My strategy is based upon the principles discussed in my previous blog, “Market Analysis,” but the execution of it has been developed and tested over time. There is no wrong or right way to trade the market. There are only techniques. This is the one that has worked for me.
I do not have to determine the exact market top or bottom, but I’ve gotten pretty close anyway. On Wednesday, November 19, 2008, the market experienced a brutal sell off after roughly 2-3 months of decline. At the end of that day I wrote down the values of major market indicators. I thought that was the bottom. I was wrong.
From late November until early March, the market basically traded sideways. I was buying the entire time. When it launched a new rally in March, I was already almost 100% invested. I began to buy on margin.
I mention this because it illustrates a real world example that proves you don’t have to pick the bottom. You just need to be ready when the market begins a new rally. My strategy achieves this objective.
So what did I buy? I did make one mistake and that was to trust my own ability to time the bottom, within a specific time frame. I believed that the new rally would begin within 3 months. Again I was incorrect. Instead of launching a new rally in early February, it did not occur until early March. By purchasing options that expired too early, I missed out on some potential gains.
That mistake aside, I made a lot of positive moves. Focusing on Asia, I purchased Chinese ADRs that were poised to move higher. This strategy worked to my advantage. Purchases of commodity ETFs did not prove to be as profitable, but served a diversification purpose and allowed for inflation protection.
Which brings me to my final and most important topic: protection. Gains from stock and option purchases have proven the merits of this investment strategy, but only because the market has continued to rally. But what if the market rally had failed or some catastrophic event had occurred? How does one protect against the unknown?
The answer is two-fold: put options and stop loss orders. In order for this strategy to work, an investor has to protect against catastrophic loss. No gains can offset a drastic and immediate loss caused by an unpredictable event. An asset could plummet and it may not even be provoked by such an event. My personal preference is to use put options for large positions with long term potential. Stop loss orders are best used for short term trades. Sometimes a combination of the two is required. It depends on the asset.
The most important thing to remember when investing is that avoiding loss is more important than creating gains. Think about it—if you outperform the market by protecting against loss during the down periods and underperform the market during rallies, you will still come out ahead. This strategy not only seeks to outperform in bull markets, but will also lead to substantial gains in bear markets. If you can get even close to timing market bottoms and market tops, you can benefit from either scenario.
As I write in early August 2009, the market is still in rally mode and has yet to show signs of breaking down. I fully anticipate that the rally will continue for 1 – 2 more months. By October, the rally should end. Even if I am incorrect, I will still profit. If the rally ends early, my put options will protect against loss. If it continues to rally beyond October, I may miss out on the end of the rally. I would rather sell on the way up than the way down. I would rather buy before the rally begins than after. I would rather be early than late in all situations. That is my personal preference and the strategy that I believe will work best in the long run.
In addition to protecting against loss, the best strategies also seek to profit from bear markets. Taking short positions, buying short ETFs, and purchasing put options are all strategies worth employing in preparation for a bear market. Protection should be put in place in the opposite manner by purchasing puts, calls and continuing to use stop loss orders. An additional technique of purchasing foreign currencies could prove to be an added source of protection. The Japanese Yen and Swiss Franc are good examples of hard currencies worth owning in bear markets. Gold is almost always a good investment and useful protection against rising inflation rates.
Thursday, August 6, 2009
Market Analysis
Market timing is a mysterious art that many have attempted to master and most have failed. So why do I believe it is possible? Because most “experts” who attempt to master this difficult task go about it the wrong way. They tend to equate market timing with predicting the future. That is not what market timing is all about. Market timing is a discipline that requires patience, attention to detail, and flexibility, but not clairvoyance.
There are a few basic market truths that one has to recognize before attempting to time the market. One is that the big money is slow. Mutual funds, hedge funds, and all other types of large institutional investors control the direction of the market, but they always “tip their hands” because it takes them so long to get in and out of a position. The second truth is that the majority is always wrong. When mutual fund purchases are peaking, that is the time to jump ship. When redemptions are high, it is time to buy.
These are not novel concepts. Investor’s Business Daily founder William O’Neil talks about them in all of his books. Being able to read the signs is just part of the overall equation. The trick is how to take advantage.
The first step is to stop listening to “experts” and to do one’s own analysis. If the majority is always wrong, then that includes the majority of financial magazines, analysts, talking heads on television, etc. Economists are the worst people to listen to. Some of them even admit that they are horrible at market timing. Don’t confuse successful economists with successful investors. Most are one or the other, but not both.
The second step is to use your emotions to your advantage. Typically, the scariest moments in the stock market represent the best opportunities. When you feel happiest about the performance of your investments it is usually time to sell.
Finally, one has to realize that market timing is not about picking the very top or the very bottom of the market. It’s not necessary. The market peaked in October of 2007. You could have sold at Christmas and still missed most of the bear market sitting in cash. The market bottomed in March 2009. You could have bought everything in sight over the Christmas break, 1 year after you sold, and you would be in great shape right now. You don’t have to be exact. You just have to be in the ballpark.
Easy enough, right? Not exactly. Now we must address the greatest obstacle one has to overcome in order to be a successful investor in the years to come. We have to recognize and accept the fact that the United States is not the best place in the world to invest anymore. This is a difficult thing for people to accept for many reasons. One is patriotism. We feel good about investing in our own country. As citizens of the United States we are proud of our country, so why should we send our money overseas when it is needed here? Even if we recognize the need to be global investors, how do we do that? Most financial advisors based in the U.S. concentrate their efforts on analyzing U.S. companies. So we have to find another country and figure out which companies to invest in?
Now comes the easy part. Picking the right country to invest in is easy. Investing in that country’s economy is also very easy. You simply have to make the decision to become a global investor and not be a buy and hold investor. The rest will take care of itself. Here’s why:
1) The growth is in Asia. We know that, we hear that on the news, we’ve seen that for the past 10 years. Any talk of Asia being a bubble like the 1990s internet scenario is inaccurate. Asia’s growth is real and its investment gains are backed by fundamentals. In fact, most companies in Asia are undervalued when you look at their current stock prices. We’ve already narrowed it down to one part of the world to focus our investing.
2) Investing in another part of the world is easier now than it has ever been before. We have ETFs, ADRs, and mutual funds to choose from. I prefer to avoid mutual funds, but ETFs and ADRs are fantastic vehicles worth taking advantage of.
3) It is generally accepted that 50 – 70% of a stock’s movement is related to the overall market environment. If the overall market is going up, there’s a much better chance that your stock is going up.
So I’ve already answered most questions. One could buy an ETF that represents the growing Asian economy and not even worry about trying to be a stock picker. Or one could buy ADRs that represent stock in Asian companies, and concentrate on the fastest growing companies. Either strategy could work.
Obviously, that’s not the only way to invest and there are other areas worth looking into. Israel, Brazil, South Africa, Switzerland and many other countries are worthy of investment consideration. But, for the sake of simplifying investment decision-making, I have used Asia as the example. Hong Kong, China, Taiwan, South Korea, Singapore—take your pick.
One final note on market timing—it is not to be confused with technical analysis. Technical analysis using Fibonacci analytics or chart patterns may be useful for stock trading, but not for overall market timing purposes. What we are focusing on is volume accumulation & distribution, market sentiment, and actual market performance. Technical analysis is useful for choosing individual stocks to buy and determining entry and exit points. The Nicolas Darvas box theory and O’Neil’s IBD technical pattern strategies are very useful when it comes to buying and selling stock in market leading companies. For overall market timing, in my estimation, they are not applicable.
There are a few basic market truths that one has to recognize before attempting to time the market. One is that the big money is slow. Mutual funds, hedge funds, and all other types of large institutional investors control the direction of the market, but they always “tip their hands” because it takes them so long to get in and out of a position. The second truth is that the majority is always wrong. When mutual fund purchases are peaking, that is the time to jump ship. When redemptions are high, it is time to buy.
These are not novel concepts. Investor’s Business Daily founder William O’Neil talks about them in all of his books. Being able to read the signs is just part of the overall equation. The trick is how to take advantage.
The first step is to stop listening to “experts” and to do one’s own analysis. If the majority is always wrong, then that includes the majority of financial magazines, analysts, talking heads on television, etc. Economists are the worst people to listen to. Some of them even admit that they are horrible at market timing. Don’t confuse successful economists with successful investors. Most are one or the other, but not both.
The second step is to use your emotions to your advantage. Typically, the scariest moments in the stock market represent the best opportunities. When you feel happiest about the performance of your investments it is usually time to sell.
Finally, one has to realize that market timing is not about picking the very top or the very bottom of the market. It’s not necessary. The market peaked in October of 2007. You could have sold at Christmas and still missed most of the bear market sitting in cash. The market bottomed in March 2009. You could have bought everything in sight over the Christmas break, 1 year after you sold, and you would be in great shape right now. You don’t have to be exact. You just have to be in the ballpark.
Easy enough, right? Not exactly. Now we must address the greatest obstacle one has to overcome in order to be a successful investor in the years to come. We have to recognize and accept the fact that the United States is not the best place in the world to invest anymore. This is a difficult thing for people to accept for many reasons. One is patriotism. We feel good about investing in our own country. As citizens of the United States we are proud of our country, so why should we send our money overseas when it is needed here? Even if we recognize the need to be global investors, how do we do that? Most financial advisors based in the U.S. concentrate their efforts on analyzing U.S. companies. So we have to find another country and figure out which companies to invest in?
Now comes the easy part. Picking the right country to invest in is easy. Investing in that country’s economy is also very easy. You simply have to make the decision to become a global investor and not be a buy and hold investor. The rest will take care of itself. Here’s why:
1) The growth is in Asia. We know that, we hear that on the news, we’ve seen that for the past 10 years. Any talk of Asia being a bubble like the 1990s internet scenario is inaccurate. Asia’s growth is real and its investment gains are backed by fundamentals. In fact, most companies in Asia are undervalued when you look at their current stock prices. We’ve already narrowed it down to one part of the world to focus our investing.
2) Investing in another part of the world is easier now than it has ever been before. We have ETFs, ADRs, and mutual funds to choose from. I prefer to avoid mutual funds, but ETFs and ADRs are fantastic vehicles worth taking advantage of.
3) It is generally accepted that 50 – 70% of a stock’s movement is related to the overall market environment. If the overall market is going up, there’s a much better chance that your stock is going up.
So I’ve already answered most questions. One could buy an ETF that represents the growing Asian economy and not even worry about trying to be a stock picker. Or one could buy ADRs that represent stock in Asian companies, and concentrate on the fastest growing companies. Either strategy could work.
Obviously, that’s not the only way to invest and there are other areas worth looking into. Israel, Brazil, South Africa, Switzerland and many other countries are worthy of investment consideration. But, for the sake of simplifying investment decision-making, I have used Asia as the example. Hong Kong, China, Taiwan, South Korea, Singapore—take your pick.
One final note on market timing—it is not to be confused with technical analysis. Technical analysis using Fibonacci analytics or chart patterns may be useful for stock trading, but not for overall market timing purposes. What we are focusing on is volume accumulation & distribution, market sentiment, and actual market performance. Technical analysis is useful for choosing individual stocks to buy and determining entry and exit points. The Nicolas Darvas box theory and O’Neil’s IBD technical pattern strategies are very useful when it comes to buying and selling stock in market leading companies. For overall market timing, in my estimation, they are not applicable.
Saturday, August 1, 2009
Reasons to Buy
Why should you buy a stock? That's a question almost everyone tries to answer at one time or another. Jim Cramer will have you believe that you should buy because of undervaluation and fundamentals. I disagree.
One reason I love Nicolas Darvas' book How I Made $2,000,000 in the Stock Market is because it reads like a journal. He describes all the mistakes he made as an early trader and all of his frustrations. I can relate to that because I had similar problems when I began trading the market. How can this stock go down? It's already undervalued! The fundamentals say it should go up!
Darvas realized that this was an exercise in futility. To buy a stock purely for fundamental reasons is wrong. It won't make you money in the long run. There's only one Warren Buffett but there are hundreds, probably thousands, of stock traders who make money every year by trading the technicals, not the fundamentals. Yet every stock "expert" or advisor, like Jim Cramer, tells the amateur investor to buy the fundamentals. How strange.
The greatest advantage an individual has over an institutional investor is speed. You can get into and out of a stock much faster with only a little money invested than you can with millions. A mutual fund has millions; I have much less. I win the game of speed. I can jump in and out as much as I want. I can sell one day and buy back the next. It costs me the transaction fee. That's it. So why should I buy and hold only to lose sleep at night because the market is tanking? I'd rather sit on the sidelines or, better yet, short the market on the way down. ETFs make that very easy these days. Oh, and so do put options. There are so many possibilities for the individual investor. But to buy for the fundamentals is just plain wrong. Unless you're Warren Buffett, and I know I'm not.
One reason I love Nicolas Darvas' book How I Made $2,000,000 in the Stock Market is because it reads like a journal. He describes all the mistakes he made as an early trader and all of his frustrations. I can relate to that because I had similar problems when I began trading the market. How can this stock go down? It's already undervalued! The fundamentals say it should go up!
Darvas realized that this was an exercise in futility. To buy a stock purely for fundamental reasons is wrong. It won't make you money in the long run. There's only one Warren Buffett but there are hundreds, probably thousands, of stock traders who make money every year by trading the technicals, not the fundamentals. Yet every stock "expert" or advisor, like Jim Cramer, tells the amateur investor to buy the fundamentals. How strange.
The greatest advantage an individual has over an institutional investor is speed. You can get into and out of a stock much faster with only a little money invested than you can with millions. A mutual fund has millions; I have much less. I win the game of speed. I can jump in and out as much as I want. I can sell one day and buy back the next. It costs me the transaction fee. That's it. So why should I buy and hold only to lose sleep at night because the market is tanking? I'd rather sit on the sidelines or, better yet, short the market on the way down. ETFs make that very easy these days. Oh, and so do put options. There are so many possibilities for the individual investor. But to buy for the fundamentals is just plain wrong. Unless you're Warren Buffett, and I know I'm not.
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