Stock Investing: A New Strategy

November 15, 2008 at 1:58 pm (Money & Investing)

OK, so as some of you know, somewhat early in the year I decided I had enough “non-essential” cash around that I felt comfortable trying my hand at stock market investing.
I knew the economy was shaky, but pundits everywhere were saying that the nosedive was likely at an end, that things should start improving any time, and that there were good investment opportunities out there if you took the time to look. So, I figured I’d look, test the waters, and see what happened.

Well, what happened is I lost a whole crapload of money.
The market would have a good week, all the pundits would go on about how it looked like the bad times may be finally coming to an end, and with hope in my heart I’d buy a stock, thinking it may finally be time for the market to start climbing and for my investment to grow.
Only to have that hope dashed within a matter of a couple of days, when some news report causes the market to crash yet again, making the value of the stock I bought drop like a rock, usually well below what I paid for it.
And this was a pattern that repeated several times over the course of the year.

Now, over that time I have learned a lot. That education was admittedly expensive, but hopefully like any learning it will end up paying off in the long run. Most of these are realizations that finally clicked in just over the last few weeks.

A) The economy is crap, and will continue to be crap for a good while – this is especially true with a new government administration coming into office that is obscure at best and that most investors just plain don’t think have their best interests in mind. Any pundit who is optimistic is full of it.

B) Due to A, making any investment that relies on improving market conditions is a losing bet. The market will, at least once every 2-3 weeks, have a “rally” of positive growth based on some tidbit of good, or even “not as bad as we thought it would be” news. As I did, lots of people buy stocks during these rallies. They will lose their ass when more bad news comes out 1-2 days later.

C) Due to B, the best way to make money in market investing right now is to bet against the market. That being, invest with the assumption that the market will continue tanking, not with the hope that it will start growing again.

How do you do that?
Well, there’s a type of stock transaction you can do that is called “selling short,” which is kind of complicated, but in a nutshell is a process in which you make money by buying a stock in hopes that it will actually lose value. In the inverse of normal stock trading, you actually make money based on how much the stock loses, not how much it gains.
That said, as I mentioned it’s a bit of a complicated process, requires buying on credit, and requires a large amount of money (at least a lot as far as I’m concerned) in your account to do, which is why I haven’t been doing it and had been taking my chances on “hopeful” buys instead.

Well, that ended a few weeks ago with a discovery I wish I had learned about several months ago: the inverse ETF.
These are funds (think something like a mutual fund, where you have another company do a bunch of stock trades in your interest and it all just goes under one account) that do all of the dirty work of short selling for you in the background. Quite simply, as a general rule whenever the markets go down, these funds go up.

As an example about 10 days ago I invested in the ProShares Short Dow30 fund, which is designed to gain profit whenever the Dow index goes down (this is the market index that tracks most of the “big hitters” on the market, such as 3M, AT&T, Boeing, Coca-Cola, Exxon, GE, Intel, and a ton of others).
It works splendidly – as usual, the markets went down over the last 10 days, with slight fluctuations here and there. But in a nutshell by about day 8 or 9 I had already gained a 9%+ profit (at which time I started to really wish I had more money invested so that percentage would equate to more actual cash).
At which point, if I was smart, I would have sold my stock while I was ahead instead of taking my chances. But, I got greedy, and held on, hoping it would go up even higher.
And then…. one of those rare “rallies” I mentioned earlier happened, for no real apparent reason. The market jumped up in value. That meant this fund dropped in value…. and I lost all of the profit I was looking at just hours earlier. The only thing that kept me from losing money is that I had set up a “stop” on the account, indicating that if it were to drop to a point where I would lose money, that it was to automatically sell at that point. It did, and I ended up with a profit of less than 1%.

But… over at TradeKing I was looking through others’ notes on similar trades, and saw that other people were actually making money on these accounts while I wasn’t making a dime… so I started up some conversation to find out what was going on.

Turns out one of the biggest lessons in this confused market is that you can’t allow yourself to get greedy. Look at the history of the fund for the last several months. Notice the highest it got during that time, and absolutely assume it will not go higher than that – that, in fact, it probably won’t even get that high again before dropping. Find a few percentages below that point, and when the stock gets there, sell. Don’t think about it, don’t wonder if it might go higher. Just sell. Using this technique, these guys were raking in 50% profits in a matter of several weeks.

I’ve also learned that when you buy a stock can be just as important as when you sell it. Just because a stock or fund price starts going up doesn’t mean it’s a good time to buy, at least under current conditions.
Most funds right now don’t have steady, predictable gains or losses. They pretty much just fluctuate all over the damned place from day to day. However, what they do that is somewhat predictable is that those fluctuations tend to fall within a certain price range.
For example, here’s a chart of where the prices were at on the Dow fund I was in for the last two months:

Notice that for about the last six weeks, although it has been bouncing around a lot, the bouncing has been mostly constrained between two price lines: the low $70’s, and the high $80’s.
When I bought, it was about halfway between at about $79 per share. However looking at these fluctuations, it probably would have been smarter to wait a little bit and see if the pattern repeats itself, with the fund dropping back down below $75 – this would both give me more “wiggle room” for the fluctuations without worry of losing money, while at the same time giving me a bunch more profit when the fund decides to “top off” in the upper 80’s again, where as stated earlier it would be time sell (for example you can tell the system to automatically sell if the price hits $89).

One more lesson: as the market reacts to news, which is mostly bad, it’s probably a good idea to take note of when financial reports and other such things will be released. And according to this calendar, next week they will be releasing some doozies: the Home Builder’s Index, the Consumer Price Index, the latest jobless claims report, and the quarterly GDP report.
Now, most of that is, of course, expected to be bad. About the only expected positive spot (based on the predictions shown on the calendar link) is the home builder’s index, which I’m surprised to see is expected to actually be in the positive.
With those mixed expectations it’s probably going to be another roller-coaster week next week, so it’ll be even more important to watch the chart for a good time to get in rather than just jump in because “it’ll probably be a bad week, so that fund will probably go up.”

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