The 6-year-old who called S&P 1701 back in April

The Opening Print

We’re midway in our special Opening Print series of Fall 2013 Outlook commentaries from experts. We’ve heard from successful working trader-educators about harmonic patterns, technical analysis, and pivots. We’ve gotten perspectives on the stock market from traders in bonds and forex. I even put in my two cents’ worth. (That two cents is now significantly overvalued thanks to the price inflation conspiracy by JPM, Glencore, and Goldman.)

I wrote that trend-following lies at the heart of any successful trading method. Perhaps because of my bias, I saw nothing but a series of trend following methods from our wide range of trading experts.

A first-grader predicts the stock market rally

ES 09-13 (Daily)  8_20_2012 - 8_20_2013It reminded me of something that happened in mid-April of this year, when my nephew was only six and finishing up first grade. He came to my room one evening to say goodnight and see if he could sneak some screen time before bed. I had a chart of the E-mini up and I asked him where he thought the line on the chart was going to go. That’s when he did something fascinating.

With his thumb and forefinger he measured out the corners of a rectangle, then measured out the same distance three times. He stood on my knees—Ouch!—looked down at me, and declared, “It will go to 700 and a thousand!”

“You mean one thousand seven hundred?”

“That’s what I said!” He turned back to the screen, did it again, and said, “No wait, 700 and a thousand and one.”

“Are you sure?” I asked.

“Uh, yeah. Before your birthday.” Then he added, “Can I play Minecraft?”

“No screen time on school nights,” I said. He hugged me and went to read The Hobbit. I went immediately to the screen and measured out with my fingers. They landed on August 2, before my birthday on the 15th. The median of the price bar that day, between the open at 1698 and the close of 1704.25? 1701.

See the forest, not just the trees

He followed the trend, which is and has been up since the beginning of the Obama administration. That’s not a political jab. Along with everything else the president inherited from George W. Bush was the upturn following the worst of the credit crisis. President Obama can’t and doesn’t take credit for that.  In fact, stocks have been on an uptrend since before he was born.

My nephew was able, in his 6-year-old’s way, to see the forest and not the trees. He saw a clear uptrend because summer was still a blank area of the chart, uncluttered by fluctuations and corrections. He didn’t predict the big dip of June. Neither did a lot of us.

Don’t leave money on the table or risk losses to finance your ego

But once the June correction was happening, it was only those with poor judgement and those with very deep pockets (and maybe a few with both) who simply held onto their long positions and rode it out. It’s not just that it was needless risk. There was money to be made shorting that nice big dip.

If you held onto your longs just to prove you were right, you were inflating the price of your own ego-satisfaction, much the way those banks inflated the price of aluminum. Goldman and their partners literally had the delivery trucks drive in circles from one warehouse to another. We drive our minds in circles, finding yet more bogus reasons why the market is just about to turn around and prove us right. Meanwhile, we’re leaving real money on the table.

A simpler, better way to catch both the long- and short-term trends

There’s a simpler way to be long in the longer term and short in the shorter term. As with everything on this site, this is a hypothetical statement and not meant to influence you to actually buy or sell any financial product such as a futures contract or option. Here’s the secret to being long in the longer term and short in the shorter term: be long calls, and then short the rallies once the short-term trend is clearly down for a little while.

I know I’ve disappointed those of you who want a buy-here-sell-here set of instructions instead of a story and advice about the attitudes of a confident trader, whatever his or her method. You can find consistently good recommendations in Danny’s morning call, though even there you can see him talking about attitude and confidence, and not focusing so much on the trees that you can’t see the forest.

Many ways to apply a few important principles

There are many ways to be long: buy out-of-the-money calls outright (which I love for the leverage), sell puts (though you wouldn’t do this if you’re shorting futures), or do bull call spreads, perhaps with a naked leg. A March 2014 1800 call bought on April 15 or so for under $500 was worth over $1600 on June 1.

And there are several ways to be short futures: scalping, taking one or two positions a day and holding for a few hours, or doing a multi-day swing trade. The hardest part of all of these is planning your exits, both the profit-taking one and the loss-taking, account-saving one. If you haven’t planned for how you will lose money (fast, early, and small fits the bill) you haven’t planned your trade. Trading includes losing, and therefore you must lose skillfully.

With all of these choices, I can’t tell you, nor can anyone else including our working professionals, how you should trade your money. That’s your job. Seriously, that is the job. It beats flipping burgers and waiting tables, trust me. Take the principles that guide all of us who consistently trade well and find your own way to apply them.

Does the method you’re using to trade right now feel right? Does it suit your temperament? I like calm, a leisurely pace, and risk control. I don’t like gambling, excessive risk, or too much adrenaline and testosterone. That’s why I like options. That’s why I day trade best when it becomes like meditation, relaxed, aware, and unemotional.

So is my nephew a trading prodigy? Maybe, but he didn’t have an exit strategy, one that guided both how he’ll take profits and how he’ll take losses. Which means for now, he’s just a smart kid. You and I, on the other hand, are or want to be professionals.

Tomorrow we’ll resume the rest of our Fall Outlook series. If you like what you read, click on the author’s name and read more of his or her work and consider signing up for their trading advisories or joining us in the IM-Pro chat room for a free two-week trial.

That’s all for now. I think I’ll go read The Hobbit and go to bed.

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