Don’t Confuse the Path with the Goal

Many are stubborn in pursuit of the path they have chosen, few in pursuit of the goal -- Friedrich Nietzsche

As we struggle through the massive torrent of earnings releases this week, it is important to remember that the path we take is not the same as the goal. The goal is to make money, either for ourselves or for our investors. The path is how we do it – what stocks we buy, what we sell, when we hold cash, etc. Many investors confuse the path and the goal – they buy a stock and then get stubborn in holding it too long, either after it is no longer cheap, or after a bad quarter because they want to "get back to even". They become prejudiced to holding a stock because they have already bought it. They have confused the path with the goal.

I have a 4 page list of trading rules, accumulated over 20 years with the help of a great friend and trader, that I keep on my desk. For the benefit of those reading this, I have posted just a few here that are particularly relevant during earnings season:

• Narrow the gap between denial and acceptance.
• Taking agonizing losses is unavoidable. Get on with it, and you'll find that your mind is cleansed by the purge. Actually, it is very therapeutic; the next day's trading will be all the more clear and you'll make it all back.
• Never agonize over mistakes. What's done is done. Be a field goal kicker.
• Averaging down in stocks with losing fundamentals is a suicide move. Cut losses; never ever lose your seat at the table. Never fight the tape for long.
• Embrace uncertainty, you wake up to it everyday. It's what makes the markets so interesting.
• When in doubt always take the profit. You can always buy it back.
• Counter trade, go where the masses are not. Think different. Then act when the time is right.
• When conditions abruptly change, sell fast. Remember there are lots of positions on the same side that need to react. There's the quick and the dead. Wait 3 days and see if it overshoots the new reality. Then you have a trade.
• Never try catching a falling knife.

Meanwhile, the U.S. Stock markets continue to grind higher. Part of the reason is "ok" earnings from the financials (today we got decent reports from Bank of America (BAC) and Morgan Stanley (MS) – earlier in the week Goldman Sachs (GS) also reported earnings good enough to cause a pop in the stock). All three of these stocks were in my basket I talked about in Despite Reassuring Headlines Out of Europe, Tension May Actually Be Growing – only Citigroup (C) had a disappointing quarter, but it is doing a decent job of regaining the loss on the report today. The key thing to remember about financials is that they don't go up on reported earnings, or good earnings. They go up on "bad to better". Once the earnings are good, the trade will be over. Right now we are at an inflection point in financials, particularly the big banks: we have stopped getting worse, and are starting to get better. We're not good yet – no one is arguing that. But the companies have switched to reporting "better" from reporting "worse" – and that is when you make the money. The path of least resistance is still up at the moment.

That said, there are still many cross-currents out there to be aware of – complacency is a killer. In last week's post Ever Dance with the Devil in the Pale Moon Light, I went through the issues facing investors in this market – since they haven't changed, a quick review is worthwhile. Particularly, Europe isn't "fixed" yet – while the recent ECB actions averted a funding crisis in Europe, there is still the solvency issue for Greece, Spain, and Portugal. See this article in the Wall Street Journal for more information, but then reread this speech from Tim Geithner to remind yourself of how often Central Bankers don't understand how bad it can get. If we can get through those issues in the next 6 months or so, then we will have a long-term trade. In the meantime, stay nimble and play defense. And don't confuse the path with the goal.

S&P 500 (SPX) Support and Resistance Levels:

Support: 1301/1303, then 1296/1298, 1285, then 1281/1283.

Resistance: light until 1328/1330, then 1345.

Positions: Goldman Sachs (GS), Citigroup (C), Morgan Stanley (MS).