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 June 27,
2004 Commentary (weekend edition)-
Well, for
this weekend's commentary I owe everyone a story. I have been getting quite a
few favorable e-mails lately with regards to my stories, so I guess they aren't
as bad as I was thinking they might be. As I said, I like telling them, so I'm
glad the reviews have been favorable. I'll tell my story, and then we'll look
at a few charts.
There once was a trader who did something quite interesting, and I
felt that my readers could learn something from this trader's experience. Let's
say for the sake of this story that this is a fictional trader, and that this
is a fictional story. This account may ring all too true for a large percentage
of my readers, and I don't want anyone thinking I was referring specifically to
them. As they say in the movies: 'any similarities to any person, living or
dead, is purely coincidental'.
This trader found himself in the position
where he needed a certain amount of money for something in his personal life.
Let's say the amount needed was $100,000. The need was urgent, and nothing less
than the full amount would do. The trader decided that this was to be
accomplished "by a judicious investment of a temporary character", to quote one
of my all-time favorite books Reminiscences of a Stock Operator. In
other words, the trader was going to take a long shot gamble on a highly
leveraged play.
The trader chose a very short-term, out of the money option on a
high-flying stock. This was common practice in the late 90's, and paid off
incredibly well for many traders during that time. Now, when daily moves of
twenty cents are the norm and not fifty dollars, this is a tough game to win
at. Nonetheless, this trader chose a stock that was really moving, and also
happened to time it just about perfectly, as far as entry.
Things
started very well. In no time at all the trader, who initially invested $3,000
we'll say, was up to $30,000. This is a 1000% return if cashed in. This did the
trader no good, though, as it was $100,000 or bust. I know everyone is moaning
in disgust and pain right now, as they know the inevitable conclusion to this
story. Shortly after this time the stock started to dip, and hit the bottom of
its dip right as the option expired. Did it expire worthless? You know it
did.
The trader felt he took his shot, and the $30,000 wouldn't have
done him any good, and so he followed his plan exactly as he laid it out. He
was very happy with his play (not the outcome, just how he stuck with his
plan). So, what's my assessment of all this? Why did I tell this story?
Since this is
a fictional account (that's my story, and I'm sticking to it), I can critique
the events without any qualms. Remember, if this sounds exactly like you, it
isn't you; it's just a coincidence. I don't want to get several hundred
e-mails, all yelling at me.
I am forever saying that I judge myself for how well I
stick to my 'Trading Plan', not by how any one trade works out. In this regard
the trader gets an A+. I also say, though, that I must have a plan that I feel
has an edge, a 'net positive expected outcome' plan. To trade without such a
plan is just crazy, to me. That isn't trading; it's just gambling (gambling as
in recreational gambling, not professional gambling, which is a whole other
category).
The trader recognized that he wasn't actually trading;
he was gambling. He could have taken his money to the track and taken a shot
there, or bought a bunch of lottery tickets. He just opted to take his shot in
the market. Hence, I should not have even labeled him a trader in this example.
I only labeled him as such as a descriptor for what his normal occupation is.
Once he went down the path he did, he was not acting as a trader any
longer.
So, if I critique this trade, I do so as a trader, and this is of
little interest to the person in this example. He did what he planned to do,
and it didn't pay off this time. I still feel this is an interesting case to
review, as many new traders still do things like this, but feel that they are,
in fact, 'trading'.
First, I manage my trades using some sort of trailing
stop plan. I get taken out 'on the way down', in most cases, on a long trade.
In some cases I do some scaling out on each thrust in my favor. Whatever
variation on the methods I use, I have decided ahead of time what I am going to
do, based on how the issue behaves. I have this all detailed out in Kane Trading on: Trailing Stops,
and I will have more to say on the topic in Kane Trading on: Trade Management,
when that gets finished up.
This is how I avoid 'letting a winner turn into a
loser'. Sure, there could be a huge gap and my trailing stops wouldn't prevent
a winner from becoming a loser, but that is out of my hands and is a part of
trading. Excepting market shock events, the plan I have allows me to get some
profit if the issue turns down (on a long trade). I never know how far a trade
may carry, which is why I don't use 'profit targets'. I still get e-mails, even
though I have discussed this at length, expressing shock, horror, and disbelief
that I don't use 'profit targets'.
I wait for the issue to finish up doing its
thing, and then I implement my exit strategies. Again, all this is outlined
Trailing Stops. I also outline how I scale out on thrusts, for when I
utilize that variation. A good example of that was in the recent corn play.
Look over that chart (try a 15-minute, just for the detail), and see if you can
guess why I would scale out on a thrust for some of that position. It's pretty
clear. More on that later.
Now, what about the 'profit target' on this one? It was,
give or take, about a 3300% profit target. Was that realistic? It's hard to
say, since a very short-term out of the money option can have insane leverage.
I prefer to analyze the chart and assess the underlying issue. In doing this, I
feel that the target very well may have been hit. To do so, though, would have
required continued strong momentum.
Certainly, as a simple example, I would not
want it to take out any daily lows. As long as it kept going up and holding
those daily lows, I can see staying with it. But with a momentum run like this,
once a daily low goes, it might be all over in the short-term. And the option
was getting close to its end. I'm just looking over some possible management
options. One look at the chart and it's pretty clear what was going on. The
momentum was gone.
I like to have plans, ahead of time, for what I'll do if
it does what I'd prefer, and what I'll do if it doesn't. This trader didn't
have any plans like this; it was all or nothing. Somehow I still feel I'd
rather have walked out with, say, $20,000 or $25,000, than nothing. But I'm not
in the trader's shoes, either. What this all points out to me, though, is that
we are looking at non-professional 'gambling' here, not trading.
Sometimes I
find some very good, very wise trades using short-term out of the money options
on expiration week, and I play them as all or nothing. I think it can be a
viable strategy at times. But that doesn't mean I only close them right before
expiration, regardless. It means I either take my profit according to my plan,
or they expire worthless. I don't try to close the play at some partial loss
with regard to the price I laid out. The total I am willing to lose becomes the
amount invested in the options.
The point is, if the management plan takes me
out after two days and there are three days left for the option, that's fine. I
don't play it like I have more time, let's see what I can get if I wait. The
chart tells me what to do, and when to do it. The management plan is already in
place. This is all part of the master 'Trading Plan' I always talk
about.
I hope that this story has given everyone some things to think
about. There are many more things I could have delved into with this example,
but time and space are finite in this column, so I'll move on.
Let's look at
some management aspects on the corn play. This one was tough because I was
about to go on 'vacation', and any management I had to do I had to do remotely.
Regardless of that, I was able to do the initial management before I left.
Let's look at a 15-minute corn chart current as of June 1, 2004, right before I
was getting ready for my break.
The arrow points to the approximate area of
my entry trigger, as outlined in previous commentaries. Recall that I opted to
ride out the initial 'heat', as it was still above my stop, and I wanted to let
this one breath. On June 1 I woke up to a lock limit up move.
I looked over
a few things here. I was trying to make an evaluation as to whether I thought
this was the start of something big, or a blow off and it was basically over.
The first thing I did was to check the options market (the technique is
outlined in most good options books). This helps me determine the approximate
area where corn would be trading, if it were able to trade. In some markets one
can also check the spot market for info.
I decided that corn would not be
trading too much higher if it were free to trade. I would not want to close out
a position that would trade way above the current limit if it were free to
trade. Given that I was going on 'vacation' momentarily, I opted to scale out
some on this thrust. I likely would have done this even without the vacation
aspect, but that made it a simple decision.
Now, on to
the rest of the play. It did turn out that corn had pretty much done it all on
that limit move. I went into management phase, as best as I could not being at
the screen. Let's look at another chart, and a rough line I drew on the
chart.
The chart is a bit hard to read, since it is
so compressed, but I wanted to show everything that was relevant. The trendline
I drew was quickly dismissed as being way too far from the action. It did point
out, though, how extended the prices had become. I added two .618 retracements
onto the chart from around the initial gap area. I frequently use those as do
or die areas in situations like this.
Keep in mind, on this 15-minute chart this
play looks over at the gap up and turn down, but this trade is based on a very
large pattern from the daily chart. I'm only on the 15-minute chart here to
show the detail for the reader. My actual management would be on a higher
timeframe (see Kane Trading on:
Multiple Timeframes and 'Context' for more details on my use of
timeframes). I have to let the trade breath on this timeframe.
Once corn
gapped down I got more aggressive on the scaling out. I was watching the .618
area on the chart as the final 'out' area. When the swing-low from just below
the lines was taken out, all remaining position in the play was closed. I don't
like to close plays just above trendlines and just above 'close the gap' areas,
but I was also not at the screen on a constant basis. If I were I may have held
a small amount to see how that area was handled (it wasn't handled too well, as
it turned out).
All in all the trade was not too bad. It didn't really go off that
pattern like I had wanted, but that's the way it is in more cases than not. The
big moves are a relative rarity. That's why I constantly harp about trailing
stops, scaled exits, and management strategy. This allows me to walk away in
most cases with something, as I wait for those big ones to unfold.
I'll never
know which ones are going to be the ones that explode, so I have to be in when
it happens. Many claim that they can tell you how to tell which ones will be
the big ones, but I won't believe that until I see it. You'll know, though, if
I figure that one out. Instead of writing this column I'll switch to a live cam
of me trading, and sipping margaritas, from my private island with satellite
uplink. And you know how likely that is to happen…
The next
commentary will be the mid-week edition, posted on Wednesday.
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