Waiting on a Train

By: Erik Swarts | Tue, Apr 26, 2011
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Cut your losses quickly.

As a trader, you hear it as often as, "Have a nice day."

The problem with these axioms is that they are generalizations towards a discipline that in many cases is antithetical to stereotypes. I wholeheartedly agree, it is prudent advice to follow in a typical continuation or trading range environment. However, when it comes to extreme market behavior, there is an exception to the rule.

By late January of 2009, the equity markets were about as psychologically bludgeoned as a market could sustain. The financial index (BKX) had loss over 70% of its 2007 market capitalization and the media was debating the merits of a broad nationalization of the banking sector. Nouriel Roubini was sharing a table at Nobu with Brangelina and ZeroHedge's byline of "on a long enough timeline, the survival rate for everyone drops to zero" was about to be penned at the market bottom.

It was dark out there - real dark.

And yet, we should have all bought more.

I started accumulating a position on the long side in the financial sector in late January after the BKX liquidated over 20% on one Monday morning session alone. And while the position became almost immediately underwater in a matter of days - I had done my research (a snipit of it here and here), believed in the trade's thesis and waited for the stars to align.

The trade took about one month to materialize.

Because I was utilizing leveraged ETFs to commit the trade, the initial position would lose roughly a third of its intrinsic value. However, by layering equal positions into the trade, my cost basis was eventually within a few percent of the market low that March.

A few months later the aggregate position had more than tripled.

I had traded the initial position's intrinsic value for time. Time would be the great revalator once again.

Buying and selling into a market extreme is one of the few occasions where dexterity doesn't count for much. Caveat being, as long as you are operating without extraneous margin on your position, have done your research and know which side of the tracks to wait for the oncoming train. This kind of trading strategy only works during major market inflection points where it pays to be aggressive and buy fear.

The angle of incidence will equal the angle of reflection.

However, if you have misread the tea leaves of continuation for exhaustion - then it's just magnified pain and in hindsight - reckless. It is a high risk, high reward trading strategy.

The comparison of my financial sector washout trade in 2009 and silver today (see here), seems appropriate because they both display(ed) all of the characteristics of extreme price action. In late January of 2009 it was a waterfall bottom. Today in silver it's a parabolic top. They are both artifacts of exhaustion in the tape. The Ying and Yang of disequilibrium. They are not discrete patterns to notice.

Leverage ETFs should only be utilized by professional traders. 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.

I have heard on numerous occasions over the past week traders comparing a silver short in todays market as "picking up nickels in front of a bulldozer."

That analogy does not seem appropriate to me, because I am not trying to pick up nickels - I am trying to pick up silver dollars.

Perspective is everything.

 


 

Erik Swarts

Author: Erik Swarts

Erik Swarts
Market Anthropology

Although I am an active trader, I have always taken a broad perspective when approaching the markets. I respect the Big Picture and attempt to place each piece of information within its appropriate context and timeframe. I have found that without this approach, there is very little understanding of ones expectations in the market and an endless potential for risk.

I am not a stock picker - but trade the broader market itself in varying timeframes. I want to know which way the prevailing wind is blowing, where the doldrums can be expected and where the shoals will likely rise. I will not claim to know which vessel is the fastest or most comfortable for passage - but I can read the charts and know the risks.

I am not a salesperson for the market and its many wares. I observe it, contextualize its moving parts - both visible and discrete - and interpret.

I practice Market Anthropology - Welcome to my notes.

Erik Swarts is not a registered investment advisor. Under no circumstances should any content be used or interpreted as a recommendation for any investment, trade or approach to the markets. Trading and investing can be hazardous to your wealth. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This is strictly for educational and informational purposes only. All opinions expressed by Mr. Swarts are subject to change without notice, and the reader should always obtain current information and perform their own due diligence before making any investment or trading decision.

Copyright © 2011-2014 Erik Swarts

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