anytime soon.  The present environment calls for a balanced portfolio, not loading the boat in a particular direction.

Weekly gain/loss:-€144

Overall balance: €19,662