How to Use a Timeless Classic to Become a Smarter S&P 500 TraderAug 03, 2012
Chad Karnes, CMT
Offense wins games, but defense wins championships. Risk control and defense is just as important as returns and offense, and knowing how to control risk will better prep an investor for long term profits and success.
Investing is a competitive sport. For every buyer there is a seller, and each buyer and seller is trying to better his or her position. This results in a competitive environment where there are always winners and losers. There is likely no better known or world renowned book on competitive undertakings as Sun Tzu’s ‘Art of War’.
Sun Tzu’s ‘Art of War’ is thought to have originated over 2,000 years ago and was written entirely for military strategy, yet there are many lessons from the book that investors can find useful today.
A Lesson in Stop Losses
“A skillful fighter puts himself into a position which makes defeat impossible, and does not miss the moment for defeating the enemy” – Sun Tzu
The quote above from the ‘The Art of War’ easily applies to investing. There are many ways to interpret the saying, but the quote applies to one of the basics of long term investing success…keeping your losses smaller than your gains and never entering a trade in which risk (of defeat) is not controlled.
The ETF Strategy Newsletter makes sure we are never put into a position of defeat by always knowing price levels that tell us when we are wrong and when to cut losses. If an investor is willing to take small losses when necessary, he/she will never risk complete defeat and will always “live to trade another day”.
In the July ETF Profit Strategy Newsletter published 6/15, 1335 on the S&P 500 (SNP: ^GSPC – News) was a level called out as confirmation that a short term bull market was underway. If price overtook that area then the short term down move would end and shorts closed. The newsletter stated, “A close above 1335 would do that (make the rally look legit) and a move above 1340 would open the door to the preliminary upside target of S&P 1360”.
The Newsletter pointed out the position where defeat for the bears would be likely (1335) and where bulls could enter trades (1340). The Newsletter also identified important defensive levels for the Spanish IBEX Index (MCE: ^IBEX), the US Dollar (NYSEArca: UUP), the Euro (NYSEArca: FXE), Gold (NYSEArca: GLD), Silver (NYSEArca: SLV), and others.
Defense Wins Championships
“Security against defeat implies defensive tactics; ability to defeat the enemy means taking the offensive” – Sun Tzu
In war, as in any competitive event, the defensive part of the game is often as important (if not more important) than the offensive part. The more modern sports saying, “Offense wins games, but Defense wins Championships” reiterates the importance of defense. In the investment world, offense is the initiating of a position for profits; Defense is the monitoring of that position for losses.
Yet, time and again news headlines and commentators on popular news outlets suggest offensive maneuvers in isolation when it comes to investing. Rarely do they ever offer defensive tactics alongside their offensive “buy” recommendations. In finance and investing, control of risk (defense) is just as important as returns (offense) and should always be known when initiating a position.
The 7/1 ETF Profit Strategy Update stated, “The key to this being a stronger move up, is to take out the highs of 6/19 at 1363…If price can close above 1360 for a day or two, then our intermediate term view will likely switch to bullish…but, the previous peaks trendline at 1375 is also likely to act as resistance." That trendline for the S&P 500 did act as resistance on 7/3 at 1375 and sent price back down to 1325 the next week .
One of our goals is to always know where defense should be placed before we enter trades, and we always know these areas before we take the offensive. We also take the offensive knowing where the enemy’s defensive strengths lie which act as targets for our trades (1375 target in this case).
By combining both offensive and defensive tactics, a trader is better set up for long term success and profitability. The ETF Profit Strategy Newsletter helps investors play DEFENSE as well as OFFENSE and to get out of the way BEFORE large losses mount and capital is defeated.