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TFC Commodity Trading Forum

Random Mind on a Random Market

Kaeppel's Corner: Random Thoughts from a Random Mind on a Random Market

Jay Kaeppel, Optionetics.com
April 13, 2011

-We are bombarded these days with so much “important” news and “useful” information that many investors tend to fall into one of two categories – 1) those who think that each days events are “historic’ and somehow more meaningful than events of the past (hint: it ain’t necessarily so), or, 2) those who have essentially given up hope that humanity – not to mention Mother Earth – will survive into the next millennia.

-When it comes time to think about investing, let me offer two words for your consideration – 1) “hype”, and 2) “focus”. To put these words into a more proper context, what I suggest is: Ignore the “hype” surrounding “today’s historic events” and instead “focus” on developing and executing a well thought out investment plan. Bottom line: More benefit, less angst.

-None of the above is to suggest that there are not many serious problems here in the U.S. and around the globe. Rising levels of debt and violence do in fact raise great uncertainties that hold the potential to create upheaval and many “macro” changes of the “not so good” kind. And yet, ironically, my thinking remains that – as long as you build some risk controls into your overall investment approach – you will likely be best served by ignoring as much of the “news of the day” as possible and focusing more on market price trends. It will likely be good for your blood pressure too.

-Let me clarify one thing. I am not suggesting that people become zombies and simply “go along” with whatever our various “leaders” decide for us. If you want to be politically active and try to effect change, by all means go to it. But the point is simply to not let one’s political opinions get in the way of sound investment decisions. Remember this: you personally have very little influence on whether politicians spend more or less. But you can always act to cut a loss on a position you hold. Therefore, as an investor the bulk of your thinking should be focused on your own investments. Period.

Analyzing Market Activity

-The question that most investors tend to ask – even if only subconsciously – is “what’s next for the stock market?” And the irony here is that while this question is asked constantly, the reality is that no one can really say entirely for sure. I know professionals investors who are darn good at picking market direction. But even they get it wrong a certain percentage of the time. The difference is, they plan in advance for these occasions and take defensive action when they occur.

-The key point here is not to “give up hope” of ever consistently riding the market’s waves, but rather to simply accept the fact that at times the market will move against you – and to prepare in advance for such situations since you know they are inevitable. Will you sell a call option, enter a collar (sell a call and buy a put), will you reduce your market exposure if the market is weak, will you use a trailing stop, etc? There are no right or wrong answers provided you do some planning and make some decisions in advance as to how you will act, rather than simply reacting emotionally when things seem to be unraveling.

-Having been in the markets for awhile (more accurately, since what I typically refer to as the “Hair Era” in my life) I am not a fan of “buy and hold” as an investor’s sole strategy for two primary reasons.

1) Buying and holding is sort of like taking a really good boat onto water while a favorable wind is blowing, but then removing the rudder. If the tide and wind remain in your favor you may reach your destination easily. If circumstances change, your only option is to “ride the storm out.” This can be a painful and surprisingly long process.

Consider this:

-Between 1929 and 1954 the market gained no ground

-Between 1966 and 1982 the market gained no ground

-Between 1999 and today the market gained no ground

It is certainly conceivable that an investor might have “picked the right stocks” during these periods and come out OK. But navigating a churning, roiling market is a lot like navigating a churning, roiling sea. Simply rolling with the tide is not a good strategy.

2) With the advent of ETF’s and the proliferation of options trading, investors and traders have so many opportunities available to them the possibilities (beyond just buying stock and “holding on”) are essentially limitless and well worth exploring.

One final note on buy and hold: while I don’t recommend it as a sole strategy I do think individuals can consider putting some percentage of their money into a mutual fund as a long-term holding. That way even if you panic with the rest of your money and sell near the bottom of a major decline you still have some money in the market for the ensuing rebound.

-One potential negative to keep in mind is that the “Sell in May” part of the “Sell in May and Go Away” theory is now less than a month away. The simplest approach to this theory is to sell at the close on the third trading day of May and then remain in cash until the close on the last trading day of October. Figure 1 displays the growth of $1,000 achieved by investing the Dow Jones Industrials Average only during the “bearish” May through October period every since 5/3/1940.

Figure 1 – Growth of $1,000 invested in Dow Industrials May through October (1940-2011)

As you can see in Figure 1, sometimes the market does advance between May and October but the long term net effect is that $1,000 invested only during this period since 1940 is today worth only $941. For comparison’s sake, Figure 2 displays the growth of $1,000 invested in the Dow between the end of October and the third trading day of May every year since 1940.

Figure 2 – Growth of $1,000 invested in Dow Industrials November into May (1940-2011)

For the record, $1,000 invested November into May has grown to over $88,000 since 1940. So in sum, since 1940:

-Investing in the Dow November into May = +8,727%.

-Investing in the Dow May through October = -6%

If you don’t see a difference here perhaps you should consider having someone else handle your investments.

Jay Kaeppel
Staff Writer and Author of “Seasonal Stock Market Trends”

Optionetics.com ~ You’re Options Education Site