Wednesday, May 30, 2012

Our Worst Call of the Year and How Tight Stops Can Save the Day (XHB, ITB)

When a position goes against you it either means your thesis is wrong or your timing is wrong.
In either case the operative word is wrong.
Last August I tried to drive the point home in "Lincoln on Bank of America (BAC)":
Embrace your losses.
Booking your losses should be a joyful thing.
The first loss is the screw it. 

Tight stops give you the opportunity to look like a moron but if an individual or a firm is to survive, you must avoid the cat lady syndrome (you've heard it every time the guys in the biohazard suits are called in):
"It started with just three but then, well. it kind of got away from me" 

The only way to prevent losses from getting away from you is to close the trade one penny above the level you've given yourself. If you are indecisive or if your ego is so childish that it won't allow you to recognize a loss you have to ask yourself what the heck you're trying to accomplish....
The market philosopher, Patty Smyth describes the appropriate weltanschauung:

One of the masters of the Chicago pits, Everett Klipp, said, in our in memorium post:
Climateer Line of the Day: "Babe Ruth of the CBOT" Edition
"Mr. Morris told me anytime you can take a loss, do it. and you'll always be at the [CBOT]," Klipp says, "I lost money that first day and kept losing until I retired in 1998." 
If you have the time that entire post is worth the read.
The point was the basis of a very large fortune early 19th century fortune:
...Ricardo’s Golden Rules Of Investing
Ricardo never wrote down his trading techniques, but business associates said that he held scrupulously to his two “golden rules”: “Cut short your losses” and “Let your profits run on.” He also took advantage of undervalued and overvalued situations, based on the observation that the investing public often exaggerates events, and he may at times have engineered these overbought and oversold conditions, as noted above....
Now back to the headline story.

On March 31 we posted "Lumber Says This Is A Top For Housing Stocks" (ITB; XHB) which we reiterated in "Follow up to ""Lumber Says This Is A Top For Housing Stocks" (ITB; XHB)" on April 1

It worked for a couple weeks and then it really, really didn't work, ITB and XHB are homebuilder ETF's:

 Via Yahoo:

Chart foriShares Dow Jones US Home Construction (ITB)

We got stopped out and I forgot about the trade until I saw this chart at Abnormal Returns.

Lumber 0512 624x310 Tuesday links:  uncommon ownership
Have you checked out lumber prices this year?  (WSJ)

Tight stops. They allow you to forget the losers.