This Week’s Battle Plan
A Second Chance
OK, I’m sure you are still smarting from last week’s test. I too
thought that 49 was less than 51. And from the many emails I received,
many of you did too. But, I’m a big believer in second chances. So
let’s try our luck again this week. We’ll only have one question to
answer, but it’s a long one. A word problem. And it’s very time-appropriate. Ready…? Begin…
This Week’s Test
After a substantial rally in late Feb through mid-March, rap singer Ja
Rule helps celebrate the occasion by appearing on CNBC singing his new smash
sensation hit “Everybody is Living it Up” (see my March
10 column if you
need an explanation). The market then (only coincidentally) proceeds to lose 650
points leading into today. Five out of the past six weeks, the market has
ended in negative territory. During this same time, the semis have lost over 15
% of their value. Individual stocks are getting killed daily (for a
description of what this means, seen
(
VRSN |
Quote |
Chart |
News |
PowerRating) from Friday). The VIX, which measures
fear, is at a two-month high, and
most importantly, CNBC has booked the rock group “X-Ecutioner” to sing
their hit song “It’s Going Down” before the opening of
trading Monday morning. What do you do?
A. I don’t have a clue. And anyways, Connors, I don’t need to take
this test. I got last week’s question correct. I knew that 49 is
greater than 51. And, I’m now enjoying my new job as market analyst
trainee for a major Wall Street firm. So there!!!
B. Sell everything that you bought six weeks ago (at the high), that
you had previously sold in September (at the low), which you had
previously bought in March 2000.
C. Rev it up and go 200% short Monday morning.
D. Buy a half (or a normal) position and use very TIGHT STOPS. If I’m
wrong, I’ll risk a small amount. If I’m right, and we get a typical
rally that’s seen from very oversold conditions, I will likely make
many times my original risk.
The Answer
If you read this column every week you know what the answer is. And therein lies a possible edge.
The Market
Obviously, we are oversold. You don’t need me to tell you this. And we will very
likely open lower Monday morning. With this backdrop, I
have buy signals all over the place for early in the week. The best
opportunities lie in buying into the snapbacks from oversold
conditions and selling into the rallies after Ja Rule is “living
it up” on CNBC. When markets reverse from extreme overbought and
oversold conditions, the moves are usually substantial. The key is
two-fold:
1) To be able to properly identify when the reversal is
going to take place, and
2) To protect yourself from the times when you are
too early.
The first is easier than the second. The first can be done
with many, many indicators and measurements. The second requires more
finesse. It also requires more guts. Because when you are wrong, you
will lose quickly. And to keep going in until you catch the move is
not a fun exercise. But, when it is done correctly, it usually leads
to substantial gains.
Yes, the market will likely snap back sharply within a few days. Until
it does, it will come down to money management. If you dip your toes
in the water, keep a tight (very tight) stop. I don’t know if the
rally will happen Monday, Tuesday or Wednesday. Or if it will happen
at these levels or 500 points lower than these levels. And the further
we go lower, the bigger the rally will likely be. And, this reversal,
as most reversals are, will likely be extremely profitable for those
who play it correctly. One thing to watch closely is the SOX and XBD’s. There
will be no rally without them.
Three Sure Things
What are they? Death, taxes, and perfecting profit taking. You will never
sell your long profits at the high every trade. In fact, you will likely never
do it once in your lifetime. Yet, we all beat ourselves up for “selling too
soon” or “covering our shorts too quickly.”
This Week’s Lesson
I’ll share with you a quick story. About 10 years ago I was invited by a
friend to meet and play basketball with one of the original traders in Jack
Schwager’s book “Market
Wizards” (if you don’t own this book, you should. It’s wonderful.
“New Market Wizards” its sequel, is also terrific). After this
gentleman kicked my you-know-what in a game of basketball (he not only was a
great trader, but he also had an outside shot that couldn’t miss), we got a
chance to talk about trading. And he shared something which will stay with me
forever. He started talking about his lack of ability to let profits ride. This
is a common theme, except that this guy had made tens of millions of
dollars (documented) from the markets (and he had the house and the
lifestyle to prove it). But that didn’t matter. He was in mental anguish
as he was relaying this to me. And the more he spoke about it, the more the
mental anguish was manifesting itself into physical anguish. He was truly pained
by the fact that he took his profits too soon. Tens of millions of dollars of
net profits (which came from an original tiny starting account) and he was in
pain! Now, if this gentleman, who in my opinion is as close to trading
god-like as you can get, couldn’t come close to selling at the highs, then there
is a very high probability that you and I never will either.
Guess what? You will have trades that after you exit, will run and run and run
on you. It happens. And, if you trade for the next 40 years, it will happen over
and over. Get used to it! It happens to every single successful trader in the
world. And anyone who tells you otherwise is lying. The key to profit taking
is to not let a profit turn into a loss. This is a crime that must never
happen. When you have a profit, your stop should be raised to break-even. And as
the position moves further, half the profit can come off the table. And then, if
you are lucky enough to get be in the rare trade that runs, you tighten your
stop even further. Let price take you out. But the most important thing to
remember is that profits should NEVER turn into losses and that you will never
be consistently selling at the highs. No one has ever done it. And that includes
the gentleman I just mentioned who created great wealth for himself and his
family in spite of his “horrendous habit of always selling too soon.”
More This Week
Kevin Haggerty’s seminar is only a few weeks away. The Early
Bird special for his seminar will end on Tuesday. Kevin’s “Trading With
The Generals” will be held on May 17-19 at the LeMerigot Hotel on the
beaches of Santa Monica, Ca. If you want to learn how to properly trade from a
man who ran Fidelity Capital Markets trading desk, then you’ll want to attend.
If you can’t make it, you
can pre-order his entire weekend and course here. Also, I’ll be at Kevin’s
seminar to learn directly from him, and if you’d like to join me for drinks
after Saturday’s session, you’re invited.
Finale
We are in very oversold conditions coming into the week. And we will likely open
lower Monday morning. I don’t have a magic bell telling me when the bottom will
occur. But it’s close. And if we have a typical reversal rally, the move could
be substantial. Just use tight protective stops. And remember, as the move
occurs, lock in some profits. Because no one, including the great ones,
consistently sells at the top.
Have a great week trading (and remember, Ja Rule sings “Everybody Is Livin
It Up” at market tops, and X-Ecutioner sings “It’s Going Down” at
market bottoms)!
Larry Connors and
Brice Wightman
Larry Connors is CEO and
co-founder of TradingMarkets. He is also the author of four books on
trading, including “Street
Smarts,” co-written with Linda Raschke, “Connors
on Advanced Trading Strategies“, and his latest release,
“Trading
Connors VIX Reversals.“
Brice Wightman is a Market
Analyst at TradingMarkets.com.