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If you think trading can be boiled down to a tip, try horse racing.
- Lawrence Szczech |
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Today's Featured Article
The fourth quarter is upon us, and a potentially volatile October, (a month known for fine market crashes: 1987, 1929, 1907...)
What, if anything, are you going to do about it?
You could build a case that the economy is stabilizing; that an exit from the global recession is on the horizon. You could point to stabilizing U.S. housing prices, and rising manufacturing indices as supporting facts. History will not repeat itself this fall. Let's start the holiday shopping early!
Or, you could point to the first anti-business ruling party in Japan since WWII, the coming calamity in an almost $ trillion of collateralized debt backed by commercial real estate, and...we might not have found the bottom of this market yet.
Having a plan
Lots of vibes occur in the fall, driving both retail and institutional investors to act accordingly. The back-to-school mentality is present: time to dust off those portfolios after a summer spent focusing more on mosquitoes and sunburns. There's the arrival of third quarter earnings with fourth quarter projections - the first full view of the year's performance -- and budget-building corporate execs making predictions (some public) about the year to come; a lot of data that can lead investment managers to change their minds. This can lead to increased volatility; and, occasionally, historically, sharp market moves.
You've likely read about the importance of having a plan and strategy when trading. There are two major components of a trading plan: a method of price prediction which signals if and when to buy or sell a particular futures contract, and a risk management program which dictates the amount of money to risk on any trade, and specifies when to cut losses. Trading plans are fluid in the sense that they are constantly being tested and amended to improve overall performance and profitability.
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Given the world we're trading in today and the weeks of news ahead, what's your plan? Are you going to do what you did last year? Stay fully invested in the market (your advisor's typical 60% stocks, 30% bonds, 10% cash portfolio) and ride whatever wave because you're a "buy and hold" investor? And then buy when the market drops and dollar-average your losses? Did you buy again after the market dropped in January of this year?
One set of ads running recently for a brokerage firm caught my eye because the catchy message, which was new, led back to a strategy which was the same one proffered in 2008. It's what they know; it's what they sell. If the economic world has changed in the meantime, someday it will change back and that strategy will work again.
Or do you want to do something different?
A different view
Perhaps it's because futures brokerages see the market from a different perspective, trading futures and options on futures. These derivative contracts expire, adding a fixed element of time into any plan. The regulated market structures they trade in do not favor buyers or sellers; they do not favor investors who believe the market is rising versus those who believe it is falling. They allow the investor to control a much larger value in the market than what exists in his or her account. Futures contracts reach beyond those markets to allow an investor to trade not just a legal entity like a corporation, such as in equities, but the entire range of building blocks of an economy (e.g.
oil, copper, euros, yen, interest rates). A key advantage of the futures market is that it has a potential for profit in both bull and bear markets.
Futures brokerage firms don't look at an investment plan as: what should we buy that's going to go up? They look at all known market conditions, evaluate the risk and plan accordingly.
It's impossible in this forum to tell you, individually, what you might do differently this time around with your trading plan. However, following are two fictitious examples of client portfolios and how those clients might want to plan for the remainder of 2009.
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Client A and Client B
Client A got lucky (or smart, depending on your perspective) and called the bottom of the U.S. equity market in March of this year. He flipped from cash to stock and his equity portfolio is up 53% on the year. While this investment is in individual stocks, as a whole, it's highly-correlated to the large-cap S&P 500 index.
The plan is to lock in this sizable annual return by buying December put options on the S&P 500 e-mini futures contract. He is using the options on the futures contract as opposed to the equity index because there are more strike prices and, arguably, greater liquidity. He will be giving up some profit to pay the premium for the options contracts, but this will protect the remainder of his gains from any market decline while staying in the market to benefit from any further upside. He's also not taking any short-term capital gains tax hit on his equity investments (still held under a year if sold in September).
Client B went into cash after the debacle last fall and has been too afraid to re-enter the equity markets all year. He's still in cash and a lot of Treasuries. However, this is not a risk-free position as rising interest rates could burst the Treasury bubble of the last 12 months, severely depressing the face value of this investor's holdings. If he can't afford to hold his investments to maturity, he might be cooked.
But you can hedge interest rates in the bond futures market and that's what client B is doing until the economy signals -- from his perspective -- a long-term bull market for equities.
And you? Client C, perhaps? Talk to your advisor about your current positions and goals and...do something different.
Disclaimer: The risk of loss in trading commodity futures and options can be substantial. Before trading, you should carefully consider your financial position to determine if futures trading is appropriate. When trading futures and/or options, it is possible to lose more than the full value of your account. All funds committed should be risk capital. Past performance is not necessarily indicative of future results.
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About the Author
With over 20 years in financial services, Mr. Szczech has worked with both institutional and retail clients in diverse roles such as managing director at the NYSE and as president of the Client Group at TD Ameritrade. He is currently the CEO of RJO Futures, the private client division of R.J. O'Brien & Associates LLC, in Chicago. |
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