LESSONS IN BEHAVIORAL FINANCE AND PORTFOLIO CONSTRUCTION UTILIZING PIMPOLOGY 101
2012 has surely been a much different experience for most investors than last year. 2011 draws up two distinct images when I look back on the first half of the year and the second half.
Looking back on 2011, the first half of the year was essentially a guy trying to get out of bed after engorging himself with a dozen greasy donuts and a bean burrito. It just wasn't happening. Every attempt to get up was met with resistance.
The second half of 2011 was a midget doing the rain dance on a stage lined with dynamite. From one day to the next, you didn't know if the market would end up falling through the floor or flying through the roof. In the meanwhile, it bounced everywhere in between.
2012 thus far has been much different. After being bullish from late-September 2011 into December, I became bearish towards the end of the year and acted on it through a good deal of short exposure. This was based primarily on some very reliable sentiment measures that were blinking off the charts with bullishness.
Here's the thing with sentiment indicators that a lot of actors in the markets miss: They don't work during bull markets. That's the bottom line. When a market shifts into full on bull mode they expand the range of what you and I deem as being "normal". You aren't smart enough to know where that range will normalize. That is really all there is to it.
Listen, they work great during mild bull phases or for attempting to find bottoms during standard pullbacks. They even work fairly well in bear markets that don't get out of control a la 2008. Runaway bull markets turn them into trash. Remember when everyone was going nuts over the AAII (I think it was) numbers coming in at the most bullish in X number of years during the first half of January? Where did that get those who believed the markets were saturated with bulls?
Your job is to be able to decipher when a market is moving into that type of bull market that will turn formerly beloved sentiment indicators into flaming turds being thrown out of the window of a Cadillac El Dorado. I quickly realized during the second week of January that I had been played. I covered all my shorts on January 10th.
Several days after I put out my first post regarding a long equity position in many months. This was followed by more posts relating to small cap companies that looked attractive on both a fundamental and technical basis.
As a result of my recognition that I was wrong in my initial assessment coming into the year and quickly adjusting, I have managed to bring in a nice gain to start out the year. What to do now?
You have two types of traders or investors in this world:
1. Those who protect their gains when they have them. Imagine the character Gollum from Lord of the Rings. He had the ring and loved this possession so much that he chose to be alone in a cave, becoming a sub-human creature rather than taking the chance of losing his precious ring.
2. Those who leverage, exploit, pimp and pander their gains when they have them. I don't want to get too in depth about the imagery I have here as my imagination is quite vivid. But Just imagine Superfly. A pink feathered hat. Large sunglasses. A diamond studded pimp cup and snakeskin boots.
My personality and attitude towards the markets is such that when I have a nice cushion of gains to start a year, I don the pimp hat, take out my silver cup and seek to make as much out of those gains as possible. I treat those gains as assets that can allow for the further accumulation of assets in a more aggressive manner than would otherwise be possible.
Don't get it confused. Having gains early on in the year isn't a ticket to be reckless. During about 1995, I was in my very early 20's and aggressively trading the markets. I had a quotrek, with a large metal antenna as my real-time quote service. I was using an online brokerage firm by the name of PCFN. I think it stood for PC Financial Network. PCFN was owned by Donaldson, Lufkin & Jenrette, who ended up getting bought out by Credit Suisse. Anyways, when I would start out ANY MONTH with a substantial gain I would get so aggressive that I was prone to blowing out my account numerous times per year. In those days, I couldn't understand the difference between being aggressive and just being outright reckless.
A lot of traders and investors cannot tell the difference between destructive aggression of a detrimental nature and controlled aggression of a beneficial nature. It takes years of experience and experimentation to be able to hone your skills to the point where you can be aggressive in a controlled manner that is no worse for your account than buying into a basket of blue chips.
If you are going to take out the pimp hat, cane, cup and walk the streets in your snakeskin boots, you had better make sure that you know your game. If you don't, similar to the streets, you will end up in a bad place very quickly. If you are unsure of your place in the ecological structure of the markets or your reliability when it comes to aggressively pursuing opportunities then it may be best to take the approach of Gollum and remain conservative in your pursuits.
However, if you are comfortable enough wearing a pink feathered hat and exploiting your gains for everything they are worth, then it would be foolish not to push when you are ahead. That is how good years become great years. That is how good traders become great traders. That is how an average pimp becomes Superfly.
