In between the islands of Maui and Moloka’i is a channel the Hawaiians call Pai’lolo, which, loosely translated, means “Crazy Fisherman.”  This channel is famous for the powerful trade winds that, via the venturi effect, produce some of the nastiest currents you’ll ever meet; in fact, the rough and volatile waters are often referred to by boaters as the “washing machine.”  The reason I cite the Pai’lolo is that the markets this year have done much to remind me of the sensation of sailing through that choppy channel. 

QE3, PIIGS, tsunamis and earthquakes, housing starts, non-farm payrolls, debt ceilings – you name it, all sorts of cross-currents have been roiling our markets.  Here the market looks as though it’s falling apart at the seams; there it recovers against all odds and rallies.  One week sees four of five sessions close at least 1% off their peak; the next it bounces as if nothing were wrong in the world at all.  Look now, the last hour of trading on the S&P has been a sight to behold for over a week.

This kind of news-driven action is enough to flabbergast even legendary operators like George Soros.  Back in April, he had this to say: “I find the current situation much more baffling and much less predictable than I did at the time of the height of the financial crisis. The markets are inherently unstable. There is no immediate collapse, nor no immediate solution." 

Soros has since closed his hedge fund to outside investors.   

Many traders are no doubt sitting on some handsome profits from the last two years.  It would then be wise to consider where the market is in the current cycle. Year Three’s tend not to be all that kind, especially to markets that have recovered from such steep declines as this one.  2011 is proof of this.  Also, one always wants to be cognizant of the psychological aspect of the craft we’ve chosen.  Achieving outsized gains and making a lot of money can actually be detrimental to one’s equilibrium.  We’re all fallible and subject to succumbing to those human flaws that are a stock trader’s worst enemies – namely, greed, arrogance and recklessness.      

All too often our greatest defeats succeed our greatest triumphs.  This is not restricted to just stock trading either.  It applies to all aspects of life.  After all, Washington probably felt pretty good about himself after his victory at Dorchester Heights…but then came New York.  

Jesse Livermore made millions shorting the market during the “Bankers’ Panic” of 1907, yet by 1914 he had filed for bankruptcy.  Why?  Avarice, pride and, later on, exasperation at a trendless market all conspired to undo the masterpiece he’d pulled off just years before.  Don’t think it can happen to you?  The Apostle Paul warned the Philippians to work out their salvation with much fear and trembling, let Livermore stand as a stark warning to work out our trading psychology with no less vigor.  

No one knows what the market will do over the next year or so. Will it be a ’38-’42 redux?  Or will it, God forbid, flatten out like ‘10-‘14?  Or will it be something altogether different and unexpected?  Impossible to say.  All we really need to know is what it’s doing now and that right now ain’t exactly pretty.    

Just as there are certain channels one would need to be crazy to try to fish, for trend followers there are certain environments where one would need to be crazy to try to trade.

"The high in the S&P on Monday was 282. I liquidated my long position at 267. I was real proud of that because it is very hard to pull the trig­ger on a loser. I just dumped everything. I think I was long 40 contracts coming into that day, and I lost $315,000.

"One of the most suicidal things you can do in trading is to keep add­ing to a losing position. Had I done that, I could have lost $5 million that day. It was painful, and I was bleeding, but I honored my risk points and bit the bullet.

"That's another example where my Marine training came into play. They teach you never to freeze when you are under attack. One of the tactics in the Marine Corps officer's manual is either go forward or back­ward. Don't just sit there if you are getting the hell beat out of you. Even retreating is offensive, because you are still doing something. It is the same thing in the market. The most important thing is to keep enough powder to make your comeback. I did real well after October 19. In fact, 1987 was my most profitable year."

-From "Market Wizards"

PCLN reports on 2/23 so an emphatic move either north or south could be in the works.   

Should the market turn tail then look to short those stocks that appear to be setting up to fail:  CTRP, V, MA, VMW and FFIV.

FFIV might be forming a “head and shoulders” pattern.  Presently, it’s running into an area of resistance around the 50 day moving average.

Bear Mkt.– First Leg – Correction – Second Leg

1901-03           54%                 10%                 27%

1906-07           71%                 27%                 17%

1919-21           61%                 10%                 15%

1929-32           101%               39%                 122%

1937-38           63%                 24%                 31%

1973-74           51%                 16%                 33%

2000-02           72%                 29%                 25%

2007-09           81%                 19%                 28% (as of 1/3/10)

 If we exclude the extraordinary rallies that followed the 1929-32 bear market, the average first run after a severe drop is 62%, followed by a correction of around 19% before resuming to the upside for another 25%.  Well, the Nasdaq has put in an impressive 81% first leg move (second only to the 101% first leg following the 29-32 bear), corrected 19% and has so far rallied a little more than 28% as of Monday’s close.  Now the question is: what’s next?  The answer, of course, is that nobody knows.  The current rally off the August ’08 lows has run 28%, right around the historical average for a second leg rally.  Can the market move higher still?     

As always, the leading stocks will tell the tale.  Monday’s session was positive.  Many of the leaders jumped on heavy volume.  So it will be interesting to watch the price action in the days and weeks ahead.  January can be fickle, so don’t get complacent.  Have a plan in place for the different scenarios that might arise.  Don’t get caught flat-footed.  Meanwhile, keep things simple and let the market and the market alone inform your decisions.                 

“Writing (trading), at its best, is a lonely life.  Organizations for writers (traders) palliate the writer’s (trader’s) loneliness, but I doubt if they improve his writing (trading)…For he does his work alone and if he is a good enough writer (trader) he must face eternity, or the lack of it, each day.” 

-Ernest Hemingway

The best, the only way to succeed in investing is to study market history and then to put real money to work.  There is no substitute for this.  It’s just that this takes time, sometimes years.  If you insist on joining a site, however, demand that they put up audited returns.  Anybody who refuses to do so is almost certainly a fraud.  At the very least they should have some real-time, third-party portfolio tracker, such as the one I use: http://covestor.com/john-ward/track-record.  Otherwise, they are most likely charlatans who know how to make money from gaining subscribers, not the stock market. 

Where there is insecurity, self-doubt or diffidence you will always find a group to join.  When it comes to money, this is especially true.  Trust me, more often than not they are not there to help.  They are there to separate you from your money.  The only person you can trust is you.  This may not be comfortable to hear but it’s the best advice there is.           

Given the day, December 8, 2010, I will also include an interesting piece of audio of John Lennon recorded on December 8, 1980, roughly 6 hours before he was to be assassinated.  It begins with what he believes about groups and why it could be that people want to join them in the first place:

http://www.youtube.com/watch?v=tYG7MuI7vEs&feature=related

As a side note, the Russell 2K’s volume came in well below average on Friday, even though it was the hardest hit index in terms of percentage loss.  I tend to think that if funds were truly dumping stock the small caps would’ve seen especially high volume.  This could still happen, of course, but right now this pullback looks pretty tame.   

I guess the point I’m trying to make is that, as it stands now, the evidence doesn’t demand much in the way of drastic action, but it does call for some caution.  If price action were to continue to deteriorate then it might be wise to reduce exposure.  Just how much depends on the market’s behavior and one’s risk tolerance.  Your best bet, however, is to refrain from anticipating the market's next move.  The price/volume action of your stocks is all you ever need.  Everything else, the news, financial media, QE2, sovereign debt, etc., is superfluous.  

It’s at times like these that I think of the market as being like the woman you live with.  After a decade of cohabitation with the woman I love, I consider myself something of an expert on how to survive under the same roof with the fairer sex.  These hard-earned lessons I’ve learned serve me well in the market too.  The market is not unlike a woman in these respects: it's best not to think too much and to simply wait to be told what to do.  This is harder than it sounds but to the extent that you obey these rules the better off you’ll be.      

On an administrative note, I've recently launched my "model" via covestor: covestor.com/john-ward/precedent-based. ; One can easily "mirror" my returns by opening an account: account.covestor.com/mirroring-account/j...; It's been a half-way decent year so far.  As of 11/11, my portfolio is up 149.12%.  Here's to finishing the year strong....