Minyan Mailbag: the mechanics of the swing
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I hope you're having a good night. When you believe the market will head lower (whenever you make that trade) what index do you use to short? Do you normally buy puts (for ex. on the OEX)? Or do you tend to short an index like the SPY or QQQQ? I know it is a roundabout question, but I'm confused and trying to get an idea what the bigger players tend to do...buy puts? Short an index? Both?
I am curious as to how you normally play your "gut" feels of future downside. On a side note, I can't make the Minyanfest-I would like to but I have 2 little kids in camp and my wife is teaching swimming. I very much look forward to shakin your hand sometime. Thanks! Minyan Scott
As you might have guessed, the answer to your question is pretty involved. As the Minx is a dynamic and intricate mechanism, it's constantly in a state of flux and, as such, never quite the same beast twice. Typically, when I'm looking for set-ups on either side of the fence, I'll walk through a myriad of parameters.
When a potential opportunity emerges, the first order of business is to define a time horizon, which will help shape both the vehicle and the instrument chosen. Is it a trade for the day? A trade for a catalyst? A part of a broader thesis? Each has its own characteristics and dictates a different approach. The constant thread of all positions, however, is that of risk definition. Discipline is the common denominator of any sustainable trading success and must be honored at all times.
Each trader has a unique approach and will define a process that works for them over time. For me, I tend to view the Minx through a stair-step process. There's the macro approach, where stocks are a monolithic vehicle that trade vs. fixed income, commodities (metals, crude) and the dollar. Within the equity arena, I view the dew as "N's and S's", then as sectors within each complex (semis, software, telecom, nets, biotechs, storage, financials (banks, brokers), utilities, consumers, cyclicals, small caps, drugs, energy, trannies) and, finally, the individual components that comprise each subsector.
With that said, and while my eyes have been trained by the aforementioned process, I'm always on the lookout for "special situations" as they emerge. Playing single stocks, in many cases, buffers some of the systematic risk that's inherent in all financial markets and often provides the ever-elusive edge. There's no "rule of thumb" involved but I will offer that during times when I'm not "seeing" the tape-and that happens to all of us-I tend to migrate my risk away from the pure market plays.
As far as the "right" vehicle, I was schooled in the derivatives and will typically eyeball opportunities in the option market, particularly in the current environment where volatilities are hovering near decade lows. They aren't always optimal tools-particularly for shorter-term set-ups-as you're forced to pay the "vig" that is the bid-ask spread. However, when approached correctly and by those who understand the inherent risks, they often allow us to tailor our risk profile with regard to both time and price.
While my answer my appear somewhat opaque, the market has become increasingly complex, with asset allocations and sector rotations constantly shifting the internal dynamics. As such, there's no singular answer to this complex question, just a laundry list of variables that must be factored into each decision. Simply remember that we're edging through a prolonged period of attrition as the capacity is weeded out of the crowded financial arena. Capital preservation is priority one and a necessary step on the way to prolonged profitability.
Good luck today.
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