By: Costas Bocelli — October 30, 2013
Wise Words From an Old Mentor...
It looks like the Fed is doling out few tricks but plenty of treats during this year’s autumn holiday.
In the Fed’s latest policy statement yesterday afternoon, the committee decided to continue its monthly asset purchases at the current pace of $85 billion a month.
No change on interest rate policy or guidance either.
And although the market had widely expected that a delay to any adjustment or QE taper would be put off at the October meeting, it did come down with a bit of a bellyache once the statement was released.
But who could blame the market that’s been continuously pumped like a foie gras duck?
A period of weakness was long overdue anyhow.
Whether it was profit taking or just a “buy the rumor, sell the news” response, the reality is that trading conditions have recently become overbought.
The S&P 500 snapped a four-day winning streak, and with the index up 9 out of the past 10 days heading into the FOMC meeting, some type of selling pressure should not have come as any surprise.
The good news for investors who are looking to put fresh money to work is that the overbought conditions may soon begin to reverse and offer opportunities to buy in at lower prices.
But don’t wait too long, or expect any significant correction, because I’m still sticking to my forecast that the market will remain relatively strong thoughout the remainder of the year. I laid out that argument in last week’s Tycoon Report, Here’s My Outlook for the Coming Weeks.
What’s interesting though is that ahead of the previous three Fed policy meetings, markets rallied. But after the statement was released, some measure of a pullback immediately followed.
If the trend continues, you’re likely going to get one more shot as we move towards the winter holidays.
Looking at the S&P 500, a two to four percent decline is probably the worst it could get, making the next pullback rather shallow.
But just because the broad markets will likely remain relatively calm heading into the final two-months of the year doesn’t necessarily mean there will be a lack of opportunity for the active investor or the “trading community”.
In fact, it’s quite the opposite.
You see, with the Fed still priming the pump at full throttle, the side effects continue to flood excessive amounts of liquidity into many speculative securities that have sent fundamental valuations off the charts.
And with this comes high volatility and plenty of opportunity from all the wild swings in the stock prices.
Many may be totally off the radar for the long-term buy-and-hold investor, but for traders looking for relatively fast triple-digit returns, these stocks can be the ideal trading vehicles.
The secret to success is twofold...
The first is really key -- and it's more like having the proper mindset than anything else.
During my tenure as a professional equity options trader, I had the privilege of working alongside one of the greats in the business. He was once a market maker too, but on the equity side of the trading floor (in fact he never traded an option in his life). He was also a past president of the Philadelphia Stock Exchange, so I was extremely fortunate to learn from his wisdom and decades of experience.
His best piece of advice to me was this:
“If you want to be a great trader, you must understand this...”
“There’s no relation between price and value.”
The first time he told me this was back in 1999 right before the Nasdaq Composite index and many of its components went parabolic during the dot.com era.
Stocks soared months on end as fundamental reasoning was replaced with exuberance. For many of these securities the story ended very badly as a lack of profitability and cash flow eventually caught up with them.
But for traders, the long run prospect of the company is rather insignificant. Instead, the primary focus for them usually lies in the price action of the stock over the short-term. Once the trade is closed out, that’s it -- and off to the next opportunity.
His statement certainly contradicts any traditional approach to investing, but when you’re trading, it’s important to achieve a different paradigm. His words of advice still ring true today, as many stocks are trading with such ridiculous valuations that boggle the minds of many investors, but simply the technical price action is primarily where the value lies.
The second secret to success is also key -- and that’s discipline.
It’s one thing to largely disregard fundamental valuations as the thesis behind a short-term trading opportunity. But it’s absolutely a major mistake to simply throw caution to the wind and not have a defined game plan when it comes to controlling risk.
Clearly defining your risk parameters on every trade is paramount to remaining solvent and prevents an unexpected and potentially devastating monetary setback.
I’ve unfortunately seen too many traders go bust during my years as a floor trader. Excessive leverage and poor risk management were the two most common causes of a floor trader or specialist post to “blow out”. Having traded through the Asian currency crisis, the demise of a systemically important hedge fund that needed an emergency government bailout and the dot.com bubble and subsequent burst, I’ve witnessed plenty of financial carnage among the exchange membership.
So putting those two simple keys together is the starting point to becoming a successful trader, even in crazy volatile stocks that trade with nosebleed valuations.
Take Netflix (NFLX) for example. The stock is currently trading at $320 per share and is an absolute beast with massive volatile price swings.
For the average investor or trader, this type of stock is completely avoided. Just 100 shares of stock ties up $32,000 in capital with plenty of risk to boot.
But if you have the right game plan and the proper strategy, you could structure an easy-to-learn options strategy that risks about $500 to potentially make $1500 in profit in less than seven weeks. That’s a 300% return on your investment and, better yet, your risk is clearly defined before you even execute the trade. To generate the maximum return, you would need about a 12% move (roughly 40 points) in the stock price, which is quite modest considering the stock’s historical price range.
This can also be done whether you have a bullish OR bearish outlook, which is another powerful benefit. And when it comes to managing risk, both trades are completely hedged, even under the worst circumstance.
If this sounds compelling to you and you want to learn more about these strategies -- in a real time setting -- then I’ve got great news for you.
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You’ll walk away with the knowledge and experience as we navigate the markets in a live market setting. You’ll see how we find, structure, manage and exit various examples that will become your case studies for a lifetime of trading.
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