Even being right 3 or 4 times out of 10 should yield a person a fortune, if he has the sense to cut his losses quickly on the ventures where he has been wrong.
--Bernard Baruch, financier, speculator, statesman, presidential adviser, 1870-1965.
Now seems like a prudent time to consider cutting our losses by selling our losers. No one enjoys being wrong, which is partly because we often invest with our emotions and our egos. A friend of mine who is an active trader often says that:
Admitting you're wrong when you're truly wrong is vital to being a good trader.
It empowers you to do what works. The sooner you admit you're wrong the sooner you're empowered to do what's right [smart].
Billionaire investors like Carl Icahn, T. Boone Pickens and George Soros are good at cutting their "losers" from their portfolio and replacing them with winners that are most likely to stay on the winning track. Pickens recently sold all his shares of Chesapeake Energy (NYSE:CHK) which was his third-biggest stock holding at the end of 2011. In a Bloomberg interview May 10th, Pickens said at the SkyBridge Alternatives Conference in Las Vegas:
We do not own Chesapeake stock... We didn't like natural gas.
So now's a good time to not only reexamine our investing disciplines, but to be on high alert for some big moves in the stock market. With worrisome media stories about European banks, the potential collapse of the European Union, and negative reports about the U.S. economy, the basis for a sharp market correction is palpable.
How can traders and investor's prepare in a prudent and realistic way?
Start by deciding which direction you think the stock market is most likely to go in the current environment. It appears that the market could fall 5 to 10% from current levels, depending on the programs and decisions of the Market-Makers. If the current headlines are any indicator, we may be in for some more downside days.
Reuters headlines over the weekend included one that read, "Wall Street Week Ahead: Market is Oversold but Major Signs say 'Sell'"! Read it and draw your own conclusions. One quote from the story sort of said it all:
"The market is extremely oversold."
"Nonetheless, all major indicators remain on sell signals," said Larry McMillan, president of options research firm McMillan Analysis Corp, in a report on Friday.
One way for traders to respond and potentially profit if the major market averages fall would be to create a "Bear Put Spread". You may want to do this with an index ETF like the iShares Russell 2,000 index (NYSEARCA:IWM). Its top-ten holdings are good examples of small cap stocks that could be caught in the down-draft of an ongoing market correction. If you don't like options, you could buy shares of another ETF that shorts the Russell 2,000, the ProShares Short Russell 2,000 (NYSEARCA:RWM).
The Russell 2,000 has already had somewhat of a correction, as this 3-month chart of IWM clearly demonstrates:
So perhaps the ongoing correction will be one more sharp and hair-raising drop that will motivate the Fed to do an emergency QE3. If that's the case, be ready to do a "Bull Call Spread" on the Dow 30 stocks as represented by the SPDR Dow Jones Industrial ETF (NYSEARCA:DIA). DIA has over 11% of its top holdings in one of the Dow's best performers IBM (NYSE:IBM). You may want to create a Bull Call Spread on Intel (NASDAQ:INTC), or if you want to buy the shares on sale (maybe below $25) you can benefit from its 3.2% dividend and its ongoing stock buyback program.
As Reuters reminded us:
Next week's economic data includes April's existing home sales on Tuesday at 10 a.m. Existing home sales are forecast at a 4.60 million-unit annual, up from 4.48 million in March.
New homes sales figures are due on Wednesday at 10 a.m. April's new home sales are also expected to post an increase, gaining about 7,000 units over a 328,000-unit annual rate in March.
Initial jobless claims and durable goods orders will be published on Thursday at 8:30 a.m. Consumer sentiment is due at 9:55 a.m. on Friday.
It should be a very interesting, news-driven week with opportunities galore. Prepare a strategy that is fitting and wish-list just in case. To learn more about LEAP strategies go the CBOE web page dedicated to that topic.
Disclosure: I am long CHK.