Thursday, November 16, 2006
“Play it!” my guide shouted at me as I struggled to land an 18-inch brown trout.
To a fly fisherman, the phrase “play it” means to reel the fish in a bit, and then let it go... reel it in a bit more, and then let it go again. This process tires the fish out and makes it easier to land the fish without risk of snapping the line.
And it’s kind of fun – at least for the fisherman. The fish, I suspect, feels differently.
Now, after the recent action in the gold market, I know how the fish feels.
Two weeks ago, I turned cautious on gold. I wrote about it in the November 3 issue of GSW. Last Tuesday, for my S&A Short Report subscribers, I recommended a specific put option trade on a gold stock.
To me, the trade looked as juicy as a fat June bug looks to a trout. So I snapped at it. And on Wednesday, as gold dropped $9 per ounce and the puts jumped to an immediate 30% profit, I was happy.
Then – it set the hook.
On Thursday, gold rallied over $18 per ounce, and my 30% profit turned into a 20% loss. I was on the line and being reeled in. On Friday, the line slackened. Gold dropped $8 per ounce, and the puts shot back up to a small profit.
So the question became, “Do I spit out the June bug and break even on the trade... or do I race downstream and try to snap the line in pursuit of bigger profits?”
I raced downstream.
And on Monday, it reeled me in again.
The game continued yesterday when gold and gold stocks opened lower and then turned around and closed higher.
I know I’m being played. But, despite feeling like I’m “on the hook,” I’m sticking with the trade because I know it’s a game of catch and release. And that’s why it’s important to keep the position size small.
You see, trading smaller positions allows you to snap at a June bug without the risk of being filleted and fried. Even if you end up getting caught on a hook, a small losing trade doesn’t destroy your portfolio. And that gives you the confidence to hold the position a little longer – and see if your original analysis plays out.
I’ve often argued that the real purpose of trading isn’t to get rich quick. Rather, the real purpose of trading stocks and options is to add a little extra juice to an otherwise conservatively constructed portfolio.
By keeping your position limits small, you can add that extra juice without the risk of becoming someone’s dinner.
Best regards and good trading,
S&P 500 hits 1,400 for the first time in six years.
Search giant Google closing in on $500.
California real-estate company Tejon Ranch hits a new 2006 high.