Connors’ Weekly Battle Plan
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This Past Week
This past week, we made money every day. Now an event like this should excite
me. Right? Not this week. Why? Because, when you add up the five days of
profits, they were small. Not enough to make any significant dent in this year’s
returns nor in the value of the account. Am I upset by this? No, not really.
Why? Because, if we were to make money on the long side this week, we knew that
it would be small. It will likely always play out to that degree, because
that’s the camp we live in. In overbought markets, we start scaling our size
and risk down in our long positions. The drawback is that when the market
continues to run, we lag and AT BEST make a little. The upside? We usually don’t
get our heads handed to us if and when the market reverses. And therein lies
this week’s lesson.
Trading In A
One-Way Runaway Market
You’ve heard me mention this before. A few times a year, usually 3-4 times on
average, the stock market will go in a one-way runaway mode. The market will go
up (or down) during this time, becoming overbought (or oversold) and then
becoming more overbought (or more oversold). Everyone will be waiting for the
correction. And in fact, some mornings the correction will begin. But, this
correction will quickly reverse and the trend will again resume. This can go on
for days, and in some cases, for weeks. If you’re a reversal trader, you hate
these periods. If you’re a pure momentum trader, you love it. Day after day of
profits. And during these periods, the momentum guys look like geniuses. Think
about last summer to the downside. Look at last July. Oversold became more
oversold which eventually went to grossly oversold. The shorts were
geniuses…until we bottomed on the opening on July 24 and reversed nearly 10%
(!) off the opening. Then many of the aggressive momentum guys got their heads
handed to them. ALL IN ONE DAY!
It’s now nine months later, and the situation is a bit different and certainly
not extreme. But the market has had one heck of a run, this time to the upside
since mid-March (mid Feb for the market leading Semiconductors…see the
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index). Most everyone has recently been coming in nearly every day for the past
few weeks expecting some sort of expected pullback or correction. But, it has
not appeared to any great degree. Why? Because as I mentioned, a few times a
year the market will move in a straight line and sometimes to an extreme off
that straight line. You never know when it will happen, but it does happen and
it’s a reality. But, this reality comes with potentially high risks and the
potential for high volatility changes in your portfolio value. Let’s move on to
discuss this.
Camps To Live In
As you structure your daily trading plan of attack,
you have to eventually choose the camps you will live in. The first camp is your
style of trading. You’re either a day-trader, a short term trader (1 day to a
few weeks) or a longer term trader (you hold positions on average for a few
weeks). From there, you need to take a second stand. You’re either a momentum
trader or a reversal trader. And from there comes the third camp you must
choose. This is the camp from this week’s lesson. You’re either going to go “all
out” and push as hard as possible when the market is trending (and there are
many, many ways to do this, including pyramiding positions, leverage, trading
high beta stocks and more). Or you’re going to aggressively lock in profits and
then stand aside as the market becomes overbought or oversold, as we do.
There are pros and cons to each approach, so lets look at them. In the more
aggressive approach, you will likely make the bulk of your money a few times a
year. That’s good. The bad is that you will likely not make money the
rest of the year. How come? Because you will be aggressively long and short at
market extremes and gains will likely quickly turn to losses. This will happen
numerous times. The “volatility of your returns” will likely be very high. You
may already see this in your trading. A few big months and then monthly returns
are all over the place. Can you make money using this approach? Sure. Some of
the greatest traders and hedge fund managers have done it this way. But, some of
the greatest losses and blowouts have also occurred this way. It’s a high-risk
game and only you know if you should be playing it.
Now let’s look at the other camp. The camp I live in. The camp that says you
lock in profits if you have them and lock them aggressively in if the market
starts showing any signs of being overbought or oversold. The drawback to
this? You have weeks like the past that you make money most of the time, but
because the markets are overbought you are taking smaller positions, taking
profits quicker in those smaller positions and you are likely passing on
potentially good trades. You do not maximize the returns from the momentum that
has just presented itself. The upside? Reduced volatility in the portfolio
versus the other approach and the lessened likelihood that we will get our heads
handed to us when an extremely overbought or oversold position reverses. And
we’ve all seen these reversals. They can be vicious and if you’re on the wrong
side of them, they are detrimental to your net worth.
Again, THERE IS NO RIGHT OR WRONG ANSWER HERE. This is just market reality. This
is the way markets work and you can take control of this by simply being
cognizant of these inherent factors of the stock market. Use the rest of the day
and make some choices. Which camps are you most comfortable learning to master?
Camp 1: Daytrading, Short-term trading, or Longer-term trading? Camp 2:
Momentum Trader or Reversal Trader? Camp 3: Aggressive Trader in
overbought/oversold conditions or more Conservative Trader in ob/os conditions.
Then from there, pieces fall into place. From there, you will know how to find
the best strategies to use and how to put together the best rules to trade these
strategies including when and how to take positions and take profits when they
exist. The more structure you have and the rules that encompass this structure,
the more successful you will be in achieving success at trading.
Let me know if I can help you further here,
lconnors@tradingmarkets.com.
Have a great week trading (and Happy 211th Birthday to the NYSE. Kevin Haggerty
and 4 other guys were smart enough to get things rolling back in 1792 and we owe
a debt of gratitude to them)!