Intelligent AccomplishmentMarket & Sector Review Plus A Short Treatise on Short Selling
This Week's Economic Reports
It's once again time for our family to spend a week at the ocean. We will be leaving first thing Saturday morning and returning on the 16th,or 17th, therefore there will be no newsletter next week. In addition the Prudent Trader site will not be updated until our return next weekend. An e-mail will be sent when the updates are completed.
Intelligent Accomplishment"Until thought is linked with purpose there is no intelligent
accomplishment." (As A Man Thinketh)
In her book, Unstoppable, Cynthia Kersey writes that a prominent psychologist asked 3,000 people, "What have you to live for?" An amazing 94% answered by saying they had no definite purpose for their lives - 94% percent!! With those kind of results, is it any wonder that there are so many unhappy people in our world today?
James Allen also tells us on this subject that, "They who have no central purpose in their life fall an easy prey to worries, fears, troubles, and self-pity." When writing or updating you trading plan the first page should be your goals: Where do you want your investment and/or trading account to be in 1, 3, 5, and 10 years from now. Then what will you use your profits for: Retirement; Children's education; New home at the beach, and so on. You will draw down your accounts, in time to realize your goals. This is your purpose in investing/trading is it not? Now that you have your purpose you will use intelligent thought and study to provide the how to.
I believe we were created with a purpose in our heart, and part of our journey here is to discern that purpose and to act on that purpose. Purpose puts power and excitement in our lives. In our case it creates a passion for the markets. It keeps us from looking at the little picture of "me" and causes us to look at the big picture of "we."
Ralph Marston, who writes The Daily Motivator, says "Your wishes, desires, hopes, dreams, opinions, likes and dislikes, at their very deepest level, revolve around a purpose. You can sense it. It is there. Pay attention to the times you really feel good about yourself. Ask yourself why this is so. Keep asking until you touch a purpose so fundamental it cannot be explained in any other way."
Napoleon Hill, writing in the classic Think and Grow Rich, said that having a purpose was so important to success that, people would have a different (and better) story to tell about their lives "if only they would adopt a DEFINITE PURPOSE, and stand by that purpose until it had time to become an all-consuming obsession!"
Many Thanks to Vic Johnson for his contribution to this section!
Vic is offering a FREE E-Book of James Allen's "As A Man Thinketh" To Download Click HereMarket & Sector Review
Below and after a very brief market discussion this week are two things I hope everyone will appreciate: First there was a topic posted on one of the message boards I frequent asking other traders to share just ONE very important thing they have learned about trading, I have copied a few down that I really like, you may want to print them out and paste them next to your computer; and Secondly as promised last week is a short treatise on selling stocks short, it is only a brief treatise sharing some of the ideas of Bill O'Neal, author and President of Investors Business Daily, and some of my own ideas, there are many, many more if the subject is of interest to you. So let's first take a brief look at the markets this past week.
Last week I said that even though the clock is beginning to turn me bearish, I still have in the back of my head that we have not seen the final blow off stage of this market which historically marks the end of bull markets, just as capitulation often marks the end of bear markets. The markets seemed to be in a narrow trading range basis the S&P 500 with volume picking up slightly on down days and declining slightly on up days, usually not a good sign. However I have been impressed with the markets ability to ignore or overcome bad news as stated last week and was wondering if the April highs around 1190 would hold (you've heard I'm sure the old axiom old highs become new lows). Then Thursday morning I awoke to the horrific news of the bombings in London and saw that the Dow Futures were down 130 or so and had been down over 200 points shortly after the news broke.
By the way we have quite a few members in England or the UK if you prefer, just want you to know that our hearts here in the states go out to each and everyone of you -> May God Bless!
Back to the markets, I thought for sure the 1190 would break and that we might even see trading curbs which we haven't seen in 18 years. Not only London, but hurricanes sending Oil prices spiraling higher because of potential closings in the gulf, how could this market rally? No way, the market said and the buyers came in just above 1180 held the market solid, and the rally commenced as the shorts most definitely began to bail out. Impressive! Remember it's not the news that's important it's the markets reaction to the news that's important. We are rallying in the face of bad news, climbing a wall of worry. Yesterday's rally brings us back on the way to a test of 1220 and the triple top we spoke of last week. If the volume picks up this week or next we could carry through the triple top mentioned and shown last week, and the elusive blow off I've been thinking about could be underway. The PT-Accumulation algorithm suggests it will happen.
Keep in mind the markets job is to deceive the majority and the marching to new highs by the small and mid-caps while the large caps and some of the major indices lag could indeed be part of the deception that turns everyone bullish that in turn sets up the reversal. But it's a little early for that and all technical signals that I find important appear on a go for the upside so enjoy for now, it's still a bull market and will be until it isn't. I'm just trying to bring a little reality and caution into the picture, nothing more.
A good place to start shopping is our most improved list stay with strength if you are playing the rally, or look to those weakening for possible good future shorts.
Can you share just ONE very important thing you've learned about trading, what would it be? ONE LINERS preferred: Below some of my favorites from the presenters
Never fall in love with a stock.
Always start by assuming your analysis is WRONG and that people much smarter and with more recent information are already positioned opposite you.
Never take on a position larger than your comfort zone. (Don't overtrade) If you can't sleep at night from worry....pare down. Bad decisions are made under duress.
Before entering the trade think very carefully what will make you wrong, write it down clearly and put it in front of you where you trade, and when your wrong get out happy you've followed your trading discipline.
Never add to a losing position! (Unless scaling in was part of the plan).
Which brings up the other important one: Always plan your trade and trade your plan.
Whenever you think you've found the key to the lock, they'll change the lock.
Markets are never wrong, although opinions often are
The market's "Job One" is to deceive; thus discussion of how the market "looks" or "feels" is counterproductive at best disastrous at worst. Context is everything.
Don’t enter a trade if you don’t know where your exits are (and be sure to have several).
In 1912, an interviewer asked "Old Man Harriman" about his stock market skills
and secrets. The trader replied..."If you want to know the secret of making money
in the stock market, it is this…Kill Your Losses! If the trade goes your way, let it run.
E.H. Harriman's family fortune endures to this day.
Wait patiently for your setup. Don't jump the gun too early don't chase it if you miss it. Plenty more trades come along if you wait...
"Everything I learned about trading I learned from Joe Montana".
Explanation: I was watching an interview some years back, and they asked Joe Montana how he was able to get sacked, lose yards, and the very next play come back with a cool head, and make a great the play.
His response was that every play is a new play, you can't allow a bad play to disrupt your thinking and throw off your plan. You forget it, and don't take it back to the huddle. Everytime your in the huddle its a new play and a new game.
I thought about that and how it applies to trading,,,,,It helps me too stay on track, and stay with a plan!!!!!
"MR. MARKET" IS ACTUALLY "MRS. MARKET" ONLY WOMEN CAN THINK, AND ACT THE WAY THE MARKET DOES. THAT IS WHY -ON AVERAGE -WOMEN ARE BETTER TRADERS THAN MEN, THEY UNDERSTAND WHAT THEY DEALING WITH!
I MEAN THIS AS A COMPLIMENT TO ALL WOMEN TRADERS.
A Short Treatise on Short Selling
First and foremost let me state unequivocally that selling stocks short is not for everyone, especially new or novice traders. Short Selling should be limited to those with a good deal of market experience who are aware of all the risks and are willing to assume them. If you are younger and never heard Kenny Rogers song "The Gambler" there is a line that states "you have know when to hold them, know when to fold them and know when to walk away." Although this song was written about poker it is applicable to market trading as well. If you are one who is not suitable to short selling or do not desire to sell short then just know "when to walk away" and at that time just retain cash in money market funds. If you must do something then consider yourself "A Gambler" and not a trader or investor who is seeking out opportunity and not just a roll of the dice.
First if you are willing to sell short two things you must be aware of: 1) You will need to make sure that you can borrow the stock from your broker that you wish to sell short in order to deliver stock to the buyer; and 2) You must sell short on an up-tick, that is at a price that is higher than the previous price where shares traded or equal to the last price if that was indeed an up-tick (note: ETF's Exchange Traded Funds are exempt from the up-tick rule which makes them popular for short-sellers). You borrow the stock from your broker, sell it short, in the hopes of buying it back later at a lower price to close out your position and return the shares you just purchased to your broker. The proceeds from the sale are credited to your account but these proceeds are not necessarily available as buying power as your account is marked to the market daily in case the position goes against you. There is an old cliché' in regards to short selling that always brings a smile to my face - "He who sells what isn't his'n must buy it back or go to prison."
Let's start with the Never's! You never want to sell short a stock that is running up (just like you never buy a stock that is falling out of bed) and looks too high to you whether in terms of price or P/E. The stock could be high for a reason and may continue to move higher regardless if we are in a bull or bear market. You never want to sell short a thinly traded small cap stock, it's way to easy for someone or some group to run the stock up forcing you and other shorts to cover, this is known as a short squeeze and happens more often than you might think. And you never want to sell short a big dividend paying stock because you will have to pay the dividend every time it comes due and you are short.
Still interested in selling short? OK let's do it! According to Bill O'Neal the best time to sell short a "former leader" is five to seven months after it has clearly broken down and topped and has rallied back three or four times in a sideways basing area and then starts to weaken. Selling short is a little tricky and more difficult than buying simply because there are more wrong times to sell short and only a few really good times, when your risk can be controlled.
First mistake many newer traders make is to sell short when it is obvious to most people, when a stock is breaking down below an old low that every amateur chartist can see. Believe me when I tell you there are pro's out there looking for those easy setups when John Q. Public will initiate short sales on a break below a previous low point, they will sit an wait till the selling pressure subsides and come in and buy in mass. The selling having been completed the price rises immediately and sometimes rapidly causing many a novice to in turn buy and run for cover. The pro's I am speaking of spend 40+ hours a week searching these situations out and they make good money doing it. So don't attempt to short an obvious point.
Again according to Bill O'Neal, when you go short, you can't afford to wait for a new low price but should short after the third or fourth rally attempt (10% to 20% or more price movement), then when it starts to fall and breaks below its 10-week moving average price line, and the volume for the day picks up. The stock should be at least 4 or 5 points above a previous low price a number of weeks ago that some chart followers might view as a new breakdown point or possible support area. This gives you a potential cushion before the stock becomes obvious to most other traders. It's a good idea to take your profits when a stock drops 20% to 30% and while it's still declining, because at some point the stock will turn and rally rapidly to run the short sellers out. After the rapid rally above the 10-week moving average the stock can probably be shorted again once it returns below the moving average line on increasing volume.
Example's from "The Successful Investor" by William O'Neal (Note Chart scale is logarithmic not linear):
While I agree with Mr. O'Neal's opinions I (as you should) have my own twists and risk assessment and money management methods. When I notice a large capitalization issue (usually means it's easy to borrow stock) break down it goes immediately on my short sale watch list and will be watched for a rally back towards or a little better than the breakdown point. If the rally does not occur within a couple of weeks then this stock is deleted from the list, in my mind it's no longer a short candidate, at least at this time.
It is on the retracement back to the breakdown point that enables me to analyze the risk to this potential short sale. Notice on the second day after the breakdown we had a high volume attempted reversal followed by the follow through down to 92ish. It is this high volume day that enables me to analyze my potential risk in any short sale. Next notice the first rally attempt back to the breakdown point occurred on low volume followed by a decline on increasing volume and then another rally attempt and again on declining volume. That is my clue that a short sale is warranted here (at about 94). Now for the risk assessment, the high volume attempted upside reversal on 1/18/05 shows that all the buyers could do that day was move IBM $1.72 (95.34-93.62), now I take that $1.72 and add it to the high of that day of 95.34 and my stop will be at $97.06 or about $3 on an almost $100 stock.
Again any risk taken is based upon my total portfolio's size and is limited to 3%. Let's say that your portfolio size is $50,000, a 3% risk is $1,500. Risking in this example $3 per share that means I can short 500 shares of IBM (500 x $3 = $1500), however $500 x $94 =$47,000 and that is much too large a percentage for this portfolio. I like to carry 4 to 6 positions at any given time totaling 15% to 25% each of the total. Therefore I'd be much more likely to short 100 or perhaps 200 (depending upon my confidence level at the time). Money and Risk Management, it's what this game is all about.
Good short sales exist in both bull and bear markets, however they are much easier to find in bear markets and the bear market increases your odds for success. There is a rule called the 80-20 rule if you're a businessman you probably understand well. It basically states that in most businesses, 80% of your business comes from 20% of your accounts and 80% of your headaches come from your accounts that provide but 20% of your business. So it is with the market, during bull markets probably 80% advance but 20% decline or stay the same, and conversely during bear markets 80% of stocks decline and 20% advance or stay the same. If I am correct (a big if) in looking for the four year cycle high to be due this year then you have 4 choices: 1) Sit with your holdings through the bear waiting for the next bull; 2) Wait out the bear market in cash; 3) Find a couple in the 20% category that will advance; or 4) Sell Short.
This has been as the title suggested a short treatise and nothing more. I sincerely hope it helps your understanding and if you are so inclined the how to, at least in one man's humble opinion.
This Week's Economic Reports
Have A Great Week!BillDisclaimer:Trading in securities, of any type, may not be suitable for all individuals. The contents of this newsletter are not a solicitation to buy or sell securities. The opinions expressed are solely that of the author. You must do your own research, contact your own financial advisor for suitability of any investments. Data gathered is from sources believed to be reliable, but NO guarantee as to their accuracy is made.
While I agree with Mr. O'Neal's opinions I (as you should) have my own twists and risk assessment and money management methods. When I notice a large capitalization issue (usually means it's easy to borrow stock) break down it goes immediately on my short sale watch list and will be watched for a rally back towards or a little better than the breakdown point. If the rally does not occur within a couple of weeks then this stock is deleted from the list, in my mind it's no longer a short candidate, at least at this time.
It is on the retracement back to the breakdown point that enables me to analyze the risk to this potential short sale. Notice on the second day after the breakdown we had a high volume attempted reversal followed by the follow through down to 92ish. It is this high volume day that enables me to analyze my potential risk in any short sale. Next notice the first rally attempt back to the breakdown point occurred on low volume followed by a decline on increasing volume and then another rally attempt and again on declining volume. That is my clue that a short sale is warranted here (at about 94). Now for the risk assessment, the high volume attempted upside reversal on 1/18/05 shows that all the buyers could do that day was move IBM $1.72 (95.34-93.62), now I take that $1.72 and add it to the high of that day of 95.34 and my stop will be at $97.06 or about $3 on an almost $100 stock.
Again any risk taken is based upon my total portfolio's size and is limited to 3%. Let's say that your portfolio size is $50,000, a 3% risk is $1,500. Risking in this example $3 per share that means I can short 500 shares of IBM (500 x $3 = $1500), however $500 x $94 =$47,000 and that is much too large a percentage for this portfolio. I like to carry 4 to 6 positions at any given time totaling 15% to 25% each of the total. Therefore I'd be much more likely to short 100 or perhaps 200 (depending upon my confidence level at the time). Money and Risk Management, it's what this game is all about.
Good short sales exist in both bull and bear markets, however they are much easier to find in bear markets and the bear market increases your odds for success. There is a rule called the 80-20 rule if you're a businessman you probably understand well. It basically states that in most businesses, 80% of your business comes from 20% of your accounts and 80% of your headaches come from your accounts that provide but 20% of your business. So it is with the market, during bull markets probably 80% advance but 20% decline or stay the same, and conversely during bear markets 80% of stocks decline and 20% advance or stay the same. If I am correct (a big if) in looking for the four year cycle high to be due this year then you have 4 choices: 1) Sit with your holdings through the bear waiting for the next bull; 2) Wait out the bear market in cash; 3) Find a couple in the 20% category that will advance; or 4) Sell Short.
This has been as the title suggested a short treatise and nothing more. I sincerely hope it helps your understanding and if you are so inclined the how to, at least in one man's humble opinion.