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++ Exit Strategies for The Precious Metals Trader +
Big Questions Part III David H. Smith *************************************************************************************
************************************************************************************* Silver AnniversaryIt was the spring of 1980. Young Grasshopper had gone to an investment conference in San Francisco. There would be several dozen speakers promoting products designed to help attendees beat the rate of inflation, then running at over 13%. T-Bills were posting record yields. Russia had invaded Afghanistan. Earlier in the year gold rocketed to an unimaginable $850 per ounce and silver had reached $50. By this time, the price of silver had backed off into the mid $40’s. On the Commodity Perspective technical charts, an incredible picture was emerging. Three distinct, and identical trading formations had occurred. Each had a price island at its apex, with successive triangles a bit lower than the last. (An Island Reversal is a one or two day price range that trades beyond the price action on either side, leaving price gaps. In a top area, prices gap up, trade for one – three days, then gap back down. Except in thinly traded markets these formations are rare, but for the technician, it offers a most telling clue about future price action.) When such a situation occurs, If the gaps are not filled within a few days (prices would – in this case, trading into the newly created space), it is highly probable that at least an intermediate top is in. Such an extreme can hold for a long time. In the case of silver, a price top lasting 22 years and counting… Note: In the current market action we are witnessing, watch for the possibility of an island reversal in either gold or silver as prices make what seems to be (we’ll only know in retrospect) an important low. This reversal sign may not occur, but if it does and prices do not fill the gap quickly, one can assume its validity with a high level of confidence. A trader can buy immediately, for a low dollar risk trade, with a close stop just below the formation. If left unfilled a for few days, a MAJOR low has probably occurred. Prices will then move aggressively away from the island formation, not returning for months or even years. To view a classic recent example, see the July, 2003 FCOJ (Frozen Concentrate Orange Juice) contract. A prominent two-day reversal occurred this past January.) If the one you have found turns out to be a “common” gap, prices will immediately retrace, and you will be stopped out quickly for a defined-risk trade. (One further refinement – island reversals tend to occur at extremes in price, either up or down. Because by definition, these are price reversal patterns, don’t expect to stumble on one early in the life of an evolving trend. Harry The first speaker up was Harry Browne. In the late ‘60’s (1968?) he had written the prescient text, How to Profit From the Coming Monetary Crisis, wherein he spelled out his view of the price adjustments that would occur as a result of U. S. Monetary policies. His prediction of massive increases in gold, silver and Swiss Franc prices had come to pass. Young Grasshopper listened with bated breath, and was even able to speak with Harry during the break after the presentation. His message: It was by no means certain that silver, then trading at around $44 per ounce, was going to move above $50 again, or even hold its current price. Therefore, his recommendation was for traders to place a stop on existing positions at $37.50. If prices declined to this level, Harry believed the bullish case for higher values would be weakened enough to usher in a major price decline. The air was electric. Here in person, was the man who more than any other had influenced the acolytes’ own thinking about silver and its investment value. In part it had led him to begin accumulating the metal at $4.23 an ounce several years before prices exploded. Above $10, futures contracts were added and subtracted, taking large profit chunks out of a rapidly ascending market. During one three day period, silver prices rose $4.00 per ounce. That, my friend, is $20,000 per COMEX 5,000 ounce contract! His final purchase, on margin, of the physical metal was the relatively small amount of 100 ounces at $38.00. Grasshopper originally intended to phone at the lunch break and call in a stop loss on all positions. What happened? Several other speakers presented their opinions, and soon the temptation to hold for higher prices took over. And then, Canadian seer Jerome Smith, Harry’s former employer and the man who literally “wrote the book” predicting $50 silver spoke. Only now he was talking $100 the ounce. A psychological opportunity to “shop first and beat the rush” --like the proverbial ant in terms of putting something away-- had been missed. Silver prices cracked, and in a few weeks had disintegrated to a panic low of $10.80 per ounce. Grasshopper did some offsetting on the way down and was able to keep significant profits; but a large equity portion went up in smoke. Later as prices laboriously climbed back toward $25, significant profits returned to the account, but a great deal of effort to get there was expended. The easy money days were over. Indeed the great metals bull market had been mortally wounded. The “Inflection Point” Individuals do it. Nations do it. Great armies do it. Massive, sustained efforts are made to achieve an objective. Intertwined with these forces are the gods and gravity. At some point, a magical event apparent only in retrospect, arrives. The summation of all opposing effort occurs and a minor element tilts the balance. Napoleon grasped its essence, saying: "There is a moment in a battle when the least movement brings decisive victory. A single drop makes the cup runneth over." This special time, which has been called the “still point”, a “climax”, or what The Daily Reckoning’s Bill Bonner calls an “inflection point”, is where the soon-to-bevictors and the defeated are sorted out. The denouement is not felt immediately, but like Caesar’s crossing of the Rubicon, the die has truly been cast. After this defining time, almost never will the roles be reversed; will “victory be snatched from the jaws of defeat.” Consider the role which “tipping points” play in initiating a position, as well as in exiting one. Many factors combine in the mind and practice of the trader to bring this about. Research, listening to the views of others, juggling fear and greed, relating possible profits to future goals and a simple gut response to the idea of even becoming involved all play their part. Ever make a trade that turns out to be a “ten-bagger” and afterwards reflect on how close you came to not taking the position? Not to mention the trade that you took, and then after losing a bundle asking yourself, “Why did I buy that stock?” “Five Minutes”During WWII, known by Japan as “The Fifteen Years War”, the inflection point came at Midway. Two fleets across the horizon from each other prepared to do battle. The Japanese strike force had just returned from bombing the US base at Midway and was rearming for another sortie, when their fleet carriers were attacked by an American sea-launched torpedo bombing squadron. Japan’s Combat Air Patrol shot down every last American plane, with no damage to them. Only now they realized there was an enemy fleet with which to contend. Rearm with torpedoes instead of land bombs? The decision was made. So on that fateful day, four of Japan’s largest carriers, with hundreds of its best pilots, worked feverishly, removing bombs and installing torpedoes, in preparation for an attack on the American fleet. Then it happened. Out of the sky, almost by accident another American bombing force had spotted their fleet. Japanese CAP was still just above the waves and could do nothing to stop the onslaught. The decks were covered with ordnance, aviation fuel and personnel. Within 5 minutes, all 4 carriers were blazing end to end, and by nightfall, each would come to rest on the ocean’s bottom. For three more years the bloody fighting would continue, but because of Midway’s “tipping point”, the strategic initiative and the back of Japan’s forces had been broken. Historical inflection points abound. With the 300 Spartans at Thermopylae and the Greek sailors in the sea battle of Salamis, where Athenian Triremes shattered the fleet and dreams of the Persians, ensuring the evolution of European culture. For the Romans and the Carthaginians at the battle of Cannae enabling another 1000 years of Roman history. On the Golan Heights, when 5 IDF tanks outnumbered 20 to 1 broke the assault of Syrian armour, granting control of this vital area to Israel for more than a generation. Some day, when the cycle of what may come to be known as the greatest precious metals bull market of all time prepares to turn, this magic moment will take place. Time will stand still --when “a single drop makes the cup runneth over.” The gold and silver bull will have been mortally wounded though the participants won’t know it – yet. It will have come at a place where price intersects with an event, fueled by the psychology of the marketplace. After that time, even as thousands of pitched battles between buyers and sellers rage, everything will have been unalterably and permanently changed. How can we as investors “panic first and beat the rush” to the bolt hole? Exit Strategy # 1: The Sandwich TraderOne way to make a buck and still get out in time is to be a “Sandwich Trader.” People of this persuasion take a position well after the trend has begun (thus proving itself to be valid) holding for only a portion of the ride. They leave well before the party is over, and even if their position is quite large, are usually able to do so without creating much of a fuss. They offset to eager buyers and walk away from that particular market for the duration. Working like this takes a great deal of self-discipline. It can also be achieved by simply disassociating oneself from trading that market again, once the final exit has been made. A very successful Canadian trader known to this writer makes his trades in this manner. Using proprietary techniques, he determines to his satisfaction that a trend run of some duration is truly underway. It is not uncommon for him to literally wait YEARS for the market and the entry point he wants. He takes large positions on reactions to the major trend, plays counter-trend movements, and when his indicators show the risk-reward ratio is changing, simply gets out. For Good. He literally burns his charts and walks away. Some times, he leaves a lot of money on the table. During the 1978-80 silver run, he bought around $11 and offset permanently around $18. Silver proceeded to climb to $50. He didn’t complain. Nor did he lose a penny when the market collapsed back down to $10, prior to its 20 year fade to below $4. If you have market-savvy, self-discipline and are able to control the “Money Dragons” of Fear and Greed, you can make and keep a lot of money from sandwich trading. Exit Strategy # 2: The 80% Solution Often a person fails to finish a new endeavor because they don’t see a way to completely solve the problem/reach the goal. It might be going on a diet, starting an exercise program or earning enough money to launch a business. Since they can’t get a handle on how to deal with all of the factors/requirements, they become overwhelmed with the task and either spin about aimlessly, or just give up. A way out of this dilemma is to practice the “80 % Solution.” Take care of the core aspects of the problem, deal with the critical pieces, and sort the rest later. Even without getting to that magical 100 %, a goal can be achieved. If you wanted to bench press three times as much weight as you can now, would topping out at a 250 % increase be considered failure? If you make significant money in gold and silver stocks, while overlooking a big rise in palladium, did you “miss the boat”? Decide what you would like to accomplish during this developing bull cycle in the metals. It might be a percentage gain from current levels, a specific dollar profit figure, a series of profitable trades, or some combination thereof. Then when the cycle runs its course and you reflect on your accomplishments, don’t beat yourself over the head if you “only” got most of what you sought. Accept the profits, turn off the computer, give someone (yourself?) a compliment, and go fishing. Exit Strategy # 3: Laddering Out Many strategies exist for measuring the possible duration/distance of a price move. Some, like the Finger Spread, are very low tech. Black Box systems reputed to divine the future are available for as much as a trader is willing to spend. And, given the track record of some (always ‘back-tested’) of these systems, one might be advised to instead toss Oracle bones while consulting the I-Ching. One relatively straightforward approach that doesn’t involve advanced math (of which the Author possesses limited ability) is that of a trader from the last century named Arthur Skarlew. His text Techniques of a Professional Commodity Chart Analyst, most likely now out of print, offers several understandable and potentially effective ways to set targets. Check out his “Rule of 7.” Over the years, it has divined a rather impressive number of accurate area targets for a variety of investment vehicles. All calculations can be performed with a cheap calculator or pencil and paper. Simple is often a good way to achieve profits. Once you have determined your price targets, set sell stops into these areas above the market. Real stops with your broker help eliminate “fine-tuning” due to fear and greed as they are approached, but for the truly disciplined and confident trader, mental stops can also be employed. Just remember, as Stanley Kroll (?) once said: “Once you take a position, you become part of the Crowd.” Then, if your targets are accurate, you might one day find yourself “flat” in regard to a position, but very “long” in terms of your account balance! Exit Strategy # 4: “Enough” (For Your Own Good) By the more astute observers of market action, it is an accepted article of faith that over time “prices revert to the mean.” This is true of soybeans, AOL stock, Tulip bulbs and silver. There is a certain equilibrium point where supply and demand are in symmetry, reflected in a price more or less acceptable to everyone concerned. Then one of the variables gets out of whack and prices either crater or explode to the upside. While the resulting unbalanced situation can last for quite awhile, karma (being good or bad depending upon your position), invariably causes prices to move back toward a balance. Unfortunately, as has been the case for silver during the past decade, the downside can get way overdone. Looking at the histories of many traders both famous and unknown, this also seems to be the case with their trading success and account balances. Stay in the game long enough, and “Mr. Market” will take back just about all you ever made. Does this ring any bells? Commodity trading records spanning decades show that almost no one can keep an “active lifestyle” in the markets and not be staggered to the mat sooner or later. Remember the Turtles and their famous trading leader from Chicago? And no, I am not referring to the 60’s singing group of the same name! – although one of their songs, loosely paraphrased may have been on the mark for purposes of discussion - “I can’t see me loving (trading) nobody but you (precious metals) for all my life.” There are rare exceptions. In the 1970’s, two brothers opened a small commodities account. They caught swing moves in silver (in the days when the metal often only moved a dollar or so per year) turning their $10,000 grubstake into $200,000. After a few months, they closed their account and disappeared. Maybe you should sit down with a cold beverage of your choice, and write out on a napkin “how much is enough” for yourself. Then if and when you reach that point, get the hell out. For good. Exit Strategy # 5: “The Sacrifice Throw” In Judo, there is a throwing technique called tomoenage, which means “sacrifice throw”. It is called this because the thrower drops down onto his back as he attempts to launch his opponent over himself. He “sacrifices” his stance and ability to attempt other types of sweeps or throws, in order to (hopefully) throw his opponent through the air and score a decisive point or ippon for an instant win. A sharp opposite may counter by stepping aside, or simply dropping down onto the thrower in order to apply a pin or choke. So the competitor who attempts this maneuver would be well-advised to understand the risks involved. Our metals trader can use this same approach to his/her game plan, if the majority of the position has already been offset, the idea is to let the remainder ride if/as the blow off continues. The ensuing price action may provide a much higher exit point to scale out the rest of ones holdings, perhaps with astounding profits. Or prices may collapse, overrunning stops and carrying away the remaining part of the position. The trader is thus willing to “sacrifice” these holdings for the possibility of “getting a clean throw” at higher prices. During the blow off phase, which can actually be several phases, the level of irrationality will increase. In the futures market for instance, a series of limit days against a position can occur. Even if a trader has the presence of mind to employ coverage via a straddle or by shorting similar commodities on different exchanges, one can still be pulverized during a melt-down. Thus he or she must be willing to accept the loss of the remaining position in its entirety in exchange for a chance at grabbing a share of what may become the final convulsive gasp of a market one step removed from keeling over – permanently. Few of us can stand to watch prices run away after we have exited even a very profitable trade. To become a “sold out bull” is not a happy place to be. As David Morgan of silver-investor.com remarks, one can expect that “Up to 80 per cent of the profit for a move (is likely) to occur during the last 10 percent” (of the move’s travel). Thus, putting together a coherent strategy of staying on board for as long as possible is an important consideration if one wishes to maximize profits, and is also willing to accept the costs of staying in the game. Exit Strategy # 6, When your wife says “Honey, maybe you should sell.” Before laughing out loud at this suggestion and assuming that the Author is writing this at 3 AM (which IS the case), reflect for a moment. Here’s making a bet of two American silver Eagles that the odds are good you have had a wife, relative or friend make this comment, after you have gone on at length about how much “profit” you had accumulated on a certain trade. Be honest now. It has happened to me a number of times - that little voice of reason coming from someone who probably couldn’t tell gold from pyrite. Write this down somewhere. The phrase “Maybe you should sell”, when uttered by an “amateur” (you’re the pro, right?) - usually a female - more often than not will mark the EXACT point and time of a market top of intermediate to long-term duration. Exit Strategy # 7: Listening to Your Gut. Primitive (early as opposed to current) man was generally much more attuned to his surroundings than is the case today. Vision may or may not have been better, but no doubt smell, taste and hearing were highly evolved and the signals they sent were acted upon quickly. One left-over specialty from that era is the so-called “gut feel.” We’ve all had this sensation at one time or another, though we seldom act on it. Instead, we seek an intellectual explanation for what our stomach is trying to tell us. Being visual creatures, we also look for confirmation from our eyes as well. If you reflect upon the number of times you have received these abdominal impulses and how often you have ignored their dictates, you might be surprised. A few years ago, this writer was cycling in a rural area several miles from town. Houses were widely separated and the landscape alongside the river was a combination of farmland and tree clusters. Suddenly a feeling of vulnerability and dread welled up inside. The writer became very cautious, deployed a stick slung alongside the bike frame and moved to the far side of the road. Rounding a sharp turn, “out of nowhere” a large gray dog launched a vicious attack. The extra awareness, evasive action and descending stick, stopped the attack just inches from the authors near side leg. Reflecting to this day on the incident, there is no recall of any signal by sight or sound which could have caused what turned out to be an eerily accurate foreshadowing. Consider the following: At the very least, when you get a “gut feel” about your market position, become hyper-vigilant until the reason or lack thereof for such awareness becomes fully apparent. And possibly, just possibly might one consider doing some selling? If, as is sometimes the case, you have received a “false alarm”, then little damage has been done. But what if something really dark is lurking out there? What if Mr. Market has a royal - sized surprise (like the discovery of “Comstock Lode # 2”) up his sleeve? Exit Strategy # 8: Doug the (East Coast) Barber Some of the best traders are never written about in trade magazines, aren’t seen on CNN, don’t make the Financial Section, and are known of only through word of mouth. One of these is a man I’ll call “Doug the Barber.” Not only is he a Master of the Trim, he also has quite a knack for selecting investments. Of course, like the rest of us, he makes a lousy trade from time to time, but has survived and flourished over the years, through a variety of market environments. One of his trades is particularly germane to our discussion, as a stand-out due to its stark simplicity. One day in 1979, a customer made the comment that “You ought to buy silver.” A couple of months later, this same individual, back in for another haircut, once again made the same comment. Further inquiry established that he was in the wholesale jewelry and dinnerware trade. Doug decided to take the plunge and scoured the coin shops in the area, purchasing several thousand ounces of silver. At the time, the spot price was around $18. About 6 months later, said customer returned to the shop and as Doug cropped his hair, commented, “You should sell your silver.” Soon thereafter, Doug sold out his position at prevailing prices, which were then close to $40 per ounce. And he never looked back. Not complicated. Not Sexy. But very profitable. Do you know someone who bought silver at $5, rode it to $50 and back down to its present $4? This writer knows several. They had many opportunities to sell as prices stair - stepped down, pausing at $10, before giving up the ghost and spending many years near $5, notwithstanding the “Warren Buffet Spike” up to about $8. Doug did not subscribe to a chart publication and did not pay for market timing services. Nor did he spend much time trying to “understand” the market. He just listened to what he heard, which apparently had the “ring of truth” and felt right in the gut. Then when the time came to sell, he followed the Nike commercial’s advice. “Just Do It.” Exit Strategy # 9: The Old Lady talks to the Guru, and “Gimme some of that Yahoooo!” This rule is supported by two examples, observed first-hand by the Author. The first incident took place in the spring of 1980 at the precious metals investment conference in San Francisco. On the first evening of the show, Grasshopper was wandering through the display areas and happened to enter a large lecture hall which, at that moment was occupied by only two people. Down at the very front was an elderly lady talking to Harry Browne’s former boss, the Guru who had correctly predicted $50 silver years before, and who now spoke of its imminent rise to $100. She was asking for advice on how to make a large investment in the metal. A few weeks later, silver prices crashed! Exhibit Two: Flash-forward to 2000 during a different bull market blow-off, but illustrative of the same principle. A broker friend had among his clients a wealthy farmer. You know the type. They roll into town on Saturday to buy groceries, in a beat up pickup, dressed in old work clothes. You might assume they are just poor hayseeds. But some of them are millionaires several times over! The broker had been trying to get this particular customer to purchase some bonds being issued by a local school district – about as safe a play as one could make. The farmer just wasn’t interested. Then one day he called in to the broker and exclaimed breathlessly. “Gimme’ some of that Yahoooo!” You know the Internet stock which, along with hundreds of other dotcoms, was headed into the solar system? A month later, the NASDAQ of which Yahoo was a component, topped and began a sickening slide that would eventually erase over two-thirds of its market value. Yahoo, at the time trading above $100 a share, tanked with the rest to well under $5 (unlike many of its brethren however, it IS still in business). Exit Strategy # 10: “The Rule of the Book”One of this writer’s greatly respected friends is a retired psychiatrist, a devotee of Albert Ellis. He likes to talk about the “Rule of the Book.” The Book is your life; most of us get just one. The chapters of our “book” are the various activities and experiences we have along the way, as we “write” it. In the case of many people who never quite master the mainsprings of their existence, their book will be written for them. The Rule of the Book is simple and is stated thus: When you have completed one chapter; write another! Some of us spend our entire lives wrapped around an activity. It can be a matter of choice, born of free will, and who can fault us? But many people keep on with something, well past the point when the benefits accrued have paled in relation to the effort expended. Sometimes we keep on because our identity has become mirrored by the activity. Sometimes the need to maintain it overwhelms our desire to do anything else. People probably just never got around to asking themselves, “Why am I still doing this?” “Is this all there is?” You probably know someone who spends 3 hours/day, weight training at the gym. What may have started out as beneficial in pursuit of overall fitness and strength-training for betterment in life’s other activities, somehow becomes an end in itself. The original purpose has become obscured or forgotten. Active investing is an energy-intensive and time-consuming, “life-time” wasting activity. If done for some reason other than just to accumulate lucre, shouldn’t there be a plan for an “end-game?” Is it unreasonable to think about when one might step aside and do something else with the finite years one has left on this plane? A small-town retailer takes his vocation for giving value, variety and service to the customer, turns it into the largest volume chain of department stores in the world, and keeps growing the business, even as he is felled by cancer. Another begins with a small television station and parlays his stake into a fortune worth $8 billion; then watches it shrink to less than $1billion. Two brothers move into silver and “hard investments.” When the bubble breaks, they proceed to lose what may have been the largest family fortune in American history. Trees don’t grow to the sky. Balance sheets don’t keep increasing forever. Lives are finite. Given this, maybe there is a time when each of us should “start another chapter.” What do you think? 2 + 2 = 5The preceding discussion has presented strategies for getting out (and being taken out) of the coming resource sector bull market, hopefully with a large portion of ones profits, health and sanity intact. It is not meant to be an all-inclusive list. It does, however, represent the current evolutionary thinking of the Author. It offers a program where involvement in precious metals investing becomes a finite as opposed to an infinite activity. Much like a fitness regimen, it will be up to the reader to mix/match/carry out a personal game plan, in ways that accord with their unique perspectives, personalities and skills. It has been presented in the spirit of inquiry and understanding, and has helped the Author clarify his own reasons for market involvement. Robert Bishop, editor of Gold Mining Stock Report, looking at the wooly beast that is precious metals investing, comments: “Until the recent cycle, I never realized what I now regard as the simple truth of resource stock investing: there are times to be in the market, and times to be out of the market. Period.” It is this writer’s sincere belief that ignoring such an observation will ultimately and assuredly lead the precious metals investor into the valley of fatigue, emotional despair and great financial loss. Please try to leave the party early. You do not have to grab the “last one-eighth” as Jesse Livermore so succinctly put it, while in the process placing all that you have earned at risk. If the Author can be permitted to give one last piece of advice-- try not to let the desire for investment success overbalance the need of attending to the really meaningful pursuits and relationships in your life. Centuries ago, Chinese philosopher Li Po said it well: “All pomp and circumstance, all wealth and power, are like clouds passing by.” Whether you exceed your financial goals by a factor of 20, or end up with less than where you began, at life’s end, you like the rest of us will be left with but one thing –Memories. May your reflection upon them fill you with an equal amount of satisfaction and contentment. Grasshopper
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