What To Do When You've Been Rubined!

It's Gary's new catch phrase for being blindsided when the market overreacts to something.
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I got Rubined! Yeah, Rubined. Right, that Rubin, as in Robert, as in Treasury Secretary, as in

Goldman Sachs

, as in FOC (Friend of Cramer), as in big-jerk-face-who-couldn't-announce-his-retirement-on-a-day-the-market-was-closed Rubin!

Since I'm introducing a new phrase into the trading lexicon (and it's always a writer's hope that this new phrase will catch on, thereby giving said writer everlasting fame), I suppose I should explain what being "Rubined" means.

Well, here it is: You are Rubined when the market dramatically overreacts to some silly piece of news. And during this overreaction, the stops on quite a few of your longs are blown through, with a pile of losses being presented to you one by one. But, here's the key to the Rubin: Every single one of those longs then proceeds to bounce back, with a few not only bouncing back, but managing to soar all the way to your profit target! And, I mean within hours of getting stopped out.

So, depending on your money-management scheme that might be a 5% or a 10% swing for every stock that got Rubined. So, yeah, you can see that I'm not exactly framing any $20 bills with RR's signature.

Unfortunately, this situation happens more often than you'd like.

I think there are two ways to play it. It really depends on your risk tolerance, confidence in your methods and your mindset that particular day.

As background, then, let me position exactly where I was, and what I was thinking on "Ruby Wednesday." (I know, I keep running them up the flagpole, praying someone will salute.) Then, I'll give you two alternatives for how to handle the next beloved-Treasury Secretary resignation.

Going into May 12, I was heavily weighted to the long side. In fact, during that week alone I had already added five new longs. In addition, I had taken on no new shorts.

I'm often asked what indicators I use to gauge the strength of the market. You know, stuff like the A/D line, sentiment indicators, and the like. Well, all those are interesting, and I do look at them, but my clearest and best indicator is always the trades I have in front of me. If I have multiple longs and no shorts, invariably the market is pretty strong.

And not only had I added a few new longs, but even the charts I had rejected looked pretty strong. In short, I was confident the market would continue to go up. At worst, it would go sideways for a few days, and

then

go up. But, it certainly wouldn't go down. Truthfully, I have so much confidence in my trades as a market indicator, that I am shocked when they

are

wrong.

On Wednesday, I was shocked. As I recall, the market opened up flat, but I was certain this was just a lull before the next move up. So, as I usually do, I set alarms on all my stocks to signal when either my stop or limit target is hit. Then, I usually minimize my quote screen and start on my next column.

It wasn't too long after I started writing, that the first alarm went off. "Hah, I was right. My first winner of the day!"

Not! I was floored when I flipped over to my quote screen to see that

Whole Foods Market

(WFMI)

, which had been acting so well, had been stopped out. Even worse, the market was tumbling, down almost 200 points at the time.

Now this was disconcerting. Down a few, I could fathom. But this was a major setback, and, more importantly, it did not jibe at all with my sense of the market.

I mean, what was it? War with China? Some awful inflation news?

Amazon.com

(AMZN) - Get Report

saying is was bankrupt? It had to be something so huge and so unexpected that it was causing the market to crater in spite of my ultra-bullish outlook.

So, to find out it was something as trivial -- at least in my mind -- as RR resigning, well, I was flabbergasted.

That's the setup. And as a case study, I think you have two courses of action in these situations:

Action 1: Stick to Your Method

If you've read even one of my columns, you know this is the path I chose. My take: Yeah, this is silliness, but who knows? What, I'm going to remove my remaining stops, only to find I've turned a lot of small losses into big losses?

In fact, this whole area gets into a question I'm often asked: How much should news impact your trading? My take: Not at all, because once you head down that path, where exactly do you draw the line? Rubin's resignation is a nonevent, so we ignore that one, right? Okay, but what about

Greenspan

resigning? What about

Clinton

resigning?

Don't care about macro events? Then what about company-specific events? Do we ignore earnings warnings? What about merger rumors? Or here's one from my personal files: negative profiles on "20/20."

Yeah, I mentioned a few columns ago that I was long

Food Lion

(FDLNA)

in the early 1990s. It was about that time that

ABC News'

"20/20" came out with the infamous tainted-meat scandal that Food Lion was allegedly involved in.

This was all interesting to me because I was both long the stock and knew Food Lion intimately. Understand that it was not only a huge customer of

IBM

(IBM) - Get Report

(my employer at the time), but I had been doing some consulting with its key executives. This was a company that had superb execution, making just about everyone else in the grocery industry look like fossils. I knew the execution and financials of everyone from

Safeway

(SWY)

to

Giant

, and only the

Albertson's

(ABS)

chain was even close to Food Lion in performance.

So, I ignored the news and the effect it had on the stock's price. Figured it was some meaningless overreaction, and my North Carolina darling would bounce back immediately. But, Food Lion never did bounce back. Even to this day.

So now when something weird happens, I just figure that I am wrong, and the market is right. I don't care if the market is down 200 based on a typo in the unemployment report, I stick to my money management parameters and let myself get stopped out. A lot of small losses I can handle. It's a lot of large losses that are difficult to live with.

Action 2: Inject Your Own Common Sense

After 30 seconds of looking at the news wires, I figured the market was overreacting, and the odds of a comeback were strong. And if I really believed that would happen, I could have easily removed my remaining stops, or, even more aggressively, averaged down.

And in retrospect, this would have been the best course of action, and I would have made a mint. For many of the reasons I stated above, though, I chose not to pursue this course. However, I will say I'm not as dogmatic as I used to be about sticking rigorously to one's methods.

Let me rephrase. I'm not as dogmatic about sticking to your method

if you are an experienced trader

. You see, lately I've been paper-trading some of my "gut feels" both within the confines of my method and outside my method. The results have been encouraging, and I'll talk about that more on Wednesday. Perhaps -- and this is a big perhaps -- there is some small bit of room for intuitive judgment within the confines of a rigorous methodology. I honestly don't know the answer yet. It calls for further study.

I do know this, though. As soon as any trader starts to open his method to subjective analysis, there is an upside and a distinctive downside. The upside, of course, is some great calls. The downside, though, is some bad calls -- and, even more threatening, a gradual erosion of confidence every time you're wrong. (For further discussion, see my methodology series, links to which are in my May 3

column.)

In summary, I currently have a method that works, without any modification. On the other hand, I'd sure like to avoid getting Rubined again. I'll probably think about changing and then do nothing. I guess the important thing, though, is that I'm always looking to improve. More to come in the next few columns!

Gary B. Smith is a freelance writer who trades for his own account from his Maryland home using technical analysis. At time of publication he had no positions in the stocks mentioned, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. This column, Technician's Take, appears every Monday. Smith also writes Charted Territory, which appears every Wednesday, and TSC Technical Forum, which runs Saturdays and Sundays. While he cannot provide investment advice or recommendations, he welcomes your feedback at

gbsmith@ibm.net.