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Timing a trade can be boiled down to
three key components: Fundamentals, Technicals and
Market Tone.
Longtime reader
Blair H. writes:
Quick question: If [I] buy into your
thesis that the EURO is a train wreck waiting to happen, how long can you
hold an ETF like EUO (euro ultra short) or UUP (US
dollar bull) to wait for the inevitable? I remember reading an article you
wrote that you can't buy these with a buy and hold strategy. If so, what
"canary" do you look for to jump in that trade?
That is a very good question.
What we are talking about here is
market timing, or even more specifically, the timing of placing a specific trade. This is the
tricky part of trading that the talking heads never get around to.
It is one thing, for instance, to have
a general view of what might happen, and then wait for events to play out
just to say, "Told ya so!" It is another
thing to not just identify a potential market development in advance, but to
position for that development and act on it profitably (with real capital on
the line).
And you are right,
"waiting for the inevitable" is a tough thing to do with capital at
risk, especially in this incredibly uncertain climate. One can wait a very
long time for markets to come to their senses... or, as Keynes so famously
put it, "the market can remain irrational longer than you can remain
solvent."
So this takes us back to the timing
question. When a trader develops a view on a situation -- like, say, the
potential destruction of the eurozone -- it does
not necessarily make sense to act on that view right away. Certain confirming
factors ("canaries") should be present, and certain tools are used
to pinpoint the timing of a good trade.
Perhaps the simplest explanation of
trade timing comes from Michael Marcus of Market Wizards fame, an early
Commodities Corp. trader who turned $30,000 into $80 million (if not more) in
the 1970s and '80s.
According to Marcus, assessing a good
trade was a matter of three things: Fundamentals, Technicals
and Market Tone (or sentiment). Marcus believed you could trade
"anything in the world that way," i.e. operating on those three
inputs. His track record suggests that he was onto something.
We can look at each of these and see
how they relate to timing:
·
Fundamentals are useful
in alerting the trader to (1) imbalance between supply and demand, (2)
imbalance between perception and reality, or (3) both at the same time. When
you get both together -- supply and demand out of whack coupled with emotion
at extreme levels -- that is when you really have something. Last year's
"trade of the decade," for example, would have been buying gold in 2002, a point at which
demand was ridiculously low and perception was about to embark on a major sea
change.
·
Technicals involve
making use of price charts to determine attractive reward-to-risk entry
points for trades. As another Market Wizard has said, technical
analysis contains a lot that is right and a lot that is "mumbo
jumbo." Putting aside the mumbo jumbo, one can do useful things with
trend lines, moving averages and pattern breakouts to identify junctures of
price where something noteworthy is happening, setting
up for a high-quality entry point. There is no magic in the chart itself, but
guidance from the chart can be indispensable in determining when to take a
position.
·
Market Tone involves
paying attention to the emotional component of what is happening. What are
the other players thinking and feeling? How are they reacting to various data
points? As one anonymous hedge fund manager has said, "the market is not a truth mechanism." Sentiment
drives prices and trends, right or wrong -- so you have to consider whether
you are surfing the waves of sentiment or trying to fight against them when
placing your trade.
To sum up, the skilled trader first develops a
viewpoint through observation, research and analysis. He then examines the
market through all three lenses -- fundamentals, technicals
and market tone. And then, finally, he uses the combination of those three
things, coupled with an eye for "inflection points" or key
developments in the market, to determine what point is best for executing on
a trade.
This is a pretty broad answer, I know.
But then again, "how to time a trade" is a pretty broad inquiry.
Trading is a craft, not unlike winemaking or professional carpentry, and thus
there are many small "tricks of the trade" (no pun intended) to
consider. We could have a two-hour discussion on this topic and barely
scratch the surface.
The good news, though, is that you
have access to multiple trading craftsmen -- such as Zach Scheidt,
Michael Sankowski, Jared Levy and me -- through our
various advisory services. I made my first trade more than 15 years ago, and
my colleagues are just as seasoned (if not more so).
That's
important too because of the final component that goes into timing a good
trade: Paying attention. Paying attention sounds easy, and perhaps it is easy
in small doses. But the rub is paying attention on a constant basis --
watching for clues and signals, keeping on top of developments, day after day
after day. You have to be a little bit nuts to enjoy tracking things as
closely as we do... but then, that's why we're traders.
Justice
Litle
Taipan
Publishing Group
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