Friday, October 17, 2008

Buffett versus Trade Triangles

By now you know that Warren Buffett is buying the market here, as per is his Majesty's missive published this morning.

As I commented on David Gordon's Blog earlier today,

Great long term strategy, for a bull market. Neither Buffett nor any one of us alive today has lived through a Grand Supercycle Bear Market, the likes of which we are encountering today. By his own measurement of success, stocks will be higher in 10 years, something that even I do not discount. But I would rather enter my positions closer to the lows, which are likely to be significantly lower and months, if not years from now. What will change my mind? Prices. Just as they took me out, they will get me back in. Whether lower or higher from current levels, I don't care. As long as I stick to what got me this far, it will be the right thing to do.

Buffett's Berkshire Hathaway is down about 25% year-to date. This puts Buffett in the ranks of market performers. Yet the world swoons when he talks about stocks. I guess that is better then Cramer, but still, a guy who does no better then the average index fund isn't exactly the kind of market guru that appeals to me.

A few months ago I introduced Market Club's Trade Triangles as a purely objective, mechanical and profitable way to move in and out the markets. Here is an update on how well the Triangles are trading the Q's:

Note that for the past twelve months, without leverage, the Triangles are +76.21%. During the same time frame, Buffett's Berkshire Hathaway has dropped from approximately $120,000 to it's current $113,150, a decline of approximately 6%.

Triangles = +76%
Buffett = -6%

Doth the Emperor be in need of some clothing?

[photo of naked elderly man omitted]



Anonymous said...

Sorry Allan, but I don't buy it. Most of all, because the short term share price movement of Berkshire has very little to do with Warren's investing skill.

We may see the bottom today, or years from now. I personally think we've got at least 5-10 years of sideways market left - both higher and lower than current levels.

But that's a guess. In my long term investing account, I'm buying stocks as well. I'm pretty confident that the companies I'm investing in will be around at the end of the day (with low debt being a primary screen), so I'm not worried what their share prices do in the next few years.

A said...

How about sharing some of your favorite stock picks here and I'll let you know if and when I buy in to some of them? There are some really tempting blue chip-high dividend paying equities available today, but my bet is they will be even better buys in the weeks and months ahead.

Anar said...

What do you think about VIX hitting all time high but S&P500 NOT hitting all time lows?

I am very bearish right now but that fact has me a little puzzled.


Anonymous said...

Your QQQQ analysis doesn't look at the longer term trend (as Market Club recommends) to see if these shorter term trends are trading in accordance with the longer trend. I bet if you did that, some of the losses may be eliminated and the overall return may be higher.

I've been using Market Club for about 3 weeks now with great results. Unfortunately, the market tanked after I joined so I didn't get started investing on this downturn exactly when the triangles said to. I wish I had signed up a few weeks earlier because my results would have been much greater.

A said...

Anar: noise, disregard it;

Anon: If you can develop a better way to trade the triangles, please share. I suspect it's possible, but nothing obvious to me, so far.


Anonymous said...

Is this triangle method of Market Club a Swing trading method?
thank you.

A said...

Yes, Triangles are based on a simple breakout strategy and has had an iron and on short side of the equity markets for the past few months.

Anonymous said...


Market club recommends that if your an intermediate-term trader to look at the monthly chart first for the main trend and then the weekly chart for entry and exit. In your analysis, you've only focused on on the weekly chart.

The monthly chart has had a red arrow since 7-15-08. On the weekly chart, a buy was indicated on 7-31-08. Under the recommended approach, market club would have you exit the short position, but not to go long because the monthly chart still showed the red triangle. You'd then re-enter the short position on 9-02, thereby eliminating that one loss on the 7-31-08 to 9-02-08 trade.

Bottom line - Market Club is a great product and a trader would have done even better than your chart shows if they followed the Market Club recommended approach to a "T".

A said...

Good point about this summer's signals. But does that hold up as well going back six or twelve months? I don't know that answer, but one of us (hint, hint) should probably back test it.

In either case, the Triangles have correctly caught most if not all of this bear market decline. It did so without hardly effort on the users part. As you pointed out, a great product.


Anonymous said...

Allan, this is #1 - I've been loading up on big caps with low debt and high cash flow. But here's the trick: if the market continues to fall, I will keep buying. I have pretty good cash flow coming in and my account gets bigger every month or two. So yeah, you may time your buy perfectly in the coming months or years, but I'll be buying then, too.

Given all the negativity out there recently, I think we're due for a bit of a rally before a fall to new lows. I think the rally could be very strong.

Anonymous said...

In an earlier post you said after the crash we would have one hell of a rally, do still think that? or do think we will be in a prolonged bear market?

Anonymous said...

What Warren Buffett Didn’t Tell Us About His Trading

My respect for Mr. Buffett aside, did he use his larger-than-life reputation to manipulate the markets in an attempt to avoid having to report further gigantic losses for his flagship company, Berkshire Hathaway?

On Thursday, October 16, Warren Buffett’s Op-Ed article ran in the New York Times where he told the investing world that he was buying stocks for his personal account and that they should too. His recommendation was trumpeted throughout the news industry and investors blindly followed his advice because, well, he’s the Oracle of Omaha, right? As Mr. Buffett wrote, “Be fearful when others are greedy, and be greedy when others are fearful.” But what would you do if maybe Mr. Buffett was being more fearful than greedy in writing the Op-Ed?

In all the news reports that I read, heard and saw, not one reporter raised the questions of why he wrote the Op-Ed or why he published it when he did. We all want to see the craziness in the markets subside, but by not questioning the motives of the timing and the content of Mr. Buffett’s letter, reporters and journalists failed to do their job. Whether you agree with his advice or not, or cheer the impact that his letter had on the markets or not, it’s a news professional’s job to consider why he wrote the Op-Ed if only so that the people he was trying to influence, including the small investor worried about his or her retirement, could make an informed decision about their life savings.

As reported in an article earlier this year on by Pablo Triana Portela, a Madrid-based derivatives consultant and author of “Corporate Derivatives,” Mr. Buffett sold $7.7 billion worth of put contracts, a form of financial derivative, that would have left him exposed to gigantic losses if the markets were to tumble. Derivatives are not easy for the layman to understand and they can be very dangerous even to the financial expert. In fact, in 2003 Mr. Buffett himself called them “financial weapons of mass destruction,” “potentially lethal” and “a fool’s game.”

According to Wikipedia, “A put option (sometimes simply called a "put") is a financial contract between two parties, the seller (writer) and the buyer of the option. The put allows its buyer the right but not the obligation to sell a commodity or financial instrument (the underlying instrument) to the writer (seller) of the option at a certain time for a certain price (the strike price). The writer (seller) has the obligation to purchase the underlying asset at that strike price, if the buyer exercises the option.” Wikipedia further explains that “the put buyer either believes it's likely the price of the underlying asset will fall by the exercise date, or hopes to protect a long position in the asset. The put writer (in this case Mr. Buffett) does not believe the price of the underlying security is likely to fall. The writer sells the put to collect the premium.”

Mr. Triana Portela wrote that Mr. Buffett, by selling $7.7 billion in puts, was betting “that both the high-yield credit markets and mainstream equity markets would not nosedive and/or become crazy.” Unfortunately for Mr. Buffett, they have done just that, and dramatically so. He characterizes Mr. Buffett’s about face on playing the derivatives game by selling puts as playing it “in one of the most simplistic and historically dangerous, indeed devastating, ways.”

During the life of the investment, Mr. Buffett and Berkshire Hathaway are required to mark to market the investments in their financial reports, which means that they must reflect the current unrealized loss. In the first quarter of this year Berkshire Hathaway reported a loss on derivatives contracts to the tune of $1.64 billion, wiping out more than half of Berkshire Hathaway’s first quarter pre-tax profits.

Mr. Triana Portela also reported that these investments have the potential to become “monstrously large” and wipe out the investor if the “unexpected or rare event” were to materialize. Hmmm, can you imagine what the impact on Berkshire Hathaway’s profits will be with the recent market meltdown of historic proportions? These are the same class of investments that wiped out Long Term Capital Management as a result of the Asian Financial Crisis of 1997. Remember the spectacular demise of the mega hedge fund Long Term Capital Management? Do you think Mr. Buffett had this in mind while writing his “call to buy”?

Mr. Triana Portela does point out that one saving grace for Mr. Buffett may be that these contracts are long term and will give him time to put the put sales proceeds to work which might offset potential losses. Unfortunately for Mr. Buffett, though, Berkshire Hathaway stock was down as much as 25% from its 52 week high prior to the publishing of the Op-Ed and is not likely to save him in a down market. The day after the Op-Ed ran, Berkshire Hathaway stock jumped almost 6%.

Now let’s look at the timing of his letter, published on October 16. As reported on, almost 80 million options, about a quarter of existing options, expired the day after Mr. Buffett’s Op-Ed was published. reported that the most widely owned S&P 500 options expiring on October 17 were the October 1,150 puts. The S&P 500's 18 percent retreat from that strike price profited buyers of those (put) contracts, which increased almost six fold in value this month.

``There could be significant volatility as market makers who are short the options try to hedge that risk,'' said Scott Nations, president of Fortress Trading Inc., a Chicago-based firm that trades options and futures. ``If you're short (meaning you sold) puts as the market goes down, you have to sell more of the underlying, and if it goes up, you have to buy more back.'' Well, according to Mr. Nations’ explanation of how these put contracts work, October 17 was liable to have been a huge selling day prior to Mr. Buffett’s letter, further pushing his put wager into the “rare event” category. Do you think Mr. Buffett had this in mind while writing his “call to buy”? And it is interesting to note that Mr. Buffett specifically referenced that he was buying for his personal account and not for Berkshire Hathaway’s account, which by Mr. Nations’ reckoning would be inclined to sell the underlying assets and not buy them to hedge its put bets.

Now that you have a better understanding of the context in which Mr. Buffett wrote his letter, do you think he was being transparent with us about his investment decisions as the Op-Ed leads one to believe? These are scary times for sure, but it behooves us all to think before we leap regardless of where the investment advice is coming from.