Trader's Thread 01 (May 08 - Dec 08)

[winston]

Some Considerations for Setting Stops in High Volatility Markets -- by Bill Kraft

"I don't make jokes. I just watch the government and report the facts." Will Rogers

It is certainly no secret that the recent past has demonstrated a period of historically high volatility in the markets. One of my very successful coaching students from this past year wrote last weekend and suggested that I write an article dealing with setting stops in this high volatility environment. I agree that subject is something that might be helpful so what follows are some of my thoughts on the subject.

First I should say that a consistent mantra for me has been to have an exit strategy in place before ever entering a position. In that fashion, the exit decision is made out of the heat of battle when the trader can calmly decide on a disciplined approach to his exit. At the time of entry I believe the initial exit should be close to the entry and it should be clear. I personally define the clarity as some line on a chart. It could be defined by a trend line, a price support, a moving average, a MACD crossover, or any number of things that remove my emotion from the exit decision.

If an exit is set in that fashion and adhered to, losses are essentially cut automatically. If I am wrong on direction I am out of the position with relatively little pain in most instances. That takes care of the clear part of the initial exit strategy. If I am right on direction, I may then follow the move by trailing stops or continuing to use the trend line as the exit (or one of a vast variety of other methods) in order to attempt to let my profits run.

The second part of my exit theory is that the initial exit should be close to the entry and that can be one of the most difficult things in trading. What is close for me may not be for you. You may be willing to risk a couple of dollars a share on a position and consider that amount to be "close" to your entry while I may define "close" as only 50 cents from my entry. This part of setting stops is one of the most subjective and difficult parts of successful trading in my book.

One of the problems is that we don't want to be whipsawed out of a position. As an example, if we set our stop too close on a bullish play (like buying a stock), the price could dip, we would be stopped out of the position, and the stock could then turn back up and head north just as we supposed it might when we entered the play.

Setting stops, in my estimation, is probably more art than science and it is one of the reasons I advocate practice trading. Paper trade stop setting to see what works for you. In these volatile days, stocks have tended to move in a wider range both on a daily and on a weekly basis -- that's simply evidence of the volatility. The first thing I conclude from that wider range is that I need to change my definition of what is "close" during volatile times if I want to avoid being whipsawed out.

How can this be done? Once again, it is subjective. A starting point may be to check out the daily range within which a stock trades. Placing a stop within that range may well result in getting taken out of the position just through the normal daily movement of the price. Recognizing that probability, we might want to be sure our stop is outside that range in an effort to avoid an exit occasioned by movements within the expected daily range.

We might also consider looking at a weekly range to decide whether we want our stop within or just outside that range. The point is that we know the range for a day or a week is going to be wider when things are more volatile than they would be when volatility is reduced. That awareness can help us reach our own conclusions as to precisely where we might place a stop. In a less volatile market, stops may be closer and in a more volatile market they will be farther away if we expect to avoid the whipsaw.

I know of no hard and fast rule to set stops depending upon changes in volatility; I only know that as volatility increases we need to change our own approach. We simply can't expect to set the same stops in a volatile market as we would in a calm market and get the same results. This area is one in which I often spend a great deal of time with coaching students and which I have dealt directly in past seminars. It is one of the hardest yet most important subjects in attempting to arrive at high levels of success in trading. It is worth working with someone knowledgeable and practicing on your own because it can truly inflate your returns.

[kennynah]

i concur that with higher volatility, one of the expectations should be to be able to absorb a bigger than normal losses if the position goes wrong. this is compensated by an equal likely that profits can be higher as well... hence if the norm is to cut loss at x%, given this higher volatility market, the investor/trader should consider cutting losses at y% (where y > x), else stay out if one is unwilling to trade at such heightened volatile conditions...

[millionairemind]

WEDNESDAY, NOVEMBER 12, 2008
GETTING TECHNICAL

Home in the Range
By MICHAEL KAHN | MORE ARTICLES BY AUTHOR

Some seasoned technical analysts are looking for an intermediate-term rally, but not much more.

THERE ARE AS MANY OPINIONS on the future direction of stocks as there are technical analysts. In today's column, I want to match some of them against what I have been writing to see where our collective judgment lies.

While these opinions are all different, they do not change my own views that value exists for long-term investors, while for traders the risks are as great as ever.

Let's start with the positive end of the opinions. Master trader Larry Williams of IReallyTrade.com says that he is very bullish on stocks for an intermediate-term rally lasting several months. Williams is well known by professional and individual traders alike so his accolades need not be repeated here. As a student of the markets for 46 years, he has tested and created many technical trading systems, and right now one that's based on changes in market breadth is looking better.

Specifically, he points out that the New York Stock Exchange advance-decline line, which measures the net number of stocks going up each day versus those going down, remains above its July 2006 low. Contrast that to the Dow Jones Industrial Average trading just above 8400 today versus roughly 10,700 in July 2006. Chart watchers call that a bullish divergence. The indicator does not agree with the current declining trend in prices.

He also cites a 13-week rate of change on the Dow flashing a similar buy signal last month. This indicator simply looks at prices today versus prices 13 weeks ago, and when the difference is extreme we know that the market has moved too far, too fast. Looking back, the same signal fired in September 2001, July 2002 and October 2002, each leading to a multiweek to multimonth advance in the market.

It should be stressed that these are not signals for short-term traders and will not pinpoint "the bottom" in the market. Williams is just talking about an intermediate-term rally and no more.

Larry Connors, CEO of TradingMarkets.com, has a more skeptical view. He says that whenever the market is below its 200-day moving average, investing in stocks is a dangerous game.

While this is a very simple classification, for investors it does serve to keep them on the right side of the trend. When prices are below the average, it tells us that anyone who bought stocks over the past nine months is holding them at a loss. Typically, they will look to sell their shares if they can break even; collectively, that break-even point is the 200-day average itself. That creates resistance above and a potential trap for investors buying too soon.

Matt Blackman of TradeSystemGuru.com agrees, saying that people have been trying to call the bottom for months. Blackman points out that the trading range that seems to be developing over the past six weeks resembles a technical chart pattern called a "bear flag."

A flag gets its name from its appearance of a flag flying on a flagpole in bull markets, so in bear markets the pattern is simply inverted. If prices move below the bottom of the pattern, and for the Dow that would be the Oct. 27 closing low of 8175, then the bears would be back in control and looking to drive the market several hundred points lower.

Of course, as with all technical chart patterns, if prices move the other way from the pattern then the reverse action will be warranted. Blackman will remain on the sidelines, content to watch without risk, until one or the other happens.

With a more historical perspective, Buff Dormeier, a portfolio manager with Wachovia Securities and winner of the 2007 Charles H. Dow Award for technical research, likens the current market to that following the Crash of 1929. But he aligns the 2000-2002 decline with the "the big one" seen in 1929-1932.

The current decline, in his view, is more like the bear market of 1937-1938 in that both followed several years of what he called mini-bull markets. And if that analogy holds true, then the next several years will offer a trading range and nothing more. Buy and hold investors will have to wait quite a while to see real profits.

While not obvious, there is a common thread here. All of these opinions leave room for a multiweek to multimonth rally before the bears reassert themselves, although one says that the risk involved would be too high for investors to safely play. Several see a floor for stock prices, and one is on alert for lower, if not much lower prices ahead.

All told, the stock market remains quite risky today from a technical point of view, but that does not mean investors should give up on it. For those able to handle volatility, there may be an opportunity to take a ride on the market soon. But as the experts cited here seem to agree, even after a nice intermediate-term rally this market is facing a long healing process and will be subject to major selloffs in the future

[winston]

Protecting Positions -- by Bill Kraft

Last weekend I wrote about the use of stops in general and in high volatility markets such as those we are currently facing. A reader pointed out that I didn't know what I was talking about since it was his view that stops don't work in high volatility markets and the only thing worthwhile to protect positions was the protective put. First, I want to point out that at the worst, it is far better to have a stop than to have nothing to protect the downside. I agree with the most recent critic that stops are more difficult in highly volatile markets and as I indicated last week, more latitude is necessary in placing them than in less volatile situations.

Truth be told, I am a great believer in protective puts as well. In fact, I just spoke about them a couple of weeks ago at the Trader's Library event, went into great detail about them in my book, "Trade Your Way to Wealth," and have previously written articles about them here and elsewhere. For those who may be unfamiliar with options, a put option is a contract in which the buyer of the put obtains the right (but has no obligation) to force someone to buy his stock at a predetermined price (the strike price) anytime until the put expires. In exchange, the buyer of the put pays the seller of the put a premium.
In return for the premium, the seller of the put has the obligation to buy the stock at the strike price if assigned (put) to him anytime before expiration.

For example, suppose I owned XYZ, an optionable stock which I bought at $30 a share. I could buy a put at a $25 or $30 strike price that expires a month or two or maybe even a year from now. The longer away the expiration, the more expensive the premium would be and the higher the strike price I bought, the more expensive it would also be. In the example, suppose I bought the $30 strike price with an expiration 4 months out and the premium was $5 a share. Now, no matter how far the stock might fall, I could force someone to pay me $30 a share if I exercised my put any time before expiration. Naturally, if I did that, I would be out the $5 a share, but I would be able to sell the stock, itself, for exactly what I had paid (less commissions on the stock and on the purchase of the puts).

One thing for which I suspect the critic of stops failed to account is the relative cost of puts. At times like the present, for example, where the implied volatility is very high, options are very expensive. Buying options may not be the wisest things to do at times when volatilities are extremely high. To look at a real life present day example (as of close on Wednesday, November 12, 2008), DUG closed at $45.26. Suppose we bought 100 shares at the close and also bought the at the money $45 protective puts. We could have bought the Jan 45 puts for $11.90 a share. Now we would be able to force someone to buy our stock for $45 a share anytime between now and the third Friday in January for $45. It would have cost us $11.90 a share to obtain that protection so come the third Friday in January, the stock would have to be up $11.90 a share (+ $0.26 since the stock would lose 26 cents a share if we sold it for $45 a share) plus commissions for us to break even.

That is one choice we could have made and it is a legitimate one. However, we should be aware that the premium we are paying is quite high because of the high current implied volatility. On the other hand, we might have chosen to place a stop loss below the uptrend line on the stock at $37. If the stock dipped to $37, our position would be closed and if closed around the $37 mark, we would have lost $8.26, a number significantly less than the cost of the put premium. Of course, one problem with stops is that there is no guarantee that we will get the stop price if it is hit.

The stop simply means that our stock will be sold if the stock price hits or goes below the amount at which the stop is set. If, for example, the stock gapped down at the open to let's say $20, our $37 stop would be hit but we would probably only get around $20 a share. With the put in our example, no matter what the stock price, we could still assign it for $45 if we had paid the $11.90 a share premium. The real point is to look at the alternatives available to us. Sometimes the stop is the better choice, sometimes the protective put.

The fellow who decided I was so foolish to discuss stops last week and took the position that anyone with a brain should only buy protective puts also failed to acknowledge that many stocks are not optionable and if one holds a position in such an issue, buying a protective put is an alternative that simply does not exist.

[millionairemind]

SATURDAY, NOVEMBER 15, 2008
UP AND DOWN WALL STREET


Another Bum Signal
By ALAN ABELSON | MORE ARTICLES BY AUTHOR

Beware shills hawking market bottoms. Why the crowd's all wet on next year's earnings.

IT WAS JOHN MAYNARD KEYNES, a great investor as well as a great economist (the two superlatives are not always compatible, much less synonymous), who with his trademark dry humor remarked that the market inevitably managed to stay irrational longer than he could stay solvent.

Since he made his fortune, as we recall, trading commodities, racy, quirky and even inexplicable market behavior was no stranger to him. All the more pity, then, try as we might, we can't seem to channel the old boy to get his acerbic fix on this year's incredible yo-yo stock market. But, whatever his precise description, we strongly suspect he wouldn't dream of accusing it of being entirely rational.

Its erratic disposition was beautifully epitomized in Thursday's wild and woolly session in which the market swung fitfully from plus to minus and minus to plus dozens of times, until when, late in the afternoon, without any visible excuse, it suddenly bolted upward, as if some mischievous prankster had given the poor confused beast a hot foot.

After being down by over 300 points, the Dow rallied with crackling esprit, topping it off with a Garrison finish that left it some 552 points higher than where it started the day. Not to be outdone, the S&P 500, which had been hammered in the early trading to the lowest level in nearly six years, bounced smartly and closed with a hardly shabby 6% gain. It was, moreover, an inclusive turnaround, with roughly three times as many stocks closing up as down.

The breathtaking change of direction was rather a puzzle to simple souls like us, who tended to shrug it off as just another but scarcely the most nettlesome of life's multitude of imponderables, or merely fresh evidence, if any were needed, that emotion often tops reason as the market's motivating force. But it drew a much different response -- something approaching jubilation -- from more than one member of that band of hardies who claim the title of market technicians.

For the uninitiated, technicians adhere to the idea that past is prologue, that all markets are cyclical and that cycles invariably repeat themselves. So they studiously consult their charts of stock-market action, sometimes stretching back to when the bids and offerings were made under the Buttonwood tree, and their copious compilations of investment history, stretching back even further, to divine what the future may hold.

For all its vaguely mysterious aura, such analysis can be, we can attest, a helpful adjunct in identifying budding trends and assessing individual stocks by revealing critical nuances about strengths and weaknesses that otherwise are tough to detect. As it happens, this market has not been inordinately kind to technicians, any more than it has been to the more familiar kind of market and securities analysts.

Some of the tried and true tools of the technical trade, sentiment readings are a case in point, have proved less than reliable. Sentiment is supposed to be a contrarian indicator: When the crowd is bullish big time, that's usually a sign the market's poised to take a serious dive, and, of course, vice versa. Maybe it needs to be sent to the shop for repairs, for it sure hasn't worked this way. Once the market started to crumble in earnest, sentiment measures turned bearish and got increasingly so all the way down. All the world's still anxiously waiting for a rebound that lasts more than a day or two.

As we persist in saying, this bear market is different, just as the economic storm lashing at us is different, different certainly from any we've suffered through for over a quarter-century. Which explains why we're so leery of the scattered exultation that gripped Wall Street after Thursday's performance (and was dampened a wee bit by Friday's droopy action).

The celebrants, not a few of whom normally sneer at technical analysis as investment voodoo, nonetheless seized on the smashing snapback from the depths as proof that stocks have successfully "tested the lows" set on Oct. 10 and, they crowed, according to technical writ that means we've achieved the long sought-after but elusive bottom.

Their buy-word was that the battered market had resolutely "drawn a line in the sand." (We'll forgive the anthropomorphism, if only because we occasionally indulge in it, ourselves.) But it's not the first time in the course of this year's bruising market descent that we've heard that glad cry. Trouble is, each time, it turns out, it wasn't any old sand the supposed line was drawn in, but quicksand.

FEW THINGS BUG US MORE than the notion that "stocks are cheap," which has become a kind of maniacal mantra among wounded bulls. It's not at all clear, at least to us, why the person so confidently intoning that opinion believes stocks are cheap. That the S&P 500 index has come down nearly 40% this year does make it indisputably lower than it was on Jan. 1. But so what?

For just as indisputable is that earnings have been coming down as well -- 20% in the third quarter. For the year as a whole, on a per-share basis, those earnings, according to the consensus estimates, are likely to total something like $80-$81. Which, if by some weird chance it is right, means the index is selling at around 11 times this year's profits.

Ah, we can hear the thunderous counter, but the consensus estimate for next year is $91-$92 a share and, by golly, on that basis, stocks are not only cheap, they're a steal. The only problem, in our bloodshot view, with that reckoning is that with the economy growing ever more rocky by the day, logic, if it has any place in this discourse, makes it far more likely that per-share earnings on the S&P will be $70 or even less.

Of course, that will translate into a 12 P/E. Provided, that is, investors' funk and fury don't deepen as the global slump exacts its melancholy toll and inspires a new selling spree (which, if it's any consolation, would make stocks cheaper still).

As Morgan Stanley's Richard Berner points out in a nifty recent piece on profits, an awful lot of things on the corporate and economic scenes have turned upside down, a monumental change that somehow seems to have eluded the good old consensus. When borrowing was no problem and times were good, Corporate America used leverage like there was no tomorrow, eagerly taking on debt for any number of louche purposes. As, for example, buying back stock to goose earnings per share and return on equity and, we might add the obvious, give a nice lift to its shares (on which management just happened to hold a bounty of options).

But, observes Berner with an almost audible sigh, that was then.

Nothing better illustrates the fact that not every denizen of Wall Street has yet faced up to the sere investment landscape and the profound and ugly consequences of the credit collapse than the refusal by so many analysts to realize, evident in those happy-hour estimates on earnings, that the party really is over. Sober up, people.

SHIMMYING UP THE GREASY POLE of prognostication is always a dangerous business. But journalists are supposed to be brave and fearless, having taken a solemn oath to speak truth to power and comfort the afflicted and afflict the comfortable, or else they don't get paid. So here goes.

We'd like to whisper a kind word for commodities. Not all of them, to be sure (we haven't completely lost our mind). The two we're feeling uncharacteristically kindly towards are oil and gold. Gold is a no-brainer (who was it out there who just said that automatically qualifies us to talk about it?).

Our thesis is as simple as it is unoriginal: Virtually all of the civilized world and a good chunk of the uncivilized world is in a race to see who can debase its currency the fastest. The big spur here is the great global bailout and the trillions in paper money being the baling instrument of choice. We can't think of a better way to take advantage of this frenzy of financial free-fall than stowing away a few nuggets.

Gold has taken its lumps along with virtually every swappable asset, hard and soft. Its current price of $742 and change an ounce is down some $300 from its peak. It's volatile, but so is life. You can't eat it, but it's durable and a reasonable haven.

Oil, no secret, has been on the skids ever since it set an all-time peak of $147.27 a barrel back in July. It ended last week at a few pennies over $57. The steepness of its decline frankly surprised us, and we don't have a decent feel for where it will be next week or next month.

But OPEC, scared out of its ermine robes (a discomfort we truly enjoy watching), is slated to take another slice out of production before year's end, while the tailspin in prices may give pause to some of the more notorious cheaters in the cartel. Meanwhile, more so it seems to us than in similar fallow stretches in the past, producers have been quick to adjust to the drop in demand.

And then, as our old pal Tom Petrie out in Denver puts it, the era of what he calls "Practical Peak Oil" has been delayed by the global recession. But it still looms in the not-too-distant future and promises -- or threatens -- to furnish a powerful lift to prices.

[Cheng]

Need help from experienced chartists here, I've posted some charts, in your opinion, do you think S-shares bottomed out already? I picked out the market leaders in S-shares usually heavily traded.

I used William O'neil's method on the charts. Please correct me if I'm wrong. Thanks a lot!

[helios]

swosh good charts ...

i remember MM ge said that he has to 'modify' the O'Neil method for Singapore's context ... is the x no. of accumulation days sufficient to warrant a buy signal? ...

are these the ones targeted for institutional sponsorship in the next playground after free trade trade?? ...

i think, there could be more China Co. to be listed in SIN once the free trade has kicked off ... no hurry on these few.

[blid2def]

Well, I don't know much about O'Neil, but here's my look from Itchy Mushroom, using just YZJ as an example (the rest are about the same, just that they've not run smack into the resistance cloud).



I think we need to understand what your trading period in question is, when you talk about bottoming. Short term bottom of a few weeks? Long term bottom taking this stock out of the bear market?

If you're thinking of a long-term bottom... do you believe the general market has bottomed?

If not, what are the chances that an individual counter could survive when the market searches for its bottom?

If the stock is that strong that it's reached its bottom before the general market has, then wouldn't it continue to float when the market does find its bottom and gushes up?

[Cheng]

Thank you gran for the great insight, learnt something new.

Was refering to the general s-share market bottoming out and going into a bull market. I still believe that there will be long periods of stagnation but my sentiments may be wrong. Just some of the tell tale signs I've noticed in the charts. Totally not experienced in chart reading, that's why need some of your comments.

Any comments from MM?

[millionairemind]

Hello Cheng,

Tot you are value investor?? Or maybe a value cum closet TA practitioner (the most powerful kind)?

GR is correct - if mkt is still searching for a bottom, then all bets are off.

I modified CANSLIM for Singapore in that when mkt is in a confirmed rally, then I start buying Singapore stocks. If mkt is in a correction, then I close my longs and consider shorts.

Right now the mkt is in a correction.

The last couple of follow thro's went no where and quickly met with resistance and failed. Furthermore, if funds don't come back to Asia, stocks won't move much. YZJ and Cosco might be the exception cos' they have lost close to 90% from peak...

Please see my posting on Jun 5 if you have the time.

viewtopic.php?f=16&t=262&st=0&sk=t&sd=a&start=20

Hope this helps.

Cheers,
mm