Ten Tips for a Tough Tape
Interesting times call for interesting measures.
The Chinese have a saying, "May you live in interesting times." I suppose we should be careful for what we wish.
After years of credit consumption, asset class inflation and dollar devaluation, we've arrived at the crossroads of our new financial fate. There are two potential paths, independent in both preparation and consequence.
We've long offered that to understand where we are, we must appreciate how we got here. The stakes have been raised, however, as it's no longer enough to recognize the debt dependency, derivative machination and structural imbalances. We must now apply our experience and extract the proper response.
As the disconnect between credit and equity comes to a head in front of what promises to be a massive move, I humbly submit ten tips for a tough tape.
Shorten Up on the Risk Stick
2008 has been a bipolar stroller with one day feeling like the doom is too gloomy and the next feeling like we need an old fashioned flush to weed out weak hands.
We've arrived at a reactive mindset where traders get bullish when screens are green and bearish when red spreads. They're chasing the tape both ways and it's a recipe for frustration if you're a half step slow.
I've adopted a much shorter time horizon on my exposure, flattening whenever possible at the end of the day and operating within the context of defined risk. This wasn't a viable strategy during the years of dormant volatility but opportunities abound given the current two-sided swings.
You Can Learn a Lot Just by Watching
Over the past few months, some of my best trades were found by simply watching the opening. When a stock or index trades flat to higher in the face of heavy futures, it speaks to the underlying demand. A flat to lower open in the context of upside gaps typically implies supply.
My vehicle of choice on many of these occasions has been Baidu (BIDU) but the approach applies to virtually any instrument. Incumbent in this methodology is the ability to remain patient, adhere to stops and understand that the ability not to trade is as important as trading ability.
The Dynamic Duopoly
When Goldman Sachs (GS) and Google (GOOG) are pointing in the same direction, the tape has a tendency to follow.
The bellwether tells change with time. For many years, Citigroup (C) and the four horsemen of Intel (INTC), Microsoft (MSFT), Dell (DELL) and Cisco (CSCO) shaped the tape. As it stands, Google and Goldman are key reads when trading in tandem.
Don't Confuse Volatility with Information
A few weeks ago, a financial television station reported that the bond insurer bailout was imminent. That sparked a 600-point short squeeze in the Dow Jones Industrial Average. The package wasn't announced despite rampant speculation regarding the implications for the marketplace.
This is an isolated incident but it speaks to an important point. When the tape rallies, bullish elements are fingered as the obvious cause. When the market sinks, bearish inputs are championed as the clear culprit. There will always be two sides to every trade and the residual friction will dictate tomorrow's front page.
Don't assign reason to the rhyme. Assimilate the metrics, weigh the probability spectrum and always allow for an ample margin for error.
Synch Your Time Horizon With Your Risk Profile
One of the steady saws in the marketplace is to sell hope and buy despair. When folks are euphoric, the reasoning is already established. When they're despondent, bad news is often priced into the tape.
Our current juncture is a prime example. The haunting headlines are highlighting many of the risks that the market has already discounted. That could work for an upside trade but the debt unwind remains in the early innings of what promises to be a long, hard fought game.
One of the toughest tricks to master is the ability to juxtapose your time horizon and risk profile. The market trades in nuances, trends, phases and cycles and each requires a different approach to effective risk management.
Let History Be Your Guide
Mark Twain once wrote that history doesn't repeat but it often rhymes.
The mainstream media is filled with folks asking the Federal Reserve to save the day. It is reminiscent of the mindset we saw following the implosion of the tech bubble in 2001. The Fed eased, sentiment briefly bounced and the S&P proceeded to fall 40%.
Perhaps a more daunting analogy can be drawn as we step back and digest the macroeconomic landscape. From Netherland tulips to the roaring twenties to Japan, excess has always, without fail, led to excess. You don't have to agree with the potential path but you should most certainly ignore it at your own risk.
Don't Fall in Love
Emotion is the enemy when trading. That's one of our principle trading commandments that bears repeating as we weigh the fray.
The current crush in the marketplace is the love affair with commodities. It makes sense, right? There's inflation in things we need to feed and power the world and deflation in things we want such as cell phones, laptops and plasmas.
This has been a profitable play in a big way since the dollar started its 40% devaluation in 2002. When wandering eyes start sizing up the prospects for deflation, however, broken hearts will litter the landscape. Commodities may out-perform on the downside but you can't spend relative performance.
If you're late to this trade, consider staying on the sidelines and awaiting a more advantageous entry point. Opportunities are made up easier than losses and it's never a good idea to run with the herd if you don't know where the cliff is.
Ready, Fire, Aim!
There are trades for the day, trades for a thesis and trades for a catalyst. Regardless of the set-up, an exit strategy must exist before you pull the trigger and initiate risk.
Use quiet time to create a laundry list of longs and shorts, complete with technical levels and potential catalysts, such that you've got a road map when the time comes.
And never rationalize your positions. The definition of an investment should never be a trade gone awry.
Recession is a Mindset
The great debate continues to rage regarding whether or not we're in a recession. I have news for you folks-it doesn't matter.
The conventional definition of a recession is back-to-back quarters of negative GDP. There are two critical points to process. First, we never entered a recession in 2001 despite the S&P getting cut in half. Second, the market is a discounting mechanism that will price in the risk long before economic validation arrives.
I'm of the view we're already in a recession, one that's been masked by the lower dollar and skewed by the spending habits of an ever-slimming margin of society. Whether or not you subscribe to that notion is academic.
Numbers don't dictate our destination. Societal moods and risk appetites do.
Be a Part of the Solution
It's tough out there. Tension is mounting on Wall Street, stateside friction is growing ahead of the election and geopolitical angst is manifesting around the world. It's enough to make you want to turn it off. If only it were that easy. If only that was an option.
The landscape will continue to shift for better or for worse. Lamenting about our lot in life or worrying about what will be is wasted energy. Focus on solutions, be it opportunities in the marketplace or capital preservation and risk reduction.
There will be winners in the new world and there is no reason why we can't be among them. Perspective is key as we find our way and do the best we can.
With a little luck and a lot of discipline, we might even enjoy the journey.
Fare ye well.
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
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