The following is an interview I had with Capital Wave Forecast editor and former hedge fund manager Shah Gilani:
Q: What are the chances for a true crash?
Gilani: A potential for a crash always looms out there. Unless the Fed comes to the rescue, we could get what didn’t happen last year. Last year, a crash was staved off because of the QE2 announcements. Ironically, the market was down 256 points almost to the day last year. We’ll have to see if the Fed comes to the rescue this year. Unfortunately, we never know which card the Fed is playing. It’s like a game of Three-card Monte.
Q: What would happen if the Fed intervenes?
Gilani: The markets could take off if that happens. People might be thinking: I missed last year. It could be like hearing a starter pistol, and the train is the Fed with a handful of cash. So people would jump back in, and we could see a big pop in the market. If you’ve got the backing of the Fed, you jump in with both feet.
The market has gone up because of the monetary stimulus since February 2009. Where did that stimulus go? It didn’t go to building infrastructure. It was used to bail out the banks. The Fed gave the money to the banks so they could rebuild their balance sheets. The Fed wanted the banks to get healthy again. And where did all that short term money go? To the stock market! And to buying commodities. The Fed engineered a stock market recovery. The idea was to create confidence and improve investor sentiment.
Q: Is there a downside to QE3?
Gilani: The downside is if the Fed threw a party and no one came. The negative is if it doesn’t work.
Q: What strategies should you use?
Gilani: First, you should be nimble. Read economic data. Everyday it comes out, read it. Be quick on the trigger and get out. If the Fed makes a move, get out of that train and switch gears.
If you’re an investor, you have to be defensive. There is always time to make money and to get back in. It’s now a stock picker’s market. I want to be in stocks that have plenty of cash flow, has global reach, and supports a nice, fat dividend. I’m not looking for high flyers but stability and preservation of capital.
Q: What else should you buy?
Gilani: If you have money, apply it to strong, international companies with good dividend yields. I like Merck, Rathion, and Microsoft.
Q: Are you nervous about September and October?
Gilani: Always! Especially this September and October. If the Fed doesn’t come in soon, I’d be concerned if the economy doesn’t show better numbers, and if the global markets slow down and pull back.
The following is an interview I had with blogger and professional short-seller Timothy Sykes:
Q: What should someone do right now?
Sykes: The odds favor doing nothing right now. The downside is so massive. If we can’t hold 11,000, it could start momentum. It could be a 10% off sale and people could pile in.
Q: What is so important about Dow 11,000?
Sykes: If 11,000 cracks, then we can see some true panic. Remember, this is just August. We didn’t plan on this. In all likelihood, this is just a precursor to a lot of trouble heading into September and October. We raised the debt ceiling but it’s only good to the end of the year. All we did was stall the inevitable. I don’t expect us to rebound to the highs and break out. Right now, all the momentum players are scared. You can be a dip buyer and make a few points here and there.
Q: Should you short this market?
Sykes: I never short market drops because it’s so difficult. Right now, it’s tough to short down here. The only angle I see is selectively buying strong stocks. You buy into strength and you short into individual strength. I short sell individual stocks that are being manipulated, but I don’t short the whole market.
I also like to trade overreactions. I find that whichever way the market is going, it tends to overreact. So I think we’re going to overreact on the downside. If we overreact in a bull market, people spend more because they’re happier. You have to be extra careful when the market is going down, like now, because a crash could lead to a depression.
Q: How about going long?
Sykes: I wouldn’t build long-term positions on either side right now. It’s better if you trade like a sniper, and be picky. The market is volatile right now. The fundamentals are saying we’re doing great, but the economy is saying we’re doing poorly. On the technical side, the charts are saying you should go short, but a long term short has never worked out well. So we have opposing sides. There is no consensus.
Q: What else should you watch out for?
Sykes: Watch out for earnings losers because they will get smacked the most in this environment. Dump any speculative stocks and focus on earnings winners. Stick with companies that have proven themselves. If the market moves higher, these stocks should move higher. Right now I like Rosetta Stone.
Q: What kind of trader are you?
Sykes: I like to trade like a coward. It’s not about who can make the most money the quickest, but who can employ risk management techniques to focus on survival and consistent profits. The idea is to remain liquid coming into these crashes. By managing my risk carefully and cutting losses quickly, I am not afraid. I’m always thinking of safety first, because it always protects me, even if I miss out on opportunities.
This is my timely article on identifying clues and characteristics of market crashes. Posted on Marketwatch: http://bit.ly/mP8Z9N
Q. Do you expect a crash?
Sykes: I would say there are better odds of a crash than a big spike. I am a short seller. I have a short bias. With our debt and government interventions, eventually something could happen, even if it won’t last. People get freaked out pretty fast.
I don’t know if there will be a crash. The debt and dollar would make the most sense. If we get downgraded, that could cause a crash. There’s a lot of danger on the horizon. One thing I do know: shorting is difficult. You cannot stay short or you will be crushed. It reminds me of the guy who predicted the end of the world several times. It’s no different than people who predict Dow 40,000. They are looking for attention.
Q. What are some clues that precede a crash?
Sykes: Seasonality is a big part of it. Another big clue is when you have a lot of speculative things flying. That is usually the end of a bull market. You can make the case about the Twitter, Facebook, Linked In, and Pandora valuations. It’s possibly a bubble. It sounds amazing; all these companies and their amazing business models. People think these businesses will never stop growing, but that is just bull. With all this stuff flying, it could well signal the end. A lot of IPOs are coming out and raising cash so we’ll have to see.
Q. When do crashes occur?
Sykes: First of all, historically crashes have occurred the most often in September and October, so you need to be extra aware during these two months. Crashes usually don’t happen out of the blue, although sometimes they do. Usually, a market will be downtrending, and people are selling, and then they’ll puke it up in one day. This is momentum that is usually built up over days and weeks. Always be aware of gradual downtrends where there are no bounces. This can lead to a blowoff.
Q. Are there other clues the market might crash?
Sykes: I look to see if the media says we’ve been down 10 or 12 days in a row, and that it’s a record. Even though it’s meaningless, it influences people. It causes people to want to exit in mass. It’s like a run on the bank, and people are influenced by fear. I follow the downtrend or very influential news. It’s no different than buying, that is, when you are looking for positive news.
Q. Can people call the top of the market?
Sykes: People love to call the top because they think there will be a crash from the top. Rarely do you find a specific crash at the top. You might find it failing to break out to new highs. Crashes don’t usually happen at the top, they usually happen after several days or hours of fading. Because people have their stops at the previous high, it can also create a massive short squeeze. That’s why I don’t try to pick tops.
Q. How would you trade a potential crash?
Sykes: I wait for a bounce. I don’t like shorting after a giant drop. I like shorting after a bounce or a failed bounce. If you short into a free-falling market, although you can make quick profits right away, you can also get a violent snap-back rally. That is difficult to protect yourself. But in every single crash throughout history, there has been a bounce, no matter how fleeting. It might not be huge or long, but if you can sit in cash during the crash, you have an opportunity. The best opportunities are during flash crashes.
Note: Part II of my interview with Timothy Sykes will be posted on this Web site in approximately two weeks.
Commentary: Day trading is popular again, and as controversial as ever.
With the huge volatility in the stock market during the last year, day traders are back. Or maybe they never left.
In the 1990s, day trading was all the rage, especially using risky strategies like scalping, where you’re in and out of hundreds of stocks in seconds or minutes, aiming to make small but quick profits. Scalping was profitable until decimalization, and the 2000 crash, when many once successful traders got wiped out.
A few years later, people switched to day trading houses. That lasted until the 2008 housing crash, when many once successful homebuyers got wiped out.
More recently, high frequency traders (HFT), the ultimate day traders, use high-speed computers to scalp for pennies in nanoseconds, which adds up to billions of dollars in profits every year.
Although retail traders can’t compete with these million dollar computers, many lone day traders have returned to the stock market.
Eight reasons not to day trade
Nevertheless, the controversy over day trading strategies hasn’t stopped. Last year, two successful traders, James Altucher and Timothy Sykes, had a blogging war over the benefits and risks of day trading. Dozens of comments from readers appeared on their blogs, attacking and defending.
Altucher threw the first punch in a blog he wrote, “8 Reasons Not to Day Trade.” Link to article here: http://bit.ly/h028VG
Here are a few snippets:
“Everyone wants to be a day trader. Let me tell you the best days. You get in at 9:25 a.m. You make the trade your system tells you to make at 9:30 a.m. And by 9:45 a.m., the trade is done, profitable, and you’re done for the day: $1,800 richer and happy about it…but it’s all a lie to yourself…” In the long run, Altucher says he has none of the qualities of a succ essful day trader. “And neither do you,” he concludes.
Here are the eight reasons why Altucher says you shouldn’t day trade:
1. Suicide 2. You’ll overeat 3. Your eyes go bad 4. Social life 5. Blood pressure 6. Nothing productive 7. No career 8. It’s impossible
Twenty-four reasons to day trade
After Altucher’s blog was published, successful day trader Sykes immediately responded with an article, “24 Reasons to Day Trade.” Link to article here: http://bit.ly/9n1C1h
Here are a few snippets from his blog:
“When I read James Altucher’s article, I couldn’t help but feel anger, and within a few hours of reading it, I experienced many of the symptoms he described, although in a slightly different context…I rubbed my eyes to see if his post was even real, somehow thinking it was impossible that he could write such blasphemy…”
According to Sykes, day trading is thrilling, exciting, mentally challenging, and educational. “Day traders talk faster, think faster, and do things faster. We get more out of life because day trading is a fast-paced job.”
He admits that day trading can be unhealthy, so he suggests hiring a personal trainer to lose weight. And yes, he says, your eyes can go bad, so get a glare protector for your computer. In addition, if your blood pressure is rising, it’s a clue to Sykes the trade is bad. He uses his body as an early biological warning system.
The cure for most trading losses, Sykes suggests, is cutting losses quickly. Learning how to cut losses can also help you in life, real estate, and relationships. Another way to survive the day trading battlefield is to enter a trade with nothing less than a 3:1 risk reward ratio.
It’s easier than ever to be a day trader because of technology, he claims, and you don’t have to be a genius. Ironically, he says he is terrible at math. Sykes says if you’re willing to aim for less profit, you can make a good living as a part-time day trader.
Finally, Sykes suggests that if you’re part of the magical 10% that succeed at day trading, the freedom it provides is worth the effort. And even if you are socially incompetent, he claims, money makes up for it.
The modern day trader
Hopefully, people have learned from past mistakes — when unknowledgeable traders quit their jobs and cleared out their 401(k)’s to day trade. Many modern day traders trade less frequently and are choosier about the trades they make. Although day trading is not for everyone and is still controversial, it can be a viable strategy during certain market conditions.
But don’t dare start day trading without first understanding all of the risks. The first question you should ask yourself before making that first day trade: “What’s the worst that can happen after I place this order?”