In our graduate seminar at Golden Gate University in San Francisco we habitually entertain bright capable students who take our course looking to put it all together — and they frequently do. In the just completed seminar one charming student named Ahmed gave his name to the trader’s dilemma — that is, is one going to take the equity fluctuations necessary to ride a long term trend (often painful) or is one going to attempt to avoid the equity fluctuations buying and selling more frequently to catch wave lows and highs. Chinese proverb: Man who chase two rabbits lose both rabbits.
Ahmed’s dilemma also reflects the analyst’s conundrum. When to hedge. After an explosive rally should one plan to take the inevitable retracement, or should one start hedging?
Of course you don’t have to have it all one way or the other. You can have a little of it — by for example putting on a few shorts and waiting to see what happens. If a downdraft starts you can progressively put on more. The last couple of days we have been stopping ourselves from pulling the trigger on buying the SDS and the QID as a hedge. But something is up. Look at the pattern the last 10 days or so:
Something is going on here, and Friday’s action may be a hint. There was some semi-serious selling on the consumer sentiment numbers. And the way the market takes news gives you and idea of market sentiment. A little bad news might start a downwave.
Some of the conceptual problems here are automatically handled by the investor’s managment of his individual positions. No position should be without a stop. The preferable stop is calculated off a Basing Point. For example, here in the SPX the aggressive Basing Point is at the low just under 970. The conservative Basing Point is just around the low at 870. Big money difference. Aggressive and experienced traders might be putting on a skinny hedge right here and increasing it if price pierces the downside in the little rectangle (?) illustrated above. These markets are so bizarre that fat filters are in order, 5 to 7% — or you can participate in Ahmed’s Dilemma and try to ride the waves.