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Posted 2/21/2005
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An inside look at trades gone right and wrong
I thought I'd be able to buy the euro and gold at low prices on Feb. 10, and I was right. But I was wrong that chip stocks would head lower. That's proof that even solid ideas don't always work out.
By Bill Fleckenstein
Knowing when to take action in the financial markets is a combination of art, science, experience and, occasionally, luck. From time to time, it's possible to create a clever trading idea that works. Often, though, even well-thought-out trading ideas fail to pan out. I hope that the following examples, from the 'win' and 'lose' sides, will be helpful to readers.
Trading ideas, from inception to action
First off, the winner: My goal was to buy euros and gold at attractive prices, and I had thought that we might see a tradable low around Feb. 10, when the trade-deficit number would be reported. That day marked the last of a series of arm-waving events that, in my mind, had been dollar-friendly. (The other three early-February events: The State of the Union address on Feb. 3, the Federal Open Market Committee meeting on Feb. 1-2 and the G-7 meeting on Feb. 4-5.)
Here's how I described the trading idea in my daily column: "I continue to look to Thursday, when the trade number is released, or Friday as potential days to take some action in the currencies and metals. . . . The trade deficit is still a huge problem. However, with Easy Al throwing his weight behind the idea that it's about to solve itself, we could see some violent moves, as people who think he is knowledgeable buy dollars."
On Feb. 10, when the euro and gold traded lower and then reversed, I implemented my plan and added to my positions. I believe that the lows for this correction in the metals and euros have been seen, and, in this case, I was able to create a trading idea to add to my investment positions.
Best-laid plans of mice and bears
Now for a look at a stock-trading idea that didn't work. After less-than-stellar news from Analog Devices (ADI, news, msgs) and Dell (DELL, news, msgs) on Feb. 10 (and Cisco Systems (CSCO, news, msgs) a few days earlier), I expected to see chip stocks come in for rough sledding when trading resumed the next morning.
The outcome was far different. As if employing baseball's rare suicide squeeze, tech bulls stampeded into chip stocks all day long; the Philadelphia Semiconductor Index ($SOX.X) finished up better than 3.5%. The bulls' rationale? Surely, this must be the trough in chip land -- never mind that that battle cry has been around for six to nine months now.
Nevertheless, I was forced to cover the stocks I sold short that morning, as it was clear my idea was wrong. (This is not to confuse investing with trading. That is a topic for another day. I did not cover any of my "investment" shorts.)
I was run over that day due to the tech bulls' steadfast belief that business must get better. But the evidence continues to point in the opposite direction.
Exhibit A: Applied Materials
If there were a prize for wide-eyed optimism, surely the dead fish following tech stocks would win it hands-down. They believe what corporate chieftains say, extrapolating a bright future from those comments, as though gospel. The misguided optimism infects not just the dead fish but the "professionals" who look to them for advice.
After the bell last Tuesday, Applied Materials (AMAT, news, msgs) announced that it had won at "beat the number." Dead fish on the call were tripping over themselves congratulating the company on a great quarter. That's nearly a comedy, given that Applied Materials' receivables were up 61% year-over-year, inventories were up 21%, orders were down 36%. Orders will be down 0%-to-10% next quarter (or flat, if they get a couple of orders).
An invitation to reality gets a 'regrets'
As I have been discussing, business at every step of the food chain is getting worse. There are absolutely no signs of improvement anywhere, only a bunch of rhetoric and arm-waving about how things are about to improve.
The world economy appears on the verge of a slowdown. (Japan and Germany, among the five largest economies, are technically in recession.) The consumer has begun to show signs of reining in spending. So one would think that semiconductor-equipment makers, as capital-goods suppliers to a cyclical industry -- one burdened by excess capacity and swimming in inventory -- would be the last place someone would want to invest. Yet that's exactly what passes for investment wisdom on Wall Street today.
The moral of the story? Trading ideas are just that -- ideas. They can go sour for any number of reasons, not least of which is the psychology of those on the other side of your trade. Be prepared for the fact that they often don't work out and set your expectations accordingly.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money. At the time of publication, Bill Fleckenstein was short Applied Materials and Analog Devices. He was long Dell puts.
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