Global Market Comments
August 7, 2020
My 20 Rules for Trading in 2020
Global Market Comments
August 7, 2020
My 20 Rules for Trading in 2020
There’s nothing like starting the new year with going back to basics and reviewing the rules that worked so well for us last year. Call this the refresher course for Trading 101.
I usually try to catch three or four trend changes a year, which might generate 100-200 trades, and often come in frenzied bursts.
Since I am one of the greatest tightwads that ever walked the planet, I only like to buy positions when we are at the height of despair and despondency, and traders are raining off the Golden Gate Bridge like a heavy winter downpour.
Similarly, I only like to sell when the markets are tripping on steroids and ecstasy and are convinced that they can live forever.
Some 99% of the time, the markets are in the middle, and there is nothing to do but deep research and looking for the next trade. That is the purpose of this letter.
Over the five decades that I have been trading, I have learned a number of tried and true rules which have saved my bacon countless times. I will share them with you today.
1) Don’t over trade. This is the number one reason why individual investors lose money. Look at your trades of the past year and apply the 90/10 rule. Dump the least profitable 90% and watch your performance skyrocket. Then aim for that 10%. Overtrading is a great early retirement plan for your broker, not you.
2) Always use stops. Risk control is the measure of the good hedge fund trader. If you lose all your capital on the lemons, you can’t play when the great trades set up. Consider cash as having an option value.
3) Don’t forget to sell. Date, don’t marry your positions. Remember, hogs get fed and pigs get slaughtered. My late mentor, Barton Biggs, told me to always leave the last 10% of a move for the next guy.
4) You don’t have to be a genius to play this game. If that was required, Wall Street would have run out of players a long time ago.
If you employ risk control and stops, then you can be wrong 40% of the time, and still make a living. That’s little better than a coin toss. If you are wrong only 30% of the time, you can make millions.
If you are wrong a scant 20% of the time, you are heading a trading desk at Goldman Sachs. If you are wrong a scant 10% of the time, you are running a $20 billion hedge fund that the public only hears about when you pay $100 million for a pickled shark at a modern art auction.
If someone says they are never wrong, as is often claimed on the Internet, run a mile, because it is impossible. By the way, I was wrong 12% of the time in 2019. That’s what you’re paying me for.
5) This is hard work. Trading attracts a lot of wide-eyed, naïve, but lazy people because it appears so easy from the outside. You buy a stock, watch it go up, and make money. How hard is that?
The reality is that successful investing requires twice as much work as a normal job. The more research you put into a trade, the more comfortable you will become, and the more profitable it will be. That’s what this letter is for.
6) Don’t chase the market. If you do, it will turn back and bite you. Wait for it to come to you. If you miss the train, there will be another one along in minutes, hours, days, weeks, or months. Patience is a virtue.
7) Limit Your Losses. When I put on a position, I calculate how much I am willing to lose to keep it. I then put a stop just below there. If I get triggered, I just walk away. Emotion never enters the equation.
Only enter a trade when the risk/ reward is in your favor. You can start at 3:1. That means only risk a dollar to potentially make three.
8) Don’t confuse a bull market with brilliance. I am not smart, just old as dirt, and have seen everything ten times over. I only have to decide which movie they’re replaying.
9) Tape this quote from the great economist and early hedge fund trader of the 1930s, John Maynard Keynes, to your computer monitor: “Markets can remain illogical longer than you can remain solvent.” Hang around long enough, and you will see this proven time and again (ten-year US Treasuries at 1.45%?!).
10) Don’t believe the media. I know, I used to be one of them. Look for the hard data, the numbers, and you’ll see that often the talking heads, the paid industry apologists, and politicians don’t know what they are talking about (the Gulf oil spill will create a dead zone for decades?).
Average out all the public commentary, and half are bullish and half bearish at any given time. The problem is that they never tell you which one is right (that is my job). When they all go one way, the markets usually go the opposite direction.
11) When you are running a long/short portfolio, 80% of your time is spent managing the shorts. If you don’t want to do the work, then cash beats a short any day of the week.
12) Sometimes the conventional wisdom is right.
13) Invest like a fundamentalist, execute like a technical analyst. This is what all the pros do.
14) Use technical analysis only, and you will buy every rally, sell every dip, and end up broke. That said, learn what an “outside reversal” is, and who the hell is that Italian guy, Leonardo Fibonacci.
15) The simpler a market approach, the better it works. Everyone talks about “buy low and sell high”, but few actually do it. All black boxes eventually blow up, if they were ever there in the first place.
16) Markets are made up of people. Understand and anticipate how they think, and you will know what the markets are going to do.
17) Understand what information is in the market and what isn’t and you will make more money.
18) Do the hard trade, the one that everyone tells you that you are “Mad” to do. If you add a position and then throw up on your shoes afterwards, then you know you’ve done the right thing. This is why people started calling me “Mad” 40 years ago. (What? Tech stocks were a huge buy the first week of January?).
19) If you are trying to get out of a hole, the first thing to do is quit digging and throw away the shovel. Sell everything. A blank position sheet can be invigorating and illuminating.
20) Making money in the market is an unnatural act, and fights against the tide of evolution.
We, humans, are predators and hunters evolved to track game on the horizon of an African savanna. If you don’t believe me just check out how sharp your front incisor teeth are. They’re for tearing raw meat. Modern humans are maybe 5 million years old, but civilization has been around for only 10,000 years.
Our brains have not had time to make the adjustment. In the market, this means that if a stock has gone up, you believe it will continue to do so.
This is why market tops and bottoms see volume spikes. To make money, you have to go against these innate instincts.
Some people are born with this ability, while others can only learn it through decades of training. I am in the latter group.
With all that said, good luck and good trading. Fresh content resumes next week when I am back from Australia.
“Just because you paid more for a company doesn’t mean it’s earning more,” said Oracle of Omaha Warren Buffet.
Global Market Comments
August 6, 2020
(HOW TO FIND A GREAT OPTIONS TRADE)
You’ve spent vast amounts of time, money, and effort to become an options trading expert.
You know the difference between bids and offers, puts and calls, exercise prices, and expiration days.
And you still can’t make any money.
Where do you apply your newfound expertise? How do you maximize your reward while minimizing your risk?
It is all very simple.
Stick to five basic disciplines and you will suddenly find that the number of your new trades that are winners takes a quantum leap and money will start pouring into your trading account.
It’s really not all that hard to do. So here we go!
1) Know the Macro Picture
If you have a handle on whether the economy is growing or shrinking, you have a major advantage in the options market.
In a growing economy, you only want to employ bullish strategies, like calls, call spreads, and short volatility plays.
In a shrinking economy, you want to execute bearish plays, like puts, put spreads, and long volatility plays.
Remember, the only thing that is useful for your options trading is a view on what the economy is going to do NEXT.
The government only publishes historical economic data, which for the most part is useless in predicting what is going to happen in the future.
The options market is all about discounting what is going to happen next.
And how do you find that out?
Well, you could hire your own in-house staff economist. Or, you could rely on economic research from the largest brokerage houses.
Even the Federal Reserve puts out its own forecasts for economic growth prospects.
However, all of these sources have notoriously poor track records. Listening to them and placing bets on their advice CAN get you into a world of trouble.
For the best possible read on the future of the US and the global economy, there is no better place to go than Global Trading Dispatch, published by me, John Thomas, the Mad Hedge Fund Trader.
This is where the largest hedge funds and brokers go to find out what really is going to happen to the economy.
2) Looking for great industry fundamentals
Do you want to give yourself another valuable edge?
There are over 100 different industries listed on US stock markets. However, only about 5 or 10 are really growing decisively at any particular time. The rest are either going nowhere or are shrinking.
In fact, you can find a handful of sectors that are booming, while others are in outright recession.
If you are a major hedge fund, institution, or government, you may want to cover all 100 of those industries. Good luck with that.
If you are a small hedge fund, or an individual working from home, you will want to conserve your time and resources, skip most of US industry and only focus on a handful.
Some traders take this a step further and only concentrate on a single high-growing, volatile industry like technology or biotech, or an even single name like Netflix (NFLX), Tesla (TSLA), or Amazon (AMZN).
How do you decide which industry to trade?
Brokerage houses pump out more free research than you could ever read in a lifetime. Government reports tend to be stodgy, boring, and out of date. Big hedge funds keep their in-house research confidential (although some of it leaks out to me).
The Mad Hedge Fund Trader solves this problem for you by limiting its scope to a small number of benchmark, pathfinder industries like technology, banks, energy, consumer cyclical, biotech, and cybersecurity.
In this way, we gain a handle on what is happening in the economy as a whole while lining up rifle shots on the best options trades out there.
We want to direct you where the action is and where we have a good handle on future earnings prospects.
It doesn’t hurt that we live on the edge of Silicon Valley and get invited to test out many new technologies before they are made public. My Tesla Model S1 is a perfect example.
That encourages me to recommend Tesla stock at $16 before it began its historic run to $295. It was the best short squeeze eve.
3) The Micro Picture is Ideal
Once you have a handle on the economy and the best industries, it’s time to zero in on the best company to trade in, or the “MICRO” selection.
It’s always great to find a good target to trade in because positions in single companies can deliver double or even triple returns compared to stock indexes.
That’s because the market will pay a far higher implied volatility for a single company than a large basket of companies.
Remember also that you are taking greater risk in trading individual companies. The options market will pay you for that extra risk.
If the earnings come through as expected, everything is hunky-dory. If they don’t, the shares can drop by half in a heartbeat. Large indexes buffer this effect, which is why they have far lower volatility.
Of course, there are gobs of market research about individual companies out there from brokers. Some of it is right, some of it is wrong, but all of it is conflicted. Recommendations are either “BUY” or “HOLD”.
Brokers are loath to issue a “SELL” recommendation for a stock because it will eliminate any chance of that firm obtaining new issue business. Who wants to hire a broker to sell new stock when their analyst has already dissed the company?
And brokerage firms don’t make their bread and butter on those piddling little discount commissions you have been paying them. They make it on new highly lucrative new issues business. In fact, a new issue can earn as much as $100 million from one firm. I know because I’ve done it.
I have been following about 100 companies in the leading market sectors for nearly half a century. Some of the management of these firms have become close friends over the decades. So, I get some really first-class information.
When markets rotate to sectors and companies that I already know, I have a huge advantage. Needless to say, this gives me a massive head start when selecting individual names for options Trade Alerts.
4) The Technicals Line Up
I have never been a huge fan of technical analysis.
Most technical advice boils down to “if it’s gone up, it will go up more” or “If it’s gone down, it will go down more.”
Over time, the recommendations are accurate 50% of the time or about equal with a coin toss.
However, the shorter the time frame, the more useful technical analysis becomes.
If you analyze intraday trading, almost all very short-term movements can be explained in technical terms. This is entirely how day traders make their livings.
It’s a classic case of if enough people believe something, it becomes true no matter how dubious the underlying facts may be.
So it does behoove us to pay some attention to the charts when executing your trades.
Talk to old-time investors and you will find that they use fundamentals for long term stock selection and technicals for short-term order execution.
Talk to them some more and you find out that the best fundamentalists sound like technicians, while savvy technicians refer to underlying fundamentals.
Get the technicals right and you can provide one additional reason for your trade to work.
5) The Calendar is Favorable
There is one more means of assuring your trades turn into winners.
I am a big fan of buying straw hats in the dead of winter and umbrellas in the sizzling heat of the summer.
There IS a method to my madness.
Have you heard of “Sell in May and go away?”
According to the Stock Trader’s Almanac, $10,000 invested at the beginning of May and sold at the end of October every year since 1950 would be showing a loss today.
This is despite the fact that the Dow Average rocketed from $409 to $18,300 during the same time period, a gain of 44.74 times!
Amazingly, $10,000 invested on every November and sold at the end of April would today be worth $702,000, giving you a compound annual return of 7.10%.
It gets better.
Of the 62 years under study, the market was down in 25 of the May to October periods, but negative in only 13 of the November to April periods.
What’s more, the market has been down only three times during the November to April periods in the last 20 years!
There have been just three times when the “good 6 months” have lost more than 10% (1969, 1973 and 2008), but with the “bad six months” time period, there have been 11 losses of 10% or more.
So it’s clear that trading according to the calendar can have a significant impact on your profitability.
Being a long-time student of the American, and indeed, the global economy, I have long had a theory behind the regularity of this cycle. It’s enough to base a pagan religion around, like the once practicing Druids at Stonehenge.
Up until the 1920s, we had an overwhelmingly agricultural economy. Farmers were always at maximum financial distress in the fall when their outlays for seed, fertilizer, and labor were the greatest, but they had yet to earn any income from the sale of their crops.
So they had to borrow all at once, placing a large cash call on the financial system as a whole. This is why we have seen so many stock market crashes in October.
Once the system swallows this lump, it’s nothing but green lights for six months.
After the cycle was set and was easily identifiable by computer algorithms, the trend became a self-fulfilling prophecy.
Yes, it may be disturbing to learn that we ardent stock market practitioners might, in fact, be the high priests of a strange set of beliefs. But hey, some people will do anything to outperform the market.
It is important to remember that this cyclicality is not 100% accurate, and you know the one time you bet the ranch, it won’t work.
Benefits of the Tailwinds
So there we have it.
Adopt these five simple disciplines and you will find your success rate on trades jumps from a mere coin toss to 70%, 80%, or even 90%.
In other words, you convert your trading from an endless series of frustrations to a reliable source of income.
If a potential trade meets only four of these five criteria, please do it with your money and not mine. Your chances of making money have just declined.
And I bet a lot of you poor souls execute trades all the time that meet NONE of these criteria. No wonder you’re losing money hand over fist!
Get the tailwinds of the economy, your industrial call, your company pick, the market technicals, and the calendar working for you, and all of a sudden you’re a trading genius.
It only took me a half a century to pull all this together. Hopefully, you can learn a little bit faster than me.
I hope it all works for you.
“In a social democracy with a fiat currency, all roads lead to inflation,” said legendary hedge fund manager Bill Fleckenstein.
Global Market Comments
August 5, 2020
(A NOTE ON OPTIONS CALLED AWAY),
(MSFT), (TLT), (BA), (GOOGL), (SPY)
“Artificial Intelligence is potentially more dangerous than nukes,” said Andrew McAfee of the MIT Center for Digital Business.
Global Market Comments
August 4, 2020
(MEET THE ITALIAN LEONARDO FIBONACCI)
(MRK), (GILD), (REGN), (AZN), (PFE), (MRNA), (ABBV), (BMY), (RHHBY)
When asked how he manages the time to be chairman of Microsoft, run the world’s largest charity, and raise three kids, Bill Gates answered, “I don’t mow the lawn.”