Friday, September 23, 2011

Value Trading

It appears that in academic hindsight the markets have ruled out Door # 3 and moved onto the remaining outcomes; either continuing down the slope of hope or meeting the requirements of a successful retest of the early August lows. 

Considering we are sitting at the bottom of the range, my confidence, with regards to pulling up to the trough and buying stocks more aggressively here - has risen commensurate with the declines. As I have maintained since the early August lows, I still hold the overarching opinion that equities will continue to be forgiving with tactical purchases on the long side of the ledger. This posture towards equities has been maintained, because I believe that although the range has been wide, it will drift higher over time. I believe to some degree you can use the 1987 crash analog as a general impression on what to expect in the coming months. 

I will continue to average into a position if and when I have been early; almost in the style a value investor approaches an asset class - just with tighter timeframes and through the window of technical analysis and not fundamental analysis. The analogy works for my style, because like a value investor, I do a rigorous study of a given market, feel a level of confidence towards the respective outcome - then start building a position around that expectation. This method is unconventional with trading shorter time frames in the sense that if my market expectations were off the mark - it would compound the positions losses, very much like a value trap. Fortunately, I continue to be close enough with my respective timing and the market maintains its considerable inertias - that I have been on the right side of the trade when I exit. Trading is typically not this complex, either from a research and timing perspective or the amount of trend reversals you need to stomach to profit from a trade. But for a seasoned and professional trader - there is no trading environment better for outsized gains if you continue to ride the volatility, are well capitalized and have done your research. With that said, this market is extremely dangerous for those a step or two behind, or unwilling to commit capital through volatility. It is no market for the inexperienced or weak handed trader. 

My returns this year have been atypical in the sense that I do not expect to maintain the degree of profitability that I have enjoyed year to date. With that said, I try not to set specific goals with regards to my ROR, because I firmly believe it causes you to chase those expectations. 

In athletics it is often said, "go for an inch and you will get the yard." It applies very nicely to trading as well.

My bottom line has always been a direct result of my own research and how I perceive the markets to function in the near to intermediate time frames. In trading environments such as these when you need to be proactively positioning and confident to withstand the volatility, it is the difference between getting bled by a thousand cuts - or holding firmly to a realized return. As always, it is much easier said than done and only comes with experience through loosing capital in different market environments and finding your own respective edge and rhythms. As a general rule, and because of the nature of this strategy, I do not use external margin on my account.  I like leverage intrinsically built into the positions - so the leverage ETF products work very well for me. I described a bit of that dynamic in a note in April - Waiting on a Train
"In the right desensitized hands they are outstanding tools for capturing a trading thesis over the near to intermediate terms. Many traders bleed themselves to death and second guess their research by entering and exiting a trade several times before the market turns. It can be death by a thousand cuts and quite confusing to navigate.

In a trading and media environment that is so heavily dominated by the approach of high frequency trading, "cut your losses quickly" can at times preclude you from missing the train entirely. It is often prudent advice to follow in the typical continuation or trading range environment.

However, when it comes to extreme market action, there is an exception to the rule."
Most traders should never use these trading vehicles for a variety of reasons. Stick with the plain vanilla ETFs. But over the years since they were first introduced, I have learned to appreciate their utility - even in markets environments such as today. Position sizing and averaging in and out is a must when trading these very volatile instruments.

As always - stay frosty.