This week was mixed, marked primarily by a desire to get smaller. I started the week by closing a couple of bad long positions I had entered the week before while anticipating a bigger rally, and ended the week covering a ton of successful shorts. I’ll start with the bad, end with the good.
Rhymes with Ass and Ack
Tuesday I closed out two of my failed trades. The week before I bought FAS and Bank of America BAC May 10 calls as long insurance against my massive shorts, playing the news cycle. What I failed to pick up early enough was the depth of the outright hostility there was to the bailout news of the last couple of weeks. FAS ended up being a 38% loss; BAC a 52% loss. With the discipline of small position sizes, this hurt, but not fatally as it might have hurt later last year when I was routinely taking positions 4-5x the size I should. The silver lining is that I acted decisively Tuesday morning and avoided further huge losses. As someone still saddled with a buy and hold mindset, this was a bit of a breakthrough to actually cut and run when the tape was so clearly against me.
In examining this, there were several problems, and several points of hope. First problem: the initial idea was wrong. I had seen several times that Congressional action had temporarily revived an industry, but this time it was different; the looming threat of nationalization gave no bounce. Second problem: execution of the idea. Rather than go into something broad (like the FAS), I traded too much. I had to hope that there was a secret surprise in there for BAC. That’s just gambling. I would have been better off trying to ride FAS up alone. Complexity kills. Finally, had I maintained some discipline around stops, I could have saved some of the BAC loss. What started as a quick trade (averaging down too early) turned into a longer duration trade, and I was adrift. Proven wrong, I at least acted decisively when it was clear I was wrong.
Conviction Closed
One of my long underwater put positions, US Steel (X), finally got back above water, and I quickly pulled the trigger, selling all calls for a 21% gain. All the profit came from the puts I bought when I averaged down. Had I waited another couple of days, I could have increased this gain to around 35%, but I was happy to salvage the bad initial buy at the transaction cost.
The lesson I learned from this one is that there are different classes of people I follow on StockTwits. There are those who generate good trend ideas but whom I may not want to treat as signals for entry points (e.g., BuyOnTheDip on this X call, although he falls into the next category on a few of his recommendations.) There are those who generate ideas and make their entry and exit criteria clear from an intraday perspective (e.g., UpsideTrader and Mandelbrot at TwitterReality and fortune8 who uses a more Socratic method—complete with reinforcing visual aids of what a double bottom looks like—of teaching the method behind his entries and exits). And there are those who also make the most sense to listen to if you’re at your computer while the market’s open—again, UpsideTrader is one of the best.
So one of the new elements for my trading and following checklist is to classify the source of the ideas based on these characteristics; is the idea recognition of a trend that just hasn’t taken hold yet, or does it come with a source who gives a clear idea of when to get in or out?
Getting Clean on Tech
My other goal for the week was to close out my tech put positions as they moved into profitability. After spending a long time in the stratosphere (relative to where I thought it would be after the Steve Jobs announcement), Apple (AAPL) came back down to earth, and I eased out of those puts over two days for an overall 8.5% gain. Palm, which I had also averaged down on, went out Thursday for a 18% gain. These exits seemed to work out okay; both recovered Friday, so I might have been able to get a better day trade price, I’m happy to be sitting with the cash now.
Back into INTC
I’ve been watching INTC for some time. $14 a share didn’t seem sustainable, but $12.75 didn’t seem fair on the downside either. With an RSI below 30, it seems way oversold, so I finally bought some July 17 calls Thursday. The technicals don’t look that strong, and I may buy some more if they strengthen, but my goal with these small trades is to be satisfied with 10-15% gains.
The main reason I’m in it, and why I dumped my tech puts, is that from the last few weeks, tech has been surprisingly resilient in the face of all the bad news. Not quite immune, but poised to lead us out of this mess. I want to have a few quality longs in this space, since I see them as bellwethers and ways to profit quickly on any false bear rallies.
Tried My First Twitter Reality Recommendation
Picked the wrong one, but after seeing Mandelbrot’s record related to story stocks, I tried one experimental trade by buying AMED with a bid below the expected open on Thursday, catching it at 49, but getting out Friday at 48.60. In the past, I might have held this longer, but the conditions for those story stock trades is to get in and out on the same day, so I didn’t have any reason to hold longer than the extra morning. I may try this again, but only when I see futures being up and the stock recommendation hitting something I’m more familiar with.
SRS: Botched, or Not?
My cost basis on SRS is around $86; I’ve been selling premium on it for some time, and watched with glee as it climbed slowly back into the 80s. When it was in the 50s, I had sold some Feb $86 call premium at a fair price, thinking that if I got taken out, I’d at least have a couple of months of premium in exchange for the trade. On expiration day, SRS stood at around $82, and I considered buying back the calls to close to keep the shares. In retrospect, the right move might have been to buy back the premium and dump the shares entirely, since it closed at $72. I still haven’t decided yet whether to just write this one off, write some more premium, or let it play out as commercial real estate hits further pain points over the course of the year. Psychologically, I feel the need to make a profit. Classic irrationality. The shares are up 40% over the last couple of weeks; they make no sense to carry overnight at any time. Yet I keep doing it, rationalizing it by selling insane premium and bringing down my cost basis. There has to be a name for that. Reverse Martingale?
And the Big Winner: FAZ
As part of my foray into the financials, I started out with a buy of FAZ at $45 on February 6. Thursday it climbed to the $70s and I decided to take the money and run, selling at $71 for a 13-day, 57% win. Had I waited another day, I might have sold it at $81. The weird thing is that it must have sold after hours on Thursday—looking at Google Finance, it appears that it never really got to $71 during the day. Given that it closed after hours Friday at 70.99, I consider the exit okay. It could have just as easily gapped down Friday as up.
Who I Started Following this Week
I started following Michael Lazerow this week; I really enjoy his blog.
At the suggestion of @sorenmacbeth, I changed the tag line on these posts to reflect the real purpose—how an otherwise inexperienced retail investor can use StockTwits to make money. (Besides, I’ve maxed out the Google juice for the phrase “idiot retail investor”; maybe that’ll come in handy in the next retail investor bubble.)
This week’s trading didn’t turn out all that well, so I’ll cover that quickly and then dive into two other topics that I’ve been pondering: how I trade, and the whether averaging down works for me or not.
This Week In Failball
Going into this week I was way short, so I tried to get long financials prior to the stimulus hijinks. Unfortunately, that didn’t work out; my position in FAS was creamed (down about 30%), and my BAC calls are still underwater by about 30% even after averaging down. I also averaged down on both Best Buy (BBY) and Palm, two trades I expect to pay off well. I tried salvaging things on the financials by selling some premium, but was a day too late to get off some call premium on FAS and FAZ.
I’m still working on ideas for next week. My hold portfolio is all long (except for about 25% cash) so a bear rally next week doesn’t hurt too much, although there’s no denying that I was on the wrong side of a lot of financials this week.
The pain is no fun to talk about right now; I’m in denial. Let’s get to the good stuff.
How I Trade
I’ve mentioned before that the demands of my real job make it nearly impossible to day trade of follow the market on a daily basis. I tend to swing trade over the course of a few days or a few weeks, and sometimes over the course of a month or two. I focus on equity options, with a mix of equity positions. Over the past 5 months I’ve been primarily on the short side, although I have played AAPL, INTC, AMZN and DGP long trades. If I broke down the trades by dollar volume, it would probably be around 70% options (with about 15% index options), 15% equities and 15% ETFs.
On average, I’d estimate I’ve been putting in about 7-10 hours a week focused on the market and managing my trading portfolio. I typically start the night before by checking the stock futures on Bloomberg to help get a sense for what’s going on the next day. Next, I check after hours quotes on the stocks I’m following, as well as any new commentary that’s turned up on my StockTwits portfolio page. After that, I place my initial trades for the next day. Since the first 30 minutes and last 30 minutes of the trading day tend to be the time that market makers screw over the part-timers like me, I generally place my trades slightly outside the money, trying to snipe overreaction in sentiment one way or another. While this sometimes keeps me out of profitable trades, it also keeps me from some of the morning shenanigans. For the most part, this has worked in my favor.
The next morning about 90 minutes before market open, I take about 10 minutes to check the futures again and the pre-market quotes. About one in every ten or fifteen trades, I’ll adjust my bids/asks based on changes in conditions. That’s where I stand most of the day (on days I work) with occasional checks and adjustments over lunch or as time and schedule permits, occasionally checking my Twitter feed for any updates.
And the next night, it starts over again; hit my Twitter network, then the StockTwits main stream, then check in on the main blogs I follow for trading purposes:
There are about a dozen other blogs I kind of half follow (or catch up with on the weekends); but since I maybe have 30-45 minutes a night to review and get trades in, I can’t follow everything I want to (or should). Really, the crest of my Twitter network acts as the filter. Over the last 6 months I’ve come to see this as both a blessing and a curse. A blessing because I find good stuff I wouldn’t find otherwise; a curse because I tend to rely more on the network than on primary sources. And that costs.
So far, I haven’t set stops on my trades. Quite a few of my winning trades have been down 40% before turning around for gains. However, I think I can improve my return slightly with a couple of adjustments to this practice described below. The main reason I haven’t been setting stops is because of the extreme volatility; it seems like three times out of four, the trade will recover quite a bit from where I might typically set a stop. Because I can’t trade during the day, I almost always set an ask price outside the spread before the day begins and take it. I shoot for something in the range of a 10-20% gain, adjusting up and letting stocks run a bit if I have conviction. To a fault, I average down when I think my thesis is right but my timing is wrong. I talk about this a little more below.
And that’s it. I was lucky—really lucky— when I started in September in that I was making trades that represented about two to three units on AAPL and ran off a great streak that doubled my bankroll of sweep cash in short order. Believe it or not, I hit a streak of 15 winning trades right out of the gate (although some took a month or so to finally be closed out.) This came from a combination of tuning into AAPL’s volatility, going against Best Buy (BBY) per Lindzon’s blog posts and tweets, and trading a couple of other stocks I was already familiar with from my portfolio. I’ve come back down to earth since then, but I’m still doing okay, and tuning how I work.
I expect that a year from now I’ll have this workflow honed even further. Early on, I didn’t really have a notion of position size. Lacking discipline, I put too much at risk and lucked out in that it paid off. I didn’t pay much attention to beta-weighting or any kind of traditional balancing. If anything, I was successful because I took my trading account extremely short during an epic downturn primarily to hedge against my hold portfolio.
Workflow is important when you only have limited time. Since getting into digital photography several years back, and processing thousands of images, I’ve come to realize that when you’re learning, you go slowly and take many unnecessary steps and make unnecessary optimizations that just take time. With changing light conditions outdoors, you jack around with white balance on every shot, and adjust the unsharp mask on every shot. When learning, processing a series of 200 shots picking and finishing winners might have taken me 4 hours to complete. Yet after you’ve done a few thousand shots, you figure out what really matters and you can get through the same 200 shots in about 1/3rd to 1/4th of the time. I expect at some point, I’ll reach this with analysis. One key element will be always tuning the social filter.
Averaging Down
Last Sunday, fortune8 reminded me that averaging down is generally a bad idea unless you have a strong feel for an idea. Since I’ve started trading more actively over the past five months, I have enough data (113 trades) to see if that applies to me.
In the last 5 months, I’ve taken “initial positions” in securities 69 times, and averaged down on an initial position one or more times for 44 trades. Of those 43 trades, 21 turned out to be profitable, 12 turned out to lose, and 11 trades are still open. The net gain per trade on these trades is 9.69%. When I average down, 67% of the time I make money.
By way of comparison, overall I’ve made 113 trades with 66 winners, 26 losers and 21 trades still open with a net gain per trade of 7.86%. (For initial positions, I’m 45-14-10, with an net gain per trade of 7.38% with 76% wins.) Overall, that’s picking right 71.7% of the time.
Overall, I’m up a little over 6 “units” of my current average trade size. Until recently, I haven’t been that consistent on position size, in some cases going as high as 4 units, with most of the average-down trades on the order of 1/4th or 1/2 a unit.
Those numbers are eye-opening to me, even though I have no frame of reference. I think I saw that some systems assume that they pick right as little as 35% of the time, willing to take more losses to let bigger winners run (e.g., typical winner might be 2.5x the size of a single loss.) In theory, with such a system, you’d end up winning about 17% per trade over a course of trades.
The numbers I’m showing are about half of that in terms of return. And what comes to mind when I see that?
Poker. The classic amateur poker player is the one who’s the happiest guy at the table, pulling in the majority of the pots, winning almost every hand, frustrating other players as he sees each deal through to the river, grinding out low-return hands. And does that guy ever really win? No. The solid poker player lets the amateur harvest all those low return pots, content to sit back and play tight until it’s time to play loose and take the big pot.
Can I change my style and let my winners run? Is averaging down throwing money into a lost hand when you’re already beat?
At this point, I don’t think so. The data shows that for the most part, the primary difference between “initial” position trades and the “average down” trades is that the initial position trades tend to close out more quickly, and the average down trades tend to get more run. But in terms of success and return, there’s not a significant difference. In other words, for the most part, they should be thought of as independent events, even though psychologically, I tend to clump them all together, trying to “save the trade” as a single unit (e.g., referring to my “cost basis” rather than treating those as separate trades).
And maybe that’s the lesson: there’s no such thing as averaging down. Each trade is truly an independent event for a swing trader. Cost basis is interesting only for tax purposes. In trading, it’s simply a psychological construct that may inhibit appropriate decision making.
As I mentioned above, I go without stops and allow a lot of play when I have time. Based on the data above, I could probably improve my results slightly by setting a stop at something as crazy as 40%. Doing so would a) maintain my overall “initial position” winning percentage, b) cut my overall return slightly, but c) keep me “smaller” (as in too small to fail) by keeping me out of some of the long-running, large position trades. And in doing so, this might also allow me to get back to larger initial position sizes, which could make up for some of the loss in terms of actual trading units.
Focus on the Feel
The thing is: it’s not simple. Part of the reason I have so few trades is because I have such limited time. When I have a “feel” for a stock (e.g., AAPL and INTC), I can dial in and trade it with great success. Averaging down is a form of that, what I call “focus on the feel”. The areas where I’ve been killed have come from stocks outside the “feel” and in places where I shouldn’t have been. USO calls in the fall. The financials pretty much anytime. So cutting out the more profitable (but lower success rate) average down trades would be a bad thing if done on stocks for which I have a feel. But I could safely do so on stocks that are outside my comfort zone.
And this is all just a long way of partially agreeing with fortune8’s comment:
New People I’m Reading this Week
I haven’t done the StockTwits Saturday brunch yet, but thankfully we have @dakapbj’s great synopsis on Keep Unread.
Not the Master(card) of My Domain
I got killed today on my Mastercard put position with their good news; that transactions are still flowing through the system and they’re still collecting their fees. My entire premise was mostly wrong because I didn’t understand their business well enough. I just thought that a downturn in consumer confidence and spending combined with their agents (the banks) going all usurious on their customers would cause transaction volumes to drop. And to a certain extent, it did slow the growth. The news was largely negative and their results were helped by major cuts in ad spending. Will morale improve now that the consumer beatings have stopped?
But at the end of the day, I flat out missed that one and my streak of being on the wrong side of financial trades continues. Props to @dmooney9 for calling this one right and staying long. I’m holding the puts a little longer simply because I can’t get my head around this irrationality and I think there’ll have to be some kind of pullback. Overall, down about 42% on that trade at the moment. The StockTwits sentiment is turning negative, so I have some company as I decide to recover from my horrible entry.
The only silver lining in this is that in the last two weeks I’ve started putting a lot more focus on maintaining appropriate position sizes, so while this is a loss, it’s not as bad as it might have been with the lack of discipline I had last fall.
And at least I wasn’t the last commenter in this thread last August, commenting on why Visa was such a good safe stock to swing trade as it sat at $72 (it closed at $53.74 today):
If, all you had done is buy and sell on every 5$ price movement on V since day one- you could have easily had 50 solid (and easy trades) under your belt. Is anyone naive enough to think the floor is going to fall out on V- and suddenly the shares will be trading in the 50s??
Backhanding PALM
Today I also finally picked up some PALM May $5 puts at my desired price. The downside is that these aren’t that liquid and I’m going against the chart. The upside is that PALM sucks and I expect this one to work out; I got in near the high of day. I intend to give this one no more than 10-15 days due to the May expiration.
NDAQ Puts on the Radar
Tomorrow, my eye is on Nasdaq (NDAQ). It shot past $23 today, but the puts order didn’t fill. If this rally continues tomorrow, I expect to get in when the stock hits 24.50 or so. Like Mr Creosote’s mint, this one feels wafer thin and seems to lead the way down when things fall apart. Better? Better get a bucket—it’s going to throw up.
I don’t see any longs that intrigue me at the moment. The downside of being negative for 6 months is that your favorites have already rallied quite a bit and it feels late to get in. I’m very short in my trading account, which is keeping about net neutral overall with my long term hold account. I sold a little INTC April $15 premium yesterday when it popped. But I need to get a little more in balance.
