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No Superstition in the Markets

Written by Briton Ryle
Posted December 30, 2018 at 7:00PM

New Year's Eve. I know, you're not supposed to talk ill of the deceased. So let me just say that I'm looking forward to a better 2019...

Now, I'm not letting the terrible performance for stocks over the last three months put a damper on the whole shebang. Because at the end of the day (or year), it is what we choose to do — or not do — that will have us reviewing the past with a smile or a frown. Here are a few things I'm looking back at as we close out 2018...

Christmas Vacation

I didn't grow up with a winter vacation. Sure, we went to my grandparents’ in South Carolina, but a week with Lucius and Pauline Corder was not a vacation. They were fine people, just maybe unfulfilled because my grandfather should have been a football coach. But his older brother was on the path to the clergy when he drowned at their swimming hole. So my grandfather took up the call, out of guilt, I guess. Now, Lucius Corder is a great name for a Southern Baptist preacher. It would've worked fine for a football coach, too. My grandfather didn't live the life he really wanted. Anyway...

When I was a kid, you vacationed in the summer at the beach. This time last year, I was enjoying a cocktail on Isla Mujeres, about a mile off the coast of Cancun. The year before, it was Puerto Rico. My daughter started college this year, so we decided to stay put. With a sizable tuition bill, we thought keeping spending in check was a good idea. And maybe the young lady might prefer some truly relaxed downtime at home after the first semester.

WRONG. You only go around once. Why play it safe? Always choose "awesome" over "play it safe." I'm a little sad that I am still learning this lesson. But I can tell you that I will NOT be in Baltimore next Christmas/New Year's...

The Volatility Spike

It started in late January and lasted only about a week. But holy moly, that spike in the Volatility Index (VIX) was amazing. I've written about the VIX before — here's a good one. Anyway, you may not remember the events from last January–February, but I had my Real Income Trader subscribers positioned in the trade of a lifetime: We had just bought VIX call options (a trade that makes money when the price goes higher), and the VIX was about to run from around 14 to over 50. 

We bought the February 17 call option on January 31 for $0.55. That means 10 of those calls would run you $550. A week later, when the VIX hit 50, those 10 call option contracts were worth around $33,000. Yeah, huge. And we missed it, because we had already sold for a 120% gain in two days.

The numbers sound painful. But if you go into every trade thinking you've got a tiger by tail and you're gonna make 50 times your money, you'll go broke before you make a dime.

I love this story, because it shows that my trading system gets me positioned for winners consistently. Do that on a regular basis, and you'll come home with a tiger from time to time. My Real Income Traders took 50 trades in 2018, about one a week. And we average just about 20% gains each and every time we put money at risk. That's damn good.

The Natural Gas Spike

This one relates to the volatility crash. Because when you have an asset that has very predictable price action over years, it attracts a lot of weird, risky trading. Maybe you've heard of volatility trading or premium selling? Well, when prices look predictable, some traders will make money by selling time.

Think of it in life insurance terms. Say you're 50, and you want to buy a million-dollar life insurance policy that will pay out if you die in the next month. It won't cost you much, because insurance companies have all kinds of data that say you're not likely to die in a month. Their models tell them that the odds of you dying in the next month are so remote, so they should sell this policy as often as they can... it works great for a while. But eventually the long shot will come through.

Natural gas has been like $2.50 per MCF for what seems like a decade. The price might jump a time or two a year, but everyone knows it's going right back to $2.50. So there are plenty of traders who will sell you an insurance policy that pays out if natural gas spikes.

Well, this November, the natural gas long shot paid, and one $100 million hedge fund blew up very publicly. You may have seen the video that went viral, the tearful admission from the OptionsSellers.com founder that a "rogue wave" not only completely wiped out the fund but also left investors with margin debt they would have to meet out of their own pocket. Ouch.

Couple things here. One, there are no "rogue waves." Weird, unpredictable things happen all the time. And plenty of arrogant assholes will try to get their five minutes by telling you they've got it all figured out. I feel bad for the investors who got crushed by this get-rich-quick scheme. I do. But c'mon. You been around long enough to amass $500K in investible cash, and you get sucked in by a hotshot Rolex-wearing DB? Wow. 

The second thing is the term "margin selling." Any time you hear these words, your ears should prick up. Margin selling means leveraged investors have just lost a lot of money, and whatever assets they have left are being sold to cover the leverage. 

People love to say that markets are driven by sentiment, by economic growth, by earnings... In fact, I say that earnings drive the stock market all the time. But the truth is that there's one catalyst even more basic than those: liquidity. If there's cash available, it will get out to work. You ever notice that people's "sentiment" is better when they've got a few bucks in their pockets? This is why in a weird, expensive way, QE works. It's why a rallying stock market really can juice the economy. 

Margin selling is the opposite. Margin selling is an act whereby liquidity is removed from the market and losses are forced onto the balance sheet. It is the vicious cycle: prices fall, people are forced to sell, prices fall more, more people sell... pretty soon people are talking about a bear market.

I'm not going to tell you that the correction we've been in was caused by that rogue wave in natural gas. I also won't tell you it's just a coincidence that the rogue wave hit just as the markets started selling off. You and I are free to have all the superstitions we want. The stock market doesn't believe in superstitions.

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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