By now I suspect that most of you are intimately acquainted with the bailout of Bear Stearns (BSC) by the Federal Reserve and rival bank JP Morgan Chase & Co. (JPM). That's why I am not going to rehash the details of this fiasco here. Rather, I think the details of the bank's demise are far-less important than the lessons to be learned by you, the individual investor.
What are those lessons? Well, I'm glad that you asked.
The commodity boom certainly is enticing aggressive investors. In last week's ETF Talk, we discussed commodity exchange-traded funds (ETFs) that tracked an individual commodity, such as gold, silver or oil. These ETFs in recent months have outperformed the market to generate positive returns.
I know this won't come as much of a surprise to some readers, but the media has once again missed the boat.
This past Sunday, the Los Angeles Times ran a cover story in the business section about buying a used car. What?
Nowhere in the entire business section was there any article on the troubles in the financial markets. What a waste of newsprint! No wonder newspaper circulation is down.
Right now, we are suffering through one of the biggest economic storms we've had in decades, and all the Times can do is give you tips on how to kick the tires on that used coupe.
There is no denying that stocks are back on the move, and during the past several days the equity markets have rallied in the face of some really bad news.
What kind of bad news? Well, the latest Producer Price Index number was up 1% in January. This is the highest monthly rise in the index in 26 years. Then, we got a report that housing prices nationwide fell nearly 9% in the fourth quarter of 2007.
As if those setbacks weren't enough bad news, we witnessed a slide on Tuesday (2/26/08) in the consumer confidence numbers, which fell to their lowest levels since February 2003.
The major market averages have, to a great extent, managed to keep a stiff upper lip in the face of record-high crude oil prices and the continuing peril in the financial sector.
I think this market's resilience is truly remarkable, especially when you consider that so many of the stocks in the financial sector have been trounced by the latest bout of subprime flu.
In a short sale, you do the selling first and then buy back later. If prices are lower when you buy back, you have a profit. If prices are higher than when you sold short, a loss occurs.
If you do not want to sell a portfolio, but feel that stock prices will be declining over the near future, a trader can sell a futures contract, buy a short mutual fund, or utilize a ETF (exchange traded fund) in the amount of his portfolio. A hedge can be total, meaning equal the amount of the portfolio, or for a portion of the portfolio.
Many a trader struggle with their trading. They will sometimes blame it on a learning curve or the type of market that exists at the time. These traders will ask me for advice and suggestions to speed up their learning curve.
The questions usually have several common areas.
When do I buy a stock?
How large of a stop loss should I use?
When do I get out of a stock?
What stocks should I be trading?
The questions are valid. The trader is really asking for a trading plan. A trading plan answers all of those questions.
A trading plan specifies –
Covered calls are not a difficult asset class for investors to use, but it is one of the least used. It has great flexibility and can help reduce volatility in a portfolio.
Buying a stock and then agreeing to sell it at a specific price at the time of purchase is one way of choosing an end point for a trade. The nice part is than you can anticipate profit and loss at various price points as well.
There are 3 things a stock can do after you purchase it. It can go up, it can stay the same or it can go down. When you put on a covered call position, 2 of the 3 are OK for you.
Some traders believe that the exit is actually more important than the entry to a trade. One of the best traders I know says "you can give any position long or short, I'll manage the risk, have a specific exit strategy and the trade can be successful." He takes the approach that he does not know where a stock is moving, but he always knows what he is going to do to let profit run and manage risk.
I asked this trader for some exit strategies that he uses. He gave me the exits for long positions. A trader can reverse many of these for short positions. Here are some of his favorites.
Success in business, life or trading has one very important similarity. A Plan. A plan is essential for success. The top traders in the country all have this one similar trait and it is an absolute. I feel that this confuses new traders who are constantly being told about success in a specific type of trading method.
You may read a book about a method of trading that the author claims makes him money. The one common denomination that the successful traders I know have, is a plan. Let's look at some of the more recognized approaches to the markets.