Warren Buffett is the world's most successful investor of all time. He is one of my Trading Mentors. When he speaks, I always listen (even if I couldn't do what he does).
One of his key teachings is Buy when everyone else is Fearful, and Sell when everyone else is Greedy. Whilst he applies that very well for himself for the past 6 decades, most people simply cannot do what he does.
For example, the vast majority of ordinary people simply do not have the experience nor the accuracy to define "Fear" and "Greed" in the market place like he does. Let's consider a more specific example.
Question: Would Buffett define the market as being currently fearful on Crude oil and ERX?
Crude Oil Charts
First, a couple of background charts on Crude Oil Futures.
Starting first with the 20 year Monthly chart on the RHS. Note in Q1/2015, Crude Oil successfully bounced off the very long term Uptrend Support Line that goes back before year 2000. This is not just any Support Line, but probably the "mother" of all Support Lines, as this Support Line is over 15 years. The question is - Has Crude Oil put a multi-year bottom?
I also show a multi-year DownTrend Line drawn from the 2008 peak to the most recent peak. It cuts through a few peaks and valleys along the way, suggesting a very significant resistance. This is also not a weak Resistance line, as it stretched back since 2008 (7 years), although not as strong as the first Support Trend line.
The question is - if you are Buffett, is this the time to buy Crude Oil stocks, when "Fear" appears to be on a multi-year high and Prices near all time "Low"?
ERX Profile and Charts
Here is the same type of chart but for ERX. If you are not sure what is ERX, click here for the profile. Basically, ERX is a 3X leverage ETF off XLE, and XLE is the ETF that generally corresponds with the Energy Select Sector. ERX is a relatively new ETF, only started since 2008.
If you are a "Dip Buyer", the price appears to sit on a very long uptrend line since 2009 (see RHS chart below), and on a Daily basis, appears to be sitting on strong support for the 5th time (see LHS chart below). Both appears to be a valid reason to "pick bottom". Momentum indicators are also Oversold, whether RSI or Slow Stochastics. Yesterday Volume is high, suggesting capitulation. Implied Volatility spikes up, suggesting fear.
So, if you are Buffett, would you buy as price is near all time low, and fear seems to be spiking up?
Before you go on the long side, consider if you have the odds on your side to win for your time-frame.
Respect the 200-day Moving Average Slope
The biggest problem I see with the ERX long trade and going long with Crude Oil today is the slope of the 200-day Moving Average, notwithstanding Buffett. It is still sloping down. As a working trading rule, when the slope is down, and your trading time-frame is 2 weeks to 2 months, my belief is that the odds are against you when you trade against the slope.
Odds are just odds. It does not mean that if you make the trade now, you will lose. Odds only applies when you have made 100 trades, not 1 trade. Anything can happen with 1 trade. It is highly possible that buying at $48.35 will win. It is highly possible also that buying at $48.35 could later see $48 support broken, followed by $47 support broken, followed by $44 support broken, followed by new lows.
What does this mean?
To me, the ERX chart means this:
1. Safer to pass the long trade, as the 200-day MA is sloping down and a time-frame of 2 weeks to 2 months puts one at the mercy of the longer term trend.
2. If you must play speculatively against the broader trend, the position size MUST be small, not larger than normal. (This however is NOT smart trading).
3. The smarter, lower risk trade is to wait for a pullback up to the 200-day MA (or another major resistance), and then take the short trade as long as resistance holds and price starts to drop from that resistance.
So, Buffett doesn't matter?
If your trading time-frame is 2 weeks to 2 months, then, Buffett's buy and hold investing methodology doesn't matter to you.
This is because, one of Buffett's risk control is the ability to hold a fundamentally great business, even if price drops 50% from $48, hold for several months and years because his "holding power" enables him to be right over the long term. He is perfectly happy if the stock market closes over the next 5 years, which makes him super-exceptional.
So, if you buy and then bail out when price drops 10%, 20% or more, you are not following Buffett, and this makes a critical difference because price will prove him right over the long term, but you have just made a loss over the short term.
In addition, Buffett rejects leveraged ETF like ERX. In addition, Buffett also reject owning a broad-based ETF like XLE or ERX because it comprised of good and bad companies.
So, it's about Trading a Style that Uniquely Best Fit You?
Yes, because you are the Trader and it's your own account. A solid system that "fits you" will increase your equity over the long term. A better system on paper that "doesn't fit you" will more likely cause your equity to reduce over the long term. Blindly following Buffett without assessing how it fits into your own specific and unique trading system will cause you more damage over the long term.
In short:
- When the 200-day MA is sloping down, don't go long. You can do nothing, or consider Selling the Rally. When you pass a trade and not make a profit, that is OK.
What if die die must still go long?
- When the 200-day MA is sloping down, and you are still extremely tempted to go long and cannot resist it, then, if it's truly life or death for you (it means something is probably wrong with your psychology), you must tilt the odds to offset the declining 200-day MA:
1. Never bet more than half the normal size to minimize damage.
2. Wait for the "best" setup - require that the price action on the downside is "extended" and "extreme". ERX is an ETF of many good companies, odds improves that if it moves too far down, some kind of a "pullback" becomes more likely. So, the further away it pulls from a mid term MA, the better.
3. Wait for the "turning point" - Require that the momentum indicators are Oversold / very oversold, i.e. at an Extreme. This is similar to point 2.
4. Give yourself "buffer" by selling a far OTM Bull Put Spread so that even if price falls, you can still come out a winner. However, be prepared to cut loss / make adjustments.
5. Make the trade a shorter-time-frame, because the longer the time-frame, the more likely the 200-day MA downslope will exert itself.
6. Look for smaller wins fast, because markets make it more unlikely to get big wins from the long side in a downtrend.
7. Time it perfectly - anticipate and require that ERX has successfully bounced off a very, very strong Support that is tested for the first time, not the 5th time. Look for reversals at shorter time-frames like Hourly or 15 minute charts.
8. Cut loss fast when you are wrong. Keep your losses small at all times.
9. All 8 points must exist. If one is missing, abandon the long trade.
In short, when you trade against the trend, expect to work extremely hard, always demand perfection from yourself, always be very precise and very accurate, always be very nimble, aim to win small, accept higher likelihood of making mistakes and lose, and expect a higher risk of making mistakes and losing bigger too.
But ask yourself this basic question first? Why must "die die" go long? Why not look for 1 foot hurdle to walk over easily, instead of looking for 6 feet hurdles to jump over?
Isn't it much easier to pass the ERX long trade and take the other much easier trades? Or wait until the 200-day MA slope starts to flatten out and rise before going long?
Contrast the following when you trade with the trend - no need to be exactly precise, more relaxed trading, small mistakes which still generates profits, lower likelihood of making large mistakes / losing. Why not trade with the broader trend?
Conclusion
Over the long term, if your trading timeframe is around 2 week to 2 months, you can't go wrong trading in line with the slope of the 200-day Moving Average consistently.
It means you will never pick bottom. It means you will never score the unlikely big win from bottom to peak. It means a "boring" way of trading, and it is not exciting at all.
But odds are, your equity will grow consistently over the long term.
No comments:
Post a Comment