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The Truth about Predicting Market Direction

Few traders earn a living by correctly predicting stock-market direction consistently. Every prognosticator is right about half the time, and anyone who can get it right near 60% of the time will be very profitable.

If you plan to make money by timing the market, I wish you the best of luck. You may become one of those very successful traders. But, I urge you not to count on achieving success that way.

I believe that trading reduced-risk, limited profit, hedged option positions offers the average trader the best opportunity to beat the market because there is no major prognostication required. If you are familiar with my writing, you know I believe that there are several strategies, when managed conservatively, that can increase the probability of making money. However, the main factor that determines profitability is not the strategy, but the discipline of the trader to keep risk in line, not violate personal trading rules, and most of all, to truly understand what he/she is doing. Please do not believe that anyone can open an options account and expect the cash to come pouring in.

Returning to the topic of market prediction, here is an excerpt from a blog post by a former star (or, in the opinion of some, a villain) stock market analyst turned blogger, Henry Blodget. This is from the Business Insider web site.

I Don’t Know What The Market Is Going To Do!
Henry Blodget

I recently expressed a cautious view of the stock market.

Specifically, I think the odds of a sharp decline (“crash”) are increasing. And I think the odds are very good that stocks will provide lousy returns from this level over the next 7-10 years.

Well, most people are bullish about the stock market these days (because the market has done so well for so long), and anytime you say something bearish when most people are bullish, you get pelted with rocks and garbage.

Specifically, you get told:

You are brain dead
You are not a money manager
You don’t know what the market is going to do

I would like to respond to each of these assertions.

First, my successful commute into work today would suggest that I am not yet brain dead (lots of cognitive decisions and motor movements!), but anything’s possible.

Second, I actually am a money manager! I manage money for one client. I know this client’s objectives, risk tolerance, and investment time horizon very well. And I try to do an excellent job for him. (That client is me.)

Third, yes, I do not know what the market is going to do.

In my defense, however, I will point out something:

No one else knows what the market is going to do, either.

Fifteen years ago, when I was a Wall Street stock analyst, I initially assumed that there were smart people who actually knew what the market was going to do. For close to 10 years, I kept waiting to meet these people. As I worked my way up the food chain, and gained more market experience myself, I began to realize that the smart folks I initially assumed knew what the market was going to do were wrong about the market just about as often as everyone else. When I learned that, I assumed that I just hadn’t met the right smart people yet. So I kept working up the food chain. And, eventually, when I became a famous stock analyst myself, I got to meet just about everybody, including some of the most legendary stock-market wizards in history. And what I finally realized was that even these folks, as super-smart as they were, didn’t know what the market was going to do. They were right slightly more often than all the thousands and thousands of average smart people — and, importantly, they were willing to bet big when they thought the odds were very much in their favor. But they didn’t know what the market was going to do.

This was a revelation for me.

When I finally realized that no one knows what the market is going to do, I developed a very different philosophy about money management. That new philosophy — own a diversified portfolio of low-cost index funds and re-balance when the asset weightings get out of whack — was more humble, simpler, safer, and wiser than my prior philosophy (stock-picking, market timing). And it has also been vastly more successful.

When you finally accept and embrace the idea that no one knows what the market is going to do — when you stop looking for that one brilliant fund manager or advisor or analyst who is finally going to make you rich without accidentally making you poor — you will be able to easily outperform the vast majority of other investors, including professionals, with a lot less time, stress, and hassle.

But, importantly,I am not selling my stocks or going short the market…

continued here

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Buying high and selling low still doesn’t make sense

From Carl Richards Jan 6, 2014 article in the New Your Times

Buying high and selling low still doesn’t make sense

Given the huge year the stock market had, there is a temptation to think that now is the time to shift more of our portfolios into stocks. It’s easy to understand why we feel this way. After all, the stock market is doing well, we are hearing about it in the news, and we don’t want to miss out. But remember, since it is now January 2014 you have already missed the opportunity to buy in January 2013. Now the market is higher, and we have already established that we do not know what the market is going to do next. We only know what it has already done. Resist the temptation to buy high, and instead focus on maintaining a well-designed portfolio that reflects the risk needed to meet your goals.

Simple, but excellent advice.

Bubbles build when investors, who became over-disappointed about money that they failed to earn during recent stock market rallies, jump in. Sure they expect to participate in future rallies, but these people (on average) tend to enter at exactly the worst possible time.

Bottoms form when these same investors suddenly decide that a bear market decline has cost them too much money. They finally decide to exit, fully expecting the markets to continue lower.

Unless you are a skilled market timer with a proven track record, my advice is do exactly as Carl suggests: “Focus on maintaining a well-designed portfolio that reflects the risk needed to meet your goals.

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The Big Win

Today I’m sharing some good ideas from Brian Lund.

Brian presents an interesting personal history behind this post, and it is enjoyable reading. For our purposes, the following excerpt represents the important part of the post

As a virgin trader that same lack of context existed. I thought that making money in the markets was easy. That it came without studying charts. Without learning risk management. That I could just roll out of bed on Sunday, read some stories in Barron’s, and with that pick stocks that would allow me to retire before I was thirty.

But just like in life, that is not the way the markets work. They may temporarily reward the lazy, the egotistical, and the unprepared, but right when you are about to crown yourself the next Paul Tudor Jones, your bill will come due, with brutal interest.

The worst thing that can happen to any new participant in the market is for them to make a shitload of money on their first trade. It sets them up with a false confidence that can drive them to trade bigger and bigger until such a point that they have all their discretionary capital at risk, and that is when, not unlike the “sevening out” in craps, the markets will wipe them out.

If you begin trading with a winning streak, please understand that you are not (yet) a star trader.

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On Getting Even

From Seth Godin

On teaching people a lesson

You’re actually not teaching them a lesson, because the people who most need to learn a lesson haven’t, and won’t. What you’re actually doing is diverting yourself from your path as well as ruining your day in a quixotic quest for fairness, fairness you’re unlikely to find.

Sure, you can shut someone down, excoriate them, sue them or refuse to let them win, but odds are they’re just going to go try their game on someone else.

When you fire a customer and politely ask them to move on, you are withdrawing yourself from their trollish dance. When, instead, you focus on the good student, the worthwhile investor, the delighted vendor, you improve things for both of you. The sooner you get back to work (your work), the sooner you can move toward your best outcome, which is achieving what you set out to achieve in the first place.

The real tragedy of the person who dumps on you is that you pay twice. The second time is when you get bent out of shape trying to get even.

Trying to get even on a losing trade is not all that different. Your time can be better spent by working to earn money from a new trade.

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Special Webinar: Trading VIX and related ETNs.

It is my pleasure to invite each reader to an important webinar.

    Wednesday, April 17, 6:00 PM CT. Register

The good news is that attendance is free for this 50-minute Webinar.

The better news is that the speaker is Mark Sebastian, COO of Option Pit. Options education is a serious business and it is important to learn how the options world works from serious educators. I believe Mark deserves membership in that class of teachers.

The best news is that the topic is something of interest for all option traders — using VIX and other volatility products.

    Trading VIX and VIX ETN’s

The relationship between VIX, VIX futures & the VIX ETNs


April 17, 2013. 6:00 PM CT

One of the more difficult concepts to grasp in the options universe is the relationship between VIX (CBOE Volatility Index), VIX futures, and VIX ETN’s (Exchange Traded Notes*). Many traders make costly errors regarding VIX options. Learn to avoid these simple mistakes.

Mark Sebastian discusses the interrelationship of VIX, VIX futures, and VIX ETN’s. Included: the pitfalls of the ETN’s. He will also cover ways to take advantage of trading VIX based options.

    *If you do not know what an ETN is, here is one definition: A type of unsecured, unsubordinated debt security that was first issued by Barclays Bank. This debt security differs from other types of bonds and notes because ETN returns are based upon the performance of a market index minus applicable fees. There are no periodic dividend or interest payments; principal is not guaranteed.

Take advantage on an opportunity to further your options education.

This webinar, presented by the 2Marks, is my way of thanking you for showing interest in Options for Rookies and this blog.

You do not have to invest in ETNs to benefit from understanding their role in the options universe.

See you at the webinar!

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Bad Things do Happen

Have you ever felt that the market was out to get you? You had a winning position. The stock was acting just as you had predicted. Then suddenly the position turned to crap when the stock price experienced a large gap at the opening. The good profit disappeared and you were the proud owner of a losing trade.

Did you take that personally? I suspect you already know better than to blame the market. We are involved in a big probability game.

Tyler offers a simple explanation of why you should not blame the market (Tyler’s Trading).

The financial market is no respecter of persons. Each trader rises or falls based on merit and merit alone…

After getting hosed a few times or treated unfairly by Mr. Market I too am tempted to bellow, “Hey! Do you know who I am?” But, alas, such an exclamation falls on deaf ears. No, the market doesn’t know, nor does it care who I am. It doesn’t care about the size of my bank account, my voluminous library of trading books, the time and effort I’ve put forth or years of experience. My shins will get kicked in just as swiftly as the next guy. The market doesn’t care about my family name, my background, my connections, or my social status. It simply provides a playing field which rewards or punishes based on skill.

I’m just one of millions of nameless, faceless traders.

It’s our job to manage risk. Sometimes we are going to be unprepared for the unlikely event. However, as a risk manager, if we take care of our trader persona and monitor position size carefully, then out trader persona will be spared the agony of blowing up a trading account.

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Beware of swindlers

On a personal level, one part of the options business that truly bothers me is that it its filled with people who want to take your money. I politely refer to them as hypesters, but a better term is swindler.

Swindle: Use deception to deprive (someone) of money or possessions. (source: Google search)
Fraud: Wrongful or criminal deception intended to result in financial or personal gain(source: Google search)

I don’t know the difference between deception and criminal deception, but these hypsters feel like criminals to me.

These swindlers publish stories that are so outrageous, that I am amazed that anyone on the planet could fall for it. Or is that just me being naive? Tell a good story, repeat it a few times, and the customers flock to you. Maybe ‘flock’ is an exaggeration, but people come to you, begging you to take their money.

There’s nothing special about the options trading business. The liars and cheats are present in every business, dreaming up scams to separate people from their money. It makes me angry.

Here’s one example, chosen via search:

Do you generate less than 20% profit every month in your trading account?… If you answered yes, what I’m about to share with you could change your life forever…

That profit can vary but if you do it right you should be able to generate at least a 20% profit each month – yea that’s right, I said each MONTH.

I don’t know whether to laugh at the nonsense or cry for the victims. He says you SHOULD be able to generate AT LEAST 20% EACH month. And how do we accomplish this miracle: By writing covered calls. If he were to say that it’s possible to earn 20% when things go your way for an entire month, I’d agree with the statement. But ‘should’ and ‘each’? Has he never seen a down market? Does he believe that VIX is always 100?

It’s beyond belief. But I’m sure he sells his costly software and courses to the gullible. $1,000 invested for one year, growing at 20% per month compounded, becomes $8,900. Do it for six years and you’d earn one half-billion dollars.

Sure, I omitted commissions and assumed taxes could be paid with other funds, but here is someone who would have you believe that this is the minimum result you SHOULD anticipate. How can making these statements not be against the law?

I recently claimed that a skilled options trader – someone who exercises good risk management skills has a reasonable chance (but it’s not a cinch by any means) to earn 20% in one year. Mark, who blogs at option pit recently held a webinar through the option and suggested that 13% is a reasonable annual expectation. So who is to be believed? The 20% per month boaster, or two experienced traders and teachers?

The Banks also play the game

It’s not bad enough to be cheated by random individuals. What chance does the naive person have when the banks openly overcharge for structured products- or options in disguise. One simple example is described by the Amsterdam Trader.

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Trading Iron Condors in 2011

It’s 4½ months into the year and I’ve found this to be one of the easy periods for iron condor traders. Of course, that’s a personal opinion, based on my results. Here’s someone who seems to disagree, yet has made decent money with this strategy.

Christopher Smith at

This year I committed to an experiment that has me trading an iron condor on the SPX every month – regardless of market conditions. The purpose of this exercise is to demonstrate techniques for managing risk and prove that with diligent risk management it is quite possible to limit losses while still creating profitable opportunities.

This year has not been particularly favorable for iron condors, but we have managed to avoid any significant loss and currently we have what amounts to a 20% yield on capital of $5,000 while risking approximately $4,000 or 80% of the capital – holding $1,000 or 20% in reserve.

One of us is living on a different planet. If not, then this comment illustrates that trade selection and risk management techniques vary tremendously among traders. I always knew that traders are different, but cannot see how Chris sees early 2011 as not favorable for iron condors and from my perspective, I could not disagree more.

It’s not a good year for the strategy, but he has already earned 20%?

I think it’s been a very easy year and have earned more during this period than I have ever as a retail investor (over a comparable period of time). I mention this for one reason: I didn’t have to do anything. No skills required. Just trade the iron condors and then exit. Perhaps a minor adjustment or two, but nothing special. I know these returns are not going to continue. And to be honest, I don’t expect to ever see a five month run that is this profitable again. Nor one as easy to manage.

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