Here are some gems just from the last week alone:

1. Perot Systems FrontRunning – ZeroHedge.
2. Blatant reinflation of housing bubble – Denninger.
3. Corruption at HUD – Karl Denninger.

The SEC was not able to catch a ponzi scheme even after Harry Markopolos delivered it to them on a silver platter. 

Paulson and Bernanke have been incredibly incorrect on their assessment of the health of the US economy.

Choose your sources of information/facts/news very carefully.  Stick with those that are honest enough to state their opinions openly and publish their predictions.

Read what you disagree with before drawing your conclusions.

There is a difference between loyalty and blind loyalty.  Blind loyalty to anything (religion, government, ideology, spouse) is deadly.

Takeaway:  Perpetual reliance on someone else’s seal of approval will rot your brain.  Complacency kills.

For those “economists” who’ve lately been singing his praises on CNBC, all I have to say is this…

It takes a special kind of system (government) to screw up this badly and still be resoundingly supported by its leader.

In his reappointment speech Obama also pledged support for the continued secrecy independence of the Federal Reserve.

How foolish of citizens to inquire where trillions of dollars are being spent… clearly we should trust the former bankers running the Federal Reserve that regulate the banking system. After all, they obviously know what they’re doing.

Instead of perpetuating the broken system financed by politically embedded financial organizations, Obama could have attempted any of the following:

• Raise awareness of the ghastly unaffordable pension schemes which will inevitably crumble
• Strictly enforce FASB mark to market accounting standards instead of allowing companies to use “judgment” to value their toxic assets
• Clamp down on High-Frequency Trading
• Require the FDIC to close and wind down insolvent banks before the government taxpayer-funded safety net has to be used
• Eliminate alphabet soup bailout programs which are forms of corporate welfare
• Demanded transparency for toxic assets which traveled from insolvent banks to taxpayers
• Slash parts of a budget (military, NASA, HUD, etc.) that are so bloated we must borrow billions from foreigners to stay afloat.

Would that severely correct the housing and stock markets? Yes, probably. Can we continue on our current path? No. Will we eventually face unbearable consequences for our decisions? Yes.

Ironically, neither Bernanke nor Obama nor either political party seem to care about the following message:

It is not the responsibility of the Federal Reserve–nor would it be appropriate–to protect lenders and investors from the consequences of their financial decisions. – Ben Bernanke

So, Obama reappointing the guy who didn’t see any of this coming, who bailed out the irresponsible, who continues to provide cover for banks in the hopes that things will return to normal still makes Obama the “man of the people”? Why aren’t those who voted for Obama clamoring that this Bush appointee is more of the same? Why do horrible decisions not matter when *their* party is in charge?

The reappointment of Bernanke does have a silver lining. All the people that bought into the hope proffered in eloquent speeches that government can provide jobs, clean energy, healthcare, education and other goodies will eventually learn a valuable lesson. The love affair Americans have with celebrity, good looks and good speeches and a lack of discourse/intellectual honesty will finally meet its match against a tidal wave of financial reality.

We are witnessing firsthand government selling Hope while funding Grift.

A generation will learn that our government system, like all systems which redistribute power and wealth, is one that is relentlessly gamed and manipulated for the benefit of those in charge.

Takeaway: Strip away the external validation that media/family/friends give to people and institutions and think for yourself.

There are several reasons why I decided to take my gains last Friday and not get greedy:

• Even though I am still bearish, I feel uncomfortable spending money in a market that is as distorted and manipulated as our current one.  There are too many examples to go into right now, but there are excellent examples of overt manipulation here, here, here and here.
• Maximum Pain dictated that I sell before expiration and lock in my gains.   In the option market, wealth transfer between option buyers and sellers is a zero-sum game. On option expiration days, the underlying stock price often moves toward a point that brings maximum loss to option buyers. This specific price, calculated based on all outstanding options in the market, is called Option Pain. Option Pain is a proxy for the stock price manipulation target by the option selling group.
• Technical analysts were broadcasting a head and shoulders pattern break (see below), which leads me to believe a lot of CNBC followers (non-institutional investors) are piling onto the short side for the “easy money”.  It makes sense to bet against the “easy money” crowd and not expect a decline.  On Monday, the market rallied very sharply.  Glad I got out.

• My price target had been hit and the price was unlikely to go much lower.  Darden filled in the “gap” between $29 and $33 like I thought it would.

• As a wise man told me, you never go broke taking profits!

Epilogue:  I have decided not to continue buying options since the market is clearly not a normal, healthy one.  Unrealistic balance sheets, excessive program trading and monetary manipulation have turned me off from the market.

Options buying is extremely difficult since it involves both forecasting the market and timing it.  I am proud I made money on the Darden trade, but I realize I got impatient with my Nasdaq trade.  Overall, a great learning experience.

Since capital gains are difficult to lock in without being an active trader, I am considering doing covered call writing on certain stocks.  If I decide to buy some shares and write calls on them for income, I’ll post it here.

I will continue to add to my RWM position, which I feel comfortable holding for the long-term.

Used to be we stole the trade secrets in the form of automated looms textile manufacture, or pillaged a patented steam harnessing device. This must be the ultra postindustrial state. Trade secrets are computer algorithms which make automated low latency entrance and exit to markets with no intent of ever taking delivery of any physical product nor are making purchases/sells based on any business, but are merely exploiting market rules to ratchet numerals to their gain.

How did we get here? How sick is that person who draws a paycheck and has neither produced, manufactured, distributed, or made any useful service? Isn’t that the very definition of a Babylon? An economy so distanced from agriculture, mining, manufacture that it provisions life with intangibles? Please wake me up. Please let me out of such a vacuous existence.

- Ben Frananke, Zero Hedge comment (emphasis Inthon)

“No warning can save a people determined to grow suddenly rich.” – Lord Overstone

1. It is idiotic to “time” the market based on your gut.  Yes, the case for bearishness remains (see below), however, Getting a Piece of the Action (GAPOTA) is a moronic way to trade.
2. Respect the chart.  Charts show us trends, consolidation, breakouts and the majority opinion.  It is foolhardy to go against the crowd.  I need to exercise discipline and wait for the top to form and develop before trying to rush things.  Let the chart tell me when the market is tired out and has exhausted its supply of buyers.
3. Trying to score big is foolish. Investing is a marathon, not a track meet.  Invest with the long-term fundamentals in your favor and have some patience.  It will greatly improve my “win” rate.

As a result of these revelations, I am taking a slightly different, longer-term approach.

I have added significantly to my CEF holdings in my IRA and I’m going to be accumulating a larger position in one or more reverse ETFs.  A reverse ETF will allow me to hold my short position in the market indefinitely, rather than being forced to time a drop in the market, like I would have to do with an option.

I lose the upside of leverage that an option provides, however, it is far too difficult for me to time the market perfectly.  As you can see from this Nasdaq chart, markets can go parabolic (like they did in 1999) and throw reason right out the window.  The market went from 2,500 to 4,700 in a few months!  That’s an 88% move in five months on horrible fundamentals!

If the market keeps rising now due to irrationality, I will be more than happy to keep buying inverse ETFs each month since they would be getting cheaper and cheaper (more and more valuable).

From a fundamental perspective I am not buying the bullish argument for a second.  There are plenty of events which have not fully manifested:

• GM Bankruptcy - The ripple effect has now begun.  Suppliers/Creditors will get haircuts and pass those losses down the line.  Visteon and Metaldyne, two large auto suppliers, have already declared bankruptcy and other large suppliers will eventually have to realign with decreased demand.
• Municipal bankruptcies/insane pension obligations are still looming.
• Credit cards are tapped - The consumer has limited purchasing power.
• Geopolitics – Chinese students LAUGH at Geithner when he says purchasing power of the dollar is solid.

“Chinese assets are very safe,” Geithner said in response to a question after a speech at Peking University, where he studied Chinese as a student in the 1980s.

His answer drew loud laughter from his student audience, reflecting scepticism in China about the wisdom of a developing country accumulating a vast stockpile of foreign reserves instead of spending the money to raise living standards at home.

• Jobs are still being lost – Job losses ultimately lead to declines in the housing market as well as consumer spending, the engine of our “growth”.
• Insane P/E ratios – S&P has the Q12009 PE ratio at 60!  60!!  Historic bear market bottoms typically occur with single-digit P/E’s.  Obviously this isn’t a perfect indicator, but it shows how far removed we are from stocks being cheap.

I remember the bubble of 1999 and how exciting it was to see stocks soaring and thinking how easy it was to buy tech stocks and sell them for huge profits.  I remember buying five shares of Yahoo in a fake portfolio for $205 a share (before a 2:1 split) and learning the lesson that bubbles can crash painfully and never come back.

There is no shame in “missing out” on returns in the stock market.  There is great shame in not learning from your mistakes.

Takeaway:  I lost on the Nasdaq options trade, but I realize that it is foolish to ignore the charts and risk capital when there is no need to do so.  I am coming around to the fact that I should be happy to not hit a home run with a juicy options trade, but rather accumulate quality positions at good prices.  I plan on adding more CEF and RWM in the days ahead.

Thanks for reading.

For the Trading Log, click here.

8 large rallies and 8 large drops. 

This is what a panicking market can look like.

Prepare accordingly.

November 2008 – March 2009 DROP: -54%

March 2009 – May 2009 RALLY: 31%

Takeaway:  We can expect a lot more of this bumpy ride.

Darden:  Things are looking good for this trade.  The stock is currently trading right at the strike price, and if the indices continue to decline over the next two months, this trade should do very well.  This option has, at one point, almost doubled, however, I am reluctant to sell since this option does not expire until the third Friday in July and the price can still go much lower.  In my earlier post, I mentioned that the stock should fill in the gaps around $30 – $32, so if the price gets down that low, I will consider placing a trailing stop.

QQQQ:  Argh!  This trade was a mistake to put on.  I didn’t follow the chart and, as a result, the Nasdaq has moved higher and more or less maintained its ground.  I was banking on a quick pullback, however, I am getting hit on both sides:

1. This option expires the third week of June.  As that date approaches, the stock needs to move quickly downward, or it will expire worthless.
2. This option is still far out of the money.  Since this option has no intrinsic value, every day the stock remains above the strike price, the more worthless my option becomes.

If the option hits breakeven, I will set a trailing stop.  If not, I will lose the money invested ($86 * 2) and learn from my error.

Takeaway:  It is easy to fall into the buy and hold mentality, however, there are numerous reasons why we could be facing a Japan style deflation or plunging stock market.  Intelligent options trading (both buying and selling) can allow investors to make money in up, down and sideways markets.  While I am a novice at trading, I believe it is helpful to learn these skills now, while I am young and make my mistakes early.

I am also thinking about how I can learn lifelong skills (like trading) now… skills like public speaking, patience through volunteering, and meditation are worth learning and now is the time to learn.

For the trade log, click here.

Rationale: My rationale for this trade was very ill-conceived and emotional.  I literally could not believe the market was rallying so strongly and felt I had to “Get A Piece Of The Action”.  While I do not have to call a top perfectly with an option trade to be profitable, it is still foolish to trade emotionally or based on gut-instinct.  I bought these options thinking the market would sharply turn down, so I bought June options which will be due on June 29th.  Like a fool, I failed to study the chart and I was disconcerted by what I found once I looked at it.

Here is the chart of the QQQQ’s:

There are two things that jump out at me:

1. There is an obvious double-bottom which is a very bullish indicator.  It is nearly a textbook double-bottom, which, despite the fundamentals of the Nasdaq, makes a compelling case for putting in a short-term bottom.
2. A common trading rule of thumb is that tech stocks lead the rally.  Meaning, the Nasdaq would be the first place any sign of strength would first appear.  As such, if the other indicies (S&P, Dow) aren’t confirming a bottom, this isn’t necessary since the Nasdaq would be the first place strength would appear.

Below is a chart of the Dow, which displays a weak, V-shaped bottom, which is clearly far weaker than the Nasdaq (shown above).

Comfort Level

I am not very comfortable with this trade, especially since the market has done so well despite news of Swine Flu and the bankruptcy of Chrysler.  To feel at ease with your trades, there are certain rules you must obey.  Feeling like you need to “Get A Piece Of The Action” is probably the stupidest way to trade I can think of.  I have done this numerous times after seeing, reading, or hearing something provocative.  Just like you cannot let an errant comment from a co-worker provoke you or cause you to react erratically, you must also exercise this self-discipline and control when trading.

Feeling like you need to “Get A Piece Of The Action” is the triumph of emotion over reason.  With reverse ETFs, option strategies and leveraged ETFs, there are ways to profit in up, down and sideways markets and you should never have a need to jump in without carefully weighing the pros and cons of a trade.  It is better to paper-trade and learn, rather than risk losing hard-earned cash, especially if you don’t have a huge account (like me).

Again, there will ALWAYS be opportunities to make money in up, down and sideways markets.  Never get into a trade just because you feel you are missing out or you want to feel like you have something at stake in the market.

Compared to the Darden trade, the Darden trade looks much better given that it is not a market leader, has more time to show weakness, and has rallied even more sharply/irrationally.

Exit

My strategy with this will be to set a trailing stop if and when the value of the options double.  A trailing stop will allow me to exit the position if the price drops below my stop price, but if the market keeps moving in my favor, it will raise my stop, allowing me lock in even more of the gains.  I have never used trailing stops, but hopefully I will get a chance to use them and learn with this trade.  Since the total cost of these options were less than $200, I am comfortable holding them until expiration and seeing them expire worthless, if the Nasdaq does not decline strongly.

Takeaway

I try to resist GAPOTA trades, but I sometimes succumb to the temptation to risk a little bit of cash when I see such a parabolic rally.  Hopefully, the Nasdaq will turn around and I will get to exit gracefully, however, I’ll learn from this trade either way.

DISCLAIMER:  All opinions expressed on this website are solely my own and do not reflect the opinions of anyone else. You should not treat any opinion expressed on this website as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of opinion. My opinions are based upon information I consider reliable, but I do not verify its completeness or accuracy, and it should not be relied upon as such. I am not under any obligation to update or correct any information provided on this website. My statements and opinions are subject to change without notice.  Past performance is not indicative of future results.  Risk of loss exists in futures, options, equities trading.

The market has shaken off bad news about two historic events:  the bankruptcy of Chrysler and the Swine Flu.

Incredibly, the market seems to be chugging right along and unfazed by these developments.  Being a fan of technical analysis (charting), I went back to the charts to look at the powerful recovery of March 2003.  Right after the US invaded Iraq, the market began to soar.  I went back to look at the chart to see if I could learn anything about that powerful, sustained rally.

Below is a chart of the rally:

As you can see, the rally in March of 2003 had two prior bottoms that were put in, both of which were nearly lower. 

As a result, this level on the Dow provided a solid level of support (buyers), that stood at the ready to buoy (via buying) the market.

The same cannot be said of the March 2009 low.  The bottom has not yet been re-tested and no solid base of support has been established.  As a result, I think the March 2009 lows need to be re-tested until we can declare that the bear is dead and this rally is for real.

The March 2003 rally was preceded by trampoline-like bounces of +11%, -15%, +18%, -13% before the sustained rally of 30% that closed out 2003.  I do not believe that the market can have a durable rally with a V-shaped bottom without putting in a rounded bottom or multiple touches of a bottom.  I suspect we might see similar 2003-like bounces up and down before any sustained rally will take place.

Takeaways:

1. The market hates uncertainty.  The post 9/11 malaise and sabre-rattling around Iraq proved to be distracting and the market from post 9/11 to March 2003 was a wreck.  Once the invasion and “quick victory” were established, there was more confidence in the market.
2. A base or bottom needs to be established with considerable support, which has been tested more than once.
3. In a “false bottom” such as this one, I feel comforted holding Puts against a consumer non-essential.

Note:  I apologize for the lack of clarity in the charts, better charts are on the way.

As I have written earlier, deliberate practice makes perfect.  I do not want to place “gunslinger” trades based on tips and buy on impulse.  When I propose a new trade, I will explain my logic and check against the eventual outcome to validate if my assumptions were correct.  I am posting my open options contracts to maintain a form of discipline over myself and make sure I do not trade out of emotion.  Please read my disclaimer below.  For the time being, I am only going to purchase (go long) options.  As a result, my potential losses will be limited to my initial investment.

First trade:

35 July PUT – Darden Restaurants Inc.

Rationale:  I have a bearish outlook on the equity markets in general and I believe our current rally (March – April) is the result of speculative buying and/or short covering.  I am not convinced that the rally in the price of Darden Restaurant from $15 to $40 has been driven by any tangible changes (higher sales, increased productivity, higher cash flow).  As such, I find this rally to be a short-term, speculative rally.  Does that mean that stocks cannot rise more?  No.  It simply means I believe the price is rallying for no intrinsic reason.  Therefore, I do not believe this rally can carry on forever, especially when I see the chart (more on that later).  With the price nearly tripling from its December lows (an almost 300% return!), I do not think the stock price can keep advancing for very long without a significant pullback.

The two strong reasons why I pulled the trigger:

1)  Going long this put means I do not have to time a downturn perfectly.  The stock can continue to rally, but as long as it finishes below $32.75, I will be profitable.  35 is the strike price, 2.25 is the price paid for the option.

When buying a Put Option, the following applies:  Strike Price – Initial Investment = Breakeven Point  35 – 2.25 = 32.75

Once the stock drops below $32.75, I will make (in theory) $100 for each $1 decline in price.

2)  There is a large gap from $28 to $36.  Gaps are often retraced and filled and in a parabolic rally, like the one DRI is in, it is not unlikely the stock will fill these gaps.

There is also one weak reason I have for buying this option.

1)  Consumer weakness will eventually manifest.  This is a very weak reason since there is no telling when the consumer will truly slow down consumption.  The save over-leveraged spending habits have been in place for years… assuming they will assert their presence in my limited time frame makes this the weakest of the three reasons.

Exit

I believe Darden will retrace to fill in the gaps around low 30′s.  If I feel the market can plunge further, I will hold my position.  If the market appears steady, I will book the profit.  Since this option trade is small, I am comfortable holding this option until expiration (expiring worthless).

Comfort Level

Although I feel confident that Darden will pull back, I am not satisfied with the way I entered into it:  with a hunch and with a “Oh well, it can’t go any higher” attitude.  Calling tops and bottoms is not a strategy with a high-win ratio or a theory that can be executed with regularity.

Takeaway

I will post this trade in my Trading Log where I can track it daily.  Please provide feedback for this trade and let me know if you find my analysis to be lacking in any way.

For more about deliberate practice, read here.

DISCLAIMER:  All opinions expressed on this website are solely my own and do not reflect the opinions of anyone else. You should not treat any opinion expressed on this website as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of opinion. My opinions are based upon information I consider reliable, but I do not verify its completeness or accuracy, and it should not be relied upon as such. I am not under any obligation to update or correct any information provided on this website. My statements and opinions are subject to change without notice.  Past performance is not indicative of future results.  Risk of loss exists in futures, options, equities trading.