Friday, September 27, 2013

Rolling away from risk

When I was a young trader, one Friday morning I looked at the markets and was troubled by what I saw. The Dow had been sluggish for a few months, had staged an anemic recovery and then started to slide a bit.

Back in those days I traded only a few stocks, in the form of shares, and on occasion traded my 401(k) out of and back into a mutual fund that tracked the S&P 500.

I had no trading plan, no system. I looked at the market action once or twice a week and if my holdings were going down, I considered getting out, and if not, then I stayed put.

It wasn't very active management. If I traded twice in a month, that was an occasion for celebration, because my strategy back then was pretty much buy and hold.

And even when ready to trade, I tended to go slow. A doubt might require a week before it became a decision. It took time to convince myself that the decision was really right.

And so it was on that Friday. I had my doubts, and made a note to keep a closer eye on things the next week with the thought of maybe getting out of the market for awhile.

I had a good weekend -- October in Washington, D.C. is a beautiful time of year.

The year in this case was 1987, and when I checked the market news on Monday, I found that the Dow Jones Industrial Average was falling at a rate faster than I had ever seen before. It closed the day -- Oct. 19, 1987 -- down 22.6%.

I learned several lessons from that day. One was the importance of acting on decisions without dawdling. Another was the importance of actively managing my positions.

A third lesson, perhaps the most important, was the need to get out of the way of major risk, even if doing so might mean lost opportunities for profit.

Good lessons all, although the tuition was a bit expensive.

Fast forward to October 2013, which begins next Tuesday. The markets started turning soft in mid-September. The Dow is down 3% from its most recent peak, not awful but not confidence inspiring.

Bigger picture: After rising steadily from November 2012, the market from last May began a series of swings. The highs were higher and the lows were higher, and the swings from high to low were enough to bounce a trader's heart up into his or her throat.

S&P 500 ETF (SPY) 2 years 2-day bars

More troubling, the Republican Right in the U.S. House has been threatening to allow the government to run out of borrowing authority on Oct. 17 unless the Obama administration makes major concessions on policy, concessions that the executive surely won't be willing to make. I mean, the GOP's ask would leave President Obama's record from 2009 onward essentially meaningless.

If the debt ceiling isn't raised and if as a consequence the U.S. is seen as potentially defaulting on its debts, I certainly believe that those events have the likelihood of causing a panic in the markets, as people and institutions and nations sell their T-bonds, T-notes and T-bills and go straight to cash. That in turn would cause a crash in the capital value of U.S. government bonds and a dramatic rise in interest rates that would endanger our still shaky economic recovery.

Reading that graf, it sounds a lot like the zombie apocalypse. But many times in the past decades we have seen countries go from prosperity one week to beggardom at the doors of the International Monetary Fund the next.

Scarier still, the more moderate Republican leadership of the House seems to have little control over their right flank, and the Democratic Left is also muttering about getting budget concessions to their own liking before supporting a bill to raise the debt ceiling.

All in all, it has the potential for major disorder in the markets, and I would prefer not to ride out that sort of storm a second time.

I have closed all of my bull positions and some of my sideways plays where the price is close to the lower boundary of the zone of profitability.

It's not a permanent closure. I'm treating it as a maneuver called a roll that I execute each month in order to keep option positions alive after they expire. For example, I rolled my September positions over to October options a week before the September options expired.

In the normal course of things I would be doing the roll on Oct. 11, the Friday before the last week the October options can be traded. So my early roll is less dramatic than it might sound; I'm only coming forward by two weeks.

The difference between this roll and my normal practice is in the way I handle my shares of stock. They don't expire and so aren't normally rolled. In this case, however, I've closed the share positions and will re-open them once the debt-ceiling question has been resolved.

Under my roll procedure, I'll re-enter, post crisis, when the stock has again pierced its 20-day price channel. And since I don't consider a roll to be the end of a position, I don't calculate profit or loss at the time of the roll, reserving that exercise for when I decide to roll no further. Generally, I close a rolling position for good when it gives a close signal by crossing beyond its 10-day price channel in a direction opposite that of the trade.

In an earlier post today, I quoted the words Shakespeare put on the lips of Julius Caesar, "Cowards die many times before their deaths; The valiant never taste of death but once," and then followed with the observation, "What's good for Caesar, however, is not necessarily good for traders. The trader, like the cat and the coward, wants to have many lives so that he or she can come back to trade again."

I'll end with another quote from Shakespeare, this time speaking through the persona of Falstaff in Henry The Fourth"The better part of valor is discretion". 

And it is the virtue of Falstaff's discretion rather than Caesar's valor that I choose to exercise today.

Or, in the words of the poet, "Go to cash and run away, live to trade another day".


My trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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