Thursday, June 23, 2005

George Costanza Investing

Remember that episode of Sienfield where George Costanza realizes that every instinct he has ever had has been wrong...that ever decision he makes is doomed to fail? So he decides to begin doing the exact opposite of everything that seems right to him, and immediately his life turns around. He gets a girlfirend, a great job, and starts to become successful. Sometimes, this is what I think trading as a contrarian is like. So often when a trade feels like a great idea it's absolutely wrong. Often my best trades feel so stupid, risky, and wrong as I'm making them. I need to get better at embracing my inner Goerge Costanza when I trade. It seems like so often every instinct I have is absolutely wrong and I need to do the exact opposite of my impulses!

Case in Point: The Market finally declined today. You'd think with those in-the-money QQQQ Puts I'd be pretty happy about this? Today, when I logged in all of my stocks were up, my account near at all-time highs and I'm thinking to myself "What the hell am I doing shorting this market? I must be insane. I hope I can get out of these puts without losing too much money". So, I put a limit order in to sell them for $0.18 below what I bought them at after commissions. A while later after taking a shower I look at my screen and see that I no longer have a position. For a brief moment a wave of relief washes over me that I was able to get out of these things for such a small loss. Then, I noticed the Q's were down a fair amount. I look over at CNBC and I see the Dow is down big, and the Nasdaq is holding in there, but has still had a considerable drop while I was in the shower. It looks like I sold into the very beginning of today's downdrop. This has to be the dumbest trade I've made all year. Those puts have made me nervous ever since I put the position on...in retrospect I should have recognized my nervousness as a good sign.

Remembering back to April when we had that huge sell-off. I remember the one day the market was up, and how relieved I was to be able to establish bullish positions into TWX and UNH before the market "rallied without me"...only to see both selling for lower every day that week. I also remember how I bought(well sold puts short) on almost every down day there-after and how it almost physically hurt to make some of those purchases, most of which turned out to be great trades. (The bad one GS...was bad because I panicked later and closed too soon, not because I didn't buy at a good price that week. ) I also remember how later in May how relieved I was to cover May GS put shorts...which it turns out was at the absolute worst price I possibly could have covered at prior to expiration. To make matters worse they even recovered their strike in time for expiration, days after I covered.

It's so hard to ignore my instincts. Every time I feel relieved at selling a position at the bottom...I usually realize at the time that I'm probably selling at the bottom and yet I still feel great about how I'm "limiting my risks by using stops". When I chase a stock up because I'm afraid I'll miss my chance to make money...I almost always realize at the time that I'm over-paying yet I do it anyway. Somewhere there is George Costanza in me and I need to find him if I'm going to continue to trade on a purely discretionary basis.

This further emphasizes the need for developing more quantitative methods for picking my positions so that I can remove my instincts from the process entirely. Even the basic techniques I use for picking puts right now help me immensely. No matter how much I like a stock, I only sell OTM puts with high theoretical odds and a 10% anual yield. This weeds out many of the non-contrarian plays. Puts get a high yield and high theoretical odds for a simple reason: Most people don't want to sell them so the price rises. When I find puts with those characteristics and short them, at least I know I'm not trading with the majority. This alone isn't the holy grail. Often the majority is avoiding the position for good reason, but at least it's a start, and has prevented me from getting slaughtered with the herd a few times now.

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