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Thursday, January 29, 2009

Trading Ideas

I have talked to a couple of different people who read my blog recently, and some of the questions have been where to put money into the stock market. If your not interested in my 2 cents on trading, skip this article. If you read on, READ MY DISCLAIMER by clicking here, or read on right side of page

The first order of business is to determine your own time horizon for the trade. (Click links in article for definitions)

Time horizon - Years
With a goal to secure a nest egg from another 40% collapse, I continue to recommend looking at "cheap" resources, such as Oil, Food, and gold (if/when its below 600 an ounce). Related plays, but riskier, are Oil companies (OIH) , Gold miners (GDX, article), food commodities (RJA, click here for others). The goal here isn't to make "millions" but to preserve wealth through the turmoil ahead. And for all commodities, more so for gold or oil, if the world enters into some REAL chaos, they should soar. See my 2009 predictions on why I don't like going into mutual funds or other financial instruments long. See "how to trade" later in this post.

Time horizon days to 2 months
For 2 week/2 month perspective, NOT day trading, the goal is to pick something that you believe will occur. For example, during the Obama Rally, that MAY be starting right now, do you think the market will rally back to DOW 9,000 or higher?

If you believe this is likely, then you want to buy an index fund of US stock markets. Specifically, an Exchange Traded Fund, (ETF), that represents the sector you believe will move in a direction. (We'll assume up for simplicity).

You have choices, but an ETF that "mirrors" the % change (not 1 to 1 dollar) of the sector or index you wish to purchase. For example, if you believe the DOW will hit 9k, then you want to buy DIA. If you are REAL confident this will occur, then there are leveraged funds, that represent 2x the percentage of the DJIA move, such as DDM. So if DIA goes up 1%, DDM should go up 2% of the NAV for the ETF. If you are REALLY REALLY sure the financial sector will rally in the next weeks/month, then you can buy a 3x ETF FAS. (I couldn't find a 3x ETF for DOW)

Read above, understand it, now wrap your head around this, there are the exact same type of ETF's but for "shorting" or betting the reverse. if the DOW goes from 8K down to 4K (50%), you can buy and ETF that goes up as the DOW goes down, 1x, 2x, etc.

Below are links to references to some of the ETF's available to purchase.
1x ETF (Qqqq, dia, spy, there are others)
2x ETFs (long or short)
3x ETFs (long or short)

WARNING, 2x and 3x etfs "over time" all degrade in value. The leverage has a cost, that takes its toll on the NAV of the ETFs. I would not recommend any 2x or 3x ETFs beyond a 2-3 month time horizon. They are best for 1 hour/1 day/1 week/1 month time horizon.

Time horizon 15 seconds to 1 day
True day traders typically trade the MOST volatile stocks or financial instruments. The goal is to have decent % changes in short periods of time. Basically you throw dice, buy & sell based upon your gut, or by looking at charts and talking yourself into believing the charts will guarantee an outcome, giving you confidence to set entry and exit point. One of the main reasons, in my opinion, on why stock charting works is so many people follow stock charting. With so many people looking at the same "palm reading" guidelines, charting almost becomes self-fulfilling. Charting is a very important tool in trading that must be paid attention to.

The 2x and 3x ETFs move dramatically, the most volatile recently have been FAS, SRS, SKF, which are basically all related to finance or real estate.
There are tons of books selling systems or knowledge of palm..er I mean chart reading. From what I gather, Fibonacci seems to be regarded as the most reliable measurements from charts. At this level, can trade options, futures, currency, etc, also to get the % changes in volatility. I stay away from TRUE day trading, mainly, since I can't spend the day watching! I have a job, so I am "stuck" with the previous time horizon to work with.

What about Cash?
Cash is still #1 safest place to be, to insure against losses. But sometime between now and 2012 this will likely be the wrong place to be. If the USD undergoes a confidence issue, your cash will be worth significantly less at a blinding speed. Iceland, for example, had their currency cut by 25-50% in days. Hence my first recommendation for 1-10 year horizon.

How to trade? (method)
There are ridiculous number of "methods" to trade. But here is what I find the most reliable.
Say, we think the market is going up, and my risk level I want to work with is ETF DDM, currently valued at 29.

Lets say, I have, for simple maths sake, $60K to play with, target at most 1/2 for playing with. First, you typically want to buy in after the market was CRUSHED, and DDM was destroyed. As an example, DDM went to 26 on Jan 20th, that would be a great day to get in. So in the face of a falling market, you get brave and buy 200 shares of DDM at 26. Now you wait. Assume in the next week or so, it DOESN'T go straight up, is goes up and down, and falls down to 25. Buy another 100. Make sure the levels are far enough out you can never run out of cash. ADD SLOWLY don't try to "make" the move you want, wait for the moves to unfold. If we are doing 1 buck increments, we are talking around 18 bucks is the cut off. Calculate how much money you will be down if DDM hits 17 bucks, and decide if you can take that kind of a loss. If not, be less aggressive in purchasing levels. Make sure there is plenty of room. Also calculate the level to "cut your losses". So if DDM hits say 18, instead of spending your last money to yet buy more shares, maybe set that as the sell level and take the loss. Be sure not to set this level too close, or you will always hit the sell level.

So you "average down" when wrong on the "bottom" timing. So when to sell? When you bought at 26, look at a chart and see where the stock/etf likes to "hover" around. Looking at the chart, DDM seems in last few months to favor hovering at the "top" around 30-33. Lets say your AGGRESSIVE. try to sell around 33. If/when DDM hits 33, you can sell the stock OR put in a stop-loss of selling DDM, say around 30.85, or something like that. If you bought it at 26, you will make 4 bucks if triggered. If DDM keeps going, just keep moving the stop loss up until the market turns and you must sell. Or just start selling some shares at 33, and more if it goes up until you sold all shares. Try not to go 100% in and 100% out at very specific levels. There is no room for error if you do!

The trick here is you will NEVER buy stock at the bottom and NEVER sell at the top. Goal is to get a good chunk of the move. If DDM goes from 26 to 40, but you get knocked out at 36 by the stop-loss being triggered, its very hard not to look at the last 4 bucks as "missed". But in reality, 26 to 36 is over 35% move! That is a great return in a few months.

There are tons of much more sophisticated indicators, etc. But the basic method I outlined above is to allow you to be wrong on the timing, give plenty of space to "average down" costs when buying into a stock, and a place to sell above.

And the #1 place I recommend for wide variety of trading is Interactive Brokers. The next best, for very light trading, I like Fidelity Investments. IB allows trading financial instruments from around the globe. Fidelity is pretty much is for trading stocks/options in the USA.

This article is a brain dump, and should be taken as food for thought, not gospel turn-key way to trade. Trade to be right by allowing room for entry and exit, avoid exacting big trades. Keep the size and risk small enough to endure the wiggles, and set thresholds to change your mind when you are wrong, but leave plenty of room for that level to avoid being pushed in and out when it isn't required.

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