By Steven M. Sears
Small-capitalization stocks are more sensitive to interest rates than their large-cap peers. When the Federal Reserve lowers rates, or even hints at it, lackluster small-cap names should surge, as lower interest expenses tend to goose their profits more than other stocks.
But rather than embracing small-cap stocks -- an idea we suggested earlier this year -- we have a different intent this time: highlighting the win-or-lose nature of trading macro-market events that captivate investors like the mythological sirens whose beautiful songs led many sailors to an early death.
We suggested buying bullish June $207 call options on the small-cap iShares Russell 2000 exchange-traded fund in March to play what was expected to be the first of many rate cuts. The trade has failed. Inflation has been stickier than expected and the Fed has put off making any cuts. The ETF is trading at $198.78.
Rather than admit defeat in April, when it was clear the Fed would postpone cutting rates, we suggested buying bearish SPDR S&P 500 June $500 put options for $5.43 when the ETF was at $518.84. The S&P 500 is now at record highs as artificial-intelligence stocks have skyrocketed higher to carry the market.
We could update the failed trades, but the better action is taking a pause to reflect on why the trades didn't work. Over the years, readers have asked for the lessons gleaned from our mistakes. Here are some:
-- Macro market events are easier to discuss than to trade, but the odds are often like a coin toss. Instead, you're better off buying and selling stocks directly -- and using options to fortify your positions. Develop an extreme skepticism of fancy talk.
-- When you lose money, understand why. The two ETF trades outlined above were win-big-or-not bets based on small-caps surging or large-caps sinking. The thesis was plausible, and it monetized prevailing market sentiment. But making money beats sounding cool.
-- Losses are unavoidable. Have a sell discipline so you never take a big hit or risk too much on one position. If you can't learn from your mistakes, or aren't interested in developing such a discipline, you're better off sticking with index funds.
-- Event-driven trading, including earnings reports and Fed decisions, seems like the ultimate expression of investment acumen. But it is often much like trying to monetize financial gossip. If the trade is successful, investors gain a false sense of confidence from their wins.
-- Develop an investment style that works for your needs. Most investors can prosper with long-cycle themes and blue-chip stocks that ideally pay dividends and are held for at least three to five years.
-- The stock market might seem orderly, but it is chaos wrapped in indexes and ETFs. Understand trends and risks and get to know a handful of stocks with the care you reserve for your spouse and children.
-- Think thematically, invest strategically. We have repeatedly recommended KKR. When the stock's price was falling, we reset the trade to take advantage of the decline, and some readers were pointedly skeptical. Our conviction never wavered. Private markets are increasingly important, and KKR knows how to invest. The conviction paid off. KKR was just added to the S&P 500 index, and the stock is trading around an all-time high.
-- Investing is about good judgment and decision-making. You win or lose based on the quality of your thoughts and actions. It is hard for most investors to have an edge when trading macro events. It easier to prosper with a good theme with a long-term investment period that can be curated with puts and calls. Get the options market to pay you to be a long-term stock investor, and you will have learned something of real value.
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(END) Dow Jones Newswires
June 14, 2024 21:30 ET (01:30 GMT)
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