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Adaptability and the Market

As Bruce Lee once said, “You must be shapeless, formless, like water. When you pour water in a cup, it becomes the cup. When you pour water in a bottle, it becomes the bottle. When you pour water in a teapot, it becomes the teapot. Water can drip and it can crash. Become like water my friend.”

This idea of adaptability applies, quite nicely, to all market participants. We must remain mentally flexible and allow the market itself to dictate our actions as traders and/or investors. Indeed, Rich and I consider ourselves to be very flexible, open and adaptable traders in the market. As such, there are many times where Rich and I will trade a stock long, exit our position at $0.50 or $1.00 per share profit, then immediately see a short entry, take that short entry and profit again as the stock falls. In fact, many of our trades each day are exactly such. We let the prints and levels dictate our actions, whether long or short, taking $0.25 per share profit, $0.50 per share profit or $5.00 per share profit on the long side, then the same on the short side (or vice versa).

For example, last week (specifically, June 23rd) NFLX was a great short at the open from $90.00 to about $88.50. I went short under $90.00 with a moderate position, chasing my entries a bit. I covered half my position just above $89.00, a quarter at $88.75 and the remaining quarter at $88.50. Once NFLX hit $88.50, I started to see both short covering and subsequently, the smart money starting to buy. While NFLX dropped below $88.50 (major support), it quickly recovered and when NFLX popped above $88.50 again, I saw smart money buying. I followed this smart money into NFLX, long, with a large position. I scaled out at $89.00, then $89.50 and let the rest run. I simply allowed the prints and the levels to dictate my actions at a trader. As a trader, I had no preconceived notions of what Netflix “should” be worth on a fundamental basis, if it was overbought or oversold, where the Fib’s were, where the various and sundry moving averages were and/or whether it “should” go up or go down. None of these variables mattered to me as a trader, as I simply followed the other smart money into and out of a stock.

The other salient issue is that as traders, investors and option traders, we can have various hypotheses, strategies, underlying techniques, time frames and therefore, different positions in the same stocks, all concurrently. While I can be long NFLX as a trader, I have been short NFLX in an investment position under $100.00 (which was major support), along with a very large position of puts at various strikes and expirations. However, I am not biased as a trader by my investment hypothesis nor am I biased by my stock and options positions. As a trader, I simply follow the smart money into and out of the stock.

Another great example of this mindset is Valeant Pharmaceuticals, VRX. I have been short VRX stock as an investment position under $225/share, under $200/share, under $150/share and under $100/share from last summer onward. Indeed, VRX has been my largest options position, by far, since last summer onward. While my investment hypothesis was that VRX was a very clear, high probability short as a long-term investment position (due to my 2 months of research into Valeant’s fundamentals), as a trader I have gone long hundreds of times as I follow the smart money into and out of the stock. Ergo, I did not (and do not) let my investment positions, nor my underlying investment hypothesis, bias or influence my trades in VRX, whatsoever.

In short, as traders we must be flexible and unbiased, which allows us to follow the smart money in the market, long and/or short, even if this means trading against our long-term investment positions. Remaining adaptable to the market and being comfortable with having different hypotheses as traders, investors and options traders is an incredibly important skill set as a market participant. As Mr. Lee said, “…become like water my friend.”

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