was successfully added to your cart.

Don’t make these costly mistakes in the current market

May 20, 2013

Russell 2000 (RUT) just crossed 1,000, the highest point ever for RUT; even surpassing the dot com bubble, the credit bubble and so on. S&P is cruising every day higher. Dow is making all time high almost every day. Nikkei is up almost +80% since Abenomics started spreading its wings in Nov’12. Advisors’ bullish sentiments are hitting and higher. Yields are near or all-time lows.

Everything seems fantastic. Central banks are on Bulls’ side. Nothing can wrong!

Apple (AAPL) was market participants’ darling (even today it is for many). The cracks were starting to surface about a year ago; it continued to make higher high. Everything seemed fantastic. There were price targets for Apple to cross $1,000, Apple was THE market and it was expected to be the first company to cross a trillion dollars market cap in modern history. It was almost impossible to imagine S&P500 making all time high while Apple will be 40% lower!

But here we are, Ouch!

Here are 7 mistakes that I think a trader should avoid, especially in the current markets-

1. Confusing momentum with value:
Facts and Values are still relevant. Even though markets can remain irrational longer than traders can remain solvent, your portfolio doesn’t need to be irrational. If you made those purchases based on appropriate “margin of safety” and the intrinsic values are already recognized in this rally, you need to re-evaluate your holding and financial assumptions behind those. Is it still offering a margin of safety? Will you make a new purchase at this price?

2. Confusing luck with skills:
Some traders call this rally as “rich man’s rally”. Some believe in it, some don’t. It doesn’t matter what it is called. However, it is an not unknown that this rally is fueled by liquidity blessed by central banks. Trillions have been dumped, rules have been changed and so on. Remember the old saying “Rising tide lifts all the boats”. Re-evaluate if your trading approach will work should your portfolio take a turn while market continues to make new high. How will you know?

We all know once markets have gone through a major correction, market leaders are not necessarily same at the next high.

3. Over investing into one single asset
Though I have mentioned this time and again that during panic diversification hardly works (check out what happened to various asset classes during 2007/08/09 declines). It maybe a good idea to reclassify your portfolio. Ask those who were single handedly invested in AAPL or were buyers of Gold at the beginning of this year.

Yes, just keeping cash idle hurts. It hurts especially when it seems there is easy money as markets are making newer highs. However, cash does hold an opportunistic value. For instance- If one was fully invested in 2006/07, he or she could hardly benefit from the subsequent massive market declines. Buy and hold works as long as one can “buy” and “hold”. Absence of cash means absence of opportunity.

4. Forgetting where the Exit is
At the beginning of this year, I mentioned that I will dance to the tunes of Uncle Ben, but I will dance closer to the door. The door for this irrational exuberance via S&P500 is 50dma followed by 50wma. This is the longest stretch in the ENTIRE history of Dow when markets didn’t pullback for 3 consecutive days!! Unbelievable as it may sound. As of now, S&P500 is stretched, almost 100 points above 50dma. You don’t have to wait for it to fall 100points to exit. Review your plans and make sure you have a good exit strategy.

(Try our OP Income Newsletter RISK FREE)

5. Forgetting Fed is still in the Driver’s Seat
There is an old saying “don’t fight the fed”. Though I suggest to keep an eye on exit, the big mistake will be to be contrary and go against the fed. While being contrarian may pay-off one day, we don’t know “when” and markets can remain irrational longer than our portfolio can remain solvent.

6. Trashing “Trading by Objective”
It’s tempting to let go a rational trading approach in exchange for momentum chasing returns. Trading is a tough business that requires disciplined objectives based approach. Let Mr. Market do whatever it wants. Let’s accept that it’s beyond your and my control and it doesn’t care what you and I think. The only thing that is in our control is our trading plan. Trashing “trading by objectives” for chasing alpha might not be a good strategy at these highs.

7. Thinking volatility will remain low
Currently we are in one of the lowest volatility (as defined by The FEAR INDEX called VIX) environment. It’s low for a reason and one of that reason is the tremendous amount of confidence in Fed’s ability to steer markets and crises. These days Good news is good, bad news is even better. Volatility is mean reverting in nature (generally speaking). Though nothing stops it from remaining low, a costly mistake will be to assume that it will remain low especially after almost a 100 day run without 3 day pullback.

Bottom-line: It’s time to re-evaluate. I am not suggesting that we are at the top and you should sell everything tomorrow. Instead, in my humble opinion it is time to start preparing. It might be too late to prepare when everyone panics. Keep the plan handy.

Profitable Trading, OP

2 Comments

  • EJ says:

    Hi there –

    Are the OPN and the futures income 2 different newsletters?
    is there a detailed track record for the futures?
    thanks

    ej

  • OptionPundit says:

    @Hi Ej

    Yes both are different newsletters.
    1) IFO uses a “directional” approach while OPN is “non-directional”

    2) IFO is newer while OPN has almost 70 months of history through bull, massive bear and another bull market.

    3) IFO focuses on purely on “future options” while OPN focuses on everything else i.e. equity, indices, vix etc.

    4) IFO doesn’t include speculative/bonus trades like OPN does. Those are short term, directional trades which have been overwhelmingly profitable as well.

    Please let me know if you would like to see details tracking record of IFO. I can send you via e-mail.

    Profitable trading, OP

Leave a Reply

Facebook IconTwitter Icon