Absurdity . . . and the Danger of Stop-loss Orders
Classic Portfolio Components
Gains for the Day (%)
100 Stocks--3 Portfolios
October 13, 2008
|
MorganStanley |
87.0 |
|
Boeing |
12.6 |
|
Honeywell |
9.2 |
|
GenlMotrs |
33.1 |
|
JNJ |
12.2 |
|
BankAmerica |
9.2 |
|
Alcoa |
22.8 |
|
NA100 qqq |
12.2 |
|
IntlPaper |
9.1 |
|
Chevron |
20.9 |
|
Merck |
12.2 |
|
Schlumber |
8.3 |
|
AmerExpr |
17.9 |
|
HewlPack |
11.9 |
|
BristolMyer |
8.2 |
|
Exxon |
17.2 |
|
Citigroup |
11.6 |
|
VerizonComm |
8.1 |
|
Disney |
16.0 |
|
DuPont |
11.5 |
|
McDonalds |
7.3 |
|
Caterpllr |
14.7 |
|
AMR Corp |
11.0 |
|
Wal-Mart |
7.0 |
|
SP500 spy |
14.5 |
|
Intrnet hhh |
10.3 |
|
ProctGamb |
6.3 |
|
CocaCola |
13.9 |
|
Pfizer |
10.2 |
|
IBM |
5.1 |
|
UnitdTech |
13.6 |
|
HomeDepot |
9.9 |
|
JPMorgChase |
0.8 |
|
DJ30 dia |
13.5 |
|
MMM |
9.9 |
|
GenlElect |
-2.3 |
An absurdity is something that makes no sense. It is without rationality, an orphan entirely of emotion. The previous day, Friday, October 10th, Morgan Stanley was down -59.5% for the week. In the table above, MS is up +87.0% from the previous trading day.
Do you think it is reasonable to take a company worth $10 billion yesterday and double its value to $20 billion today? On what basis?
Is General Motors worth 33% more in one day when it has dropped 45% the week before? Why isn't General Electric not only not up but down?--the only one on the page!
The human mind steps in to 'explain' this wildest kind of behavior. It cannot stand to be without a reason. So it creates one--it doesn't matter what the words are as long as they sound rational. That describes fairly the millions of words that flow across monitors, screens, and speakers globally, everywhere, all day and all night.
Do those reasons help you make money in the stock market? Absolutely not--because they change as rapidly at the market itself changes. Check it out. Track the text from one day to the next after every move. If you base your trading on the ephemera of news and shifting reasons, you're out of luck nearly always.
Picture the market as a circus, the biggest in the world. Hundreds of millions of spectators crowd under the Big Top. There are three rings. The first has lions and their trainers. Once in a blue moon the lions get out of hand and kill or maim the guys with the upended chairs and the whips. It is devastating. The crowd goes wild with fear and awe. (Remember the Colosseum c. 80 A.D.)
The second ring has the clowns. They are funny or sad with happy or sorrowful faces. It doesn't matter which. The crowd is entertained. They laugh and cry, mostly laugh. It is the ring of absurdity.
The third ring has you in it, alone--with your system. The hundreds of millions don't even notice that you are there, and if a few do, they don't care. You have the advantage. You are hidden. They don't see you. You can track them. Their attention is riveted on rings one and two. They don't track you. In your ring, you are the sole producer, writer, director, actor, and self-audience of your own show. You have a control panel, like a telepromter. It tells you what to do. It says, buy, wait, or sell.
But you have learned from experience always to use stop-loss orders. Unfortunately, in an age of devastation and absurdity (D&A), they destroy trader and investor capital more than they preserve it. You are safer, by far, relying on system methods alone rather than stop-loss techniques. More on those here.
Still, there is another, alternative, technique that you can use to bypass the need for stop-loss orders. It will let you trade any system or method with safety and comfort, without stops: use options. Buy long-dated options to open new positions. Then sell them when you feel like it. They will not prevent losses, but those losses will never be triggered by D&A and blown devastatingly through your intended limits.
Their use can be structured to replicate your standard dollar allocation to a trade in the stock. For example, you wish to take a $10,000 long position in a stock. Your inviolate(!) stop-loss-order level is 10% below purchase price. You can live with a $1,000 loss.
Instead of buying the stock, you take the amount of the loss limit and buy call options on the stock instead. For example, you expect the current leg of the bear market to end soon. The QQQQ's stock price is $30. For $12,000 you can buy 400 shares. Your 10% stop loss would be $1,200--if you don't get devastated. Instead, buy options with the $1,200. The March 2009 Calls cost $4 each. You buy three of them. You can't be stopped out. Your maximum possible loss is $1,200, which matches your original-intent limit. Your potential profit leverage on the options is five to one over the stock. Done deal!
Coda. The circus goes on--and is likely to continue in its after effects until 2010 to 2012 (just in time for the next U.S. presidential election) if the Republic can last that long.
Notes. Another anecdotal market session like this one above, that some may have applauded, does not carry sufficient significance to attach convincing meaning to. And so the drum roll goes on. The current D&A will be subsumed and buried with the passage of time. New and excellent results will ensue--until its next resurrection.
It takes about two generations for D&A to recur, one to undergo it, the next to have forgotten that it ever happened. Thus 1857, 1929, and 2000.
The intervals are just about 72 years--double that perennial standby, the 36-year cycle.
Meantime, there is Monday morning to act on. Buy, wait, or sell. Let us see what prices unfold. We know today exactly what to do the morrow.
Written
10/24/2008 12:07 p.m. EDT
Posted
10/27/2008 6:07 p.m. EDT
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