Avoiding the Trading Mistakes of 2008
By Ray Wadhawan ISSUE 804 | April 2009
Despite the recent rally in the stock market, most investors are still trying to recover from the losses of 2008. From a high of 1540 on December 28, 2007, the S&P 500 futures have fallen to as low as 665 on March 6, 2009.
Foreclosures and unemployment have been at historically high levels. There are more than 12.5 million people out of work in the United States, with potentially more to come. There is currently a lack of trust in the financial system, and I sometimes wonder, how did we get here? The answer lies in two simple words: fear and greed.
We have witnessed excessive greed, followed by excessive fear. Most people look at trading from the point of view of making money, but I look at it from a different point of view. How much can I afford to lose?
Regardless of whether I’m right or wrong, I always want to be able to come back to the market to trade another day. Unfortunately, many people trade with the intention of making big money from a few trades. In baseball, you don’t have to always hit a homerun to be successful. Base hits can also bring you much success. The same goes for trading. Little wins can add up and make you successful.
Some people make trades and hope for the best. For example, if a trade is losing money, many will hope that the trade will come back to make a profit. Many times this doesn’t happen and the trade just gets worse and worse over time. On the other hand, some traders take positions that are making money, and hope that it continues to make money. Many times, a winning trade becomes a losing trade because the trader waited too long to get out of the trade.
There are three simple questions every trader should ask themselves before making a trade:
- Why am I making this trade?
- What should I expect from the trade?
- When will I get out if things go for or against me?
Growth Areas in the Global Economy
Throughout the world, it is commonly believed that the U.S. stock market is the safest place to invest money. America is a great country and it will continue to be a great country, but we have to make some major changes in how we do business in our financial system.
In my opinion, the global economic center of gravity is shifting to Asia. We have seen how our economy has been performing for the last 10 years and it has become more evident that China has become the new growth engine of the world economy. Most of the near-term growth will be coming from China. Just look at the growth of the U.S. compared with that of China and India. China is forecasting growth this year of 7 percent, while India projects growth of 5 percent, all in the face of a worldwide recession.
The U.S. stimulus is just beginning to take root, but it will take some time to see the results of that. Speculation is still looming, whether or not the policies that take effect will have a positive or negative impact. The Obama administration has also been very cautious of raising expectations of a recovery in 2009. I think we can safely assume that 2009 will not be a huge year for the stock market. We may get the bear market bounce, as we have recently seen, but most do not expect it to last. I expect the near-term growth to be more evident in places like China and India. There will also be a hangover from the U.S. stimulus as the government is spending more than it can afford. That hangover should stay for some time.
In the last few months, the U.S. dollar has been gaining strength. This is largely because the U.S. dollar is still the currency of choice for global investors. Investors find comfort in keeping their money in dollars, but I don’t think the long-term fundamentals will support this view.
The U.S. government is increasing its deficits to record levels, and GDP is not growing enough to support the U.S. dollar in the long-run. In the short-run, the U.S. dollar will still be the currency of choice, but in the long-run you should be cautious. Once inflation comes around, the U.S. dollar could take a hit.
Investing with the Mentality of a Trader
Some people feel that they can diversify their portfolio simply by choosing stocks in different industries. This has never been true, and it’s been debunked once again in the last year. In 2008, stocks in nearly every industry have gone down like a ton of bricks. Because of market volatility, a buy-and-hold strategy does not always work.
This is why I approach the markets with more of a trading mentality than an investing mentality. You can use volatility to your advantage. Volatile markets are much more advantageous toward traders than buy-and-hold investors.
What are you trading for? Is it for capital gains or income? Some traders try to go for the big kill, by taking big risks in a short period of time. The quickest way to lose money is to try and make it quickly. There are no shortcuts in trading. It is a game of patience. You must be organized and disciplined.
You should always have a plan when you trade. I don’t go into trades until there are opportunities screaming at me. I don’t take a position until I am confident the fundamentals agree with the trade that I am about to take.
You need to follow the market carefully and have a trading plan. I update my plan every week as the market conditions change. I don’t know how much money I’m going to make going into a trade, but I will have a profit target. At the same time, I focus on the maximum amount of money that I can afford to lose. If a trade doesn’t go my way, I have to be out of the market. If I’ve accomplished my goal for the day or the week, I am done.
Portfolio Allocation & Risk Management
To manage my risk I try to use an asset allocation that helps me achieve zero or negative correlation between components in my portfolio. For example, let’s say for a $100,000 portfolio and the goal is to make 20 percent per year. I usually allocate 10-15 percent of the portfolio in a fast moving market such as the S&P 500 futures. This is where I would plan to make one or two trades (sometimes more) per week, depending on how the markets are moving.
I allocate another 25 percent of the portfolio into medium-risk positions, such as stock options. These positions will be longer term, possibly a few weeks or months. The rest of the portfolio can be allocated into a mix of bonds which can include U.S. Treasury bonds, municipal bonds and corporate bonds.
Allocating your assets in this way can keep you diversified while allowing you to take some risk without getting completely wiped out on a trade. Achieving zero or negative correlation simply means that the components of your portfolio do not always move in the same direction. If you look at the stock market, regardless of how many industries you “diversify” into, you are still invested in the stocks that are positively correlated. When the stock market is down, most stocks are down.
An example of a zero correlation would be the copper and orange juice futures markets, for example. There is almost no correlation between these markets.
Although it is difficult to achieve a zero or negatively correlated portfolio, allocating your portfolio in a variety of asset classes can help you achieve this. There are a number of asset classes to choose from, some of which include:
- Futures contracts of various types
- Foreign Exchange (Forex) / Currencies
- Long-term Treasury bonds
- Long-term corporate bonds
- Large company stocks
- Small company stocks
Hitting the Panic Button When Things Don’t Go Right
No one has ever made money by trading in panic. You need to trade with a plan and plan your trade before you get into a position. This means using stops and having price targets. By doing this you leave no room for panic because every trade is well thought out. You know when you’re getting in and when you’re getting out.
Day trading can be very profitable, but can also be very risky. If you’re a day trader, you can’t just trade for the sake of trading. Overtrading is the easiest way to lose money quickly. You need to treat your trading like a business and make sound decisions with exit strategies backed by reason.
Are you trading with a plan? Are you diversified across a variety of asset classes? Remember that it is more important to pick the right asset class than to pick the right asset. Markets will continue to be volatile, which means that buy-and-hold strategies do not always work. You need to study the markets and understand why you are trading before you actually trade.
Ray Wadhawan is a trader with over 20 years of experience trading stocks, commodities futures and forex. He is also the founder of SmartMoneyLetter.com a weekly newsletter service providing trade recommendations and daily updates. For more information, visit: http://www.SmartMoneyLetter.com. Ray can be reached at admin@smartmoneyletter.com.
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Kristina Zurla Landgraf is editor of Lind eWire. She can be reached at editor@lind-waldock.com.
Futures trading involves substantial risk of loss and is not suitable for all investors.
Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.
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