Professional Investing: Master the Detail; Manage the Risk

A reader writes...

"Of course I do want to make "big" money. However, I am concerned as to the current market environment; slowing economy, excessive consumer and government debt, high commodity prices (sorry, I can't complain about oil), current disarray in financial, residential and commercial markets (soon), Federal Reserve with questionable priorities, government policies which make no sense, on and on. Do you still subscribe to Fred Hickey's newsletter? He certainly paints a negative scenario and has for several years. I am confused. Help me out."

The items you mention are each a major concern; they worry investors and consumers alike. And bankers, especially the Federal Reserve Bank [FRB]. In effect, does the economy teeter on the cusp of a tailspin of generational proportions? Perhaps, but no one truly knows, and least of all me.

Problems, issues, and fundamental concerns always lurk in the news backdrop. Again, the items you note are a major concern, but I view them, by their obviousness, as today's problems, and thus not necessarily tomorrow's problems; i.e., their severity lessens by their popularity. (The media, business leaders, and consumers each discuss the effects of the current litany of woes on their personal life or business.)

Investors naturally share these concerns, but professional investors seek a different input; not the news itself, but the news response syndrome. The distinction is crucial. "How do prices react to news?" So we each, as a professional investor, set up a rules-based methodology. For example: 1) The tendency for markets to open higher but close lower is decidedly bearish;
2) The tendency for markets to open lower but close higher is decidedly bullish.

The difference is the markets' ability to slough off the news of the day - the news response syndrome - and is only one of a set of subtle clues that chart readers and market technicians seek. Crucial turning points occur during the moments I term extreme, obscene weakness (or extreme, obscene strength). As any trend matures (becomes extreme), it also becomes readily discernible to all observers - a sure thing - and many investors invest for that trend.

But all trends die (reverse), or correct the excesses of the prior move, and then hibernate (base) for an extended period. My term for that singular moment when prices reverse to up from down (or down from up) is obscene weakness (strength), and always comes after a trend of extreme weakness or strength (i.e. an extended trend). This moment typically manifests as a large continuation gap in the existing trend, but proves to be, in fact, an exhaustion gap, as the shares reverse course from the day's opening price gap, and then closes at the opposite end of that day's price bar. Best action is when the reversal occurs at a level of crucial price support.

Alas, the notion of support and resistance is horribly misunderstood. Most investors seek only a prior low that reversed and proved prefatory to higher prices, or a high that reversed and proved prefatory to lower prices. But no additional measures of validation support their interpretation. Here is one identifier: once resistance, now support. The mere identification of a low in an uptrend (or a high in a downtrend) that was not itself prior resistance is not support; certainly not crucial support.

I do not claim that my every decision is perfect, or that I make no mistakes. Nor will I pretend that my every wrong decision and action were all proved correct with the passage of (sufficient) time. Such actions are folly, and serve only to mislead me more than they do you. In fact, my personal motto is "Always wrong, but never in doubt." I find this sentiment to be incredibly liberating; it allows me the opportunity to make each decision free of of the (emotional) need to be correct. I no longer require the markets to ratify my analysis before I take action; i.e., purchase before the up trend resumes (and vice-versa). Now I make the decisions, and take the actions, and then manage the positions; up, down, or sideways. Whether correct or incorrect. Master the detail; manage the risk.

As an investor - as an adult - I take full responsibility for all my decisions and actions; if in error, I immediately own up to the bad decision, not sweep it under the rug. "Full responsibility" equals making the hard decision: stopping out when wrong, taking profits when correct. After all, I made the decision to enter the position, so I take the responsibility to close the position. The inability to close a position is, to me, purely emotional ("The market will probably scream higher after I sell!"), and has no place in an investor's awareness and apprehension of risk and opportunity.

Of course, I seek guidance to be correct more often than [I am] wrong. In life, I heed the guidance of those smarter and better than me (especially you, S); when investing, I heed the message of the markets. For an investor, for me, the markets tell all... far more than the current crop of news headlines.

Full Disclosure: Always long the market via my favorite investments, but with varying percentages.