Sample chapter from

BEAR TRADING: STRATEGIES FOR SURVIVAL

Daryl Guppy © This abbreviated extract copyright 1998.

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RUN WITH THE BULLS. HUNT WITH THE BEARS. Daryl Guppy ©1998

When you spend three days in an evacuation centre surrounded by floodwater stretching three kilometres on either side and contemplating an almost total loss of your trading office, I assure you trading, and bear trading in particular, looks easy. In just a few days in January 1998, my world was turned upside down with substantial losses. My stop loss was the one in one hundred year flood level and as my home and office were above this level, I did not bother to insure for flood. I did not count on a one in three hundred year catastrophe so my 'stop loss' was literally washed away. Recovery required patience, skill, determination and added a piquant flavor to this book.

In just a few days in September, 1998, world financial markets took a nose dive dragging the All Ordinaries with it. Many market participants believed they were safe. Their stop loss was set just below the most recent high - if they even bothered to think about it. It was a terrifying ride for novice market participants who believed you make money when the market goes up and lose money when it goes down. For experienced equity traders who were already trading in a defensive manner, the collapse delivered money making opportunities using warrants and other derivatives.

This is no teddy bears picnic so our objective is to develop a survival pack for bear markets rather than a fully equipped camping safari. We do not attempt a complete coverage of all the available strategies. Our concern is with survival and once achieved, readers can take the time to follow up the additional reading references scattered through the text.

We start with ordinary shares.

SECTION 1 -LONG BEARS

The first section is centered around equities, or fully paid ordinary shares. These are bread and butter trades for most private traders and can remain so in a bear market. The comfortable living available from trading equities in the bull market hits turbulence when the bear stomps in. Distracted by media hysteria many traders assume all bear markets are the same. Chapter 1, BEAR NECESSITIES is a closer look at the variety of bear market activity. Defining the nature of our particular market collapse allows us to select the best combination of trading tools.

Equity trading from the long side offers a limited range of trading opportunities so BEAR RALLIES defines the first of these. Finding good stocks performing counter trend is easy with computer assisted searches. Deciding the best trading tactics is more challenging. These are not true trend trades so short term tactics are more suitable. The clues come from volume and momentum.

Office towers tumble into rubble in the best disaster movies. In a full bear market the special effects are the same and as Malaysia knows, just as spectacular. The rubble is never totally flat and this offers BEAR SURVIVAL trading opportunities. Many stock prices slip into life support mode, breathing gently, alive but not vigorous. These trading bands, or trading channels, are a steady income for traders content to feed like sparrows - a crumb at a time until the cake disappears - rather than like pigs, always looking for a little extra.

Hope springs eternal, so bullish fundamental traders see bargains as heavyweight stocks fall below book and asset value. The novice buys them with shivers of anticipation at the prospect of a breakout or trend reversal. Traders DANCING WITH BEARS, Chapter 4, watch their feet carefully. This dancing partner is clumsy and heavy footed so we use some traditional analysis tools in some new ways to avoid being stomped.

Traders are hampered by instinctive reactions buried deep in human ancestral memory. When it comes to fight or flight too many choose the former, walking right into BEAR TRAPS with an aggressively unsuccessful fighting strategy based on averaging down. This loser can be turned into a winner and chapter 5 considers how this is done.

PART 2 - BEYOND THE BEAR

Relying on equity trading alone for survival means fighting with one arm tied behind our back. It is impressive, but not powerfully effective. Two armed traders turn to derivative financial instruments, such as warrants, options and futures.

I am a refugee from the speculative end of the equity market. When I first approached warrant trading I carried baggage from speculative gold stocks. Warrant charts added the same sparkle to profit projections as junior nickel explorers. The joy of specs, apparently, was not dead and chapter 6, DERIVING SATISFACTION, is an introduction to this pleasant trading mirage. Trading profits do lie here, but not in the shape or style we first expect. This glittering prize is more difficult to grasp.

Hard trading experience throws warrant speculation into perspective. All mirages are a distorted image of something real. PREMIUM TRADERS steps out to find the source of the mirage. Leverage does deliver spectacular returns, but only under certain circumstances. It delivers reliable returns when we master an applied understanding of VOLATILITY AND THE BEAR. The concepts that served us so well in the equity market need modification, and although it means a brush with options trading, the adaptations are not as complex as we feared.

Slowly we slough habits dragged from the equity market. With derivatives trading volume does matter in significantly different ways. We TURN UP THE VOLUME in chapter 9 to show how it is loudest when trading is most effective. This defines the reality of the mirage, and BEAR VALUE includes new concepts of time and intrinsic worth. We aim for a working knowledge so we are able to transfer the relevant equity trading skills into this new market.

NOT AN OPTION

Warrants do provide a way to short the market - to make money when the market goes down - and are similar to options in many ways. It is not our intention to trade options. We want a working knowledge of them so we get a foot in the door before the bear slams it shut.

When I open a book on options trading my head hurts within the first few pages. I am a trader, not a mathematician. I trade crowd reactions at the emotional extremes. Yet I need to know how others think in this very mathematically constructed market if I am to trade it successfully. In our discussion of derivatives we have tried to remove the pain of options by considering the way the peculiar behavior of warrants is different from equity market patterns. We look for trading opportunities in these differences, and show how options theory explains practical trading opportunities.

As your trading skills develop you can return to explore options style strategies in greater depth and we provide some relevant references.

PART 3 - SHORT BEARS

HUNTING WITH THE BEAR assembles tools, tactics and knowledge in a series of sample trades. More than just hunting stories, they are designed to show how our skills from the equity market are turned into derivative market success. From here it is an enticingly small step into full options trading and Chris Temby provides an expert introduction into HEDGING THE MARKET. Others, uncomfortable with derivatives, wish to apply short trading techniques to ordinary shares. It is possible in Australia, but it is not easy. Colin Nicholson, President of the Australian Technical Analysts Association, shows the steps in chapter 13, SHORT BEAR EQUITIES.

Part 4 - GRIN AND BEAR IT

Bull markets allow us to develop bad habits so we end up with THE GOOD, THE BAD AND THE BEAR. Bull market conditions hide trading mistakes so we often confuse good outcomes with good planning. Trading survival depends on making rapid contact with reality, discarding inappropriate habits. Sometimes this means LEARNING TO TRADE AGAIN by more realistically factoring in the way we learn to live with losses. Bear markets bring many more of them and they will kill us unless we limit them quickly. This ability goes well beyond the mechanics of money management. Success is a mind game so we explore the limits. RULES TO TRADE BY define how our mind game is played.

Our focus is on the way the tools of technical analysis are applied in bear markets. While the bear is strong it is their playground. Our survival, while never guaranteed in any market, is more precarious than ever. Traded with skill and discipline, the private trader can turn the average ugly brown bear into a golden bear.

In SHARE TRADING and TRADING TACTICS we looked at some ways to run with the bulls. In this book we take a close look at ways to hunt with the bears.


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