Delicate Balances

So much for that tight range....and low and behold GOOG has made it's breakout....I was 1 week too early! Timing is indeed everything especially with options and there's no difference between being wrong and being too early when it comes to options.

I was going to talk a bit about what Draghi said yesterday but I'm getting sick of fixating on the day to day central bank drama. It's causing me to lose focus. I've touched upon some important sentiment indicators that have been "holdouts" with respect to the market making a ST/IT peak. One of them has been money flows. Last night I was surprised to read that there was a $6 Billion outflow reported. Since the June lows, fund investors have not even remotely embraced the market and now we have a market that has made a new 4 yr high and yet they still shun it. That's a LT bullish sign.  Next we have AAII sentiment which showed a neutral reading of 1:1 bulls vs bears -  nowhere near what you see at ST/IT tops. These guys have been fighting the rally as well.  I realize other indicators like Rydex, NAAIM and insider activity do suggest the market is toppy but I have a hard time betting on the short side for a swing trade when I see those important holdouts that I just discussed. I might take a stab at a quick downside play if the market gets ST overbought though.

This is around the time of the year when stocks exit from their summer doldrums and as a result I started scanning the TSX stock list and I have already uncovered a few potential candidates. I look for small cap stocks that are trading a great values (p/bv <1.5), low debt and positive business momentum (ideally, an early turnaround story). If I see any good candidates I'm going to pull the trigger with a starter position with upto 60% total  longs exposure. I have plenty of cash on hand and I can always hedge away market risk.

Switching gears now, I want to share a story. A couple of years ago a good friend of mine confessed to me how he lost over $100,000. He committed pretty much every cardinal sin you could make in this game. He put all his capital in Fannie Mae stock (greed). He bought it solely on the notion that nothing could go wrong given that the US government was backstopping it (ignorance). The stock dropped over 50% from where he bought it a couple months later. It gets worse. The money he was playing with was borrowed money. It gets even worse. The borrowed money was from a credit card that had a 6 month teaser rate. When my friend told me about this my jaw hit the floor. Not only was I shocked about his losses and the stupidity of the trade, I was was equally taken with how he never consulted me about it. He has little knowledge about the markets and although I'm no Warren Buffet, he knew very well about my experience and expertise and knows I do this for a living. When I asked him why he didn't consult with me first he said he wanted to be responsible for his own decision. I know he's a proud guy but I think the real reason was that he was so blinded by greed that he didn't want anyone to try and persuade him out of the trade which he knew I would.

There's few avenues like the stock market which allows for unlimited financial potential. I play the market for a living and so I intend to make the most out of it. I'm not interested in making a few percentage points a year....I want to make big money but I'm fully aware of the pitfalls in doing this. Most people get attracted to the market because of the lure of unlimited riches. Unfortunatley, most people fail largely due to greed and ignorance like my friend did. People want to get rich quick and their greed blinds them from rational thinking and it's just a matter of time before such people blow up their account.  Having said that though,  if you want to make big money you do have to be aggressive at times and have the courage of your convictions. At the same time though, you can't be reckless.  Putting all your capital in one stock like my friend did  is reckless and borrowing money to do so is reckless squared. At the same time though, if you spot a rare opportunity through sound analysis (not ignorance) you need to be take full advantage of it and be aggressive but  how much is too much? There's a delicate balance between conviction and discipline (prudence). This is a balance that I struggle with at times...knowing what exactly is the optimal amount of capital commitment I should have with a position given what I believe are the risk/reward parameters.  I suppose you can never know what exactly is optimal because you can't really know for sure what the risks and rewards actually are. But no matter how strongly you feel about something, you can't put yourself in a position where if you get it wrong you get badly crippled or wiped out....this is what I mean by discipline - tactics to ensure you remain in the game when you get it wrong.

Here's my philosophy when it comes to aggression when you have a conviction. Make a larger than normal bet...say 15% of your capital to start off with a position. DO NOT average down if the price drops. Add only if the price moves up. This is valid for 2 reasons. 1) The market is suggesting you are right 2) You are in a position of strength for now you will have a larger amount committed with an avg cost basis below the market price. So, if things go wrong you will probably be able to exit the trade with little or no damage done whereas if you average down and you get it wrong you're fucked.