A Moment for Reflection

 | Dec 29, 2011 | 9:00 AM EST
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"Happiness is conceivable only for those who enjoy themselves without thinking that they will always want more and thus be discontented, or for those who are content without thinking that they have no pleasure." --Marcellus Emants

With just two days of trading left in 2011, many market players are done for the year and the action is extremely thin and unstable. This morning the euro is hitting a fresh low for the year on a slightly weak Italian bond auction and that is sending precious metals down hard, but mild strength elsewhere is holding up the indices.

I'm not going to try to read much into the market at this point. It is too thin and random right now to be meaningful. In addition, the end-of-year games prevent us from having confidence that stocks will move on their individual merits. I call this a coin-flip market: you might be lucky and catch a move one way or the other, but it will be due to luck and not any great insight or skill.

If we step back, forget the end-of-year stuff and look at the big picture the failure of the S&P 500 to hold above the early December lows and aggressively attack the 1275 level is a bit troublesome. Now that we have been turned back, the risk that the downside could gains momentum is high. We have good support at the 50-day simple moving average at 1235 (the really key level is 1200, which is quite a ways down there), but it looks a bit slippery here. The fact that it is the end of the year just makes it more uncertain.

While it is a difficult time to do much trading, it is a good time to reflect on our performance this past year. What worked? What didn't? What changes might you make? No matter how well you might have done, it is impossible for the ambition trader to be content with the results.

In my mind, the most notable change in trading during 2011 was that a rigid technical, momentum approach, as illustrated by Investor's Business Daily, didn't work as well as it did in the past. Much greater flexibility was needed to deal with this market since so much of the action was macro driving and did not adhere to the conventional rules. Individual stock picking did not work well as stocks tended to move in a group as we danced to global news.

In addition to the high correlation between stocks, there were fewer chances to find good entry points because the focus on Europe caused much of the action to occur overnight. Typically, you had to anticipate gaps the next day to catch good-sized moves.

That style does not work well for momentum investors looking for confirmation of a trend before embracing it, and there really is no easy way to change that. You might try averaging in slowly using a contrarian approach, but a stylistic change like that can can't be made without a good amount of stress.

Another challenging aspect of trading this past year was the continued inclination toward low-volume, V-shaped moves. In January, March, May and October we had some sudden bouts of levitation. It was great if you just jumped in and rode the move but, typically, we went from oversold to overbought so quickly that the charts never really developed well, and once they did run for a bit it was on light volume and the momentum was not trustworthy.

The lesson is that if you want to catch a rally, you can't be too selective about technical setups. You needed to loosen your standards a bit to ride some of the moves. I'm not going to get into why this sort of action tended to occur right now, but it presented plenty of problems for pure technical, momentum traders, and I suspect it is one of the key reasons that so many hedge fund managers have done poorly this year.

The key in 2012 will be keeping an open mind and looking for styles and themes that work. Once everyone tends to see something, it no longer works as well, which means we always have to be pushing for the next big development.

I'll be reflecting more on this during the slow trading today and tomorrow. Even though I expect 2012 to be very challenging, I feel good about our ability to adapt and to find ways to profit as events unfold if we put forth the effort. As always, the great thing about the market is that opportunities will always exist. We just need to find ways to seize them.

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