Some thoughts about the market that you should know? (October 1, 2012)
Team, just a note about the overall market. I am NOT getting a real “feel good” about the current environment. The transports have been a big issue — see my morning notes. The transportation sector traded up for about 30 minutes this morning and then rolled over right along with the S&P. So it’s interesting — the Transports have NOT at all been correlating with the broader market. I.e., they have not been in sync. While the S&P has fallen 2% from its recent high, the Transports have fallen 7% during that same time.As noted earlier — the “Fitz Theory” matters because the Dow Theory matters. I just heard a discussion on CNBC where one of the guests was saying that the market is NOT trading on fundamentals; but rather, it is trading on money flow. I understand what she was saying, but I believe it’s a bit deeper than just “ignore fundamentals — go with the trend.”There is nowhere else to invest right now. Treasuries are a joke. You’d do nearly as well with a CD at the bank, without the downside. So money comes into equities. BUT (and man, this is a big butt), if equities roll over, we will see a fairly significant pullback…BECAUSE there is nowhere else to go except cash. Rotation from equities into Treasuries? Sure. There will be some of that. But the flight to safety will really be to cash. Perhaps gold as well, but certainly cash.Now, don’t read too much into this. I am NOT suggesting that we’ll see a big pullback. Remember…there is nowhere else to go right now. Rather, I am suggesting this:1. Be vigilant and don’t be a blind bull. Don’t fall into that silly trap of thinking that because we did NOT see a big selloff in September, then it won’t happen. Corrections don’t happen when people expect them to. That’s why they’re corrections. Remain vigilant.2. Be chart-driven. You can always buy a stock back if you happened to sell it and wish you hadn’t. But you’ve got to use charts to your advantage — you must know HOW to read charts. If you don’t, then you’ll buy every breakout and sell every pullback because that’s what you see on the chart. Don’t do that. Do not let your conviction trump your discipline. Losing 10% requires a gain of 11% just to get back to even. And it takes time to achieve that 11%. Always remember that. It’s just a function of mathematics.3. Manage Risk. When you focus on risk management, your life is a bit boring. It can be frustrating to miss out on the big move. You don’t get that adrenaline rush that many traders love to get. The discipline of risk management is supposed to be boring. If you want excitement, ride a Harley while blindfolded. Ride your mountain bike on a bumpy road without tightening the front wheel nut. Go skydiving with a parachute packed by someone who has never packed one before. There are many things you can do for excitement. Managing risk is not one of them.4. Have realistic expectations. If your trading account is $10,000, don’t expect to double it next year. Sure, you might. But you might also cut it in half…or even worse. Don’t fall into that group of option traders who say, “I know I’m trading with excessive risk and I’m swinging for the fences. I know I’m doing it wrong…but man, I’ve got to make some money! Once I double my account, THEN I’ll start trading the way I’m supposed to. THEN I’ll stop taking so much risk and will focus on protecting my money and will be happy with more reasonable returns.”Hello! Think about #4. Is this you? (You don’t have to identify yourself publicly. Please don’t. But at least acknowledge that I’m describing you.) Think about how silly this is. Think about how ridiculous it is! You KNOW you are doing things wrong, but are expecting extraordinary results. Frankly, (yes, I’ll say it), that’s stupid. Wealthy people have the most margin for error. They are the ones most able to withstand excessive risk. People of modest means can least afford to take excessive risk. They need to focus on managing what they have…and then growing their wealth steadily and consistently…and with reasonable expectations.Yet despite this disparity between rich and “modest”, the folks who are most averse to risk are the folks most able to bear more risk — the wealthy folks. Why do you think that is? It’s because they understand how difficult it is to make money, and they darned sure don’t want to lose what they have. Think “Rocky III.” When Mickey the manager is yelling at him, asking him why he won’t stand up and fight, Rocky says, “I don’t wanna lose what I got!”Guys, that’s trading. That analogy breaks down when you take it too far, but it works for our purposes. Ultimately, you’ve got to stand up and fight. But you should ALWAYS be vigilant and strive to avoid losing what you’ve got.Don’t worry about catching every move. Don’t worry about outperforming when the market is uncertain. Just worry about managing your risk; things will ultimately work out. Strive to be boring. You’ll live longer and make more money.–Dan
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