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The Law of Small Numbers


Few trading opportunities in what remains a structural bear market.


"Money's only important if you don't have any."

Money, get away.
Get a good job with good pay and you're okay.
Money, it's a gas.
Grab that cash with both hands and make a stash.
New car, caviar, four star daydream,
Think I'll buy me a football team
"Money," Pink Floyd

The first key to making money in the markets is not to lose money - or at least to keep your losses to a minimum when you make a poor decision. There are many ways to express this rather simple concept: "Buy when you can, not when you have to"; or "Buy low/sell high."

While I have not been the most bullish guy on Earth for a few years, there was a method to the madness: To be able to buy when others have lost much of their capital.

While investing seems complicated, the arithmetic is pretty easy. If you lose 50% in an investment, you must double your money to get back to break-even. Clearly, doubling one's money in nearly any investment is not an easy proposition. But when prices fall far enough (like the recent experience with the S&P 500 in the July 2007-November 2008 period - a 50% decline), it's those who have their capital mostly intact that can pounce at low levels to take advantage of what I like to call "the law of small numbers."

Consider this: Even after the recent 20% move up in the S&P 500, the market remains down nearly 40% year-to-date. To the investor that believed the "buy and hold" mantra of the conventional crowd, the move from 740 back up to 890 in the S&P 500 was nothing more than a move from being down 50% to being down 40% - hardly awe-inspiring.

While I have made it very clear that my initial target in the S&P was 750 (I did buy aggressively in the 740-770 vicinity, as I mentioned in a couple of alerts last week), I already sold that position as of this past Friday.

The gains in some stocks and sectors from a percentage standpoint were staggering:

  • UYG (200% ETF on financial sector) moved from 3.30 to 6.20, up over 80 % in a week, but still down more than 90% from last year"s highs.

    Click to enlarge

  • BKX (KBW Bank Index) moved from nearly 120 to 33, or approximately 72% from last year"s highs then bounced 50% in a week but remains more than 60% below its high.

    Click to enlarge

Click Here to Purchase "Bond Basics: A Q&A with Bennet Sedacca"
Position in RLF

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