Strategy for earnings season

This is from a post I wrote last year detailing my strategy for earnings season. With earnings season upon us once again, I thought it might be useful to revisit this post.

Do keep in mind that it is the earnings season and the big guns start reporting today onwards with Intel reporting after hours. Any surprises and all the technicals get thrown out of the window. I know (and hope) that this is stating the obvious but please do see when a particular stock is reporting before getting into it. Also, do remember that what is important is not the news itself but the reaction to the news. It is very common to see a stock beat the street estimates easily and still fall down hard and similarly, a stock can easily rally on "bad" news.

I personally don't like holding any stock through its earnings. I feel that no matter how much one thinks one knows about a stock, holding a stock through its earnings is basically gambling. A bad reaction and one might not even get a chance to get out with a small loss. If you are great at studying the fundamentals of the company and the particular industry, you will be justified the argue the validity of this point here but again keep in mind, that a stock can fall down hard even on an earnings beat. If you are like me, you will just enjoy the action from the sidelines!

 

Take care and good luck!

1040 just had to break

No charts today dear readers. Not much technical analysis either. Instead, I will just put some thoughts out there and hopefully, give you readers something to think about. Well, here goes nothing.....

1040 just had to break. Why, you say?? Well, because it was a very strong and very obvious support. Wait a minute! That's counter intuitive, you say. Exactly dear readers. It was a very strong support and that's why it had to break. Hear me out before proclaiming me crazy. 

The key word in the above paragraph is obvious. 1040 was a very obvious support. Why does it being so obvious matter, you ask? Well dear readers, we live and trade in times where most of the trading is done by computer algorithms. The objective of these algorithms is to cause maximum pain or in other words, to take money from small traders like us. The markets don't work on the obvious any more. Now, I am not saying that technical analysis doesn't work anymore. If it didn't, I would certainly stop trading and you would have to bid farewell to this blog. My point is that technical analysis doesn't work the way it used to work in 80s or the 90s. With the advent and dominance of these computer algorithms, things are not as easy and straightforward any more and one has to think a bit outside the box.

Consider this. A lot of traders, going purely by TA, had their stops just below the 1040 mark. If you were looking for some easy money or cheap buys, it makes perfect sense to spike the market down and run over these stops and then go back up again. Seen stocks fall through MA(50) easily recently and then go back again, with you getting stepped out? Well, its the same thinking here again. You just got owned by these computer algorithms. I wouldn't be surprised to see the markets bounce from here now that these stops below the 1040 mark have been taken out.

But all is not lost. There are ways you can fight these algorithms and come out on top. You just have to realize that the obvious doesn't work anymore. Adaptability is the key here. I could give my thoughts on some of these ways but I see a bottle of bourbon with my name on it calling out to me. 

Take care and good luck! I will be most interested to know what you readers think about the above.

Its all about risk management

I posted the chart of MDVN earlier today. I will post it again for the benefit of those who haven't seen it yet. Here it is.

Yes, it can happen. It can most certainly happen. It is a trader's worst nightmare. No matter how good a trader you are, it can happen to you. It can happen to the best of us. The scary part is not that it went down over 60% for the day. Big deal! But the fact that it gapped down over 60% and hence, those who were long coming into today, didn't even have a chance of getting out for a reasonable loss.

How do you escape something like this? Basically you can't. Like I said, it can happen to the best of us. But there are certainly ways you can minimize the effect of a loss like this. Firstly, I try not to trade any pharmaceutical stocks. A drug accepted or rejected or any announcement by FDA and it could gap either way. Like what happened with this one. But that doesn't mean that this couldn't happen to a stock from any other sector. Where does that leave you? Read on.

In the end, its all about risk management. Its all about the risk/reward ratio. I like to think that if you take care of the risk, the rewards will take care of themselves. That's why I take my profits quick and losses even quicker. But that's just me. A very important part of risk management is position sizing. And if I can "implement" position sizing with a small trading account, there is no reason why all you readers can't do so with your accounts. Here is how it would have helped you in a situation like this.

Say, I don't believe in position sizing and I went all in a stock like this. And the stock gaps down 60%. Ouch! Now to break even, I will need 150% profits on my remaining capital! Tough, isn't it?? Could take you years to break even after a loss like this.

Now let's consider the alternative scenario where the maximum I allocate in any position is 10% of my trading capital. That's still a pretty aggressive strategy if I have a large trading account. Again, my stock gaps down 60%. But now, due to my allocating only 10% of my trading capital in this stock, I suffer "only" a 6% loss on my total capital. To breakeven, I need a gain of 6.3% going forward.

150% vs 6.3%. Think about it!

Lessons from my mistakes

“All men make mistakes, but only wise men learn from their mistakes.” 

- Winston Churchill

The regular readers of this blog know that I had a brutal week last week and by now, also know of the exact trades I made. (For the uninitiated, please see here and here). But you also know of my determination to learn from my mistakes, and make last week the most "profitable" week. I have thought long and hard of my mistakes from last week, the kind of mistakes I thought I had stopped making, and reached some conclusions about where I went wrong and how not to repeat these mistakes in the future.

 

Here it goes.....

1) When I started trading actively about a year and a half back, my biggest problem was learning how to take losses. After I learnt how to take losses, the problem evolved  into how to deal with these losses emotionally. I am glad to say that now I am quite comfortable in taking a loss. But in going through my recent trades, and you can go through them too here, I have realized there is a disclaimer attached to the last statement.....I am "pleased" in taking the first loss. I am comfortable in taking a second consecutive loss. But after three or more consecutive losses, its starts affecting me and thus my trading. I start getting the feeling of trying and getting my money back from the markets which as we all know, is a very very wrong and quite possibly, disastrous emotion. Markets owe me absolutely nothing. So, this brings us to my first "rule"

 

Start trading real small after second consecutive loss.

2) The second rule follows directly from the first rule but involves two losses on the same day. You gotta know when to hold them and you gotta know when to fold them. Most importantly, you gotta know when to walk away.

Stop trading for the day if I take two losses on the same day.

3) Both the above rules apply to losses. But I have noticed that one has to be careful while doing well too. My account was up almost 10% for the month and ~ 175% in the past one year before last week. Trading seemed easy, in fact a little too easy - the easiest it has ever seemed. Looking back, this should have been an alarm bell ringing loud and clear right there. The markets have a way of bitch slapping you when you start showing even the slightest signs of overconfidence. So, that brings us to rule number 3.

 

Be extra cautious when in the middle of a hot streak and at the slightest sign of overconfidence, start trading small. 

4) I shouldn't have to explain this one to you readers if you have read the posts of last week.

 

Always have a stop loss in place for your positions if you cant follow your screens even for a minute. 

 

That's what I have till now. I will be labeling this post "lessons" for easy access in the future. I will be adding to this post in the future as I am sure I will be making more mistakes, but hopefully not the same ones. 

 

Let me know if you readers think I have missed out on something and should add some more "rules". Growing and improving together as traders is the whole purpose of this blog and there is no better way to learn than from each other's mistakes.

Sophie's Choice - Stop Loss or Sell Limit

Hello readers!

I was faced with quite a dilemma this morning. To sell or not to sell? No, this wasn't it. Rather, the question was how to sell. This calls for a little background.

Going into the day, I held positions in PAL (entered at 4.30) which closed yesterday at 4.46 and SWC (entered at 12.62) which had closed north of 12.70. The trouble was, being occupied, I knew I would have no access to the market from 9 AM to 11:30 AM. I had seen enough of the pre-market to know we were going to have a down day, something that I was expecting in the near future anyway as indicated in the posts below and the poll to the right. So, I made up my mind that I was going to sell my position at the market open. The primary reason for this was that I was already up around 9% for the year (overall account) and I was ready to miss out on any potential gains in the hopes of getting out with a smaller loss. After the kind of run up we have had, capital preservation should be your primary strategy.

I always use a stop loss for taking losses, but I started considering the option of stop limit this morning. For those who do know, a stop loss would sell my stock at or below my specified price whereas a stop limit would sell my stock at or above the specified price.

My fear with a stop loss was that even an odd lot selling at a unreasonably low price, as it regularly happens in low volume stocks for the first order or two, or an overreaction to a potential down day would make me liquidate my positions and suffer large losses.

The disadvantage of a stop limit was what if the stock never reached my entered price and went on going down from there. Again, heavy losses!

The decision I made was to set a stop limit at a lower price (but higher than a ridiculously low price at which my stop loss could have been met). I had seen enough of the pre market to have an idea of the range that these stocks might be at in the few minutes. A stop limit at the lower end of the range would make my stock sell at a higher price if the market opened in that range.

So, I decided to go ahead with the stop limit.

I got out of PAL at 4.35 for a 1.16% gain and out of SWC at 12.59 for 0.2% loss.
PAL recently touched 4.20 and SWC 12.00. I guess all's well that ends well.

I hope this helps some of you in case you are ever faced with a similar choice. Remember to go with the stop limit at market open only if you are confident of the opening range of the stock and set it at the lower end of the range.

Good Luck trading! I will be back later in the day with a daily review. Hope none of you got hurt too badly today.