Update revised performance result

I have revised my results after the Nov and Dec results came in after my last report.

Market Updates

I apologize that that I have not written for about 2 weeks.

Meanwhile, a lot has happened in the precious metal market. I had written on Jan 5th 201 comments that I had gone short term bearish and thus collaring all my holdings in precious metals.

This short-term  correction could last a few weeks to a maximum of 2 months. Gold can bottom at 1320 to 13230 and if it does not hold, it can drop to 1270. 

My best bet now is that there may be a short-term rally. But the intermediate term is still down. Thus upon this rally, I am maintaining my put and rolling down my SC taking some profit and at the same time adding more protection for another month.

The overall market is getting nervous this week. Because the expectations are so high, any slight miss on earnings or revenue or any bad news, the stock can take a beating. Examples of these are CREE and FFIV. Also, for GOOG and APPLE, the stocks fell after delivering extremely stellar results because of news of their CEOs leaving the job. The market is clearly look for reasons to sell off.

As I said, after going up so much since August 2010, there WILL be a correction.

I got out of 90% of my junior minors and 50% of my precious metal big caps at the beginning of this year. It was a great move but it was not entirely that I foresaw the correction so clearly but because by coincident I was moving my old account to a new account. For the remaining of the big caps, it is now fully collared.

Be patient. The fundamentals are still overwhelmingly sound. Upon bottoming, the upside could be explosive this year. It is my belief that both gold and silver will reach new high in 2011. I am looking forward to get back in the game of PM again but not before a bullish signal is given

A few updates on my trades. I closed my double diagonals trades. I make some money all the trade but it is too slow for my style. Also, the WMT trade was assigned twice when it goes ITM.  Apparently, someone is watching WMT very closely to take assignment of options that went ITM just before expiration or just before dividends.

For AEP, I got out with a profit. I did a very bearish write-up. But recently, there are some developments and merger that make the utility segment bullish. Technically, AEP is issuing a bullish signal. But because I am not convinced on the fundamentals financially, I am not getting into this trade.

XEC continues to perform strongly. I got onto the trade twice with a covered call.  Unfortunately, I got out and did not get back to a new trade again. I am waiting for the right opportunity to get back again. The overall oil segment is still bullish.

The BYD trade is not doing well. I still believe in the long term fundamentals. Although the stock has dropped 25% since I bought but I am losing only 7% because of my hedge. My cost position is greatly reduced. I am waiting for the right opportunity to average up on my shares.

Through this period, I have collected many thoughts on my trading process. I had written it here in a separate posting. In addition, there are some trades, which I will post this week.

Watch out for the new posts.

My Trading Process

"Money itself isn't lost or made - it is the transfer from one perception to another: - Gordon Gekko in Wall Street 1

  

My trading process is relatively simple. It consists of a few major steps.

1. Determining the fundamentals
2. Align the Technical with the fundamental
3. Decision on the trade structure defining the hedge and exit points.

I outlined my trading methodology in Jan 2009 and subsequently added options to my strategies in October same year.

Over the time there various models written on how the processes were deployed.

After the above analysis, I need to make a decision entering the trade.

Let me discuss the above process in greater details.

1. Fundamentals

 Deciding on the fundamentals is basically examining the drivers for the stock. It could be positive or negative. Normally, I keep a certain percentage of my trade in negatively bias trade as a hedge.

The process filters down from the macro economic environment, to the  industry drivers and to the individual company’s management, product, earnings, debt, cash and growth. In many of my blogs, I have outlined  the process and thus I am not going to elaborate here again.  Many times it can be a very specific fundamental opportunity and it is best discussed with specific stock.

2. Technical

Many times I was asked whether technical trumps fundamental or vice versa. I am firmly on the camp that fundamental trumps technical. Technical basically measures the short term investor sentiments through the price actions. Psychology and emotions are a major part of trading. More often, psychology is more important than maths, perception is more important than reality.

Technical analysis is an art. I consider a good technical system if it gives me 70% accuracies. Also, it can only predict short term directions. On the other hand, if the fundamental analysis is correct, given enough time, the stock will align with the analysis.

So while I love the fundamentals, I will wait for the technical to agree before I enter a trade.

 

So what are the technical indicators?

 

The key strategy is to stick to the primary trend. The trend is your friend. Ride the trend as far as you can but never hesitate to execute additional protection once it breaks the primary trend. A simple way to see the trend is to draw a straight line on a few points during the last few months and determine whether it is sloping up or down. Sloping up means bullish trend and sloping down bearish trend. 

I can say that any reasonable system will work fine. There is no need for too many indicators or a complex system.

I use a combination of MA, slow STOCH, MACD and William %. These are lagging indicators. More important are the leading indicators – price actions, patterns, support / resistance and candle stick for short term movements.The leading signals will give the initial signals and often confirmed by the lagging signals.

It is easier said than done to follow the trend. Often it means buying when it goes up and selling when it goes down.  It is counter intuitive.I understand the need to buy low and sell high.  Most of us are tuned to try to buy on dips But sometimes the dip never come and we missed the train totally. Striking a bargain has its role but once the trend is clear, jump onto it.  The market has a way to leave you behind.

Many times the reality is different from your perception.  It was said that the irrationality can last longer than you remaining solvent. So many times it is totally contrary to the fundamentals.

I saw the whole housing bubble a full 2 years before it collapses. I short FNM, FAE, DHI and all kinds of housing stocks. I took losses a couple of times until the big collapse finally came. I finally got to take the ride. Even then, I got out too early.

We are undergoing a gold correction now. I see gold bulls complaining "it ann't fair, it can't continue; the fundamentals are too strong for this to happen etc" . But it is what is is. I got out of 90% of my juniors and collared everything on Jan 5. I protected most of my gains. You can be sure I am getting back again but not until my system tells me to go ahead. It will not be too late.

Another factor is that we tend to second-guess our technical analysis. Once you have determined your system, stick to it. You have to trade almost mechanistically. You will be wrong at least 20% of the time.

But the key to make money is to know when to lose money. I had said that risk control is the holy grail of trading. If you control your risks, the profit will take care of itself.

 3. Decision on trade structure: defining the hedge and exit points

First step is to take action. Do not expect to be right all the time. Once the fundamental and technical aligns, make a decision and execute the trade. If you expect to be right all the time to make the trade, you will be right eventually but you will miss the trade.

 My favorite structures are:

1. Most often, I start with a covered call or married put and moving to a collar when needed. Less often,  I may  start with a collar. There are times I start with just the stock.
2. On the negative bias trades, I may start with a covered put ( short stock + short put ) or a synthetic put ( short stock + long call ) and moving to a reversed collar when needed.

Most people knows how to trade bullish but seldom short the market. For me, I keep a certain percentage of short trades as a hedge to my overall portfolio.

The above covers 80% of my trade structure.

For the other 20%, I venture on Calendars, bull puts and even straddle and strangle. These are more speculative trades.

I seldom use double diagonals, Iron Condors or Iron Butterfly as a trade. But sometimes during the adjustment process,  the whole structure evolves into such trades.

Adjustments;

This is the interesting part. Like technical, it is an art but there are certain principles that I follow.

a. First, do not adjust when the trade is working. You will over trade if you do.

When the trade goes wrong, the adjustment process kicks in.

I use options for adjustments and hedge. Many people use options to leverage. Contrary to common practice, I use options primarily for adjustments and hedge.

b. Determine the DNA of the stock. Is it a volatile stock?  Does it gaps often? What is its possible directions and potentials? Has it got dividends?  From here you get an idea on what kind of trade structure to use and determine the primary exit ( if you are right ) and secondary exit ( if you are wrong ).

c. Below are situations I make adjustments. I am using example of a positive bias trade. Similar principles can be used for negatively bias trade.

-        Do not place a short call in front of earnings. You may limit the profit. If you need to place a short call in front of earnings, make it OTM and longer term.  Following the same principle, I will convert a covered call into a married put just before earnings by buying back the short call and adding a protective put

-        When the stock is reaching resistance or showing signs of resistance, add a short call.

-        If you are not sure of the resistance but feel that the trend  is slowing down, add a OTM short call and probably longer term

 Adding puts

Adding put is a difficult decision. I have to confess that I lose money on my puts 70% of the time. It is a necessary evil and insurance to control my risk. I am losing money to make money.

I add puts when:

i.                 It breaches support and primary trend. Often, if it breaks down, it will break down further and FAST.

ii.               In front of earnings, add a protective put especially for volatile stock. It is not worth the risk without the protection. If the protection is just to go through the earnings, I will add a short term put and take it out after the earnings. Normally, I add a ATM put. But if I am not so bearish, I may add an OTM put.

iii.             Protect my profit. If the stock has gone up considerably and I have made good money, it is often prudent to add a protective put if you want to continue to ride the trend but not sure it will pull back. A stock that has gone parabolic will pull back aggressive. Thus it important to implement the protection. If you intend to get out, an ITM SC may also do the same job.

Often if the trade continues to be bearish, maintain the put until near expiration date. Because the long put is deeply ITM, it will have a high delta and low extrinsic. So there is less worry about theta decay. You can put in additional protection only when it is near expiration.

You can sometimes reduce the cost of the protective put by:

i.                adding a front month short put to the long put making it a bear put calendar. Once it is confirmed bullish, remove the long put. You will still lose money but compensated by the short put

ii.              convert the long put into a bull put by add a short put at a higher strike price.  You do this  adjustment only if the trend is clearly bullish.

I have to say that adding put is a critical task. You will have no regrets if you go through a situation like 2008 again.  Warrant Buffet had said about successful trading. “ Rule no. 1 – do not lose money. Rule no. 2 – see rule no. 1”

If it shows support, remove the put or sell a SP below to reduce cost. Eventually, when the trend clearly reverses, take out the put.

Keep your hedge – unless the trend is so clear. Even so, more often, just apply a small OTM short options in case you are wrong, you have time to adjust it down.

Taking losses

I take small losses. If you look at my trades, 20% are losses. When I decide to take smaller losses, the percentage of losses will increase to 30%.

There are times I adjust to the stage that I make money. But sometimes it is not worth the effort especially when the fundamentals have changed. I can still make money. But it requires a lot of effort and time. It may take many months. The capital may be gainfully deployed on other trades.

Also, when I feel that adjustment process is out of control and it is difficult for me to recover, I rather take losses, get out and enter the trade again.

Summary

My key objective is the “catch and latch” to ride onto a trend using the various options to turn volatility and time to my favor. It is not an easy task. You can do it with a clear and discipline system. As any surfer knows, it takes skills and experience. Beneath the wave, there are coral reefs that could kill you. While surfing, at least you must determine the directions based on the long term fundamentals and  short term technical indicators.

It is difficult to do it with pure directional trades without options. You need to maintain the balance while the wave are going up and down. Options act as stabilizer during the process. My experience is that without options,  the market will whipsaw on you until you are confused.

The core of my profit will come from the ability to ride the trend. But also, in a stagnant trend, I will make money. I will only lose money if the trade goes seriously wrong in the other direction. Even in this case, the losses are limited by the options.

I wish I could be right all the time. But this is not the case. In my trade analysis last year, I was 80% right.  I suspect that I will have 10% more losses this year as I reduce the percentage loss on my trades.

Word of Wisdom for Trading

Happy New Year!

Below are are some wise thoughts for the New Year. It is gathered from common wisdom by various traders. Keep it in your thoughts regularly and you will find it helpful

My definition of wisdom is the ability the deal with complex situation and successfully overcome it. It is not a moral decision of right or wrong but the ability to recognize the reality of it. On the reverse, a fool is defined as someone who is out of touch with reality. A fool can become mad and insanity is defined as doing the same thing again and again but expecting different results. So do not become a fool or worse be a lunatic. Be a man of wisdom.


• Portfolios heavy with under performing stocks rarely outperform the stock market!
• There is nothing new on Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again, mostly due to human nature.
• Sell when you can, not when you have to.
• Bulls make money, bears make money, and “pigs” get slaughtered.
• We can’t control the stock market. The very best we can do is to try to understand what the stock market is trying to tell us.
• Understanding mass psychology is just as important as understanding fundamentals and economics.
• Learn to take losses quickly, don’t expect to be right all the time, and learn from your mistakes.
• Don’t think you can consistently buy at the bottom or sell at the top. This can rarely be consistently done.
• When trading, remain objective. Don’t have a preconceived idea or prejudice. Said another way, “the great names in Trading all have the same trait: An ability to shift on a dime when the shifting time comes.”
• Any dead fish can go with the flow. Yet, it takes a strong fish to swim against the flow. In other words, what seems “hard” at the time is usually, over time, right.
• Even the best looking chart can fall apart for no apparent reason. Thus, never fall in love with a position but instead remain vigilant in managing risk and expectations.
• When trading, if a stock doesn’t perform as expected within a short time period, either close it out or tighten your stop-loss point.
• As long as a stock is acting right and the market is “in-gear,” don’t be in a hurry to take a profit on the whole positions. Scale out instead.
• Never let a profitable trade turn into a loss, and never let an initial trading position turn into a long-term one because it is at a loss.
• Don’t buy a stock simply because it has had a big decline from its high and is now a “better value;” wait for the market to recognize “value” first.
• Don’t average trading losses, meaning don’t put “good” money after “bad.” Adding to a losing position will lead to ruin. Ask the Nobel Laureates of Long-Term Capital Management.
• Human emotion is a big enemy of the average investor and trader. Be patient and unemotional. There are periods where traders don’t need to trade.
• Wishful thinking can be detrimental to your financial wealth. HOPE is a four letter word in the world of trading.
• Don’t make investment or trading decisions based on tips. Tips are something you leave for good service.
• Where there is smoke, there is fire, or there is never just one cockroach: In other words, bad news is usually not a one-time event, more usually follows.
• Realize that a loss in the stock market is part of the investment process. The key is not letting it turn into a big one as this could devastate a portfolio.
• Said another way, “It’s not the ones that you sell that keep going up that matter. It’s the one that you don’t sell that keeps going down that does.”
• Your odds of success improve when you buy stocks when the technical pattern confirms the fundamental opinion.
• As many participants have come to realize from 1999 to 2010, during which the S&P 500 has made no upside progress, you can lose money even in the “best companies” if your timing is wrong. Yet, if the technical pattern dictates, you can make money on a short-term basis even in stocks that have a “mixed” fundamental opinion.
• To the best of your ability, try to keep your priorities in line. Don’t let the “greed factor” that Wall Street can generate outweigh other just as important areas of your life. Balance the physical, mental, spiritual, relational, and financial needs of life.
• Technical analysis is a windsock, not a crystal ball. It is a skill that improves with experience and study. Always be a student, there is always someone smarter than you!

And very important commandment, "Thous shall not trade against the trend"

Cystall Ball for 2011

Putting up a crystal ball for the future is a risky thing. Nevertheless, it is a good exercise to mull over all the various factors that will affect the market for next year, set a direction and develop a trading plan from a high level perspective.

I believe I will be 70-80% correct in my forecast. But if I am 50% right on the forecast, it will be considered an achievement taking account into the all changes and dynamism on the market. At 50%, I will make money considering the factor majority of my trades are hedged. In addition, there are risk control actions that will limit my loss when  I am wrong.

Despite the conviction I have on the directions of gold, stocks, currency, commodities or even the economy, there is no such thing as buy and hold position.  I am a trader. If fundamentals and technical change, I reverse my trades. There must be no preconceived ideas or prejudice.

My key trading strategy is to “catch and latch” to the trend. A variety of techniques are explained in the various parts of my blog. These are tools I had used successfully and will continue to deploy it on my trades.

So lets start with examining the bulls and bears argument for the market in 2011.

Bullish View

·       Current yield curve is very positive for banks. The financial sector should continue to outperform

·       Earnings momentum is strong and will probably positively drive the market for another quarter or two. There are so far no signs of slowing down

·       Corporations have plenty of cash on their balance sheet. Thus, M & A activities should continue into 2011 which is positive for the market. With the high cash level, dividend will increase and there will be more buy back of stocks.

·       One of the factors for the bullish market in 2010 is continued boom in technology sector. Internet infrastructure is undergoing a major overhaul with increased applications of media streaming, cloud computing, e-commerce  and smart phones applications. Corporation will be forced to upgrade their infrastructure. Technological companies and its users will continue to outperform. In 2011 we have seem astronomical rise in stocks like Apple, Netflix, Priceline, Amazon, VM Ware and Akamai. The excitement in the technology segment will continue.

·       While unemployment remains high, it is showing signs of improvement. The huge stimulus by the Fed is taking effort. Besides keeping interest rates low, hopefully it is driving corporation to hire.

·       US stocks will  trade higher despite the economic conditions and rising interest rates. Corporate profits will be maintained as cost-cutting measures and lack of spending allow businesses to maintain reasonable profitability. There are few other places to put capital to work. Asset inflation will cause price of fundamentally sound stocks to go up.

·       Valuation is still reasonable.  It is trading at 13.6 X forward four quarters. This is moderately cheap although it can easily go cheaper.

·       ISM index is the big surprise. It was the highest in 20 years!

.     2010 ended with consumer sales went up. How consumers manage to spend more with more mortgage default and unemployment remains a puzzle to me. However, one must not forget that 30% of the consumers are responsible for the sales. These are people that probably do well in the recent bull of the stock market. However, there are signs of strains:

• Walmart is 10% of US retail sales, has 150 million customers, and its stock it is down 6 consecutive quarters;
• Sears is the largest department store in America: "their stock is terrible"
• Best Buy had a huge earnings miss
• Toys'R'Us loss increased last quarter
• A&P filed bankruptcy
• Loehmann's filed bankruptcy
• Charming Shoppes is going to close 100 stores
• TJMaxx just liquidated AJ Right

Bearish View

·      

·       One of the biggest threats is that Europe will implode. It is almost inevitable that one of the countries like Ireland, Greece or Spain will default. If one of the countries decides to default, it will cause a domino of negative effects possibly causing the Euro to collapse. The situation is still very ugly. There are no signs of a good solution. So far, actions are mere band-aids. There will be continued effort of bailout through printing of money otherwise also known as quantitative easing, as they do not have the funds to support.  Undercurrent for bailout is losing steam but the need is rising.  Very visible recently is the collapse of the Ireland and Greece. Increasing there are reports of stress in Italy and Spain. In the Telegraph, there is a report of Italy's debt reaching the red alert. Keep in mind is that Italy and Spain have economies that are over 10 times the size of Ireland and Greece. Both these nations are under tremendous stress.  A bailout of Italy or Spain will spell the beginning of the end for the euro. No way can Germany support a bailout of either country.

·       Another big negative is the US Budget deficit and debt. It is a problem for many years but will continue to haunt the economy. The figure is accelerating. The latest count is the debt is US$14 trillion.  It is translated to $680,000 per household. US is bankrupt. There is no way they can repay the debt.  The only foreseeable solution is for US to devalue its currency selectively without causing geopolitical chaos. That is the reason asset prices and commodity will continue to go up.

·       Probability is Bernanke and the Fed will launch QE3/4 in response to the housing and municipality crisis, as well as to ward off the potential sell-off in the financial markets. The “audit the Fed” talk heats up and this becomes Bernanke’s last stand. However, the economy is saved by the thought that it “needs to get worse before it gets better” and that the “extend and pretend” policies of 2010/early 2011 are finished. Each successive bailout will produce smaller and smaller effects until systemic risk hits all at once. The world’s central banks are in fact powerless to stop systemic risk once contagion hits.

·       There are arguments on deflation and inflation. Arguably, housing price goes down and high unemployment will keep prices down. I know when I travel, I am paying the same price or lower for airfares and hotels compared to what it was 20 years ago. But commodities, gas, and even tuition fees for colleges have gone up. My bet is on inflation.  When it comes, it will surprise the Fed chairman who is confident to control it within “15 minutes” as he claimed during the 60 minutes interview. It is too simplistic and obviously he is lying.

·       Potentially, the bubble in China housing market is worrying. It has all the signs and symptoms of US housing market in 2007.  The only difference is China has a huge surplus that could help to control the crisis when it hits. Also, they are taking pre-emptive actions by restricting credits with regular interest hikes and setting new regulations to defuse wild speculations. Nevertheless, the crisis will hit. But question is how severely it will affect China. My bet is that China will be able to contain the crisis and recover. Also, it may take a little longer for the crisis to hit. The situation is certainly better that what is happening in Europe.

       We must not forget there are many toxic assets, “market to market” collaterals at banks, assets at  Fannie and Freddie that are not recognized. These are ticking nuclear bombs for the financial sector. Foreclosure is still an issue not resolved. Housing price is still going down.  Thus despite the yield curve today, I am staying away from the financials with a 10 feet pole. I have been wrong so far. But I will be right some day..

Summary

My bold forecast is that market is over extended. There will be a correction within 10 weeks of magnitude of up to 10%. Sentiments are far too bullish. It is at the most extreme levels since 1965 and 1958. We were in a similar situation at the end of 2010. The market went into a correction lasting a few weeks.  A similar scenario may happen this year. Probability is that market will again rebound after the correction and do pretty well baring any external crisis kicking in like default of one of the countries in Europe, China housing bubble burst and one of the municipalities in US default and declare bankrupt.

Commodities will continue to do well. I will continue to be bullish for gold and silver. I will add coal, palladium, oil, and agriculture into my list. All these commodities are very over extended. But as with all bull market, it can continue for a while. But it also can undergoes a correction before it goes up. Thus, the ability to trade will give one an edge.

Many times, the market can be totally illogical for an extended period of time, I will keep in mind not to get emotional over the issues but understand that the fundamentals will catch up.  The market has gone considerably in 2010 especially from September to Dec. The Dow Jones Industrials rose 11%, a second straight year of double-digit upside. he S&P 500 rose 13%, also the second straight year and the first time recording back-to-back double-digit gains since 2003-2004. Let the “don’t worry be happy” sentiment moves on. I am certainly watching for a reversal anytime especially a quick correction before moving up again.

Although the VIX index is low now, volatility will be high again.  It is the new paradigm. There will be increased uncertainty

US$ will be down. I watched CNBC on Friday on the interview with Peter Schiff. I cannot understand how they argued that US$ will be up. It is up against the Euro but down against most major currencies It may get a bounce again if Europe crisis worsen. But, in the long term trend is down as with what is going on the past decade.

I am on the inflation camp. So I am betting interest rates will go UP.  I will continue to be bullish on TBT. I have been totally wrong on TBT in 2010. Currently, I am collared on TBT and still positive on my trade. I am betting it will give me double digit gains.