This week ends in a continuous correction movement while trading volume is not heavy. The forecast from last week's outlook predicts a light volume institutional selling for profit taking or to continue heavy buying from individual investors. The former scenario happens. As previously mentioned, individual investors does not have enough confidence to significantly increase the equity stock proportion of the portfolio. Therefore buying frenzy lasts only for just a few days. Institutional investors then use the opportunity to sell at the market top when the buying demand fades out. Selling is in an orderly manner and limited quantity. The amount can be used in other investments such as IPO or emerging markets, or to wait for a lower entry point again.
Although the guess on market movement is somewhat correct, the speculative trading portfolio incurs a loss this week due to inappropriate timing. Long holdings are liquidated and short holdings are initiated too early before the peak. Loss mainly comes from emotional short covering near the peak, thus a very bad timing. For profitable trading activity, such mistake should be avoided. One cause of panic in volatile market condition is over-leveraging. As mentioned in a previous post on the destructive power of leveraging, an over-leveraged portfolio can be easily shrunk or even annihilated by unfavorable market movement. An example is the investment portfolio that is reduced by an order after the financial crisis. The remnant is a major component of current speculative trading portfolio.
There should be a profit if the portfolio remains intact for the last two weeks before the recent rally after Federal Reserve announcement of "Quantitative Easing" plan. This indicates that the trading activities destroy value of the portfolio, hence incorrect investment decision. Objective of the speculative trading portfolio is to recover the investment (gambling?) loss during the financial crisis. Thus the experience will be used to avoid similar mistakes in future. It is expected that a portfolio with quality equity stocks can grow appreciably in the coming years. However, the growth rate is not large enough to recover all the loss within reasonable amount of time. i.e. a few years because the portfolio destroyed during the financial crisis was over-leveraged with damage for extended period of time.
There are two mistakes in the trading activities this week, namely over-leveraging and inappropriate timing. The portfolio is in a margin trading account. It allows margin borrowing while the broker can earn interest from lending to traders. However it seems that some brokers may be very sensitive to volatile market turbulence. It will cause panic if the account is stretched to maximum borrowing and market moves sharply in unfavorable condition. Therefore there should be enough buffer in borrowing to accommodate temporary portfolio loss. Previously it is mentioned that the trading strategy is to allocate 60% of portfolio value for equity stock (30% small cap and 30% mid/large cap) and 100% of portfolio value for leveraged ETF. Assuming 35% and 75% for margin borrowing rate respectively, it is already very close to the limit. If hedging tools are included it can easily exceed maximum borrowing limit. The maximum allocation limit of equity stock and leveraged ETF is still considered within reasonable risk. But in a volatile market condition, it should be avoided to have both reaching the limit at the same time. At current market level, there is no definite direction in short term market movement. Buy and hold strategy for equity stock may not be profitable since many strong stocks have reached or close to historical high. Only weak stocks remain at low but the prospect may not be attractive. There may be oscillation with the increase in interest from returning market participants who have been waiting on the sideline since the rally from bottom in 2009. Therefore leveraged ETF would be the more appropriate trading tools in such environment. Therefore the speculative trading portfolio will reduce holding in equity stocks to provide more buffer for trading activities.
Secondly, the trading activities in this week are made in wrong timing although in correct sequence. Nevertheless it results in overall loss. It is correctly estimated for a rise in market and an aftermath correction. There is existing long holding before the surge. Soon after the surge, there is long holding liquidation and then short initiation later. However it is too early and the surge continues further. Emotional fear on additional loss while waiting results in the decision of short covering. Curiously the expected correction occurs at the same time. Seeing the surge created by frenzy investor buying and the loss from short covering at the peak, it is decided to initiate long position again soon after correction starts. However the correction extends much longer than the surge although the rate is smaller. At the end of the week, it nearly returns back to the level before the surge, only slightly higher. If the long liquidation, short initiation, short covering, long initiation activities are delayed to matched with the best timing, it would maximize the profit instead of the overall loss in current portfolio. Obviously the wrong timing is caused by emotional fear for further loss and then desire to recover loss. This may be common behaviour of many traders. During the 2009 rally, traders are initially selling along the dip on emotional fear. Then suddenly the direction changes. When correction just starts, some late entry traders do not believe in the correction and some even still insist on a double dip today. There may be symptoms for a cycle from observation of the behaviour of market participants. However it is very difficult to predict the peak or trough of a cycle. Unfortunately even if the cycle is predicted correctly, a wrong timing can still incur significant loss. There are plenty of scenario similar to this in prior trading activities. In conclusion, this experience indicates that an appropriate strategy would be helpful to time the waiting in trading execution. It is also important that there is enough buffer in the portfolio to absorb temporary loss during the waiting period. The assumption is that market cycle can be predicted correctly. From past experience, market cycle is predictable because market participants and their behaviour are observable events. However market timing is unpredictable because there is no measure for the tipping point of a market cycle. In order to ensure profit in speculative trading, it is important to assess the timing of trading execution. Accumulated trading experience may help to evaluate a systematic approach.
Currently market is struggling to move in either direction in short term movement. Individual investors triggered the start of the surge and did not continue to hold up the market. Nevertheless they are closely watching with cash on the sideline. It appears that the "wealth effect" from asset inflation will sustain and affect the investment strategy regardless of whether it is equity stocks, bonds, treasuries, commodities, currency, etc. Institutional investors have successfully unloaded portion of the portfolio to diversify to other markets. Current correction may extend for some more time. But eventually, institutional investors will align with individual investors to participate in the asset inflation process triggered by "Quantitative Easing".
As mentioned, it is difficult to predict the timing. However, the correction will end some time soon. Then there may be a calm period before another gradual climb or rally. There is always possibility that a sudden dip or extended reversal may occur due to any events or news. However it will not change the long term direction since the equity stock market will reflect the wealth as well as economic growth in a society. The economy of United States is driven by technology while the economy of developing countries is driven by increasing productivity. Japan and Europe exhibits a stable and developed economy with gradual improvement in living standard. At the present moment, equity stock is still a better investment tool than money market for long term investment. Speculative stock trading can generate more profit/loss than buy and hold strategy.
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