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Three Takeaways from UNG Collapse


If the price fooled you, here's what you can learn.


There's recently been a lot of talk about United States Natural Gas (UNG) in terms of how it's been disconnected from the underlying fundamentals. As always, the popular media is the last one to pick up on any story.

I last exited a profitable long trade on UNG at $15.6 on June 16, when these concerns that are abuzz in the media today first surfaced. The note was entitled Nothing Natural about UNG.

"If this were a chart of a regular company, it would be a phenomenal technical set-up and would most likely lead to a happy ending. But something has been going on in UNG lately that goes beyond technicals and is confounding experts. Here's an interesting article.

"So, I'm starting to take profits after this 15-18% move. Yeah, let the price not fool you into believing that this is something tame."

Can investors learn anything from this?

1. Jesse Livermore said: "If a stock doesn't act right don't touch it; because, being unable to tell precisely what is wrong, you cannot tell which way it is going. No diagnosis, no prognosis. No prognosis, no profit."

I often talk about the "known-unknown" and "unknown-unknown" components of trading, as known risks and unknown risks. When it comes to UNG, Minyans have been aware of the unknown risks known since June. As this 40% decline from June shows that respecting unknown risk is the most essential component of trading.

2. Ed Seykota said: "The elements of good trading are: cutting losses, cutting losses, and cutting losses. If you can follow these three rules, you may have a chance."

The consistent pursuit of profitability in the markets is backed by some of the brightest minds and deepest pockets in the world. And yet, there is no one system in the world that's foolproof, neither fundamental analysis, not technical analysis, since the markets are dynamic. That's why investors ought to always supplement any thesis with proper money management. Any investor who was brave enough to think that UNG is a good buy regardless of their thesis, could have been stopped out at a pre-determined stop-loss.

3. Daniel Kahnemann said: "The combination of overconfidence and optimism is a potent brew, which causes people to overestimate their knowledge, underestimate risks, and exaggerate their ability to control events. It also leaves them vulnerable to statistical surprises."

And the most important takeaway in my mind is to always respect market action, more than your own ego. John Maynard Keynes, when asked about his changing views about the market, is reported to have said, "When the facts change, I change my mind -- what do you do, sir?"

This exemplifies the kind of attitude that's required to drive success. It's good to have a thesis based on which investments are made and trading decisions are taken, but the market is the ultimate arbiter, and its decisions have to be respected. A flexible approach allows traders to change their views when the market presents them the evidence to the contrary. This, in turn, keeps them aligned to the trend of the market so they can deliver consistent trading results. The goal of trading isn't to stroke your ego, or prove your intelligence, or even win or lose a single trade. It's only to try and consistently grow your account.

As William Butler Yeats said: "The best lack all conviction, while the worst are full of passionate intensity."

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No positions in stocks mentioned.

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