Rally or just another bounce off the upper end of our trading range?
The Dow rallied back two days in a row to close up +65 for the week. On Thursday I mentioned that a rise to 9400 could possibly signal the next drop back down to the bottom of our range at 9200. At 3:30 Friday afternoon it looked like a prophecy come true as the DOW, up 97.04 at 9395.67, quickly dropped -100 points to negative territory again. Only late day bargain hunting in the last 10 min tacked on the +41 at the close. The fear of the weekend just will not go away. The global currency markets are still too fragile for many traders and nobody wants to wake up to another devaluation on Monday morning.
Other noteworthy possibilities for trouble this week include the the G7 meeting and the Greenspan Humphrey Hawkins testimony. Tuesday Mr G. is before the Senate Banking Committee and Wednesday the House Banking Committee. We expect pointed questions and soft shoe answers but whenever Mr G. talks the traders listen for the ticking of a market bomb. Actually Mr G. could be in hot water. His strong disagreement with Clinton and the plan to invest Social Security in the stock market has led some analysts to believe Clinton may not reappoint him in 2000. Gore likes Rubin and former Fed vice chairman Alan Blinder. President Bush partly blamed Mr G. for his defeat in 1992 so a win by current Texas gov George Bush could also unseat him. The market would definitely not like to see Greenspan go home. Investors have a great respect for Mr G. and could probably get him elected president if only he could talk plain English. They feel the last eight years of economic expansion has been due to Greenspan firmly at the economic wheel.
The positive news Friday that the CPI only rose by +.1%, or only half of the expected +.2%, and the announcement of an almost 10% drop in the foreign trade gap, gave the market some much needed reassurance. With inflation no where in sight the much dreaded rise in interest rates by the Fed just keeps slipping farther and farther into the future. Falling commodity prices and Internet sales competition are keeping retail prices in check with only a +2% rise for the year. This lack of inflation can only be seen as a good omen.
Without any negative news over the weekend and a lack of any "irrational exuberance" comments from Mr G, the techs could continue to recover from the serious profit taking of the last two weeks. The main problem is still the lack of market breadth. The advance decline line was negative on the NYSE again Friday even though the market closed positive. Declines beat advances by 1,532 to 1,392. On the Nasdaq the advances won 2,121 to 1,865. Overall 3,257 advances to 3,395 declines. For a solid market rally we need to see NYSE advances of at least 2,000 and Nasdaq advances of at least 2,500. Anything else is a lack of conviction and should only be viewed as a trading rally. The forecast, more of the same. 9200 seems firmly entrenched and hopefully the breakout of this range will be to the upside.
We have received many emails about the disappointed subscriber letter we posted in the Readers Write section last week. The following letter moved us so much I requested permission to comment on it today.
I've been reading the DELL lamentations on your web site, and I want to add my two cents, since that is about what I have left.
Actually, I want to put in a good word for you and your staff, both for picking great plays, and for telling us so before we broke the rules and went broke. I can say, along with a lot of readers, that in the last two weeks, I broke every rule, and paid for it. I put all my eggs in one DELL basket, I held over earnings, I didn't take profits when my plays went over 100% profit, I continued to take positions in a down market, I traded on emotion (that bastard analyst has to be wrong), I have sinned.
So, what do I have to show for my troubles? $10,000 bucks, more or less. But, I had about $150,000 of gains on February 1st when DELL hit 110, and my plays went from +50% to +250%. And I watched it dwindle away, then took profits, then put those profits back into DELL plays as DELL dipped with a reversing market, having faith in Mikey and the numbers.
But am I mad at you? Am I bitter? No. You told me so. Your rules, even one or two of them, would have saved me. And your picks have been dead on. I played AOL in January for a 150% gain. I played MSFT in Jan for a 100% gain. I took those profits and ploughed them into DELL while the market was still rising, and had a huge gain. I went from $22,000 in my brokerage and $8,000 in my IRA to a combined profit of about $150,000, and, through violation of the rules, rode it back down to +$10,000. I'm angry at myself for not following your rules, but I am grateful that I have those rules to judge my performance as a novice option trader.
As they told me in the Marines, "Judgment comes from experience, and experience comes from bad judgment." Keep up the good work, and kudos to you and your staff. My $10,000 in profits will more than cover your fee, and at +25% every two weeks, my profits are going places this year.
I reprinted this for several reasons. I have dozens just like it from the last two weeks. I have hundreds from the last year. The common thread here is a violation of the rules. The major rules!! Every time you invest $5 in an option you enter the play hoping to get back a $2 or $3 profit. Most of the successful traders I correspond with only expect $.50 to $1. Nobody enters a play for $5 and realistically expects to get back $15 or $20. Sure it happens sometimes but those cases are very rare. To be up +250% and not sell is tempting fate and Murphy. (as in Murphy's law) Whenever a play goes up that much that fast it has just as good a chance of coming down even faster. Another major rule violation was the "bet the farm" on one play disaster. Even with the amount of money in this portfolio the maximum at risk in any one play should be 25%. NEVER BET THE FARM. Murphy knows!! Just because you have more money to lose does not mean you should be willing to lose it!! There is no such thing as a "sure thing".
I know from experience you cannot "hope a stock up". Your optimism about XYZ stock has no bearing on the stock price unless you are Warren Buffet. Do you know that even Warren owns stocks that go down? When you own 50 mln shares of something that drops -$10 it ruins your whole day but it happens. Now if Warren bets on stocks that go down, what makes you think that all of your stocks will only go up? Be honest, how many times have you bought an option on a stock and NEVER even considered that it could go down? I do it every week and every week some stock drops within seconds of the execution on my order. You must always consider that the next drop could be the beginning of a series of drops. Nothing goes up forever.
If you are going to trade options you must be ready to lose some money. Some plays are never going to work and others will work beyond your wildest expectations. When a play goes bad, GET OUT. Nursing a bad play will only make your other plays worse. As I mentioned recently, when you are in a bad play your total focus is on the losing play and it causes oversight or bad judgement on any other plays you have in progress. Do you think this gentleman would have been happy to get out with only a $25k loss or even a $50k loss. Sure! Knowing what he knows now he would GLADLY have lost $50k. That hurts just writing it but it is much better than -$150k. Everybody works on different scales. $50k to him may be the equivalent of $5k to you. It is still a lot of money and nobody wants to admit the deal is dead and bite the bullet. We would all rather ride it into the ground and face getting 1/16th on expiration Friday, hoping all the time against hope that a miracle will occur. The common question I get is "I am down $5k on this $10k play, what should I do. I can't sell because I can't afford to lose the $5k." Can you afford to lose $10k?
Need I even mention the cardinal rule of "never hold over earnings"? Do the recent DELL, IBM or SEPR earnings disasters prove my point? Even the magic STOCK SPLIT ploy did not help Dell.
Enough, I have run out of space and your patience. Let me leave you with a final bit of wisdom. "Losing plays tend to stay losing plays". It boils down to that "time decay" problem AND the loss of "potential expectations". Once the "expectation" for a stock is crippled by a drop in price the previous option value is very rarely regained.