Category: Market Insights

October 19. 2016 marks 29 years since the so-called “Black Monday” when Dow Jones lost 22% in a single day. Coming into Black Monday, DJIA was already down 20% from its annual highs achieved in August and trading below its 200-day moving average. Paul Tudor Jones, who was one of the lucky guys to make a fortune in 1987 says that he used the 200-day MA as a sign get out and get short. He made 127% net of fees that year.

Not everyone was as fortunate as PTJ in 1987.

Stanley Druckenmiller lost a lot of money during the crash by trying to pick a market bottom.The Friday before the 1987 crash, Druckenmiller goes from net short to 130% long. Here is his conversation with Jack Schwager in The New Market Wizards’ book:

– You’ve repeatedly indicated that you give a great deal of weight to technical input. With the market in a virtual free-fall at the time, didn’t the technical perspective make you apprehensive about the trade?

– A number of technical indicators suggested that the market was oversold at that juncture. Moreover, I thought that the huge price base near the 2,200 level would provide extremely strong support— at least temporarily. I figured that even if I were dead wrong, the market would not go below the 2,200 level on Monday morning. My plan was to give the long position a half-hour on Monday morning and to get out if the market failed to bounce.

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Another important lesson to be drawn from this interview is that if you make a mistake, respond immediately! Druckenmiller made the incredible error of shifting from short to 130 percent long on the very day before the massive October 19, 1987, stock crash, yet he finished the month with a net gain. How? When he realized he was dead wrong, he liquidated his entire long position during the first hour of trading on October 19 and actually went short. Had he been less open-minded, defending his original position when confronted with contrary evidence, or had he procrastinated to see if the market would recover, he would have suffered a tremendous loss. Instead, he actually made a small profit. The ability to accept unpleasant truths (i.e., market action or events counter to one’s position) and respond decisively and without hesitation is the mark of a great trader.

The infamous day trader, Marty Schwartz had a tough day on October 19, 1987, but he managed to cut his losses quickly:

I came in long. I have thought about it, and I would do the same thing again. Why? Because on October 16, the market fell 108 points, which, at the time, was the biggest one-day point decline in the history of the stock exchange. It looked climatic to me, and I thought that was a buying opportunity. The only problem was that it was a Friday. Usually a down Friday is followed by a down Monday.

The high in the S&P on Monday was 269. I liquidated my long position at 267.5. I was real proud of that because it is very hard to pull the trigger on a loser. I just dumped everything. I think I was long 40 contracts coming into that day, and I lost $315,000.

One of the most suicidal things you can do in trading is to keep adding to a losing position. Had I done that, I could have lost $5 million that day. It was painful, and I was bleeding, but I honored my risk points and bit the bullet.

I thought about going short, but I said to myself, “Now is not the time to worry about making money; it is the time to worry about keeping what you have made.” Whenever there is a really tough period, I try to play defense, defense, defense. I believe in protecting what you have.

Looking at the charts above, I have a few main takeaways from 1987.

1.  Crashes in stock indexes rarely happen when they are near their 52-week highs. They happen below 200-day moving averages.

2) The tape gave plenty of warning signs to decrease substantially your equity exposure. SPX made lower low below its 50dma a week before the event. People had plenty of time to raise cash or hedge their long-term long positions.

3) Any quick pullbacks of 20% or more in the general stock market are usually a good buying opportunity for long-term investors. The market took its sweet time to recover from that flash crash and I am sure that buying the right stocks made a big difference in returns.

It is funny how the best traders of all times basically repeat the same things with different words.

Gerald Loeb is the author of ‘The Battle for Investment Survival’ and is one of the most quotable men on Wall Street.  Here are five of the smartest things he has ever said about the stock market:

Financial markets are often forward-looking.

The market is better at predicting the news than the news is at predicting the market.

To make money in the stock market you either have to be ahead of the crowd or very sure they are going in the same direction for some time to come.

Patiently wait for your pitch

Profits can be made safely only when the opportunity is available and not just because they happen to be desired or needed.

Willingness and ability to hold funds uninvested while awaiting real opportunities is a key to success in the battle for investment survival.

The single most important factor in shaping security markets is public psychology.

In addition to many other contributing factors of inflation or deflation, a very great factor is the psychological. The fact that people think prices are going to advance or decline very much contributes to their movement and the very momentum of the trend itself tends to perpetuate itself.

How to recognize future leaders

One useful fact to remember is that the most important indications are made in the early stages of a broad market move. Nine times out of ten the leaders of an advance are the stocks that make new highs ahead of the averages.

It is not important how often you are right or wrong, but how much money you make when you are right and how much you lose when you are wrong.

The difference between the investor who year in and year out procures for himself a final net profit and the one who is usually in the red, is not entirely a question of superior selection of stocks or superior timing. Rather, it is also a case of knowing how to capitalize successes and curtail failures.

 

The fastest way to become a legend in financial markets is to make a lot of money when almost everyone else is losing a lot of money. It doesn’t matter what you do afterward. Jesse Livermore made 100 million dollars during the market crash in 1929. Five years later, in March 1934, Livermore filed for bankruptcy. No one really knows how he managed to lose so much money in such short period of time. Nowadays, he is still one of the most quoted men in the trading circles. His book “How to Make Money in Stocks” is cited as one of the favorite trading books by just about everyone who is anyone in finance.

Here are a few of Livermore’s most interesting thoughts about markets and speculation:

1. The only leading indicator that matters

Watch the market leaders, the stocks that have led the charge upward in a bull market. That is where the action is and where the money is to be made. As the leaders go, so goes the entire market. If you cannot make money in the leaders, you are not going to make money in the stock market. Watching the leaders keeps your universe of stocks limited, focused, and more easily controlled.

2. Patterns repeat because human nature hasn’t changed for thousand of years

There is nothing new on Wall Street or in stock speculation. What has happened in the past will happen again, and again, and again. This is because human nature does not change, and it is human emotion, solidly build into human nature, that always gets in the way of human intelligence. Of this I am sure.

All through time, people have basically acted the same way in the market as a result of greed, fear, ignorance, and hope. This is why the numerical formations and patterns recur on a constant basis.

I absolutely believe that price movement patterns are being repeated. They are recurring patterns that appear over and over, with slight variations. This is because markets are driven by humans — and human nature never changes.

3. Your first loss is your best loss.

When the market goes against you, you hope that every day will be the last day – and you lose more than you should had you not listened to hope. And when the market goes your way, you become fearful that the next day will take away your profit and you get out – too soon. The successful trader has to fight these two deep-seated instincts.

When you make a trade, “you should have a clear target where to sell if the market moves against you. And you must obey your rules! Never sustain a loss of more than 10% of your capital. Losses are twice as expensive to make up. I always established a stop before making a trade.

4. On the importance of sitting tight and being patient with your winners

They say you never go broke taking profits. No, you don’t. But neither do you grow rich taking a four-point profit in a bull market.

I did precisely the wrong thing. The cotton showed me a loss and I kept it. The wheat showed me a profit and I sold it out. Of all the speculative blunders there are few greater than trying to average a losing game. Always sell what shows you a loss and keep what shows you a profit.

The market does not beat them. They beat themselves, because though they have brains they cannot sit tight. Old Turkey was dead right in doing and saying what he did. He had not only the courage of his convictions but also the intelligence and patience to sit tight.

After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting.

5. You don’t have to be active every day.

First, do not be invested in the market all the time. There are many times when I have been completely in cash, especially when I was unsure of the direction of the market and waiting for a confirmation of the next move….Second, it is the change in the major trend that hurts most speculators.

Always remember; you can win a horse race, but you can’t beat the races. You can win on a stock, but you cannot beat Wall Street all the time. Nobody can.

There is the plain fool, who does the wrong thing at all times everywhere, but there is also the Wall Street fool, who thinks he must trade all the time. No man can have adequate reasons for buying or selling stocks daily– or sufficient knowledge to make his play an intelligent play.

Remember this: When you are doing nothing, those speculators who feel they must trade day in and day out, are laying the foundation for your next venture. You will reap benefits from their mistakes.

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