The Oracle of Omaha and Traders' Reality

There are few traders in the universe who have done better than stock guru Warren Buffett of Berkshire Hathaway. Every year thousands of investors converge on a small town in Omaha, Nebraska, just to get close to him and hear him talk. His trading style of picking undervalued companies and buying and holding the stock has helped investors make billions of dollars. Wherever he goes he gets a rock star's reception. Whether it's with Becky Quick from CNBC stepping off his jet in China or going to his favorite restaurant in his hometown, everyone loves and adores him. But over the last few years some of the shine has worn off. His “buy and hold” did not work really well throughout the credit crisis. Millions of investors who followed his “buy and hold” style of trading saw huge losses. And then recently one of his heirs apparent was caught buying stock in a company that he was trying to get the firm to buy. Things have changed in the new world financial order and many of the big companies are no longer making the money they used to. The overall economic conditions of the U.S. have not been good for long-term investing in the stock market. Problems started in 2007-2008 during the subprime crisis. Buffett was quoted in the New York Times article he wrote saying “Buy America, I am.” He called the downturn “poetic justice.” But in the third quarter of 2008, Berkshire Hathaway suffered a 77% drop in earnings. He had allocated capital too early in suboptimal deals that were running into large mark-to-market losses. We questioned the buy-and-hold strategy back then and we still question it today. With so much risk tied to the markets, investors know that at any point a big rally can turn into a bigger decline. We have said many times that the rules have changed, things that used to work don't anymore, that in order to keep up you need to retool, and based on yesterday's announcement that Buffett had cut the firm's stock holdings we are sure things have changed. He said he was dumping positions in Intel and cutting positions in Visa, Procter & Gamble, Johnson & Johnson and Kraft (big names) and adding to Wells Fargo, ConocoPhillips, DaVita, DirectTV, CVS and BNY Mellon. We are not saying the shine has worn off completely, but the markets are just not what they used to be. In 2010 I was asked to speak at a conference in the Bahamas. I had prepared a full hour of talking about the markets and how we make money on the trading floor and what we use to do it, but after getting to the conference I noticed that the “traders” who came to the event were not kids just coming to learn to trade but people in their 50s and 60s and older. They had come there to learn to trade crude oil for three ticks. They had been sold that if they “learn” they could make $200 a day or more. As a retiree, what more could you ask for, right? The day before I spoke, an older couple, both over 65, approached my wife and me at dinner. They were very polite and the lady asked me if it was OK to sit down with us and I said that it was, that I was down there to help. After a little chit-chat I knew there was something they wanted to ask. The wife said, “Danny, can we make money doing this?” I had to take a deep breath. I told them that they could make money but that I needed to ask them something first. I asked how long they had been trading and they said a few years. Then I asked them how much they had invested in classes and how much they were up or down. They told me they had spent about $10k on classes (which didn't work) and that they were down another $10k from trading losses. My heart was sinking. When I asked the next question I knew the answer: “Are you using retirement money that you may need someday?” and the answer was like I thought it would be: YES! I went on to talk to them about the “downside risk” of what happens when the trade does not go their way and asked them how they manage that risk. They said they were only taught to trade and that they were not told how to get out. It was amazing. The room was split up in groups and from the looks of it some people were actually making money, but the ones who were not (most of the room) were frozen when the markets went against them. I knew then that I had to change what I was going to say when I addressed the near 200 people. When I finally got up and spoke, I went into a long talk about trading scared, meaning using capital that should not be used in the futures markets. I also went into some trade management and the downside risks. The people who threw the event wanted me off the stage, but I was not leaving until I got to my point. I spoke directly to the crowd and I spoke individually to people right in front of me. I told them a story about how my mom would always call me in at the end of November and ask me what trades we were going to make for her she so she could pay for Christmas presents. Every year for 30 years she would call, and every year I would make a trade that covered her expenses over the holidays. The older people in the room were all smiles. And then I went on to tell them the truth. I had never actually made a trade for my mom, I just gave her the cash, because “I could never put a losing trade in my mom's account.” I told them how she loved that I could do that for her every year but I really never put one trade on. I said that in the new world order, small accounts get sucked up like a vacuum picking up dust on the floor. I went on to say before you trade know your risk, know how much you can lose. In the end I did what I thought was right. Maybe the company that charged $2k per person to go down there was OK with that, but I wasn't. From the big investors like Warren Buffett to the small investors, it's all about trade management and knowing your risk. In today's economically depressed world, the last thing I want to do is cause more losses. I think Warren would agree …

The S&P ran the buy stops above 1402.80 yesterday up to 1407 just like we thought they would. After the push, the markets slowly drifted back down below 1400 but closed above. In all honesty, the markets feel tired. The way we see it is the S&P needs to come down a little and do some back and filling before it goes back up. According to the S&P cash study, the Wednesday before the August expiration has been up 18 / down 10 of the last 28 occasions. This may work, but we have some big economic releases to get past first. Sell the early rally and look for a good spot to be a buyer. Inital support comes in at the 1388 to 1390 level. As always, keep an eye on the 10-handle rule and please use stops. -It's 6:00 a.m. and the ESU is down 3.25 handles at 1398.25, crude is trading 93.12, down 31 cents, and the EC is down 44 at 1.2291.

-In Asia 6 out of 11 markets closed lower (Shanghai Comp. -101%, Hang Seng -1.18%).

-In Europe 6 of 11 markets quoted are trading lower (CAC -0.28%, DAX -0.42%).

-Today's headline: “U.S. Stock Futures Decline Before Industrial Output Data.”

-Economic calendar: Weekly mortgage apps, CPI, Empire State mfg survey, Treasury int'l capital, industrial production housing market index, oil inventories, Minneapolis Fed president Kocherlakota speaks in Minot, ND, credit card default rates reported, Facebook lock-up expiration and earnings from John Deere, Target, Cisco, Applied Materials and Limited Brands. -

1.43mil ESU and 9.4k SPU traded

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67 SPU/Z spreads traded

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S&P -2.70, Nasdaq +1.50

European, stateside vacation(s) and back to school preparations continue to steal market share. During the past week or two the economic data has been a bit more friendly and the earnings, although weak, were not as bad as feared. Complacency is running high as the VIX retested the year's low yesterday and the spoos are trading +6% from 200-day and +4% from 50-day… 50-day moving average is 1,352 and 200-day is 1,327 on the S&P 500. Both negative and positive news continues to add support and power the QE chant, but chatter has started to make the rounds. The bulls are tentative to lead the charge as the VIX is testing the year low of 13.66 made on March 16. Interesting that the VIX futures and options profile is much different than the ETF VXX as the VXX made its low of 15.57 on March 26 and has now traded well below to 11.13 leading some traders think the VIX is less important than it once was. Today's retail sales data were initially thought of as a beat of expectations, but Zerohedge posted something quite interesting; Mystery of July Retail Sales “Beat” Solved: It Is All in the “Seasonal Adjustment” http://bit.ly/NgFO5q Chants of QE and chasing performance have been the market leaders, but the higher the equities go the more tentative traders are becoming – except for those that need to chase performance and the algo's of course. This was posted in the chat room 68 minutes after the today's opening. mts2 (09:38:45): Mike_V Daily Pivot 1400.25/Lower Level 1400.00/3 dayer 1399.50 – time to say hello Roger_Volz match 1399.50 and William Blounts the weekly 1398.4 pivot Tuesday's S&P 500 trade started with 270k ESU and 950 SPU traded on Globex, trading range 1409.30 – 1401.60 / Monday's range 1402.70 – 1394.00, settled 1402.60 up .2 handles. The RTH's opened 1406.70 – 1407.00, up over 4 handles and traded an early high of 1407.20 before flopping to 1403.70. The financials and banks showed some early leadership, but chatter of seasonal adjustments and inconsistent factors versus previous figures in today's retail sales data began to weigh on the equities following their breakout of recent highs. EUBIE (08:45:30): AAPL “PUNCHING” dailies thru $637.. look at the 2X TOP from APRIL potential / for those that haven't had a leg SWING SHORT ON yet / time today 1405/07. The spoos were unable to take out the opening range and made a new low of 1402.50 at 9:56CT as the VIX was bid all morning and traded an early high of 14.78 following yesterday's low of 13.70. A minor new low of 1402.20 traded at 9:34 tony_rago (09:48:37): pop drop grind to the 1405.30, then rejected at 1407.00 just shy of the RTH's high and flopped to retest the lows and trade sideways thru the noon hour(s). AAPL traded above $638 mid morning and gave back over four dollars trading $634.25 up $4.25 at 1:30. The spoos held 1402.50 area on the afternoon retest(s) as BAC and JPM were leading the banks and the equities lower, 1401.60 new low, matching the Globex low at 2:15 before electing small stops below on the next pass as 1399.50, then 1399.30 marked the low as AAPL was making new lows for the day $8 off the day's high. The closing imbalance showed 24 of the Dow 30 for sale, decent size and the broader market showed $690M to the sell side and minutes before the close, whittled down to only $220M to sell. At 2:53 1398.00 LOD printed and the cash close traded 1402.00 before settling at 1401.60 down 1 handle. MTS video: http://www.mrtopstep.com/2012/08/8-13-2012-mark-sebastian-covering-options/ Please visit www.mrtopstep.com and take a look. There are webinars, market updates, news and more… Also, please click on the education tab http://www.mrtopstep.com/trading-101/ We believe there is very useful information on the MTS site – so take advantage and check it out while you start your free trial.