"Only those who dare to fail greatly can ever achieve greatly" - Robert Kennedy

It seems fitting with so many tributes to Robert Kennedy this past week to include a quote from him that can easily be applied to stock market trading.  Indeed the quotation may be considered analagous to Buffett’s famous adage:  "Buy Fear and Sell Greed".

What is not so well known is that Buffett later revised his quote.  Recognizing that few have the mental fortitude to trade bullishly in the midst of panic and bearishly in the midst of exuberance, he expanded upon his statement with this more recent remark:

"You know, I always say you should get greedy when others are fearful and fearful when others are greedy. But that’s too much to expect. Of course, you shouldn’t get greedy when others get greedy and fearful when others get fearful. At a minimum, try to stay away from that."

Moreover, Buffett commented that

"Stocks are a better buy today than they were a year ago. Or three years ago."

But how many will have panicked following Friday’s move and failed Buffett’s ammended statement?  The likelihood is fewer still will have dared consider any bullish position. 

At Stock and Option Trades, we were fortunate to side-step both Thursday’s greed and Friday’s fear.  Indeed, in Thursday’s blog, we stated:

"Factoring in the fickle nature of the markets recently, it only reinforces the fact that caution and patience are needed when trading.  We have seen far too many attempted breakouts fail during an unstable market."

With that said, we have commented that more aggressive investors can start to dabble (buying the fear).  And by dabble, we mean scale gently into the market.  We expected co…

This week we considered a position on the XLF, the Financial Select Sector SPDR.  But before deciding whether to enter a trade, we needed to sneak a peak behind the XLF in order to view its consituent components and hence discover whether the reward to risk ratio might be attractive at this point in time. 

The first step in uncovering the XLF is to discover the primary holdings for the Select SPDR. Yahoo! Finance reports that the top 10 holdings are:

American Express (AXP) - 2.48%

American International Group (AIG) - 5.95%

Bank of America (BAC) - 8.84%

Bank of New York Mellon (BK) - 2.5%

Citigroup (C) - 5.93%

Goldman Sachs (GS) - 3.38%

JP Morgan Chase (JPM) - 6.84%

US Bancorp (USB) - 2.77%

Wachovia (WB) - 3.03%

Wells Fargo (WFC) - 4.94%

Looking at some of the major holders in some more detail, we can find out even more about the XLF.  Let’s start with American Express.

American Express started an uptrend in March and so far the uptrend has remained intact despite the most recent correction in the market and in financials on the whole.  That’s a good start if we’re considering a bullish thesis on the XLF.

AIG has had its share of woes lately, but late in the week received an upgrade from Morgan Stanley citing the most recent correction as being ‘overdone’. 

Certainly from a reward to risk perspective, AIG is looking attractive as a longer term play.  2-0 for the bulls.

If good co…

From a young age, many of us are conditioned to believe that the harder we work, the greater will be our successes.  The advice stands up to scrutiny in most respects.  Whether studying hard to graduate from school or working hard on the sports fields to ‘make the team’ and ‘beat the competition’, hard work pays off.  And then we transition into the professional world and soon discover that promotion and increases in pay follow from going the ‘extra mile’.  So, by the time we have amassed a level wealth with which we can trade or invest in the stock market, we our heavily conditioned to believe that hard work means greater success; the habit was formed through a lifetime of practice.  The cause (hard work) and effect (greater success) relationship becomes so ingrained that we often consider it indisputable. 

Yet, for many new traders and indeed many experienced ones, translating the habit of working hard into stock market trading does not lead to the expected level of reward.  The attraction for so many is to confuse working hard with trading actively.  Working hard in the stock market is necessary for long-term success.  It means conducting due diligence: fundamental, technical, sentimental, and economic.  However, trading frequently should not be so easily equated to working hard.  While many outstanding traders engage in active, short-term day-trades, a great many others engage in trading excessively because it offers a level of excitement.  Indeed, Tony Robbins contends that two of the six primary needs of humans are certainty and uncertainty.  As humans, we need to be excited on a regular basis in order for our interest levels to be maintained.

Examining aspects of our lives, we can quickly see that this contention may be very accurate.  Why is it tha…

This weekend, let’s digress into the murky world of psychology!  Murky only because it is not often as clear as the clean world of technical analysis that can provide crystal clear buy and sell points!  And murky because it involves something less tangible than fundamental or technical due diligence.  Instead, it demands an understanding of the human psyche and how we can be affected by different behaviors and circumstances.  In this section, we will share with you some findings from leading psychologists and we encourage you to relate the findings to your own stock market trading.  If possible, look honestly at your own trading activity and try to improve from the observations noted below.

In stock market trading, understanding the psychology of the crowd is critically important when attempting to improve your own trading activites.  Psychologists are aware that the psychology of a crowd differs from that of the separate individuals composing that crowd.  It is generally considered that there is a crowd of separate individuals and a composite crowd in which the emotional natures of the units seem to blend and fuse.  The change arises from the influence of attention or deep emotional appeals, or common interest.  Think only of the fear that dominates traders’ minds and drives their actions when big sell-offs occur.  The predominant characteristics of this "composite-mindedness" of a crowd are the evidences of extreme suggestibility (hitting the panic button and selling all positions!), response to appeals to emotion (fear-driven panic sales), vivid imagination (it could get worse!) and action arising from imitation (everyone else is selling so I should too!)

Professor Frederick Morgan Davenport once noted

"The crowd is united and governed by emotion rather than by reason.  The expl…

Dear Diary,

Last week’s Market Commentary to members concluded:

"Technical analysts will cite bullish breakouts and push retail traders into bullish trades now.  We spoke in recent weeks of the potential for the stock market to remain bullish through early May, which would lull investors into complacency, believing that "Sell in May and Stay Away" would not materialize.  Everything is going according to plan in that regard.  The markets remained bullish through last week and optimism is high again that 13,500 will be just around the corner…..we are highly skeptical of any meaningfull bullish follow-through.  By week’s end we will be very surprised if the strength has been maintained and, as a result, are entering bearish positions"

As it turned out, the Dow Jones Industrial Average ended 3 of last week’s 5 trading days lower and ended the week substantially lower. 

On April 14th we wrote in our Monday blog that we expected "strength over the next couple of weeks in the markets assuming the 1325 level can hold…we’re looking for anything above that key threshold level to signal high likelihood of a bullish follow through to the end of the month."

As expected, the bullish follow through materialized once the critical 1,325 level held firm.

One of the factors we consider heavily when trading is general sentiment in the market.  In early May, optimism was high.  The Volatility Index, for example, had not been quite as low since the December and Octobe…

For many options traders, earnings season equates to trading dilemmas;  should a straddle or strangle be entered before an earnings announcement to profit from an expected big movement afterwards or should iron condors or iron butterflies or even naked short options be entered to profit from the inevitable implied volatility crush after the news event? 

If the stock doesn’t move much at all after the earnings report, the straddle and strangle strategies suffer from implied volatility crush while if the stock moves much further than expected the iron condors/butterflies and naked short options run into trouble.  For the iron butterflies/condors, maximum risk is incurred if the stock moves beyond the long option strike prices.  If naked short options were entered, the risk associated with the short calls is theoretically unlimited if the stock were to keep rising while the losses in the naked puts would continue to accumulate if the stock were to continue dropping. 

In short, trading at earnings appears nothing short of gambling.  None of us know (or at least should know) with certainty which direction a stock will move subsequent to an earnings report.  As good as our estimates may be, a chance always exists that a stock will move opposite to our expectations.  For example, we may have created a fundamental thesis that postulates a stock will drop at earnings based on what we project will be disappointing earnings or revenues figures.  However, if management reports in a conference call that forward-looking guidance is considerably more positive than analysts’ estimates, disappointing results may quickly be disregarded by investors in favor of the rosy guidance.  Even if we do manage to correctly assess the direction a stock will likely move, the magnitude of the move is certainly in doubt. 

If we take a look at a hist…

By February 2006, Apple had increased approximately 6-fold in the space of two years.  The stock made an attempt to rally above $72 but failed.  A scary decline ensued as the stock fell to the $58 level, but ultimately found support at its 200-day moving average.  Then it rallied sharply to the $72 region once again, before enountering stiff resistance.  Another bounce back up in May 2006 resulted in an intra-day spike above the $72 region, but ultimately a close below $72.  And that last failure for Apple was the start of an even more scary decline.  For two and a half months in May, June and early July, the stock slid until its July earnings report catalyzed a bullish reversal.

Within weeks the stock had powered higher, but didn’t have enough momentum to reach the $72 level and retraced close to $62.  Another surge higher and finally in September of 2006, the stock broke above long-term resistance at $72.

In both May and September, the stock price spiked above the $72 level.  The difference between the spikes was simply that in May the stock spiked intra-day above the resistance level but ultimately closed below it, while in September the stock closed above resistance.  Moreover, subsequent to the bullish September close, the stock re-tested the old resistance level, failed to close below it and began a surge higher.  The breakout had indeed occurred!

Why discuss the movement of Apple in 20…