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Jani Ziedins (pronounced Ya-nee) is a full-time investor and financial analyst that has successfully traded stocks and options for nearly three decades. He has an undergraduate engineering degree from the Colorado School of Mines and two graduate business degrees from the University of Colorado Denver. His prior professional experience includes engineering at Fortune 500 companies, small business consulting, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two children.
By Jani Ziedins | Free CMU
Cracked.Market University
Making money in the market is easy. Even trained monkeys with darts can find winning stocks. The challenge is not giving those profits back in the next losing trade.
Losses are inevitable. Anyone who believes they can achieve a 100% win-rate is not realistic and coming to the market with unhealthy expectations. Losses to a trader are like inventory for a retailer. They are simply a cost of doing business. As long as revenues exceed expenses, the business is profitable and everyone is happy.
There are two ways to make money in the market. One is taking small profits from a large number of trades. This is how market makers, high frequency traders, and option sellers make their living. The challenges in this business model are avoiding big losses that wipe out all the small profits. The other strategy is capturing huge profits from just a few trades and breaking even or taking a small loss on everything else. These are the black swan traders betting on the next big crash, or high-growth speculators targeting the next big thing.
The small profit trader typically has a laser focus in one area of specialization. The market maker specializes in just a few securities or stocks. High frequency traders find a niche and exploit certain pricing phenomena. Option sellers focus on one stock, index, or strategy. Each of these specialists has the knowledge and experience necessary to avoid taking a big loss and can comfortably concentrate his entire portfolio in a single area, idea, or strategy. This is the proverbial doing one thing and doing it well.
The big-hit strategy is on the other end of the spectrum and makes a lot of small bets in the hope that a few will pay off huge. Rather specialize, this approach requires diversification. The rate of success is abysmal and successful traders often lose money more than 60% of the time. But they can sustain these high failure rates because the losses are small and the winners huge. Since the big-hit trader doesn’t know which one will work, he has to try lots of different things.
But no matter what approach a trader uses, money management techniques are similar. A good rule of thumb is never risk more than 3%-5% of your total account value in a single trade. The reason for this is quite simple, it is easy to recover from a 3%-5% loss. Even a series of them. In fact it would take 24 consecutive losing trades to cut your account value in half. While losses are normal and expected, 24 losses in a row is an extraordinary stretch and highly unlikely. But even following a historically improbable string of bad luck, the trader still has 50% of their account balance remaining. The key isn’t avoiding losses, but ensuring we live to fight another day.
Now I will clarify what I mean when I say never risk more than 3%-5% of your account value in a single trade. This doesn’t mean everyone should use 3%-5% stop-losses on all of their trades. Several examples are the easiest way to explain this concept.
Bob has a $100k trading account. He has his portfolio diversified across five different trades in equal amounts of $20k each. Bob tends to be conservative and uses the 3% loss limit in this trading. Losing 3% of this $100k account value equates to $3k. When applied to each $20k investment, that $3k loss means he can afford to take a 15% loss on an individual trade without doing serious damage to his account.
(A word of warning, diversified means dissimilar trades. Five airline stocks or five 3D printing stocks is clearly not diversified since a failure in one trade likely means a failure in all five.)
For an index trader, if his entire account value is in a single trade, then he can only afford to lose 3% to 5% on that single trade before he should be pulling the plug.
Another way to use the 3% to 5% loss limit is to help you size your trade. Let’s say John is an aggressive options trader also with a $100k account. John is willing to risk 5% of his account value on a single trade, which comes out to $5k. His strategy uses a stop-loss if the option value falls to 50% of what he paid. That means his position size should not be more than $10k. If John is willing to let his premium go all the way to zero, he should not put more than $5k into any single trading idea.
Losses are an inevitable part of trading. But it will never be a problem if you manage your money properly and ensure you always live to fight another day.
Of course the above assumes a worst case loss. Successful traders learn to recognize their mistakes long before a stop-loss is reached. I will cover closing a losing trade proactively in another CMU post. Sign up for Free Email Alerts so you don’t miss it.
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By Jani Ziedins | End of Day Analysis
End of Day Update:
The S&P500 finished Thursday flat after spending most of the day in the red. Republicans unveiled their Tax Reform proposal and traders chose to sell the news. But “sell” is an over-statement since we were only down a fraction of a percent in midday trade. The tax plan was everything the leaks told us it would be, so there was little to get excited or disappointed over. Exactly as expected resulted in a mostly flat day.
I’ve been wary of this market for a few weeks, but it held up surprisingly well. My biggest concern was how traders would react to infighting within the Republican party. But so far the market has tolerated criticism from Trump and 21 Republicans voting against the budget. If infighting was going to spook the market, it would have shown up in the price-action already. Without a doubt volatility has picked up, but the slow climb higher is still on track.
A few weeks ago I said this was a better place to be selling stocks than buying them. And I stand by that statement. Just because the market continued creeping higher doesn’t mean betting on the continues rally was the smart trade. Long-term success is about managing risk and sticking with high-probability, high-reward trades. Trades will always go against us, that is simply the nature of this game. It is no different than inventory expense for a retailer. But just because a trade lost money doesn’t mean it was a bad trade, and just because a trade makes money doesn’t mean it was a good trade. Success isn’t measured over how this trade or the next trade does, but how all of our trade so.
My reluctance to trust this market was largely built on the the size of the rally since August’s lows and the looming battle over Tax Reform. So far my concerns have been unnecessary. If we were going to pullback because of Tax Reform infighting, it would have happened by now. If the market isn’t worried about infighting, then we don’t have to worry about it.
That said, the risks are still elevated and buying up here is definitely not a low-risk, high-reward trade. The market will likely keep creeping higher over coming weeks, but creeping higher is not a great reward given the risk underneath us. Long-term investors should keep holding, but traders can wait for a better risk/reward. The higher this market goes without resting, the harder we fall when it eventually happens.
Jani
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By Jani Ziedins | End of Day Analysis
End of Day Update
The S&P500 inched higher Thursday, but for all practical purposes this was another flat session. We smashed through 2,540 earlier this month, but have been struggling to add to those gains ever since.
Volatility has been picking up over the last several days, producing the largest intraday swings since Trump’s war of words with North Korea. Most of these gyrations have reversed within hours, but the transition from calm, one-way moves higher is a material change in behavior.
Previously the Bulls were firmly in control and Bears were helpless to stop them. But this uptick in volatility tells us Bulls are losing their grip and Bears are growing stronger. Volatility often increases just before a reversal in direction. We saw that during the North Korean lows and could be witnessing the same thing now as the latest rally runs out of steam. Markets go up and markets go down, that’s what they do. There is nothing wrong with a healthy and normal pullback to support there.
After Thursday’s close, GOOGL, AMZN, and MSFT put up strong results. Without a doubt parts of the tech sector are doing very well. But this strength doesn’t seem to be carrying over to the broad market as overnight futures are only up a tenth of a percent. If tech earnings were poised to launch us higher, we would see a larger reaction in the futures.
But this isn’t a surprise. There is only one thing that matters to this market and that is Tax Reform. The House passed the Senate’s budget. Last Friday the market surged to record highs when the Senate passed their budget, but today market was much cooler to the House doing the same thing. That’s because 20 Republicans voted against the budget in protest over cuts to state income tax deductions.
Everyone loves tax cuts and the market has been rallying on that positive sentiment. But now we are transitioning to the debate over what taxes will be raised in order to pay for all those lovely tax cuts. Interest expense, 401k, and state income tax deductions all find themselves on the chopping block. On Thursday twenty Representatives demonstrated their displeasure with the proposed changes. Trump already said he was opposed to cutting 401ks. And let’s not forget our president is a real estate mogul. Anyone think he will sign a bill that eliminates interest deductions for his business and real estate loans? Yeah, me neither.
November 1st is when we are supposed to see this widely anticipated bill for the first time. If the healthcare debate is anything to go by, there is a good chance this bill will be delayed coming out of committee. Once it finally sees the light of day, it will get shredded by special interests. If there was one thing Republicans could agree on, it was their disdain for Obamacare. Yet even with that unity driving them, they still couldn’t repeal it. What is going to happen populist moderates, fiscal conservatives, and pro-business Republicans duke it out? It won’t be pretty and it won’t be fast.
Expect the hope of Tax Reform to give way to despair over political infighting. There is a good chance Republicans will pass something…..eventually. But it definitely won’t be as grand as many are hoping for. In the meantime, expect the stock market to give back a chunk of recent gains as it consolidates and allows the 50dma to catch up. This is definitely a better place to be taking profits than adding new money.
Jani
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By Jani Ziedins | End of Day Analysis
End of Day Update:
On Tuesday the S&P500 tried to recover Monday’s selloff, unfortunately the follow through never materialized and we finished well off the intraday highs. Traders still seemed more inclined to take profits than buy the dip.
If this market was poised to rip higher, this was the bulls’ opportunity. The lackluster buying suggests this weakness will likely extend past Monday’s dip. But this isn’t a bad thing. The recent runup leaves us 70-points above the 50dma and a check back is long overdue. The only question is if we dip back down to this key moving average, or trade sideways and allow it to catch up.
Falls from unsustainable levels typically happen quickly, so the longer we hold current levels, the more likely a sideways consolidation becomes. But we need a few more days because two-days definitely doesn’t qualify as solid support.
Last Friday we broke out to record highs when the Senate finally agreed on a budget. That clears the way for more significant Tax Reform. Unfortunately those fuzzy feelings didn’t last long and rifts within the Republican party started showing as Trump and key Senators started throwing barbs at each other. Trump definitely has a more antagonistic leadership style and that will likely lead to more tension during the Tax Reform debate. The market hates uncertainty and this conflict will likely erase a big chunk of the hope that lifted us to these levels.
I’m most definitely not a bear and still think the path of least resistance over the medium-term is higher. But I have also been doing this long enough to know the market doesn’t move in straight lines. After a period of nice gains, it is perfectly normal for the market to consolidate the runup. This is part of the healthy process of moving higher. In fact I would be more concerned about the sustainability of this rally if we didn’t consolidate recent gains. The higher we go, the harder we fall when the inevitable consolidation eventually happens.
All of this means this is definitely a better place to be taking profits than initiating new positions. But just like how we shouldn’t overreact to recent strength, the same level-headed thinking will be required if we dip further over the next several days. Additional weakness is creating a buying opportunity, not an excuse to reactively abandon an otherwise healthy market. Remember, smart money trades proactively by selling strength and buying weakness. Reactive traders bleed themselves dry by doing the opposite they buy high and sell low. Don’t be a reactive trader.
Jani
By Jani Ziedins | Scorecard
Welcome to Cracked.Market’s weekly scorecard:
This post includes a summary of the week’s market developments, links to the free posts I published, and analysis on how accurate each post was since I wrote it.
Weekly Analysis
It was another strong week for the S&P500. This was the sixth consecutive weekly gain and the eighth out of the last nine. For historical perspective, only one other stretch since Trump’s election strung together six up-weeks. Unfortunately the next week started a 70-point pullback. The question on everyone’s mind is, “How many more weeks can this keep going?”
The attached chart shows the market’s waves over the last 12-months. Five periods of up followed by sideways and/or down. When prices dipped to the 50dma, the consolidation tended to be brief. The times we didn’t dip, the market traded sideways until the moving average caught up before staging the next leg higher.
Currently we are approximately 80-points above the 50dma. Early in the rally we found ourselves as high as 100-points above the 50dma before peaking. Other times we stalled 40-points above the 50dma. 80-points is definitely on the higher end of the range, but not the most extreme and it is possible we could go a little higher. But it would break precedent if we went a lot higher.
Bulls are definitely getting cocky and my last few posts generated a fair bit of criticism when I suggested this was a better place to be taking profits than adding new positions. But this is actually a good thing and I find their criticism reassuring because I get nervous when too many people agree with me. Without a doubt momentum can keep this rally going for a few more days or weeks, but history tells us we are definitely close to the end of this ride. Famous last words often start with, “This time is different.”
And to be clear, I’m not bearish nor am I predicting a crash. The 50dma is a little too far away and we either need to pause and let it catch up, or we dip back down to it. Nothing more, nothing less.
October 19th: Why smart money will sell the Senate’s budget
If anyone believes our leaders will have constructive dialogues, quickly arrive at consensus, and pass a great Tax Reform Bill clearly isn’t paying attention. Politics is messy and I have no doubt Tax Reform will stumble countless times before it has a chance of passing.
There are two key rules every politician learns when they get to Washington:
A) Throw a fit until you get what you want.
B) If you don’t get what you want, blow everything up.
That is how Healthcare Reform went down and if anyone thinks Tax Reform will be any different, there is a medical term for that, it’s called insanity.
There are several opposing forces in the Republican party that will make any compromise difficult. First are the pro-business Republicans who want aggressive business tax cuts to stimulate growth. Second are the fiscal conservatives who bristle at the thought of adding to the deficit. And third are the moderates who want to see most of the tax cuts benefit the middle class. Three very different factions whose ideas are in direct conflict with each other. Without a doubt we will see someone throw a fit and refuse to support the first draft of the bill. Get three of those someones and the whole thing goes down in flames.
There is a good chance a compromise will eventually be reached, but politics is ugly and most likely this process will teeter on the verge of collapse moments before it is salvaged at the last possible second. Expect a lot of bad news between now and then.
Score To Be Determined: We won’t know how accurate this analysis is for several weeks, but I haven’t seen Congress pass meaningful legislation without relentless bickering and infighting. And that is a normal Congress. This group of Republicans is even more fractured and divided than normal. I would be shocked if Tax Reform progresses smoothly and we should be prepared for the volatility this heated debate will trigger.
October 17th: Why bulls need to be careful
For those of us that are paying attention, this looks a lot like a lethargic wedge higher and suggests this market is running out of gas, not on the verge of exploding higher. Explosive moves are by definition explosive. A tiny trigger blossoms into in a much larger move. Sometimes it is an unexpected headline, other times a technical breakout. But something triggers a surge of buying and away we go.
Unfortunately this wedge higher is the opposite of explosive. We keep getting good news. Today the Trump administration said they wouldn’t put conditions on repatriated profits and companies could use their newly liberated cash for dividends and buybacks. More cash in shareholders’ pockets is always a good thing. Then there was the technical the breakout as we moved into record territory. The cumulative result of both of these bullish developments, a measly 0.07% gain. Something so small it doesn’t even qualify as a rounding error.
Every day bulls are trying to push us higher, but the gains are getting smaller and smaller. That reeks of exhaustion, not unbridled potential. Without a doubt it is encouraging we managed to hold recent gains. Typically markets tumble from unsustainable levels quickly. This strength comes from owners who are confidently holding for higher prices and few are taking profits. Their conviction keeps supply tight and props up prices. Unfortunately propping appears to be the best bulls can manage. We need new buyers to keep this rally going and right now those with cash are reluctant to chase prices any higher.
Score 7/10: The market popped 0.5% Friday following the Senate passing a budget. By itself this event doesn’t mean a lot, but it brings us one step closer to Tax Reform. I still believe this will be a bumpy road, but any progress is good. The market is up 15-points from when I wrote this post so I docked myself a few points, but I still think the analysis is valid. The true test will come next week when we either extend Friday’s gains, or that breakout fizzles and we slip back to 2,550. Most likely prices fizzle, but there is a chance a frenzy of buying sends us dramatically higher. But the higher we go without consolidating gains, the harder we fall when it finally happens.
Cracked.Market University
Excerpts from my educational series. Click the title to read the full post. Signup for Free Email Alerts to be notified when news posts are published.
CMU: Why most traders screw up counter-trend trades
Counter-trend trades are one of the hardest ways to make money.That’s because traders fight an uphill battle and their timing needs to be flawless, otherwise they get run over. Despite these overwhelming odds, all too often traders cannot resist the temptation to argue with the market. In this post I will help you understand why counter-trend trading is so difficult, when it is okay to go against the trend, and the risks you face when doing it. Knowledge is power and the more you know going in, the better chances you have of coming out the other side alive, and maybe even with a little extra money in your pocket.
CMU: Are You a Victim of Beginner’s Luck?
Unfortunately beginner’s luck is not sustainable and all too often trader’s mistakenly believe their early good fortune was due to skill, not luck. Rather than dig in and learn from more experienced traders, they assume they have this game figured out and don’t need any help. Their early success convinced them they already know everything they need to know. Only after they lose their first stake do they start looking for outside guidance.
If you are reading this, most likely you experienced some early success and that encouraged you to keep at it. But now things have gotten harder and losses are more common than profits. While it hurts, realizing trading is not easy is actually a good thing. And if you figured this out early, count yourself lucky. Traders who experiences too much early success keep upping the size of their trades until inevitable fall goes from emotionally demoralizing, to financially ruinous.
Knowing what the market is going to do is the easy part. Getting the timing right is where all the money is made. Have insightful analysis like this delivered to your inbox every day during market hours while there is still time to act on it. Sign up for a free two-week trial.
Have a great weekend and I hope to see you again next week.
Jani
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By Jani Ziedins | End of Day Analysis
End of Day Analysis:
The S&P500 fell out of bed Thursday morning when it started the day with the biggest losses in over a month. But within an hour supply dried up and dip buyers rushed to our rescue. Not only did we finish off the early lows, we actually managed to close in the green. That said, volume was unremarkable given how dramatic the price-action was.
This was an impressive reversal and it leaves us wondering what it means. Decisive reversals are often strong buy signals when they follow multi-day selloffs and the rebound occurs following yet another piece of bad news. Selling capitulates when then the crowd is most uncertain and fearful. That is when the last of the nervous sellers bail out and moments later prices rebound when there is no one left to sell. Unfortunately that setup looks nothing like today’s dip and rebound.
Things got more interesting late Thursday evening when the Senate passed a budget. While it was nice to finally see something not crash and burn in the Senate, the budget is largely a procedural matter and really doesn’t count for anything. The only significant thing is it allows Republicans to avoid a Democrat filibuster when voting on their yet to be announced Tax Reform Bill. Overnight futures popped 0.3% on the encouraging developments.
So what is a trader to do on Friday? Thursday’s intraday rebound appears constructive. Then you have the good news coming out of the Senate. Most likely the best plan is to sell the news. There are a couple of reasons why.
The easiest to explain is politics. If anyone believes our leaders will have constructive dialogues, quickly arrive at consensus, and pass a great Tax Reform Bill clearly isn’t paying attention. Politics is messy and I have no doubt Tax Reform will stumble countless times before it has a chance of passing.
There are two key rules every politician learns when they get to Washington:
A) Throw a fit until you get what you want.
B) If you don’t get what you want, blow everything up.
That is how Healthcare Reform went down and if anyone thinks Tax Reform will be any different, there is a medical term for that, it’s called insanity.
There are several opposing forces in the Republican party that will make any compromise difficult. First are the pro-business Republicans who want aggressive business tax cuts to stimulate growth. Second are the fiscal conservatives who bristle at the thought of adding to the deficit. And third are the moderates who want to see most of the tax cuts benefit the middle class. Three very different factions whose ideas are in direct conflict with each other. Without a doubt we will see someone throw a fit and refuse to support the first draft of the bill. Get three of those someones and the whole thing goes down in flames.
There is a good chance a compromise will eventually be reached, but politics is ugly and most likely this process will teeter on the verge of collapse moments before it is salvaged at the last possible second. Expect a lot of bad news between now and then.
Next comes the market’s price-action. As I’ve been writing about for the last two-weeks, the market is extended and needs to consolidate recent gains. Everyone knows markets move in waves and we are near the upper end of the latest wave. I’m definitely not predicting a crash, but catching our breath is a normal and healthy thing to do following a 100-point move from last month’s lows.
The market is fatigued and this is easily seen in the lethargic breakouts to record highs. Gains of 0.18%, 0.07%, 0.07%, and 0.03% over the previous four days show how little interest there is in buying the record highs. If there was explosive upside left in this rally, we would have raced higher by now. Instead these insignificant “breakouts” tell us demand is drying up.
Don’t get me wrong, I’m not bearish, just realistically cautious. Consolidations are a normal and healthy part of moving higher. The quickest way to refresh a market is pulling back to support. The longer way is drifting sideways for an extended period and allowing the trend lines and moving averages to catch up. Either one will work for this market and only time will tell which one we get.
I’m most definitely not calling a top here, just warning that the upside is more limited than the downside. Long-term investors should stick with their favorite positions, but shorter-term traders need to think about locking-in profits and waiting for better prices.
Jani
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