Option Investor
Educational Article

Rudyard Was Right

Printer friendly version

By David Popper

"If you can keep your head when all about you are losing theirs and blaming it on you. If you can trust yourself when all men doubt you, but make allowance for their doubting too..." Rudyard Killing wrote these first few lines of the poem If over 100 years ago. He must have been trading for family and friends in a bear market. A market like this can really get inside your head. The lessons of the last 3 years are just not applicable. The moves are so violent and so sudden.

So here we sit, afraid to buy because these stocks can fall further, and afraid to sell because these stocks can turn on a dime and laugh as you sold on the bottom. Many traders are frozen like a deer in the headlights having lost all confidence in their ability. So many traders just hold. The time to exit was 50 points ago right? Surely these stocks will turn around like they have before-won't they? To further complicate the scenario, the charts do not seem to provide any degree of predictability beyond the next two hours. The charts begin to look good and the rally fails in 2 days. Traders who try to trade themselves out of this mess and recoup their losses quickly find themselves sinking deeper into the quicksand.

Finally, during these times I think of the technical lessons that I have learned through OIN, Investor's Business Daily and others which strongly recommend short term or position trading which requires regular monitoring of positions and cutting losses short. On the other hand I am well aware of the rich rewards those brave individuals earned holding CSCO, SUNW and others for 5 to 10 years through thick and thin.

So how did I get in this mess? By violating my sell rules. How did I justify violating these rules? Simple. When I entered these positions, October was ending, the charts indicated a bottom was in place, and Bush was leading. Everyone expected the market to rally once the election was over, regardless of who won. Everyone expected a solid rally if Bush won. The probabilities of a rally were in place because the market was in an oversold condition and because election closure was near. Then the totally unexpected happened, no winner and no closure. Even worse, the rhetoric from both sides and the prospect of a weakened presidency has had a short term damaging effect on the market. So front end call buyers and fully margined traders poised to reap huge rewards were severely damaged. The rest of us find ourselves in an unusual position not of our choosing.

So how did I avoid severely damaging my account. First, I always keep approximately 25% of my account in cash during a down or trendless market, just in case. Yes, it does cut into the upside potential but with volatile stocks, a little bit can go a long way. One hundred shares of JNPR, GLW, or PMCS can quickly give you thousands in profits while not risking the integrity of your account during uncertain times. Second, I only trade stocks that I would not mind owning over the long term. If stock selections are limited to potential core holdings, you are never worse off than a buy and hold investor. Any premium earned through a covered call or through short term profit taking is just gravy.

What will the market do now? I don't know and neither does anyone else. All of the market experts predicted a November rally. They were wrong. Analysts upgraded the optical sector 60 days ago when the stocks were high. They apparently did not do their homework because these same stocks are now downgraded. Analysts and experts are no help. So what makes sense to do from this point forward? As for me, I am cognizant that many stocks are in a downtrend, but I realize that these stocks are long term winners. They will have their day, and when they do, they will rocket up the chart quickly. Technology is not going away. It is normal for high PE stocks to experience extreme highs and lows as analysts vacillate over the long term prospects of the underlying businesses. This is why it is wise to maintain a small position in these issues. You can not allow short term aberrations to harm you. I intend to maintain a heavy cash position until the market sorts itself out. I also intend to hold my positions. I am not going to try to make up any losses overnight. I am going to remember that people who did not panic in 1987, 1990, 1994, or 1998 were amply rewarded. Of course I would rather not be sitting on losses. I am not used to this, but I will not become impatient. Instead, I will try to play the cards that I am holding in as unemotional a manner as is possible.

In short, it may pay to avoid margin and front end calls because the short term is unpredictable. However, it is not the time to lose confidence. Many of you have significant gains over the past few years and this too shall pass.

Options 101 Archives