Don’t get Married to a Chinese Bear (FXI,FB)

Grantland Rice was among the greatest, most lyrical of all 20th century journalists, and is remembered best, perhaps, for this oft-quoted bit of poetic pith:

For when the One Great Scorer comes
To mark against your name,
He writes – not that you won or lost –
But how you played the Game.

And so it is, too, in the investment arena, where fortunes are struck and lost every day that a person’s conduct makes a difference. Indeed, how you play the game, in the end, determines whether you win or lose.

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That’s right. We’re talking about humility, honesty, and a steadfast character – and the pitfalls that await you (and your portfolio) if you’re lacking in those qualities. Or, to put it another way: the inevitability of massive losses for those who possess that most undesirable of traits, pride.

Pride is the one quality the market will not tolerate, the one trait that’s sure to cost its possessor everything. And then some.

Arrogance is the death-knell of traders and investors alike.

Why do we say this now?

Because this latest round of market volatility has got many marketeers anxious, and a goodly number of them believe with cocksure certainty that this is the end for stocks/the economy/the world/America/etc.

But it’s not the case.

Yet the arrogant one says – sell everything! Short everything! Get rich with me as I profit from a freefalling, panic stricken New York Stock Exchange! Join the selling frenzy! We’ll be rich on the way down just like we were on the ascent – together! Let’s do it!

The Market is Always Right

As Grantland Rice might have said in a different context: Look at the scoreboard, buddy! It doesn’t matter if you think yours was the better team. It doesn’t matter if you outplayed the opposition for the entire match. It doesn’t matter that you had a bad break or two. What matters is the result. Look at the scoreboard, fella. You either won or lost.

The market, too, is a cold judge. It matters little if you got the call right but your timing was off. It matters little if everything was pointing to a selloff, and every single indicator and Wall Street wiseacre and all the pundits on every market channel were with you. If you lost, you lost. The Market won’t be trifled with.

So consider it well: if you continue to believe in your story when reality indicates otherwise, if you got the call wrong and lost everything, it’s a near certainty that your ego got the better of you.

You don’t know better than the market, friend. It doesn’t work that way.

Healthy Trading

A trader who has no pride, who’s humble enough to realize his mistakes and to act accordingly, will save himself from a world of hurt. He’s the man we want to partner with. Because who, after all, doesn’t make mistakes? Who doesn’t stake out the wrong side of the trade from time to time?

The difference between the winners and losers in the market game is very simply this – those small enough to say ‘I goofed’ are rewarded with the greatest riches. Those too big for their britches… inherit the wind.

Remember it.

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We turn our attention now to the tumult on the domestic indexes that resulted from the Greek debt imbroglio and the Chinese stock market crash of the last two months.

Let’s start with Shanghai.

As we’ve mentioned many times, the easing of rules regarding investments in Chinese A-shares has been both blessing and curse. The rise that followed the liberalization regime (seen in red, below) was swift, ecstatic and overdone.

Have a look –

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It also resulted in the waterfall selloff that we’ve been watching for the last ten weeks.

Above is a one year chart of the iSharesChina Large Cap ETF (NYSE:FXI), a proxy for the Shanghai market and the most popular ETF in its class. And from our vantage point, the chart is indicating that the damage is done.

To start, the selling brought FXI down to its long term moving average (in yellow), a level it hasn’t seen since the buying spree began last October. This, we believe, is a healthy development.
• Second, the drop to the long term MA, a decline of 25% that marked the worst trading week in China in seven years, also triggered a deeply oversold read from the Relative Strength Index (RSI), circled in green. Such readings nearly always coincide with strong bounces in stock prices, and, indeed, in the last few sessions we’ve seen exactly that.
• Third, we got a powerful surge in volume (in blue) as price bottomed in the $39 range. That indicates that there was a sufficient scare delivered for the time being to shake the weakest hands out of their positions, and return control to the bulls.

The China meltdown put nearly the entire world into an oversold condition, including Europe, where the damage was exacerbated by fears of a worst case scenario in Greece. The German DAX, however, was only off by 13% peak-to-trough and now looks ready to climb.

So how do we play all this?

First off, we appreciate that any market that just lost a quarter of its value (read: China) is unlikely to spike higher in the near term. The bottom may be for Shanghai, but a return to the springtime highs is more likely a distant prospect.

On the other side of the coin, we have leading stocks stateside that have barely been touched by the brouhaha globally. Companies like Facebook (NASDAQ:FB), Goldman Sachs (NYSE:GS) and Netflix (NASDAQ:NFLX) are just inches from their all-time highs and show little if any signs of having topped.

Take a look at Facebook –

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The chart’s the very epitome of an easy ride higher.

It’s for that reason we feel it an auspicious time to pair a freaked-out FXI against the social media giant.

Wall Street Elite recommends you buy the FXI October 41 PUTs for $1.77 and sell the FB October 82.50 PUTs for $1.70. Total debit on the trade is $0.07 per pair traded.

You profit on any Facebook outperformance.

With kind regards,

Hugh L. O’Haynew

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