Long-term bullish vs short-term bearish

Or - investments vs trades.

The recent situation in Apple has me thinking about a classic trading conundrum - what to do when you think the short-term outlook is bearish, but you think the long-term is bullish. For example, let's say you are bullish on the investment outlook over the next few years, relative to the valuation; but you see that the recent market action has turned bearish.

There was a similar dilemma in late 2008 - stocks were very cheap but the market action was still bearish until March 2009.

There seem to be a few main options:

1) Purely trade it, have no long-term/investment positions. In this case, it would mean shorting or at least being flat as long as the market is acting weak. This has the advantage of clearly defined risk, and no need to experience extended losses during market swoons. However, this comes at a cost of not being able to profit from long-term moves, or attractive investments. A great example is gold, I was bullish long-term for about the last decade or so, but did not fully capitalise because for long periods the market action was neutral or bearish, and sometimes I missed buy signals through inattention or simply not having enough clarity & conviction that now was time for the next leg up.

2) Purely invest - ignore the market action. This seems silly for any trader, and only makes sense for a pure investor. In any case, it has potential for large drawdowns.

3) Do a mix. E.g. overlay your investment/long-term view with short-term view. Example: if you are long-term bullish, then be flat if you are short-term bearish; be long if you are short-term neutral, and be long more if you are short-term bullish as well. The problem with this approach is it is quite easy to sell out for short-term reasons, then fail to get back in; or to stay in a poorly performing position because of a long-term view.

4) Treat them as separate positions. Have a long-term/investment account, and treat those plays as totally different to your shorter-term trading. The problem here is you could see bearish price action, but not enough conviction to go short, and yet you are still long-term bullish - so you still take a loss on the investment side despite correctly identifying a bear trend/bear market. In this case it would seem to make sense to limit your investment size to a modest amount, given the potential for being long during a possibly very large drawdown in any given position (or group of positions e.g. stocks in 2008).

The lowest stress approach seems to be to stick to it as a pure trade. But I'm uncomfortable missing out on potentially large long-term gains just to avoid a few challenging trading decisions along the way.

The other appealing (but difficult to manage) alternative would be to have investment positions, but to jettison them if the market action/environment becomes outright hostile to them, then re-establish the positions as soon as the market environment becomes neutral or positive. There is potential for whipsaws and mistakes, but if the trading and investment process are both net profitable and have good risk management, this should perform best. More work but more reward.

Any thoughts? I'd be especially interested in any real life examples people had experience with. I may list a few later on this thread that I tried and failed or succeeded with myself.

 

One classic example was the gold bull market from 250 to almost 2000. I was 'long-term bullish' but short-term bearish during 1997-2000, thinking gold was very cheap and probably a great investment, but unwilling to be long while it was still clearly in a bear market. Then the fundamentals saw some bullish catalysts like the Bank of England puke out, the central bank accord to restrict gold sales, and miners finally giving up on hedging programs (due to getting screwed by margin calls on spikes). I was a bit late to get long after the momentum turned, but then got bullish on a pullback to $300.

The market then went on a multi-year bull run, but was interrupted by several sharp pullbacks and corrections. Time and again I experienced a similar pattern - being long in a confirmed bull market, then the market getting extended after a big run, then correcting, then consolidating, then farting around for a while before resuming the climb, without necessarily giving any clear buy signal. Usually I would either sell too soon during the rally and miss out on further gains, or hold on too long and then sell out part way through the next correction, and then fail to buy back once the selloff ended (due to lack of any clear buy signal).

I was not sure how to reconcile the two approaches. If I followed my long-term conviction, I would inevitably suffer several large drawdowns (gold corrected 25-35% several times during the bull market) - and my personal risk tolerance prohibits me from staying long during a correction of that size. If I followed more short-term views, I would never be able to capture the bulk of a historic move where an asset goes up 5-fold or more. It was frustrating to feel 100% conviction that gold would go from 250 to (at least) 500-1000, be totally correct, and yet capture maybe 1/3-1/2 of the move overall, on size quite smaller than my conviction.

After analysing several such cases, I concluded that one possibility was to overlay the short-term and long-term views, and if one or both were 'high conviction', to overlay with the other. For example, if long-term bullish with conviction, I should be long all the way during a bull market, except at those points where being long seems to be a major error for short-term reasons. I.e. either i) I am so short-term bearish that I would strongly consider selling short ii) the market is in a period of extreme risk iii) the market action is now in a confirmed bearish trend.

That still leaves the problem of when to buy back i.e. how not to miss subsequent rebounds after a correction. Many times I sold out of gold before significant falls, but never got a clear buy signal at the lows, and then often missed clear but maybe 'marginal' buy signals later on. I eventually realised that, if the long-term picture was bullish, then it didn't actually require a buy signal to justify going long - rather, it was sufficient for the 'sell signal' or hostile conditions to no longer be prevalent. I.e. if the short-term market action is neutral, and the long-term is bullish, that justifies a long-term position even without any short-term buy signal. And, if a buy signal comes along later, that justifies an even larger than normal bullish position.

So, my approach evolved into this:

Long-term bullish = default long position

go flat if the short-term market environment becomes highly risky, or goes into a confirmed short-term/medium-term bearish trend

go short (on moderate size) if the short-term environment presents an outright short sale opportunity

as soon as the highly risky conditions or bearish trend no longer apply (e.g. there is capitulation, or the technical picture turns into a clear trading range or better), go back to a default long position.

as soon as any actual buy signal occurs, go to a large long position

maintain the long position until either the long-term picture changes, or the short-term becomes hostile again

repeat for the duration of the bull market.

Flip everything for bear markets.

 

The main problems I found were the psychological conflict between holding two different views at the same time, and the subsequent tendency to bias short-term market interpretation when it conflicted with long-term views. If you are a raging long-term bull, it is easy to interpret mixed signals as bullish, and to be a bit stubborn recognising the onset of legitimate risky or outright bearish conditions. The same is true of breakouts to the upside - if you are LT bullish then it's easy to jump all over every potential breakout, and end up getting whipsawed.

There is also the issue of missing signals if you were not following each market carefully. When you have a position on, you watch it like a hawk. When you see a clear buy or sell signal, it triggers your instincts to prepare urgently and act decisively with a trade. But being decisive when something merely returns to being 'unclear', was not in line with the trading instincts I had honed over the years.

I still don't feel I have fully got to grips with this conflict of timeframes. Perhaps it would be worthwhile starting a trading journal just to experiment with this. In the meantime, I would be interested to hear everyone else's views on the subject - hopefully we can arrive at a set of principles, then test them in the market with several active bull or bear trends on both long and short-term timeframes.

 

Depends to a large degree on how much capital you have, your goals and risk tolerance, and the nature of your trading system(s).

Right now I'm moving my overall portfolio strategy in the direction of #4 - maintaining a long-term investment account where I simply diversify across asset classes and make only marginal changes in response to changing macro views. The idea being to take money 'off the table' and minimize the possibility for my own decisionmaking to screw things up, hopefully ensuring decent capital growth over the long run in almost any reasonable scenario at the cost of foregoing the prospect of extraordinary returns. At the moment however I have a fairly minimal amount of capital deployed in this way - basically what's in my IRA plus some cash I was previously just sitting on.

I've tried very hard to minimize variance in my trading results to where they're generally consistent from month to month and relatively unaffected by the overall market environment. When adjusted for risk, effort involved, and the inherently far greater uncertainty (at least in the short to medium term) of most long-term value plays, the returns from my regular trading are high enough that only a tiny few investment opportunities make any sense. Precious metals are one of these (hedging against inflation, currency debasement of my cash holdings, and extreme disaster hedge against Zimbabwe/Argentina/Weimar-style chaos), real estate is another (same as above, plus the consistent minimal base income provided by rents at a far better rate than you can get in bonds etc., plus the safety factor of having wealth held outside the financial system).

The upshot is that my trading-returns profile is such that if I simply wanted to maximize risk- and effort-adjusted profit, I'd dedicate all available capital to trading - this would be your #1. The marginal value of returns on anything which can't be used due to liquidity constraints is low enough that I'd rather use a passive, stress-free approach and do other things with my time, only bothering with long-term value plays in very rare low effort, low long-term risk, high conviction situations - for instance if the whole US market became significantly undervalued on numerous measures.

I can imagine dedicating more capital to long-term thematic or value plays (as opposed to passive portfolio investment) if my expected trading returns were meaningfully lower or more volatile, to the point where the sort of returns from a typical 'home-run' investment (maybe a 300-500% gain over 4-8 years?) were high enough to be worth the wait, uncertainty and opportunity cost as well as the risk. I'd also do if there was some diversification benefit e.g. if my trading results tended to be very poor in rip-roaring bull markets but excellent in volatile bears, it would make sense to maintain some sort of long position in most cases to smooth overall returns, especially if there was also a bullish fundamental thesis.

In my view options #2 and #3 have very significant downsides which render them impractical. #3 is more or less exactly what I did in 2009: at that time I'd only been trading for a couple of years but I had enough sense to load the boat in February, only to (mostly) sell out in June, patting myself on the back for successfully nailing the bear-market rally. Well...

 

One problem I see with your gold example is the failure to distinguish between an investment made for reasons unrelated to price action (fundamental value in terms of financial metrics, high-conviction beliefs about future political or economic events, etc.) and a long-term trade based on TA. If you truly have the highest possible conviction level that an asset is fundamentally undervalued and will rise in price by 2-4 fold with a possible 10 fold+ increase, and you are unlevered long, to me it doesn't make any sense to sell out based on price action. Instead manage risk with size, which could conceivably involve selling some if the price has risen so much that your position size becomes unacceptably large as a percent of total capital. Add more on corrections if your conviction level is unchanged but price declines have left you too light. Feel free to layer swing trades on top if you see a setup, but the rationale for the swing trade should be independent of fundamentals. Only sell everything if you think the fundamentals may have shifted.

The underlying rationale is that most technical trading (the way I do it anyhow) is based on game play, squeezing, stop-running and being present to take advantage when the other side has made a bad decision - selling too low or buying too high. Price action patterns and technical levels are all well and good when being used to identify and exploit these situations, but exiting a high-conviction investment position simply because the price has declined some arbitrary amount from the last swing high - or god forbid, shorting - is actually what creates the opportunity for smart money to buy more at good prices. Whatever you lost on the decline is after all a sunk cost, and in an early- or mid-stage bull market where the repeated setting of new highs is driven by fundamental shifts in portfolio allocations and assessed valuation by unlevered big money players, your typical "break of support," moving-average cross or whatever just doesn't carry any significance. It's actually more likely to be a buy signal, or a heads-up to look for one, than anything else.

Obviously if you are just buying something because you observe a technical uptrend and don't have any high-conviction beliefs about fundamental value, then you have to manage risk with stops based on the market action. I think it's also problematic to co-mingle the concept of a long-term investment based on present undervaluation with a bear-market short thesis; shorts are necessarily going to be shorter-term plays and you almost have to incorporate some sort of price action component, due to the issues of capped gains vs. unlimited theoretical risk, the commonality of massive short-term 100-200%+ bear market rallies and the inexorable long term upward drift of both financial asset prices and underlying cashflows. Unless you can play the short thesis using CDS or some other means which offers an 'unlevered long' type of risk-return profile, shorts pretty much have to be treated strictly as trades.

 

Well, I tried that approach and it lasted until the first time I saw a serious decline coming, and then lost money despite being right and having a high conviction I would be right. I concluded it was senseless to lose money if the signs are strong that a market is going down over the next few weeks/months, just because I think a year or few later I think it will be a lot higher.

I've also had numerous investments over the years that had large drawdowns (luckily I kept the size of these investments moderate), even though sometimes they eventually came back. In hindsight it would have been better, on average, to jettison them once they went into correction/bear market mode, then get back in IF and when they started stabilising and re-entering a bull market. Even if this did not improve returns, it would definitely reduce risk and psychological pressure/distraction.

For similar reasons, I would not own something for its fundamentals, if I was very confident that it was in a bear market (unless there were signs the bear might be at an end). So in an important sense I am not really willing to be an investor - an investor risks 99.9% quotational loss while waiting for value to ultimately be recognised, and I do not wish to see my mark to market net worth fall 99.9%, or even 30%.

You have hit on an important point, which is that I am not really investing with the bulk of my capital. A true investment is one where it is so cheap that you would own it even if you thought a major bear market was going to drop its value by 50%. So to me, that means I can't truly invest with more than say 30% of capital. The rest, even if held for years, is long-term trading positions. And trading positions, every long-term ones, should never be held in the face of very hostile market action. If the price is going down 20-30%+, every long trade should be sold, and in fact you should get short or buy some puts.

Perhaps you've answered my question - how much % of capital am I willing to commit to something very cheap, if I am almost sure it will become 25-50% cheaper? The answer is basically zero, or maybe 20-40% at most if the expected LT return is absurdly high (e.g. certain assets in late 2008/early 2009 were yielding 20-30% pa cash returns - with that payout you can own them and ignore the quotational fluctuations entirely). But in all other cases I would much rather just wait for the storm to clear, and I am confident I can get back in fairly soon after it does.

So, it then becomes long-term trading bullish vs short-term bearish. In this case the answer is obvious - the long-term positions should be sold if the short-term is clearly bearish; and then immediately replaced as soon as the short-term stops being bearish (assuming the long-term case remains intact). So in the case of Apple, for example, in the short/medium-term it's been experiencing bearish momentum and price action. The correct trading position for a long-term bull is to be flat, or short, during hostile price action - and then wait for either capitulation, or clear signs of meaningful support and an emerging uptrend, before getting long again.

This made me realise another thing, which is that genuine investing cannot by definition rely on the price quote at all. So you should only invest if the internal return (i.e. things like dividend, cash earnings, net liquid assets) is high enough that you would be satisfied even if you could not sell the asset for any acceptable price for the next 5-10 years. If you require an eventual sale price, then you are ultimately relying on a market quote to be 'reasonable' and hand you a profit - and it is quite speculative to guess what that quote will be in the future.

There is one final point - if you have conviction in both your investment thesis, and the short-term trading thesis, then there is nothing stopping you having on both. This would result in selling some, all, or more than your investment position, so long as the short-term trading thesis demanded a bearish position. For example, if you had a crystal ball and saw the S&P was going to fall 30% tomorrow, why would you refrain from going net short? Even if you keep your long investment picks, you should hedge them and make some index bets on the downside.

 

For a short-term bearish/long-term bullish strategy, why not just apply any combination of write short-term call/buy short-term put/buy long-term call/write long-term put on your target companies?

This solution would be low-cost if you stick to OTM options, as well as low-risk if you diversify across multiple stocks and sectors (unless your outlook turns out horribly wrong).

 

This is what I learned last year. I have ran 2 distinctly different strategies, the primary being my trading acct at the majority of my net worth and the secondary being a longer term value investing framework holding up to 2 yrs. Last year I tried mixing the 2 and taking long hold periods in my trading acct, because I was unfortunately handed a very good return in 11' only to see my 12' turn from a 11% yr to a -1% yr up from a minimum of -11%.

I've concluded based on my experiences and research that most of us are 1 of 2 types:
1)ST trader
2)LT investor
The main strategy you run with be correlated with your type and therefore your holding period. It doesn't mean you can't make money at the opposite end of the spectrum, just that most ppl are suited to a certain style.

So I have found out the hard way (again) that I cannot put the majority of my net liq into stuff that could drop 20-30% or more. Hell, I don't like it when my trades go even 1% against me. That said, I have made money using a Ben Graham style approach and will continue to do so, but at least I know my limitations. I may not be catching a 500% gain, but at least I know I'm not suffering say a 50% DD in said acct.

Final point I will make is that mkt conditions also can dictate what you do. In low vol periods, variance is different and usually requires longer hold periods to achieve some equal % move vs a high vol environment. I have been having longer hold times for my current positions at least in index because of the current VIX.

All in all, it's about knowing what you are and what you can live with. If you're a trader, trade. If an investor, invest.

 

I think this is pretty much the point I was trying to get at. Things like gold and commodities would be special cases as these can't be valued using traditional financial metrics, but the idea would be similar: you're expecting a price rise of large but unquantifiable magnitude driven by some underlying political or economic condition, and it therefore makes sense to maintain the position irrespective of MTM gains or losses until the fundamental driver is no longer present (perhaps coupled with some basic price analysis, e.g blow-off top action). Risk in these type of plays is managed by being better than dead wrong on your analysis, limiting the capital allocation to a sensibly low amount, and ultimately by the zero lower bound.

It may also be that talking about 'trades' versus 'investments' obscures the real issue. It seems like the problem you actually have is with trend trading in general, where you observe strong momentum but don't have an obvious target or exit price which you expect the market to hit more or less directly - as distinct from trading within an S/R range, or a pattern with a defined target, or taking reversals where you're just trying to capture one impulsive move and take a quick exit based on relatively clear criteria (e.g. previous S/R, or time- or volatility-based fixed target). Essentially all my trades fall into those latter categories, partly because of my chosen timeframe and style, partly because I ran into exactly the same problems you describe: the market typically offers you a choice between exiting long before the trend is actually finished, versus holding firm and risking a loss of 25-50% from peak equity in position trades, or 50-100% of unrealized profits in swing/daytrades. AAPL today, gold in 2008, crude in 2006, SPX in 2010 and 2011 all come to mind.

I think there are basically two ways to deal with this:

1) Maintain a breakeven stop and treat every decline as an opportunity to average up at minor support areas or on breakouts etc., with your breakeven stop rising along with your average price. Decide in advance on some exit conditions (may be a combination of market action suggestive of a top, favorable local price extension, amount of time elapsed in the trade, fundamental price target, etc.) and sell the whole position once these are met. Most trades will go to breakeven or be exited too early, but every now and then you'll catch a tremendous winner on full leverage. Yes I understand and agree with the arguments about mental accounting, etc. but several good traders I know do trade this style.

2) Maintain a trailing stop below the last significant support level, tightening it up if the market action suggests a swift major decline could be near (for instance the parabolic-type action last year in AAPL or late 2011 in gold, or the 2010-11 breakaway rally in SPX which left a significant air pocket under the market). Be ready to re-establish the position at major support or on a breakout if you believe the trend is still intact. Pretty similar to the approach you described in your first post.

Really there's no perfect solution and I suspect it's all kind of a wash in the long run: what you're mostly doing is deciding what profile of returns you'd like to have, i.e do you want occasional tremendous winners at the cost of larger and more frequent peak-to-trough losers or do you want to take smaller chunks with more consistency. You were right on $1000 gold but only got half the advance, but maybe you were wrong on $200 crude or $1000 AAPL and saved yourself a bundle by managing risk tightly, etc.

 

I keep them both seperate, at different brokers

I've been 100% long stocks for years in one account

has nothing to do with what's going on in the trading account

the idea is to sweep the trading account, and get it to constantly be a smaller percentage of total net worth