Option Investor
Educational Article

Deja Vu

Printer friendly version

By David Popper

When we were kids, we would often play basketball. Sometimes we would be standing on the foul line imagining that if we hit the shot, our team would win the NBA finals. Often, we would miss and then take a "do over." A "do over" permitted us to relive the experience and make it right. With enough "do overs" our team always won. Unfortunately, life does not often provide "do overs". A mistake on the job can cost you your career. An unkind word can cost you a friendship. But in the market, a "do over" is always possible. The market does not remember your past mistakes and does not care. Substantially the same situation will emerge and reemerge. Though no situation is always identical, understanding the tendencies of the market and how your particular stock acts in that environment can help you trade more effectively the second time around.

I am sure that it comes as no surprise to you that in the last three months we have experienced a serious uptrend, a serious downtrend, sideways action, another weak uptrend and now, another downtrend. These sudden changes can damage one trader's account and yet be a boon to others. I personally know many people who have lost in excess of $1 million in the past two months. I also know those who have made substantial amounts of money. Most of those who made money this year suffered major losses in 1987, 1997, or 1998. In the debris of the losses, these serious students were able to analyze their trades in light of the market conditions and zero in on their cause of failure. They realized, maybe for the first time, that there is no easy way to make money. There are no gimmicks. There are no magic formulas or eight secret steps to market success. Instead, they realize that there are 1,001 different ways to trade the market.

Based on one's temperament, one can trade options (long or short or in the form of spreads, strangles, straddles, etc.), trade futures, indexes, commodities, etc. Every strategy has its owns strengths and weaknesses that can only be learned through reading and actual trading. These traders analyzed not only their trading strategies, but also their money management and emotional makeup. They eventually learned which strategies they are most comfortable with and how much money they feel comfortable placing at risk. From experience, they learned to adhere to strict trading rules, such as those constantly preached on this website. They further developed their own list of favorite stocks which hopefully are leading stocks in leading sectors of the economy, such as networking, semis, etc. They learned the tendencies of these particular stocks and can recite almost from memory their different levels of support resistance.

Finally, they have different strategies in trading these stocks under different market conditions. In essence, these traders have learned how to take as much of the guess work out of their trading as is possible. By incorporating all that they have learned, these traders are much more comfortable in any market environment and exude a certain confidence that can only be developed through such preparation.

These days, it is obvious that the volume is low on the up and downside. Institutions simply have not bought in yet. The market will be choppy between now and the upcoming Fed meeting. In short, this is a day trader's market. Perhaps after May 16 there will be a rally. The point is that rally techniques will not work in a day trader's market. We have seen the same situation last October and also in April. If you are successful during these downturns, trade the same way. If you are not successful, trade differently or do not trade at all. Try to survive this downturn better than you have any other downturn in the past.

Personally, in this volatile time, I prefer to trade only half of my account, leaving the other half to buy the bounces after dips. Currently, I own BRCM and PMCS with covered calls against the positions. When support levels are broken, I repurchase the calls cheaper and buy puts. Specifically, I purchased BRCM at $150 and PMCS at $152 two weeks ago. I sold the May 180 calls on PMCS for $22 and on BRCM for $22.75. Both of these positions are worth about $6 today. Yesterday, I purchased puts at the $150 strike price in both stocks. The idea is to allow the calls to depreciate and the puts to appreciate. The options have all moved the correct way but I have lost ground on the stock. This is still better than I handled the last downturn, but maybe a straddle would have been better. At least owning strong stocks that I know gives me at least the confidence that any downturn should be temporary. The learning continues.

In short, downturns will happen often. You will have a chance for another "do over".

Contact Support

Options 101 Archives