Today’s Trading Lesson From TradingMarkets
Editor’s Note:
Each night we feature a different lesson from
TM University. I hope you enjoy and profit from these.
E-mail me if you have
any questions.
Brice
Using RS Lists to
Aggressively Trade on Long and Short Sides
By Mark Boucher
One of the most
important lessons that a
successful stock investor needs to learn is that there are times when the market
is presenting plentiful, low-risk opportunities and there are times when making
money in the markets is quite difficult and far less certain. Adjusting one’s
strategy for these different market environments is key. You can trade
aggressively in a terrific market environment and make triple-digit annual gains
with ease. But trading just as aggressively in a very difficult market
environment could result in a huge drawdown of capital. Remember that a 50%
drawdown erases a 100% gain, and requires a 100% gain just to get back.
Over the years, one of the most common
stories I’ve seen is for a smart investor to begin investing very aggressively
during a strong market run-up when the environment is fairly easy pickings. This
smart investor will have a strategy that exploits the good environment quite
well — and he’ll typically make huge gains of around 500%-1,000% on his money
in a one- to three-year period. But when the market environment changes, this
investor refuses to change with it, and in the following one- to two-year
period, the investor loses most or all of his trading capital. Witness Foxhound
funds’ recent wipeout — a leveraged 300% gain in 1999, but a total 100% loss of
everything by April, 2000.
Clearly, learning to understand when
one can be aggressive, and to understand when to be defensive is important to
investors desiring to maximize gains with minimum risk.
We’ve already discussed (in prior
lessons and courses available on TradingMarkets.com) some macro tools investors
should watch — like interest rates, market breadth, and timing models both
short and long-term — to help distinguish an environment conducive to
aggressive vs. defensive trading. In addition, investors should watch carefully
the number of flag and cup-and-handle breakouts or breakdowns in stocks with
upfuel or downfuel to see how abundant the market’s opportunities are.
Probably most importantly, investors
should watch carefully our daily list of
Top
RS New Highs (on TradingMarkets.com) and the groups and sub-groups based on
this list as well as the
Bottom RS New Lows and the groups and sub-groups based on it. When the list
of Top RS New Highs is more than 20 stocks every day and there is clear
leadership in several groups that are broadening with more and more new highs in
that group each day, the environment is more conducive to aggressive buying.
Conversely, when the list of daily Bottom RS New Lows is more than 20 stocks
every day and there is clear downside leadership in several groups with more and
more new lows in those groups each day, the environment is conducive to more
aggressive shorting. When Top RS New Highs and the number of issues in leading
groups thin out, the environment is one to become defensive toward on the long
side. And when the Bottom RS New Lows and the number of issues in lagging groups
making new lows thins out, the environment is one conducive to becoming
defensive toward the short side.
“…in early March…we advised investors to take half profits on all positions. Leadership was failing and the opportunistic environment was at a sea change.” |
Until early March 2000, both the
short-side and the long-side showed broad participation and seemed to be
indicating an aggressive posture. However, beginning in very early March, the
environment began to change abruptly. Top RS New Highs began to thin out to
under 20 issues and the leading groups began to show fewer and fewer new highs.
Similarly on the downside, Bottom RS New Lows began to thin out to under 20
issues and the lagging groups began to show fewer and fewer New Lows. This is
why, in early March, when we had been previously advising fully leveraged shorts
and longs, we advised investors to take half profits on all positions.
Leadership was failing and the opportunistic environment was at a sea change.
Since early March, the stock market
environment has changed. There is no clear leadership on either the upside or
the downside. In addition to reducing leverage, tightening up trailing stops,
and taking 1/2 profits on all positions, investors need to trade more
defensively in their approach going forward until a better environment returns.
In future lessons, we’ll discuss a
number of ways of becoming more defensive while still leaving ample room for
profiting from market movements. But a huge part of knowing when to trade
aggressively and when to cut back is revealed simply by watching carefully the
breadth and number of flag breakouts and cup-and-handle breakouts to new highs
in stocks with upfuel on our Top RS New Highs list — and in watching the
leadership and breadth of stocks and groups on these lists over time. Similarly,
a huge part of knowing when to trade the short side aggressively or when to cut
back is revealed simply by watching carefully the breadth and number of downside
flag breakdowns and downside cup-and-handle breakdowns to new lows in stocks
with downfuel on our Bottom RS New Lows list — and in watching the downside
leadership and breadth of stocks and groups on these lists over time. These
lists are some of the most incredible tools available to investors anywhere.
Click Here To Learn How Mark Boucher Has Been Successful For The Past Decade