Connors’ Weekly Battle Plan

Opening Day!

By the time you are reading this, the first game of my daughter’s Fast Pitch
Softball League that I manage will be completed. I have the honor of managing
the season opener against the City League’s All-Star coach and it should be
quite an eye-opener. Suicide squeezes, double steals, delayed steals and more
are the beginning of this man’s repertoire and from there he has his team
execute “the really good stuff” (other coach’s words, not mine). I’m
hopeful we can keep the game within a 30-40 run differential in order to assure
the League doesn’t run me out of town. But with eight All-Stars on my team,
including a 12-year old pitcher who throws nearly 60 miles an hour (from 40 feet
away), who knows, we may actually stand a chance. I used to think being “full
position” going into the trading day was stressful, but now I know how silly
that thought is. It’s nothing compared to potentially having a pack of wolves,
err, I mean families, screaming at you that you are destroying their kids’
chance for a Division I college scholarship seven years from now because you
gave them the bunt signal instead of having them hit away. If you think I’m
kidding, you only need to know what happened the other day to one of the other
coaches. A father drove into the parking lot during his daughter’s practice,
only to see her taking balls in right field. Without asking any questions, this
man bolted from his car and began a verbal tirade on the coach of the team. He
went absolutely wild because his daughter was playing right, and he was
going to let the coach (and everyone else within a 30-mile radius) know that he
was not going to tolerate this. It turns out the coach was running a drill where
all the players rotate from one position to the next, covering all the fielding
positions. But that didn’t matter to this father. No daughter of his was
ever going to be seen in right field and he made sure the coach and the league
knew it. Yup, just another ordinary day in Little League ball… especially in
Southern California. You gotta love it!

Again, and this remains the case for the next three months, if you don’t see my
column next week, you know I was either shot, hung, “body snatched”, or all the

Profit Taking

This week I’m going to finish the profit taking lesson we started a few weeks
ago. I want us now to focus on locking in gains when markets reach overbought
and oversold conditions.

Let’s assume we are long a stock and we are short-term traders. We’ve all been
taught to “cut our losses short and let your profits run.” This advice is about
as useful as someone telling us to “buy low and sell high.” It’s pure
generalities and generalities are next to useless when you are making hundreds
of decisions a year in an effort to create profits.

But, let’s assume we do have “a specific, exact plan to cut losses.” This means
we know ahead of time exactly where our stops will be placed once we go long or
short any one position. And, let’s assume we are going to attempt to “let our
profits run.” If we are not stopped out, we need to lock in gains at some point.
And unless you are blessed with the clairvoyance of those analysts and
prognosticators who give you their price targets for where a stock will
magically go, you need to have a trigger to lock profits in.

Last week we looked at piecing out profits as they occur. Now we’ll look at
getting out of our remaining piece (or your entire piece if you hold a full
position), when the overall stock market tells us to.

It’s A Killer When They Reverse At Extremes

Some of the biggest swings in one’s account value occur when you are long (or
short) the market and it goes on a one-way tear. This happens a few times a year
and while the move is occurring in your favor, the gains most times tend to get
bigger and bigger. But, as the market becomes more overbought (or oversold) it
is not only giving you great gains, it is also putting you at maximum risk
for a drawdown
(meaning losses off your peak equity highs). Why are you at
risk? Because this is when the biggest reversals happen. They happen after the
market moves strongly in one direction, adding more and more participants, until
there is no one left to buy. And then the selling occurs, and it occurs hard. On
the other side, when you are short and the market plunges, the risks of loss
from reversals are even higher because the bounces from oversold conditions tend
to be sharper than the sell-offs at tops (I’m talking about weekly/monthly
extremes, not multi-year extremes like we saw in 1987 and 2000).

So, how do you take advantage of this knowledge and apply it to your trading?
You become more aggressive in locking in your profits the more the market
becomes overbought and oversold
. As I mentioned two weeks ago, the downside
is you miss the few times a year where the market moves even further. But, you
usually only miss a few days of this and it many times is given back very

Here’s an example: Let’s look at the S&P
$SPX.X |
Quote |
Chart |
News |
] in July 2002.

The market went from oversold
to even more oversold. The easy money was made on the short side. But, as we
started getting oversold it was a signal to start locking gains in. Yes, maybe
you missed the further sell-off as the third week of July emerged. But, it
all ended in one day
. Look at July 24. The lows hit 770 in the morning and
within hours, they were trading nearly 10% higher! All those guys who were full
short and refused to lock in their gains as the market plunged, got their
behinds handed to them in less than a day. And, it only got worse for them over
the next week. These reversals of fortune can many times be avoided! How? Use
overbought/oversold indicators to guide you. None are perfect but they do act as
your compass. The more overbought we become, the more you lock in long gains.
The more oversold we become, the more you lock in short gains.

Your Nightly Routine

Here’s a routine you can follow nightly that will act as this compass for years
to come. Look at a basket of timing indicators. Look at the VIX (it’s the best
indicator in my opinion), advancing/declining issues, and the TRIN. Look at them
over a 10-day period and look if they are reaching extremes today. If all three
are saying the same thing, you have a pretty good idea how aggressive to be in
locking in your gains and reducing your position size. The game of trading is
the game of locking in profits. No secret here. But, the best traders lock in
profits at the right time. And, in my opinion, one of the better times to be
taking profits is when the market is in a vulnerable (and likely) position to
reverse. Markets move stocks, not vice versa, and the overall market is
the best way to gauge how and when you should be locking your stock gains in.

Next week, we’ll focus on the dilemma of “getting taken out” at the highs/lows
of the day.

Have a great week trading (and even though my daughter is one heck of a middle
infielder, maybe I’ll consider starting her in right field, at least for the
opening game)!