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Thursday, November 4, 2010

Small Accounts, Hedging, the Challenge Project and Rule No 2

"That which is static and repetitive is boring. That which is dynamic and random is confusing. In between lies art." - John A Locke

With Quantitative Easing round two (remember how I said it was like crack they just couldn't drop?) the markets were off to the races this morning.

It seems buy and hold is alive and well. Especially for those investors who don't get sucked into every headline that sends some traders into a tizzy and a blather-panic.

And with that push, the stocks being held in the tiny Challenge Project were off to the races, and broke above their recent resistance.

Johnson & Johnson (JNJ)
Daily Chart

Coca-Cola (KO)
Daily Chart

That does not mean that I believe Coca-Cola (KO) or Johnson & Johnson (JNJ) is a 'buy' at this time.

I've been thinking about applying rule no. two towards the dividend investing 'sister' account. First and foremost, because it needs the maneuvering capital just based on basic principle. Cash allows for maneuverability. And although I am enjoying a great rally here for the Challenge Project? I still have very little room to maneuver. I want the Challenge Project to get to the point where I can start thinking about implementing hedges, beyond using rule no. two as such.

How do I implement such hedges? Let me give you an example.

The newsletter is coming to a close on November the 9th. But before it went, I wanted to stress the need for protecting dividend investing gains. But I did not want to spend capital out of that Model Account on premium for an insurance hedge just for the sake of being protected. I set up parameters by which I would hedge that model account, that was at $5,627.06 including cash. For those folks, I discussed the need to hedge the model portfolio of that newsletter with an SDS if the market broke below 1164 on the S&P 500 Index. That was the parameters that I set up for myself, to initiate a hedge for that model account. It costs money to hedge an account. Money away from profits made. So I wanted to be sure that if a hedge was initiated, the market was definitely beginning to turn in that direction.

Which obviously it did not. Which means the hedge was never purchased for that model account. Which means that the model account could enjoy profits unimpeded by a hedge.

But what about for smaller accounts? What would I have done for the Challenge Project, at it's tiny little level, if the SPX had broken below 1164?

Applied rule no. 2 to the dividend investing 'sister' portion of the book. And I probably would have used 85% of rule no. two towards the cash that is reserved for maneuvering capital. Of course, this is all besides the point, as the SPX rocketed higher today. But sometimes, it's best to know the decisions that were not implemented, and the reasoning behind such decisions.

But since it's not going that route? I'll just go ahead and tell you that this means that I can use rule no. 2 for the trading account next week. With this recent push in asset prices? I have even more time. At some point however, I'm going to start having to add more capital to that account just for the sake of 'maintenance'.

On a related, but separate note ... I discussed Quantitative Easing in the podcast that I referenced at the beginning of this entry. I have been asked by several folks for a bit more clarification, and explanation. So what I'm thinking of putting together ... is a video entry that explains quantitative easing in the same manner I explained de-leveraging so long ago almost two years ago.

So I'm thinking of putting together a: Quantitative Easing ... illustrated. Keep your eyes peeled.

(Don't miss the other entry that is posted today)

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Note: This is not an investment or trading recommendation. The losses in trading can be very real, and depending on the investment vehicle, can exceed your initial investment. I am not a licensed trading or investment adviser, or financial planner. But I do have 14 years of experience in trading and investing in these markets. The Challenge accounts are run for the education of other traders who should make their own decisions based off their own research, and tolerance for risk.

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