Larry,
It looks like if your trading the Nasdaq you could modify the 20% principle to at least 25%. The Nasdaq has gone to about 30% three times. I wonder if during the second phase of the bear market when everyone starts to lose all hope if we'll see much lower levels and should modify our profit taking principle. Do you have any data from the depression era or maybe even the 70's?

Gary

Gary,

In October of 1974, the S&P reached a low of about 62. That was about 28% below its 200 day moving average and the absolute low that we've seen since then. However, it still would have worked out very well to take profits on shorts a few weeks earlier when it got to 20% below. Trying to pick the absolute bottom is not a good idea.

Larry

So what your saying is that you picked 20% because it gives you a decent margin of error of a least 5%. It seems reasonable to use 25% for the Nasdaq then since that would also give about a 5% margin of error. It appears that when the bear takes hold again it might be more profitable to trade the QQQ's than the SPX. What do you think?

On another train of thought. Did I hear this right that the Boston option exchange will trade using decimal spreads?

Gary

Gary

I didn’t choose 20%. It was research that was done by a hedge fund manager and published in RealMoney.com. I think he went back to 1950. And then I verified it back to 1970 to see if it made sense. It does. There are two ways to handle Nasdaq shorts. One way is to key off the S&P. When the S&P gets 20% below its 200 day moving average, take profits on the Nasdaq wherever it is. The other way would be to do independent research on the Nasdaq to determine a good percentage. From the little I've looked at it, going back to 1986, 30% seems like the right number.

When the bear market resumes (if it hasn’t already) it would be logical to assume that the Nasdaq will be weaker than the S&P. But the higher beta of the Nasdaq requires better risk management skills.

I haven’t had time to pay any attention to the Boston Option Exchange yet. So I don’t know what’s going on there.

Larry

Larry,
Today could be a very intersting day I think. The Nasdaq had a pretty big down day yesterday and is threatening to fall below 2000. That would be an important pychological level for the market don't you think? I wonder if we may see the flagpole rally today. It will be very interesting to see if it will be successful this time.

Gary

Gary, I don't know if 2000 will be as important a psychological level on the way down as it was on the way up. I do know that all eyes are on tomorrow morning's job report. So today is likely to be choppy.

Larry

I didn't think of keying off the S&P. That sounds like the correct approach to me. How would using a trailing 1% stop when the S&P hits 20% work?

I don't know. But my guess is that if you back tested it, in most cases the only thing you would accomplish is to give up 1% of your profits. I know that in 1987, 2001, and 2002, the market rallied sharply within days after getting 20% below the moving average.

Larry