Daily State of the Markets
Good Morning. The title of this morning's missive is "The Price of Perfection." The first point that needs to be made is that using the word "perfection" in anything related to the stock market may get me in trouble with Ms. Market. As anyone who has been in this business for any length of time knows, angering the lady in charge of this game can bring a Louisville Slugger to your forehead in a big hurry. However, my hope is that she will read far enough to get the point of the report before reaching for the bat with my name on it.
To me, the word "perfection" in the stock market means getting the majority of the big moves "right." Note that I did NOT say the goal was to get ALL the moves (big or small) right. While I hate to disappoint those new to the game, the simple truth is that there is no Holy Grail system or indicator that can get all of the market's moves right. This is simply impossible and don't let anybody tell you differently.
One of the tricks to succeeding at this game is to identify what you are trying to accomplish. For example, if you are fast-money trader type, you may be striving to make money on your "hot dot" trades on a daily basis. However, I can say from experience that getting in on the Tesla's (NASDAQ:TSLA) is more difficult than it looks. But if this is your goal, I say go for it and would recommend that you read "Way of the Turtle" by Curtis Faith and the entire "Market Wizard" series by Jack Schwager. By reading what made very successful traders tick, you can learn a lot - mostly about what mistakes to avoid.
However, this approach isn't for me. Call me an old fogy if you must, but I've been there and done that. And although I've written about this subject a fair amount already this year, I'm going to "go there" again this morning. The bottom line is my objective is to get what we can, when we can, from the market's big moves.
You see, getting the important moves right is where the really big money is made. Not missing out on a substantive move is what makes your year. And in short, this is our goal.
Below is an example of what I'm talking about. This is a chart of the S&P 500 weekly from late 2008 through Friday. The black rectangles indicate the type of uptrend I want to capture while the red ovals show the type of decline I'd like to try and either avoid or profit from.
I'd like to make two other key points this morning. First, please note that not every move on these weekly charts is surrounded by a rectangle or an oval. This is due to the fact that you simply can't get all the moves right and you have to understand that going in. A perfect example of this is the wild and woolly moves in the fall/winter of 2011. These moves were simply too fast and too violent for most traders to "capture" or profit from.
Going back a little farther, the picture becomes even clearer. Below is a chart of the S&P 500 on a weekly basis from 2005 through 2008. As you can see, missing or profiting from the 2008 massacre was a big deal.
For those with an open mind, I think you will agree that getting the big moves right can be quite beneficial over time. But... It is vital to understand that doing so comes at a price!
There A Price To Be Paid For "Perfection"
This brings me to the title of this morning's missive. You must first recognize and then be willing to pay the price for anything even remotely related to "perfection" in this game. Remember, nobody gets it right all the time and there simply is no free lunch available at the corner of Broad and Wall.
Put another way, you have to have realistic expectations about what you can and can't accomplish. Understanding the plusses and minuses of an approach will help you stick with it when the going gets tough (and trust me, the going WILL get tough at times). For it is the ability to stick with your strategy when things are difficult that separates the successful investors from the "strategy hoppers" who tend to have a keen ability to know what they "should have done" after every market move.
I have a confession to make; I struggled with this very problem for many years. I didn't want to make mistakes. I didn't want to get whipsawed. And I definitely didn't want to "look dumb." However, I finally learned that making mistakes and "feeling dumb" was the price I had to pay for what I call "perfection."
The big problem is that times change and markets change. Thus, one has to remain flexible and be able to adapt to a changing environment. And it is for this reason that I think it is important to incorporate a healthy dose of trend-following into our approach - if for no other reason than the fact that unlike so many indicators, price can't deviate from itself.
However - and this is critical - I'm of the mind that a trend-following approach should only be used at certain times. As I've written a time or twenty, we believe in staying in tune with the overall market environment. For this reason, we let our Market Environment Model tell us what to do the vast majority of the time. When the model is positive, history says the odds favor the bulls - so you should be long. And conversely, when the model is negative, history has shown that this is when it is okay to play the short side of the game.
But when our Environment model is neutral, THIS is when things get tricky. I like to call these market environments "iffy" because there is just no way of knowing which team is going to dominate the game next. Therefore, THIS is when we believe it is important to keep things simple and just stay in tune with the trend.
When the market is "iffy" such as it is now, the goal isn't to be a hero. You aren't trying to "nail" every little 2-3% wiggle and giggle in the market. No, the goal is to be READY for the next BIG MOVE.
Makes sense, right? But here's the problem. When one employs a trend-following approach in a neutral or "iffy" environment, you WILL get whipsawed. You WILL look/feel dumb. And your patience WILL be tested as our research shows that only 53% of the trend-following trades we make in an "iffy" environment are profitable. And of course, this means that 47% of the time we are going to be "wrong" and look/feel dumb.
However, years of experience has taught me that using such an approach is the best way to be ready for the market's next major move. Why not just sit in cash and wait for the Environment Model to go positive, you ask? In short, waiting for the market to "prove" that its okay to get back in the water is expensive because. Unfortunately, waiting for "proof" can cause one to miss out on the early part of the next big move.
So, the bottom line is this: if you want to capture the big moves and you want to "be there" for the early part of the move, there is a price to be paid. And in short, that price is "looking dumb" when things are neutral or "iffy."
This approach may not make work for everybody as "looking dumb" and sticking to the strategy can be emotionally challenging when markets are being difficult. But remember, if you are shooting for some semblance of "perfection" in this game, you need to be willing to pay the price of admission.
Looking for a disciplined approach to managing stock market risk on a daily basis? Check Out My "Daily Decision" System. Forget the fast money and the latest, greatest option trade. What investors need is a strategy to keep them "in" the stock market during bull markets and on the sidelines (or short) during bear markets.
Turning to This Morning...
After falling into what the press calls "bear market territory" (i.e. 20% or more), Japanese stocks rebounded nearly 5% overnight. However, the slew of weaker than expected data out of China over the weekend is keeping the enthusiasm for risk assets in check on both sides of the Atlantic this morning. European bourse are mostly lower and U.S. futures are currently sporting only modest gains. And with no economic news to speak of, traders are likely to keep prices within the recent range today.
Here are the Pre-Market indicators we review each morning before the opening bell...
Major Foreign Markets:
Crude Oil Futures: -$0.52 to $95.51
Gold: -$0.60 to $1382.40
Dollar: lower against the yen, higher vs. euro, and pound
10-Year Bond Yield: Currently trading at 2.176%
Stock Futures Ahead of Open in U.S. (relative to fair value):
Thought For The Day...Never get so busy making a living that you forget to make a life... unknown
Positions in stocks mentioned: none
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