Sunday, October 25, 2020

Top 11 Trading Lessons

With the last big week of earnings season ahead and plenty of news expected, not to mention the many other things weighing on investors minds, next week promises plenty of volatility.  For stock traders, this is actually a great setup and gives them opportunities to make more money than possible in a market that has little to no volatility.  So while volatility can be nerve racking for a long term investor, for a trader it's a opportunity to profit.  Of course, it's also an opportunity to lose money if you don't know what you are doing.  

Trading stocks is really about taking calculated risks and managing your risk.  I wanted to use this post to talk about some lessons I have learned over the past few years trading stocks and options that I think might be helpful to some newer traders.  These lessons have been painful and costly, but I feel like they have been very valuable and have made me a better investor.  I'm generally a pretty risk averse investor, so my approach to trading stocks and options, while certainly aggressive, has a definite tilt toward my inherent conservatism.  This approach may not work for everyone and as usual, I'm not recommending any particular approach - you'll have to figure out what works for you.

Here's a rundown of my top 11 trading lessons learned:

  1. Portfolio Size - Keep trading portfolio allocation modest relative to overall portfolio size (Financial Fortress) - It's important that when you are trading, you want to make sure you isolate the money you are using from other life savings and asset "buckets" to insulate yourself from trading losses, should your risk management strategies fail
  2. Position Size - Keep individual position sizes small relative to your trading portfolio - 2-3% for individual options positions and 10-12% for stock positions
  3. Company Size - Stick with the large cap stocks - the markets for these stocks are generally more liquid than smaller cap names and bid/ask spreads are generally tighter which means it's easier to buy and sell positions and to get better pricing; also if you do suffer a temporary setback in a particular trade, you can always hold the stock until it recovers especially if the long-term trend has been positive (this does require some patience, of course)
  4. Margin - Don't use excessive leverage - if using margin, keep the percentage low to avoid triggering a margin call in the event your portfolio value drops (I like to target 30% or less since most brokers will let you margin at most 70% depending on the stocks in your portfolio); when trading options, always use cash
  5. Earnings Season - Unless you are "long" in the stock or option or are selling covered calls (to capture the elevated premium and you don't mind continuing to own the stock post-earnings), avoid earnings week trading of calls and puts (especially the ones that expire that week or the week after) - that's basically gambling and while you can make 10x sometimes, you can lose everything and in my experience, that's what happens most of the time - the sellers of those calls and puts are banking on it
  6. Risk Management - Remember that options trading is a zero sum game - there is one winner and one loser in every trade - try not to be the loser by focusing on risk management
  7. Risk Management II - Understand your break-even point for each trade and the maximum loss you are willing to take - sell when you hit that point to keep your losses small (remember that with options, the price goes to zero at expiration if they are "out of the money," so selling early for a loss may be better than waiting for a miracle)
  8. Risk Management III - If a trade is not working, close it out - don't wait and hope for a rebound, your money can be better deployed somewhere else
  9. Don't Sell too Soon - If a trade is working, let it continue to work and set a reasonable profit target to exit
  10. Trades that Work - My favorite trades that have most consistently worked:  selling covered calls on "household name" stocks (I found a great free webinar on Barchart here that you might be interested in that does a good job of explaining this strategy), and also buying long-term call options (3-6 months out) and taking small profits along the way - 10% to 30%
  11. Trades that Don't Work - My least favorite trades that have not worked:  selling short term put and call credit spreads - these are difficult to risk manage if the stock moves in the wrong direction, since there's not much time to recover and they are costly to exit and mitigate losses; to make money on these trades, you have to be right about 80% of the time, which is not easy to do; longer term put credit spreads can work, but generally the further out they are, the lower the premium relative to the risk of loss you take, which is not appealing

The Financial Fortress approach would ensure that you are broadly diversified across asset classes and your stock trading portfolio should not be a large component of your overall financial picture, so even if you suffered heavy losses (which shouldn't happen if you are managing risk appropriately), the impact to your net worth should be minimal.  The diversification in your stock trading portfolio need not include other asset classes like bonds or real estate, unless you don't have exposure to those areas in other parts of your Financial Fortress.  I'm not recommending any particular stock or strategy.  Stay safe, healthy and positive.  

I hope you find this post useful as you chart your personal financial course and Build a Financial Fortress in 2020.

To see all my books on investing and leadership, click here.

Sunday, October 18, 2020

Managing Through the Uncertainty

Over the past week, the stock market seemed like it wanted to break out, especially with some positive news from generally better than expected bank earnings.  However, the market's performance was muted, with uncertainty about rising COVID cases in Europe and the US, setbacks in vaccine / therapy development reported by Eli Lilly (vaccine study paused due to safety concerns), Johnson & Johnson (vaccine study paused due to safety concerns) and Gilead (Remdesivir may not improve COVID survival rate), proposed regulation of "big tech," the US presidential election and the nature / timing / amount of fiscal stimulus all serving to tamp down the bulls with all three major stock market indices up only slightly for the week.  Some other potential negative news was China looking at approving its own technology protection law (restricts sensitive exports vital to national security), which could make doing business more difficult for all technology companies in China, including those with foreign investors.  

Positive news included Apple's announcement of its new iPhone product line, but as usual the stock sold off after the announcement.  Apple reports earnings the week after next (on 10/29) and could see a run up to earnings after last week's sell off, so that one is worth watching.  Retailers got a boost from the "new Black Friday" Amazon Prime Day and similar events held last week by other big box retailers (Wal Mart, Target, Best Buy) and also a positive retail sales report on Friday.  While goods seem to be leading the recovery, services (including food service and drinking establishments not to mention travel and leisure) which account for 2/3 of the US economy are still firmly in a recession, which is the cautionary note coming out of the otherwise positive report.   In other positive news, General Motors (GM) announced that it will be deploying fully autonomous vehicles in San Francisco, which follows news that Google's Waymo launched a fully autonomous service in Phoenix.  GM is also launching an electric version of its iconic Hummer truck, which will certainly get some attention.  Up until now, the autonomous vehicles were required to have human "co pilots."  This is a significant development, particularly as Tesla (TSLA - also slated to report earnings next week on 10/21) has talked about a "robot taxi fleet" program where Tesla owners could rent their car to the program when not in use and earn extra money.  That program, if launched, could be a game changer since estimates are owners could earn up to $30K a year from leasing their car to this program.

For now, it seems like volatility will continue at least until early November and the election results are known.  Some analysts think there will be as much as a 10% dip if the election is contested, but polling and betting oddsmakers currently show that will be unlikely.  Many believe there will be a relief rally once the election results are final.  As always, trying to time those events will be difficult so it's best to remain broadly diversified and appropriately invested in the market.  I'm still bullish, but I am increasing my overall cash position to wait out the election and its aftermath, given all the volatility in the past several weeks and the related uncertainties discussed earlier.  I'm mostly looking at smaller bullish earnings option plays for select companies reporting in the next four to six weeks.  My favorites are the big box retailers (especially in light of the aforementioned retail sales report, early kickoff to the holiday shopping season and continued strength in housing), such as Home Depot (HD), Lowes (LOW), Target (TGT), Wal Mart (WMT) and specialty retailers Lululemon (LULU) and Ulta Beauty (ULTA).  I also like Fed Ex (FDX), which looks to continue to do very well in the post-pandemic world and especially as the holidays approach and which will certainly see the highest ever online purchasing due to COVID.  Similarly, McDonald's (MCD) seems like a good play for affordability and safety (drive through / delivery) in the midst of the pandemic / recession and also it's great marketing, recently partnering with celebrities to drive sales.

Diversification, managing leverage and position sizing are critical.  Borrowing too much on margin or taking too large a position in any one stock / option could wreck your portfolio.  A good rule of thumb I have learned is limiting to no more than 2% of your portfolio in any one position for pure option trades (buying or selling puts or calls).  For stocks, it's good to limit yourself to 10% - 15% of your total portfolio in any one stock, unless it's a very low volatility cash flow / dividend play, in which case a higher percentage may be okay.  

The Financial Fortress approach would ensure that you are broadly diversified across asset classes and your stock trading portfolio should not be a large component of your overall financial picture, so even if you suffered heavy losses (which shouldn't happen if you are managing risk appropriately), the impact to your net worth should be minimal.  The diversification in your stock trading portfolio need not include other asset classes like bonds or real estate, unless you don't have exposure to those areas in other parts of your Financial Fortress.  I'm not recommending any particular stock or strategy and full disclosure, I do own / manage positions in the stocks mentioned above.  Stay safe, healthy and positive.  

I hope you find this post useful as you chart your personal financial course and Build a Financial Fortress in 2020.

To see all my books on investing and leadership, click here.

Sunday, October 11, 2020

Earnings Season Kicks Off - A Look Ahead

Next week earnings season kicks off again with most of the big banks reporting.  Two banks that are favorites of some analysts are Morgan Stanley (MS) and JP Morgan Chase (JPM) for different reasons.  Morgan Stanley continues to establish itself as a wealth manager (a better business with steady, growing cash flows and less dependence on interest rates and ability of borrowers to repay loans), most recently with its acquisition of Eaton Vance.  JP Morgan is expected to have good investment banking results, good results from mortgage refinancing and possibly better than expected loan loss reserves compared to last quarter.    The outcome of next week will certainly set the tone for the next few weeks.  Although expectations are low, some improvement over the last quarter is to be expected.  While stimulus talks are on again and off again, the stock market seems to be adjusting to the reality that it's coming, it just might not be until early next year.  And assuming a Democratic sweep, which polls and betting odds seem to indicate, the fiscal stimulus when it does arrive, is likely to be substantial.  Plenty of economic data continues to point to a slow and steady economic recovery, however the there continues to be broad governmental support for additional fiscal stimulus to ensure the recovery stays on track and to help the many people who are still unemployed and the small businesses who continue to struggle.  Other items of note next week include Apple's (AAPL) reveal of the next generation of IPhones, which should generate some investor interest.  Zoom (ZM) has a two day analyst event which should provide some new insights into its business and future prospects.  Finally, stimulus talks will continue which could add some volatility into the mix.

For next week, I'm looking at selling covered calls "at the money" with a 10/16 expiration for a few stocks that have great recent and longer-term upward momentum, excellent business prospects (post-pandemic "winners") and strong top analyst support.  They are Peloton (PTON), Etsy (ETSY), Twilio (TWLO) and Fuel Cell (FCEL).  Fuel Cell in particular has recently gotten an upgrade from JP Morgan, a recent Department of Energy contract, and stands to benefit from the global push to develop alternative fuel hydrogen vehicles, particularly for heavy trucks.

Longer term, I think the focus on cyclical / industrial stocks will continue and I like chemicals, basic materials, transportation stocks (railroads in particular) and industrials like 3M (MMM).

As the recovery slowly grinds on and the stock market rally continues, there will be many investment choices, but it's important to do your research and look for the companies that stand to benefit the most from the recovering economy and are not "over-priced."  Often, you will get conflicting opinions from the Wall Street analysts, "talking heads" on TV and your own research.  It's important to digest all that information and make your own decisions.  

Diversification, managing leverage and position sizing are critical.  Borrowing too much on margin or taking too large a position in any one stock / option could wreck your portfolio.  A good rule of thumb I have learned is limiting to no more than 2% of your portfolio in any one position for pure option trades (buying or selling puts or calls).  For stocks, it's good to limit yourself to 10% - 15% of your total portfolio in any one stock, unless it's a very low volatility cash flow / dividend play, in which case a higher percentage may be okay.  

The Financial Fortress approach would ensure that you are broadly diversified across asset classes and your stock trading portfolio should not be a large component of your overall financial picture, so even if you suffered heavy losses (which shouldn't happen if you are managing risk appropriately), the impact to your net worth should be minimal.  The diversification in your stock trading portfolio need not include other asset classes like bonds or real estate, unless you don't have exposure to those areas in other parts of your Financial Fortress.  I'm not recommending any particular stock or strategy and full disclosure, I do own / manage positions in the stocks mentioned above.  Stay safe, healthy and positive.  

I hope you find this post useful as you chart your personal financial course and Build a Financial Fortress in 2020.

To see all my books on investing and leadership, click here.



Sunday, October 4, 2020

More Volatility Ahead

When I wrote my post last week about the potential for a lot of stock market volatility in the month of October, I didn't expect it to happen in the same week.  Of course, one thing missing from my list of investor concerns was the President of the United States contracting COVID and being hospitalized.  Now that's what you call a "Black Swan" event and even though there was some encouraging economic data on Friday and stimulus talks are continuing (although new stimulus legislation is still highly unlikely before the election), the market sold off significantly.  This theme could very well carry into next week with more ups and downs ahead.  Between the President's health status, news of more COVID cases in the mid-west and New York City shutting down again due to COVID, investors will certainly be on edge next week, despite the slowly improving economy and hopes for more stimulus from Congress.  

I still think a short-term bearish and long-term bullish positioning is the best way to profitably navigate this market.  Three long-term plays that I like right now are Nikola (NKLA), Terex (TEX) and DraftKings (DKNG).  

I think the selling in NKLA is overdone right now and the company still has a great business model and very savvy investors behind it.  As long as the OEM partnerships (including GM) and the pre-orders  remain intact, the company still has plenty of potential to succeed in a very large market opportunity to replace diesel long haul trucks with fuel cell / battery electric trucks and launch a new fully electric pickup truck.  Although loss of the CEO Trevor Milton was a shock, I think in the long run it will benefit the company to move away from some of the "noise" and focus on execution of the business plan.    

TEX makes materials handling and high reach equipment and there was a recent article in Barron's about them that is a good read.  They are a relatively cheap, small cap play on the nascent economic recovery for a number of reasons, not the least of which is recovery in basic materials industries (and associated demand for mining equipment) and replacement cycles for high reach equipment used by rental operators and other companies, as well as the Company's good execution through the pandemic period.  

DKNG has been a great stock to own, although I liked it better in the $30's, it has the potential to be a $100 stock.  Their dominant position in the legal sports betting market in the US and potential for more states to open up as a solution to budget woes is the long term driver of their growth.  The restart of professional and college sports has been a tremendous boost to the stock, causing it to more than double from recent lows.  As sports continue to figure out how to navigate the post-COVID world, the opportunity for growth in online gambling will continue.  The company is also one of the only pure plays in online gambling, which is particularly advantageous without the need for physical locations and has certainly helped drive the high valuation unlike many of it's competitors such as Penn National Gaming (PENN).

As for short plays, selling a short-term call credit spread or buying a short-term put on SPY or QQQ will work or also buying a leveraged VIX ETF like UVXY.  Underneath the stock market index declines, select individual stocks (such as cyclicals like industrial / materials companies, banks and even airlines) have been doing well in the past few days, while the broader market, driven by technology stocks has sold off in the midst of the volatility.  This is due to investors continuing to shift from technology to cyclical stocks as the economy recovers and to seek out greater value, which has been a big theme recently.  Technology stocks still present great long term growth potential, but their valuations for the most part have gone up so much since the March lows, that investors are more willing to sell those companies to find better upside (or to simply raise cash if volatility is too high).

Every market provides an opportunity for profit, but the key is to stay informed and do your research.

Of course, you will need to do your own homework and invest where you feel comfortable.  I'm not recommending any particular stock or strategy and full disclosure, I do own / manage positions in the stocks mentioned above.  Stay safe, healthy and positive.  

I hope you find this post useful as you chart your personal financial course and Build a Financial Fortress in 2020.

To see all my books on investing and leadership, click here.

Disclaimer:  I use affiliate links where I get paid a small amount if you buy the service or product. This helps support my blog.   


Sunday, September 27, 2020

Stock Market Outlook in the Coming Weeks

The next several weeks promise plenty of news and market volatility, with numerous issues / uncertainties on investors' minds including:

  1. US Presidential election outcome 
  2. Lack of a new stimulus bill out of Congress (highly unlikely prior to the election, even though some lawmakers are still holding out hope of a deal - this also seems even more unlikely given the Democratic uproar over the President's Supreme Court nominee, the confirmation of which is to be completed before the election)
  3. Course of the COVID-19 pandemic as we move into the winter in the US and as other countries in the world begin to see a resurgence and some countries are forced to take lockdown measures again
  4. Persistently high unemployment (rate of improvement has slowed over the past several weeks)
  5. Sluggish economic recovery 
  6. Continued flow of IPO's (9 next week) which causes investors to sell other stocks (mostly tech stocks) to buy, which can drive down the market if selling is concentrated in the FAANG group as we have seen with the recent market pull-back
Some analysts are predicting more volatility in the coming weeks and perhaps some further declines in the major stock market indices as stocks sell off due to the numerous uncertainties.  However, once we are past the election and more fiscal stimulus is available, the markets are expected to stabilize and continue to march higher with the economic recovery, perhaps led by sectors that have lagged in the most recent runup including "traditional" cyclical stocks such as industrial / material companies.  The S&P 500 (SPY) shows a very noticeable break from the rising trend since the March lows (see chart below).  This could be an indication that a further decline can be expected before the selling is done, possibly as much as another 10% to 20% downside, according to some analysts.  Considering how much and how quickly the markets have recovered from the March lows, that would not be surprising.


Similarly, the NASDAQ (QQQ) shows a similar pattern and faces similar downside risks, as shown below:


It may be wise to hold some cash to take advantage of the bigger dip if and when it comes.  Individual stocks poised to benefit the most from the economic recovery should be held with a time horizon of at least four months (January) to allow for election and fiscal stimulus resolution, not to mention possibly a COVID-19 vaccine and more data on how the recovery is doing.  Investors may even be able to look forward to a "Santa Claus Rally."   As mentioned above, "traditional" cyclical stocks seem poised to benefit from a rotation and better performance as the economy recovers, since they have not seen the same post-March rally as technology stocks.

It may also make some sense to make some small short-term bets in further declines in the indices either by buying puts or selling call credit spreads over the next four weeks or so.

Another great idea for capitalizing on the coming volatility, which is expected to spike significantly during the month of October (historically a month that has extremely high volatility) is an exchange traded fund that tracks 1.5x the VIX index, the ProShares Ultra VIX Short-Term Futures ETF (UVXY).  As you can see, the VIX recently started to trend back up slightly but has been on a general downtrend from March as you would expect due to the recovery in the market.


In summary, a short-term bearish and long-term bullish strategy appears to be the best way to approach the current stock market environment over the next few months.  There are several ways to play this as discussed above.

Of course, you will need to do your own homework and invest where you feel comfortable.  I'm not recommending any particular stock or strategy and full disclosure, I do own / manage positions in the stocks mentioned above.  Stay safe, healthy and positive.  

I hope you find this post useful as you chart your personal financial course and Build a Financial Fortress in 2020.

To see all my books on investing and leadership, click here.

Disclaimer:  I use affiliate links where I get paid a small amount if you buy the service or product. This helps support my blog.   








Sunday, September 13, 2020

Volatility is Back!

The last couple of weeks have shown that volatility is back in the stock market.  In particular, technology shares have taken a beating the last couple of weeks with the Nasdaq (QQQ) now testing a key technical trend line (the 50 day moving average).   Similarly, the S&P 500 (SPY) is also testing the same trend line.  Many market watchers think a break below the 50 day moving average means more downside to come - how much is anyone's guess, but an additional 10% correction (SPY is down about 7% and QQQ is down about 11% from their recent all time highs) is not out of the question.  Most agree this correction is "healthy" in that the technology stocks have had quite a run since the March lows and even if you sell now after this small correction, you are locking in some pretty large gains if you own some of the more popular stocks such as Amazon, Facebook, Apple, Nvidia, Tesla, Google, Netflix, etc.  

With the large weighting of these few technology stocks in the stock market indices, their decline (along with many other technology stocks) is pulling down the averages.  Uncertainty about the US Presidential election, the course of the COVID-19 pandemic in the fall/winter, and the lack of another stimulus package from Congress, which almost everyone agrees is vitally necessary to keep the economic recovery on track, have been weighing on investors' minds and have added to the volatility.  However, underneath all the headlines about tech stocks and stock market averages, many stocks that do well in an economic recovery are showing considerable strength.  

Here are a few of my favorite "heavy industrial / cyclical" large cap stocks that look to perform well over the next several months as the economy recovers and investors continue to rotate from tech:

  • Caterpillar (CAT) - 2.7% dividend yield, up 8% in the past month and expected to grow as demand for heavy equipment grows in the recovery
  • United Parcel Service (UPS) - 2.5% dividend yield, up 2% in the past month and poised for further growth potentially after FedEx earnings next week, which is expected to show more growth in package deliveries due to the pandemic
  • Du Pont (DD) - 2% dividend yield, up 2% in the past month and expected to grow as demand for chemicals grows with the recovery
  • Ulta Beauty (ULTA) - No dividend, but up 6% in the past month and expected to be one of the better "reopening plays" as the economy opens post-COVID and people renew their focus on health and beauty products
  • Rio Tinto (RIO) - 6% dividend yield, up 3% in the past month and expected to grow as demand for basic materials (iron, aluminum, copper, diamonds) grows with the economic recovery
  • PPG Industries (PPG) - 1.7% dividend yield, up 6% in the past month and expected to grow as demand for paints, coatings and glass products grows with the economic recovery
A good allocation to cash is also wise in these times to take advantage of opportunities as they arise and if you follow the Financial Fortress concept, you are already well diversified and not worried too much about the stock market's (or any other market's) short term gyrations.  

Of course, you will need to do your own homework and invest where you feel comfortable.  I'm not recommending any particular stock or strategy and full disclosure, I do own / manage positions in the stocks mentioned above.  Stay safe, healthy and positive.  

I hope you find this post useful as you chart your personal financial course and Build a Financial Fortress in 2020.

To see all my books on investing and leadership, click here.

Disclaimer:  I use affiliate links where I get paid a small amount if you buy the service or product. This helps support my blog.