“We have 2 classes of forecasters: Those who don’t know . . . and those who don’t know they don’t know.” — John Kenneth Galbraith
Looking at today’s markets, the forces of deflation and inflation continue to slug it out in a titanic struggle for dominance. Options traders face ever-changing wind conditions as they attempt to pilot their portfolios to profit. Over the years, we’ve managed to navigate the stormy seas with a steady hand on the tiller. One of the keys to our success is keeping a sense of perspective. As our service sails along toward its 28th year of advocating sensible speculation, I’d like to share some seemingly impracticable musings you may find useful.
In 2008, volatility skyrocketed beyond belief. Most market participants, even professionals, were caught by surprise. Big money was made and lost, both up and down, with astonishing speed. It’s long been known speculators make their fortunes from changing prices and leverage is an important tool for speculators. Leverage involves using OPM (Other People’s Money) to try to make more money than you can with your own funds. Using OPM may augment your reward when you are right; but it may also greatly accelerate the risk of additional loss when you are wrong. That’s the aspect of leverage that so many forgot during the heady times of money trees growing to the sky.
Even some of the market’s smartest participants are done in by blind arrogance. The famous story of the 1990s rise and fall of hedge fund giant Long-term Capital Management, excellently chronicled in Roger Lowenstein’s When Genius Failed, comes to mind. That cautionary tale is particularly apropos to the 2008 financial crisis and should well be remembered as these days of low volatility could be coming to a close. Successful trades blinded the firm’s brilliant partners to the possibility of failure, ultimately sealed their fateful demise, and threatened the stability of the entire financial system.
In this business, I believe you are better served by checking your ego at the door. Having a complete game plan includes preparing for the worst in every trade. Remember to always speculate based on what you can lose, not what you can gain. Applying sound money management principles (such as never adding to a losing trade) and utilizing the tools of Superleverage* (exchange traded put and call options) allow you to stay in the game and avoid being knocked out through inevitable times of losing trades. If you have anticipated the possibility of loss, and are prepared to withstand it, no matter the severity, because you positioned with always known and completely limited risk vehicles; never be surprised when the market moves against you.
Since taking the helm of Options Hotline, in October of 1999, I’ve compiled an impressive record of forecasting the twists and turns of market price. People invariably ask me what I think the market is going to do. I always say that if I knew what the market was going to do, I wouldn’t have to work. Use technical levels of support and resistance to set your exit strategy for each trade. Make sure that you, or your broker, monitor your positions closely. The market doesn’t ring a bell when it’s time to get out. Have your plan in place ahead of time and you can smile, laugh, take your profit a step ahead of the crowd, and enjoy your accomplishment with a sense of wonder. No matter your success, always be surprised when the market goes your way.
So, like me, never be surprised and always be surprised. Don’t forget that forecasters, even those with good reasoning and strong opinions, are practitioners of uncertainty. That view will serve you well.
I hope you found the abovementioned thoughts helpful and wish you all good fortune as you vie for fun and profit in the years ahead. Click here to subscribe to Options Hotline and see how we help our readers stay a step ahead of the crowd.
*When leverage is applied with an always known and strictly limited risk, it takes on a more sensible aspect. It becomes Superleverage, defined as the art of profiting from changing prices, with limited risk, AT ALL TIMES, without ever getting a margin call to come up with additional funds or a forced liquidation. The instruments of Superleverage are exchange traded put and call options. Buyers of puts and calls are the ONLY ONES who possess the full profit power of Superleverage.