#18 MARCH 2012 THE MONSTER MISTAKE: THE INADVERTENT TRADE

Situation: I had initially gotten long when market lower by buying FXI calls. As market rallied, I hedged by scale-up selling in NQ, QQQ, XRT outright and long puts, anticipating a potential high in those markets. I thought I was approximately neutral. But then in March, equity starting evaporating as FXI weakened at same time Nasdaq and XRT stayed firm and even moved higher. Although I had not intended to place a ratio spread trade (or even generated this chart until damage was done), that is the trade I had inadvertently backed into. As losses accelerated with losses virtually every day, whether market up or down, I threw in towel, covering net short NQ and ES positions and cutting all other outright and option positions in half one day before the low point on the above chart and one day after what proved to be the relative high in XRT, ES, and NQ.

Mistakes

  1. The worst mistake was that I ignored a day when FXI down about 2% when NQ and XRT up—more than once! I knew this was terrible action in FXI, but ignored it. I was effectively long the weakest index and short the strongest indexes and did nothing! The correct action would have been hedging my long calls in FXI and commensurately reducing my short exposure in NQ, QQQ, XRT, ES and others. If I had acted on the initial signs of divergent price action in FXI versus the other indexes, I would have locked in the large loss on that day, but have spared myself most of the loss that resulted from my portfolio positioning. NEVER AGAIN STAY LONG THE WEAKEST AND SHORT THE STRONGEST.
  2. I ignored until it was too late that I had one giant position: long FXI versus short everything else. Caution against having almost all of a long or short equity exposure in a single index or stock.
  3. I had allowed myself to believe I was hedged when, in fact, I had a giant spread position.
  4. The dive in FXI was triggered by China lowering their growth target below the psychologically important 8% level. This development was akin to a Fed action that has a market impact.  I knew but ignored the fact that important government actions or pronouncements of intended policy usually have a prolonged impact.
  5. I was short NQ and QQQ even though I was bullish AAPL (because of Martin Taylor interview), which was a major mover of Nasdaq. I had even entered buy call orders, which had not been filled, when AAPL was at lower levels. I had allowed myself effectively to be short an index that was highly correlated to a stock I thought was a major bull.
  6. I wanted to look at ratio charts, but didn’t know how to generate on TOS (has to be done via creating a study). I let the fact that I was very busy keep from finding out how to create ratio chart until it was literally too late. If I had generated these ratio charts earlier (e.g., FXI/QQQ, FXI/XRT), I might very likely have taken the action I eventually did much earlier, rather than at virtually the worst possible point.