Letters, We Do Get Letters
Robert: Dave – I don’t understand with your view of the market and the current high correlation between the market and oil, how there can be a current opportunity for buying CENX? The trend is down and you are expecting an emerging uptrend in oil. Why not wait for CENX to actually break out and start a new trend, then buy on the pullback?
Dave: Trend transition pattern. Energy stocks also turning up. Yes, more risky but w/risk comes reward.
Robert: I meant CNX but same applies to CENX as it is a commodity.
Dave: CNX can trade contra to the market. Each position is an independent event. If it doesn’t make sense to you, then ignore it.
Dave: Metals turning corner too. Also, commodities can trade contra to market.
Robert: Hmmm. My point is buying CNX is directly contrary to your view of the market and the rest of your portfolio (shorts) and the pattern is a break out pattern (to the rest of the world) which is much riskier than a pullback. And the reward comes most likely only if you get stopped out on all of your short positions.
A Few Words About Emerging Trends
Before we get into some thoughts and Random Thoughts on the above, keep in mind that I get more questions about my emerging trend patterns than all of my other patterns combined. If you’re just learning to trade trend, then trade only established and obvious trends—i.e. trend resumption patterns. Once you’re successful at that, you can then venture into the trend transitional patterns.
Let’s define an emerging trend. An emerging trend is when a previous trend comes to an end and a new trend begins. Sometimes, it can be more of a process than an event. A market bottoms out for months or even years before it begins to rise again—this is my “Phoenix Strategy.” Landry Bowties (see free reports and Videos) are often a good pattern to help illustrate a “process” bottom.
Now, inspired by the aforementioned email thread, here are 5 things that you must know when building your portfolio:
1. Don’t Confuse The Issue With Facts
In markets you have to be careful with WYSIATI-“What You See Is All There Is” (Thinking Fast and Slow). True, right now, the market is trading in tandem with oil but I can assure you that’s not always the case. The media is having yet another all-you-have-to-do-is-connect-the-dots field day with the current correlation. Unfortunately, you can’t always just connect the dots. If you could, a lot more journalists would become traders. I’m just saying.
Also, you have to be careful with too much extraneous analysis, otherwise you’ll end up with analysis paralysis and never make a trade.
2. Do Not Hedge (and we’re not)
When one sees both shorts and longs in the same portfolio, one has to wonder if we are hedging. The answer is no. We are taking each setup on a “stand alone” basis and seeing it to its fruition (read further).
Now, I don’t want to digress too far but I did name this column series Random Thoughts because I know myself. With that said, hedging is one of those in theory vs. practice things. In theory, theory and practice are the same, in practice, they are not. If you are “hedged” and the market goes against you, then your hedge makes money-yay!! I’m going to tell all my friends! Settle down Beavis. Unfortunately, you’re losing money on your core position(s). On the flip side, if you’re making money on your core position(s), your hedge is losing money. Hedges cost money too. You have to constantly reset them. My point is, as a general statement, a hedge is a constant drain on your portfolio. True, there are some rare cases when you’re implementing a complex option strategy where a disaster hedge can be beneficial. However, unless you’re doing that and have made that trading style your life (see the last Dave Landry’s The Week In Charts), it’s a bad idea that seems good on paper but isn’t in reality.
3. Can A Potential New Setup Stand Alone?
In an ideal world, the stock, the sector, and the market, are all headed in the same direction before you make a trade. In fact, if you’re newer to trading, I suggest that you only trade when they are. You’d spend a lot of time waiting but that’s okay—read my Random Thought archives for a plethora of my preaching on patience. Anyway, my point is that each potential trade should be able to stand alone. It should look good enough to take regardless of the overall market and sector action. And, the worse the sector and market action, the better the setup should look. When conditions are less-than-ideal, make sure the potential position passes the “can’t stand it test.” If you can walk away and be okay then pass. If you can’t stand it—you’d hate yourself if it took off without you, then take it. This is the Steve Winwood trade-“If You See A Chance, You Take It.”
4. Ideally, Make Sure That All The Stars Align (but they won’t be with emerging trend patterns)
With emerging trend patterns, you’re a bit of a pioneer. You’re looking to get in early. Getting there first brings the possibility of a huge reward. Unfortunately, with reward often comes risk. You have to embrace this. We get paid to put capital into harm’s way. f fact, that’s the only way we get paid. This is not to say throw caution to the wind. The risks must be carefully calculated. Again, you’re a pioneer and like the American Pioneers, you’re either going to get the gold or the arrows. The chance of the gold makes it all worthwhile-there’s a potential to be wrong small but right big. And, never forget, one or two good trades can make your whole year.
By being a pioneer, the stars often won’t all be aligned. The overall market might not agree. The sector and/or many stocks within the sector might not agree either. The setup might be speaking though. And, as the stars begin to align and it becomes obvious to the masses this will propel your position higher.
5. See Each Position To Its Fruition-Write That Down
Obsess before you get into a trade, not afterwards—stop me if you’ve heard that before. You must plan your trade and trade your plan. Micromanaging can quite often pay over the short-term but never longer-term. Assume that you’re in a position and it begins to go against you but hasn’t hit your protective stop. What should you do? Nothing. If you get out at the first signs of adversity-either at a tiny loss or when open profits begin to erode-then you will never capture a great trend. We’re playing to win. And, the only way to win is to capture a trend. Write that down too.
Micromanaging will make you look smart-at least shorter-term. However, we’re not playing to be right or look smart. How do you think I got the name “Trend Following Moron?” We’re playing to make money, big money. And, that means following the plan by following along. We will not be right all the time-one of the few things that I can guarantee. We will be right over time. I can almost guarantee that (almost being the key word in that sentence).
In for a penny, in for a pound. Each position must be seen to its fruition. It’s funny, in my daily Core Trading Service I outline exactly where the stop should be. Yet, when positions aren’t headed in the intended direction my inbox begins to fill with a plethora of “shouldn’t we just get out?” emails. Nope. Follow the plan Stan (and Robert, Bill, Susan,…).
Getting back to aforementioned email, yes, there’s a chance that the shorts will stop out if the longs work and vice versa, creating a wash. Maybe this “wash” will just be temporary and the portfolio will be purged from trends that have come to an end and will keep those that are just beginning to begin. In an ideal world, maybe both the shorts and longs could live together in harmony. Again, each trade is an independent event. Commodities can trade contra-to the overall market. And, it does appear that a commodity bull market is beginning to develop. The overall market doesn’t appear to be out of the woods just yet. So maybe, just maybe, the shorts continue to work as does our new little emerging trend friends.
To The Markets
What’s scary is that the Ps (S&P 500) could be in one of those aforementioned “process” emerging trends. They have essentially gone sideways for over a year. Again, we’re still under a major weekly Landry Bowtie sell signal. What happened the last time this happened? Take a look at 2000 and 2008. Does this mean a bear market is imminent? Nope, but like Greg Morris says, “We treat all signals as if they will become the big one.” He told me to stop mentioning his name in the same column that I use the word moron, so I won’t.
Hey Big Dave, hasn’t the market pretty much gone up lately? OOOHH, somebody gets to wear the Captain Obvious hat today. Yes, it has. And, if it can make it to new highs and stay there, the trend follower in me will start following along to the upside. Until/unless that happens, I’m going to remain cautious. This doesn’t mean that I’m not going to buy anything. It’ll have to be awesome or at the least, in an area that can trade contra to the overall market. One other point, after a slide, markets can often have the mother-of-all retrace rallies, suggesting to everyone “come on in, the waters fine” and then turn back down.
In the sectors, if you made it this far then you know that I like the Metals & Mining and Energies. Looks like the breakout from low levels continues here so you might have to wait for the next pullback. In my best fake Jamaican accent “no worries mon, pullback will come soon.”
So What Do We Do?
As mentioned above, continue to keep an eye out for opportunities in the commodity related areas. In general, I’d hold off on any other longs unless you really think you have the mother-of-all setups. Based on the length of the pullback and choppy action, I’m not seeing any new potential shorts at this moment. Check back soon though just in case the current retrace rally is just that. And, of course, follow the above 5 things that you must know while building your portfolio.
May the trend be with you!
(your reply: And also with you!)
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Dave Landry has been actively trading the markets since the early 90s. He is managing member of Sentive Trading, LLC (est 1995) and author of 3 books of trading including The Layman’s Guide to Trading Stocks. He has made several television appearances, written articles for numerous magazines, He has spoken at trading conferences throughout the world (including Russia, Hong Kong, Australia, Germany, Italy, and others). He has been publishing daily web based commentary on technical trading since 1997. He has a B.S. in Computer Science and an MBA. He was registered Commodity Trading Advisor (CTA) from 1995 to 2009. He is a board member of the American Association of Professional Technical Analysts. Dave can be reached at www.davelandry.com