Friday, June 11, 2010

Cramer Explains Why I Lost Over $600 Yesterday

(c) 2010 F. Bruce Abel

From last night's Mad Money by Jim Cramer. A classic for understanding the market. I tried to get in with four stocks after setting below-market prices which didn't go off. Then an hour later I raised my prices and cut the number of shares for each order. Got in. Handled client matters and telephones. Checked midday and saw positions going from small profits to losses mounting; began selectively getting out. Still thought the market would go higher but did not want to take the pain. Stop losses would have worked better but because I had so many positions I didn't think of that.

Market took off again in mid-afternoon. I was not in. Rather I was out with losses on each new trade.


Jim: You want to understand what caused today's magnificent rally?... You really want to understand it?... Where the Dow vaulted 273 points, and the S&P advanced an astonishing 3%?... I mean, really understand?... Not just in terms of the sterile economic news out of China or Europe that you might have heard all day today...

You have to recognize that this spectacular rebound isn't just about improving fundamentals of economies around the world. How simple would that be, right? No...

It's about the fundamentals of something I'm going to let you in on... something far more important... It's about the fundamentals of the money management business.

That's right! It's about how the managers of wealthy people trade and invest.

Sure, we got some great news... I'm not denying it! We got some great news out of China, which is why checked it off last night. Remember that checklist, as a precursor to this gigantic, fantastic move?

But, more important... more important than the events... is how the big hedge funds react to those events, so pull up a chair and listen to what really happens on a big 3% day...

More important than the facts, is how these facts are perceived, and how the big boys are positioned... which is one reason why the market can be so hard, so unfathomable, for the homegamers to understand. So, as your investing coach, let me explain to you what really happened today. You haven't heard it from anybody... how the reverberations from Asia caused the hedge funds to change their position and created a major move higher that you saw.

To get there, though, first you've got to know how the stock market really works... not how everyone publicly says it works... all the managers... no... I'm going to let you in on the secret history of the market from the hedge fund perspective... because they're the marginal buyers... they're the controllers... they're the guys who move your stocks up or down with a whim or a vengeance...

You see, the big boys... they've got a playbook... They all follow the same playbook together. It's a total "herd" mentality, and it can move mountains, let alone markets...

Go back to the colossal selloff that began in 2008. The whole thing started because some key indicators... oil, copper, the Baltic Freight Index... peaked, signaling a slowdown in the biggest market for all commodities... China. Now, these hot-money hedge funds, which control trillions of dollars, have been betting almost entirely on the so-called "China trade," playing a ton of oil, mining and fertilizer stocks, all because of growth in the land of... you've got it... Mao Tse Tung...

When China peaked, these hedge funds were borrowing vast sums from brokers to own... or really more accurately, rent... your stocks... the stocks of all the companies relying on the Chinese boom. You ask about them all the time in the Lightning Round... the copper miner, Freeport-McMoRan (FCX)... or iron producer, BHP Billiton Ltd. (BHP)... Heavy machinery makers... Joy Global (JOYG), Bucyrus International (BUCY), Caterpillar Inc. (CAT)... fertilizer giant, Potash (POT)... coal king, Peabody Energy Corp. (BTU)...

These hedge funds figured China would grow forever. And, when China downticked, they were almost all caught off guard... trying to pile out all at once... They just panicked... yeah, they panicked... and they crushed these stocks, with all their (selling)... We'd got all of these hedge funds gone wild, as they frantically raised money to meet both margin calls from the brokers, and redemption calls from their own investors who were shocked at the losses they had just racked up.

Sure, there were huge problems with the economy at the time, but it was magnified by these guys... The selloff in these china names was so colossal... that it brought the part of the whole market, that wasn't financial, to its knees.

The ripple effects were felt in everything from aerospace to industrials... from Boeing (BA), 3M Co. (MMM), Chevron Corp. (CVX), National Oilwell Varco (NOV)... There was simply nowhere to hide from these reckless death-spiraling sellers.

So... a collapse in copper, oil, coal, fertilizer prices, Baltic Freight Index... all off of China... led to the worst possible timed, industrial stock selloff that we could ever recall. It's how you got the "Great Recession," down 53%... It's how you got the third-worst decline in the stock market in history, because it was also happening at the moment that AIG, Washington Mutual, Wachovia, GM, Lehman, and Fannie and Freddie collapsed.

Then... in 2009, this whole trade started reversing again, as China stimulus... a brilliant one... all about having the consumer get more money in their pocket... started taking hold...

So what happens?... The hedge funds came right back into the exact same names. That's how you saw those unbelievable rallies... uh, because they only look at these indicators... This reversal led to the rise in all the commodity futures, which then translated to the sector ETFs and, ultimately, into the S&P, in those same stocks that I just told you about... It was the combination of the end of "hedge funds gone wild" and the beginning of the stimulus that took us out of the Chinese stimulus... not ours... Hey listen, if ours were working, we wouldn't have that 10% unemployment... okay, 9.7%... please... Out of the morass... We were aided, though, by Ben Bernanke. He used kind of a Malcolm X style "by any means necessary" monetary policy... and a "line in the sand" on bank nationalization. Hey, let's give Tim Geithner (i.e., U.S. Treasury Secretary) his due too... with that stress test thing...

Bernanke's assurances, the stress test, and the China commodities... That's what took us... That was the combination that took us from Dow 6500 to Dow 11,000.

Remember the troika?... Banks, oil and tech... That was all China, except for Bernanke... and Geithner.

Three months ago, though, China realized that its stimulus had gotten out of control... particularly when it came to construction and residential housing... and the Chinese communists decided to tighten credit to slow down the economy and property inflation. They didn't want any sub-prime housing boom like we had... And, when the hedge funds saw the vicious slump in oil and copper in reaction to the Chinese tightening... what did they do?... Well, what did the playbook say?... Once again, they dumped everything... fearing this was a 2008 redux... So we got the worst May in 40 years.

That's what happened, people... These hedge funds never learn. They kept up their "group think"... so the reversal was once again swift... especially then... the euro collapse, the Greek and Spanish tarry... you know, it all started after China.

In the last week though... really, in the last... hey, the last four days... we got China back!...

We just learned last night that Chinese exports and imports took off... exports jumping the most in six years. The Chinese had throttled back inflation, but kept up the growth. Hey, that's nirvana. You can't short nirvana.

So what happened today?...

Here they come... the hedge funds... there it is... piling right back in... and that's how we rallied 3%. Not because of some point percentage this... or some 4,6,7,8, 9% Spain... no! See, until today, the hedge funds had been shorting the China plays, and our stock index futures... and, when they sense they are wrong... oh boy... they do this dramatic shift... hence the dramatic shift we saw on our screens.

And then that tape underneath (i.e., the ticker moving right to left at the bottom of the screen)... I know it's just crazy... But it's all them... believe me. It's all their flailing and flopping and chopping... that's driving this market way down, and then way back up, like we saw today.

Look, the fundamentals can matter. I mean, don't get your hopes down, that the fundamentals don't matter, and the homework doesn't matter... But who moves... and who moves the market... matters much more... which is just the opposite of what everyone teaches. The hedge funds really do have this much power. I know. I was a hedge fund manager.

Individuals don't move stocks. Mutual funds just buy when they have money come in and, right now, they don't. Hedge funds, on the other hand, must perform every day. I used to have to report daily. Sometimes hourly. Sometime every half hour. That means you've got to make money every day, which means they've got to react every day to every single data point. Their daily pressure creates this schizoid craziness. And that's how your stocks got caught up in the bizarre maelstrom, where their movements are dependent on the kindness of money managers, not the fundamentals of the underlying companies. And there isn't a lot of kindness out there, frankly.

See, the power of the hedge funds is magnified. They use leverage. Easy credit from brokerage firms. The employ weapons of financial mass destruction, like those double and triple ultra ETFs.

Let me give you this incredible arithmetic... I used to run - or manage - $500 million. With that, the brokers lent me $250 million, okay... And, with that, if I were trading today, I could buy or short an unbelievable amount of stock. I could buy or short... literally... three times the money that I put in, alright... And that is what got this market going today. You could short triple... triple the amount of money that you had. These are "hydrogen bomb" ETFs.

Okay, so let's do the arithmetic...

Hedge funds, with half a billion dollars, can now create $2.25 billion in buying or selling power. If they stay on the sidelines, their clients just take their money away. So they're constantly over-reacting... they're constantly firing nuclear weapons as stocks that can only handle conventional firepower. There's no way anyone... retail investors, pension funds, mutual funds... can stand up against this enfilading fire that we saw... down or up...

Here's the bottom line...

▼ ▼ ▼ ▼ ▼

Yes... As I do my checklist... remember the checklist? I mean, we did get something good here, alright... we got this thing. I told you this yesterday. It's nice to get ahead of it, isn't it? Hey, I got tomorrow's story yesterday... that's good. But anyway... things have gotten better. landing... because they over-react to everything..But today's action wasn't just about a soft landing in China. It was about the over-reaction of the hedge funds to that soft . especially to the things they were betting against... like China. We're hostage to the hedge funds sometimes, like today. Today it was a good thing. But I don't expect anyone to like it. Only someone who started a hedge fund and worked at it for a decade and a half can understand these kinds of moves. And, from now on, you can understand them too.

News Symbol Qty Cost Proceeds P/L $ Open Date Close Date

AAPL 35 $8,658.85 $8,643.29 ($15.56) 06-10-10 - 10:35:20 ET 06-10-10 - 11:34:11 ET

APC 100 $3,852.56 $3,753.77 ($98.79) 06-10-10 - 10:08:19 ET 06-10-10 - 12:42:13 ET

APC 150 $5,778.84 $5,630.21 ($148.63) 06-10-10 - 10:08:19 ET 06-10-10 - 12:42:14 ET

APC 72 $2,773.84 $2,702.56 ($71.28) 06-10-10 - 10:08:19 ET 06-10-10 - 12:42:14 ET

APC 28 $1,078.72 $1,050.95 ($27.77) 06-10-10 - 10:08:19 ET 06-10-10 - 12:42:14 ET

LVS 500 $12,358.95 $12,295.84 ($63.11) 06-10-10 - 10:06:28 ET 06-10-10 - 11:34:47 ET

Total $34,501.76 $34,076.62 ($425.13)

Somehow the above did not pick a small (-$100) loss in a 1000 share ge trade. And a small CMI trade of similar loss.

Exported from™ for account XXXX-8342 on 6/10/2010 at 13:08 EDT