Subprime Trade Nailed (With a Little Help From Napoleon and Trump)

Last week, the week of the 400 point DOW meltdown, was the worst week I have had trading since the Internet collapse of 2000. On Tuesday, I woke up to Bloomberg discussing China’s 9% fiasco and the concerns of it carrying over to our markets. Certainly stops would be triggered, at the opening, which would set off a domino effect. Where would the market stop for a breather? It was anyone’s guess. Not being a fan of hard stops – I thought that my mental stop strategy would work in my favor. My preference is to set mental stops and close out positions at the close if triggered. This is a technique that I use to take the intra-day emotions out of my trading strategy.

Since I trade primarily commodity stocks, I had one eye on the DOW – but my focus was on Gold. As the markets gapped down at the open the Gold ETF (GLD) followed suit down 1.5%.

Then it stabilized and started rising. This was exciting. Money was flowing out of the general market into Gold as a safe-haven. However, as the DOW continued selling off Gold gave up ghost and followed suit.

The DOW’s 200 point freefall around 3PM was simply too much. I couldn’t stand it anymore and I started selling. Although most of my stops were triggered, I selectively sold off stocks. That’s one of the problems with using mental stops. Your emotions can still get in your way. Obviously, I felt like a schmuck on Wednesday as the market bounced. Thursday would be another down day and I would sell some more.

After the market closed on Thursday, I reflected on a story that I shared with a wife a few years ago. In 1991, I started a video production company. When I resigned from my job as an engineer, I left on positive note. In the back of my mind, I knew that I could always go back if the business didn’t work out. In less than a year, I would be back there working. Several years later, while thinking back on my entrepreneurial experience - I would wonder if I had given it my all. I would recall that some of the people in the business didn’t have a safety net; they seemed to work a little harder than I did.

While reading Napoleon Hill’s book “Think and Grow Rich,” the demise of my business would become apparent. In describing the power of a definite desire, he shared a story of Edwin Barnes - a man who desired to become a business associate of Thomas Edison. According to Hill, “Barnes desire was not a hope! It was not a wish! It was a keen, pulsating DESIRE, which transcended everything else. It was DEFINITE.” Barnes described his desire as such, “There is but ONE thing in this world that I am determined to have, and that is a business association with Thomas A. Edison. I will burn all bridges behind me, and stake my ENTIRE FUTURE on my ability to get what I want.”

When I started my video business, I didn’t burn any bridges behind me. I conscientiously created an exit plan that was executed on cue. Now in my current moment of self-doubt, I reminded myself that this time the bridges figuratively have been burnt. Nearly one year ago, I left my 9 to 5 to trade full-time and I have absolutely no plans to go back.

After the reflection / pep talk, I started devising a trading plan for next day. I considered a non-trade that had been haunting me for weeks. I have been keeping tabs on the subprime industry and recently wrote an article “Subprime Lenders Gone Too Far – A Time Bomb Waiting to Happen.” I made a few bucks shorting a couple subprime lenders last year, but have only been an observer lately.

On February 12, I half-heartily joked in a weekly email to my subscribers that I should short the subprime lenders. This was after HSBC and New Century (NEW) had imploded. Since they had already taken a pounding, I really didn’t think they would continue in free-fall mode. Best case it would be “dead money” for awhile. However, I was quite certain that they were not going up anytime soon. Here are their results since that email through March 1:

Accredited Home Lenders (LEND) -8.0%

Countrywide Financial (CFC) -8.3%

H & R Block (HRB) -8.4%

New Century Financial (NEW) -7.9%

Obviously, shorting now after such moves would be asking for trouble. I pulled up their charts. For the day, the group was up on a bogus upgrade. I decided that if it sells off tomorrow I am going short.

The subprime lenders gapped down on Friday. So at 11:15, I went short NEW. I added a LEND short at 12:30. At 2:30, 3:40 and 3:50, I added more NEW shorts. By the close, I had a nice short position that was already profitable. Check out the headlines that were released after the close. Each one gets progressively worse.

Lender New Century lays off 4.4 pct of work force

S&P cuts New Century deeper into junk on mortgages

New Century says accounting errors being probed

New Century says investigators are probing stock trades

New Century faces probe, Fremont to quit subprime

New Century says it won’t meet financial duty to banks

New Century says it faces criminal probe, will breach covenant

On Monday, New Century gapped down at the opening and closed the day down nearly 70%. Needless to say this turned out to be a great trade.

The market enjoys giving a body blow on occasions, but how you respond will determine your success. I am not much of a fan of the Donald, but he is well known for saying the following: “Never, ever give up. Never quit. You can never be successful if you give up.”

Thanks Napoleon. Thanks Donald.

Note: I had a “friend” review this article before it was published. Notice the quotes around friend. I wanted to make sure that article did not come across as boastful. He said that it didn’t appear to be, but pointed out a couple of trading mistakes that I made early in the week. After I calmed down, I admitted that he “may have” some valid points. However, considering that the DOW was down 500 points intra-day and cratered 200 points in one minute. Gold dropped like a brick - with two days of $20 declines. Silver completely buckled. It’s surprising that I didn’t make more mistakes.

Going into the week a trading service that I use was 50% cash and 50% bonds. However, I had a better idea. Unfortunately, it went awry and put me into scramble mode. Net-net I made money and now have this story to share.

I chose to publish this article in spite of my “trading mistakes” to hopefully communicate a larger message. That is - how do you respond to adversity? After Thursday, I could have crawled into a hole and relied on the good old “buy and hope” strategy. However, instead I formulated a new plan and acted on it.

Disclosure: Author holds a short position in NEW and LEND.