I sincerely hope you weren’t majorly short the Financial sector the last few days - if so, I hope your stops took you out before carnal and potentially devastating damage was done to your account. Let’s look at what went wrong (and right) so quickly.
Let’s assume you heard the news of how Financial stocks were collapsing, Indy Mac was taken over, the US Banking system was on the verge of collapse or any other manner of bearish news. Let’s assume you’d heard that you can ’short’ the financial sector (make money while they go down) in an ‘inverse’ fund (meaning, you ‘buy’ the fund to get short). Let’s assume that you were told you can make a lot more money with an inverse leverage fund, such as the SKF. Let’s assume you got short early this week. May we also assume you didn’t know much about ETF funds and this was one of your first experiences with them?
SKF: UltraShort Financials ProShares:
So early in the week, your position was way up. Something ‘bad’ happened on Wednesday. Shares you had purchased in the $200 per share area suddenly plunged to $160 - weren’t the financial stocks supposed to plunge? How could they possibly be rallying (and your position falling) if there’s so much bad news out there? For heaven’s sake Jim Cramer - Mr. Bullish man - even told you to “sell everything, especially Financials” last week.
How could something so ’sure-fire’ go so wrong so quickly?
From a high of $210 a share on Tuesday to a gap-down today and low of $136 on Thursday, the UltraShort (two times the leverage of the XLF) Financials ETF has absolutely killed the many people and funds that aggressively accumulated it, thinking it was a safe bet with all the rampant horrific financial news out there.
We generally learn that when extremes permeate the marketplace, short-term capitulation or euphoria takes over, and literally everyone who wants to buy has already bought (or sell) and there then exists a vacuum to the opposing direction, which is then exacerbated by profit takers and stop-loss levels being triggered.
If you failed to put in a stop-loss - even a ‘damage control’ stop beneath the rising 20 period moving average - you were in for a massive and tremendously unexpected surprise. Even if you weren’t involved in this calamity, there are many lessons to learn.
1. Never buy something that’s grossly overextended beyond its 10 or 20 period moving average
2. Never buy (or sell) something when it seems it is a ’sure-fire bet’ that can’t go wrong - often, trader confidence is negatively correlated with ensuing price action (if we’re “sure” prices will go up, then they’ll often go down - hard).
3. Always trade with a stop loss, even if it is considered by you to be a ‘disaster’ loss.
4. Try not to follow the crowd in our out of a stock or sector
5. If you’ve learned these lessons, it may be safe to trade against (fade) such uniformity of thought
Also, only use leverage if you know what you’re doing, how the leverage affects you on the upside and downside, and know the worst case scenario provided it occurs - you may need to place tighter stops with a leveraged position. Also, it’s best to use leverage only with proven experience and time in the market.
Also, don’t give up - the lessons we learn today, even if painful, will only make us better traders, if only we learn what NOT to do.
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