Thursday June 01, 2006
There are few investment areas in which professional guidance and advice is more strongly recommended. And there is no advisor better prepared to help you navigate these waters than Bernie Schaeffer.
Since his childhood in New York City, Bernie recalls that he went with his father to the visitor's gallery of the NYSE. His notes that his favorite pastime was watching the tape and reading the Wall Street Journal.
He later majored in mathematics at NYU, where he studied calculus, probability and statistics. He says, "This in-depth mathematics background perfectly complemented my love for investing. It gave me the tools I needed to add technical analysis to fundamental analysis." After college, he became an actuary for an insurance company.
Despite being one of the best options traders around, and operating the nation's most widely-circulated options advisory service, he maintains his humility by continuing to remind himself of the steps required to get to where he is today.
He says, "I spent most of the 1970s making very mistake possible. In fact, during my learning process, I repeated some mistakes with numbing regularity." These initial failures were not a deterrent to him; rather, they motivated him to find new and better methods of trading.
From educating himself and learning about other traders and trading systems, he realized that "the great traders recognize when they are wrong as well as when they are right. The great traders also develop a trading method that has the flexibility to adjust to changing conditions. They then stick to their plan."
His search for the right plan took him through various twists and turns. The result, like so many other advisors, is a completely new approach that avoids the inflexibility of any one static strategy and incorporates the value of various market methods.
Bernie first looked towards fundamental analysis, but found this traditional approach lacking. He explains, "The problem with fundamental analysis is that it is a good reflective too! but it is not a forecasting tool for stock prices. I have generally found that p/e ratios, dividend yields, and other well-known fundamental indicators are not particularly useful to the options trader.
While the fundamental factors do assert themselves over a longer period of time, they are of little use over the short term." He then looked towards technical analysis, and while he found it more useful than a strict fundamental approach, he still found it lacking.
He notes, "Although technical analysis is certainly not the Holy Grail for predicting stock price movement, it offers an advantage in that analyzing price and volume patterns is grounded in the real world of how investors are currently viewing a stock or a market."
On the downside, however, he notes, 'Technical analysis has its own limitations, as there is a strong tendency for the technical approach to extrapolate and to assume that past price patterns will repeat themselves."
While unsatisfied with either a fundamental approach or a technical approach, he continued his search. The answer, ironically, came from a book - Humphrey Neil's classic The Art of Contrary Thinking. While the book was written with stock investors in mind, Bemie intuitively saw the value of combining the principles of contrary investing into an options strategy. He says, "This book profoundly changed the way I approached investing."
e says, "Although it is usually necessary for a stock or and industry sector purchase candidate to have strong fundamentals and strong technicals, it is not enough.
Investor expectations affect the power and the importance of technicals and fundamentals. Contrary opinion, therefore, becomes vital to options trading success." In fact, he notes, "I attribute the lion's share of my market timing success over the years in stocks to this additional component - the sentiment component."
Importantly, contrary opinion is not simply going against the crowd. He says, "There are definitely times when you don't want to get in front of a bullish freight train or catch a falling knife. If one doesn't get you the other one will. The crowd is right during the trends, but wrong at both ends."
As a result, it become critical to determine when to follow the crowd - during the middle of a trend - and when to go against it - at turning points. Bernie's goal is to determine where in each cycle a stock or a market is by following the crowd's current expectations.
"Buy low expectations, not low prices," he explains. Unlike traditional investing which emphasized the notion of "buy low and sell high", his approach focused on the concept of 'buy high, sell higher'."
He explains, "The success of options trading depends on your ability to correctly predict both the direction and the timing of a move in the underlying stock. The stock trader can afford to wait for his stock to slowly climb out of the basement, but the options trader doesn't have the luxury to buy low and wait out a developing positive move. Buying high and selling higher is not an irrational method, but a logical one."
When sentiment reaches too much of an extreme, it is time to take a contrary position. He says, "When many speculators are bullish (exemplified by a low put/call ratio), the market is poised to fall, or at least consolidate within a bull trend. And just as this wrong way crowd becomes exuberant at market tops, it feels gloomiest at market lows. By identifying extremes in public opinion, put/call ratios offer one of the most valuable tools available today to tell you where the market's turning points are likely to occur."
"Very profitable opportunities can be uncovered by observing what inexperienced options traders frequently do and the trading against their activity," he explains. "These traders often react to widely ublished news stories and inevitably jump on the trend too late. When these small speculators are in agreement en masse, they generally send a powerful contrarian signal."
Making these overall determinations under expectational analysis is not a simple exercise and Bernie's arsenal of tools is vast. "To measure expectations, I look at what sentiment is telling me. A lot of times this has to do with what's going on in the options market. A lot of time, with how much short selling is going on. And you can look at magazine covers as signs of sentiment. This doesn't require any quantitative work, just thinking." Among fundamental indicators he primarily follows earnings momentum.
He notes, "The magnitude of a stock's quarterly earnings surprise tends to be a short-term catalyst for the stock's performance." Among technical factors, he considers implied volatility, option volume and open interest. He notes, "An awareness of unusual option activity in a stock can give you a significant edge in the prediction of the stock's short-term direction."
He also reviews other technical indicators, such as moving averages, standard deviation bands, oscillators, regression channels, the relative strength of a stock versus the market and moving average convergence divergence, among others.
To many, this may sound like we're speaking another language - and I don't introduce these terms to confuse. Rather, it is to point out that a lot of complex and sophisticated analysis is necessary when operating in the options world and to emphasize the value of having the benefit of Bemie's experience and knowledge as you tread these waters.
What is an ideal buy candidate? Bernie says, "I'm looking for strong price action. I'm a technician and I want to see a good chart. I'm looking for strong fundamentals. But I want to see low expectations, because I want to have evidence that the short coverers and the put buyers and the sideline money are going to continue to drive that stock higher. On the reverse side, the ideal sell candidate shows weak price action, weak fundamentals, and high expectations.
Bernie has earned accolades throughout his career., including the Market Technicians Association's "Best of the Best" award for his contributions in the field of Sentiment/Psychological Analysis. Forbes.com recognized his website. SchaefferResearch.com, as the Best of the Web among all options websites - three different times.
He won The Wall Street Journal stock-picking contest several times. Timer Digest has been monitoring Bernie since 1984 and in 2002, ranked him as the #1 Long-term Market Timer for the previous three very dfifficult years and the #5 Intermediate Market Timer over the preceding decade, from among more than 100 of the nation's top market timers.
In addition, was rated as the #1 Gold Timer over a recent 10 year period. According to Timer Digest, "Mr. Schaeffer called the exact market top and turned bullish at the exact market bottom in 1987. He was steadfastly and correctly bullish throughout the 1990s due in large part to his vast array of sentiment-based indicators. He changed his long-term market posture to bearish in February of 2001."
Finally, Bernie notes, "At the risk of being flip, I would mention the fact that options trading is fun. It may not be fun for everyone, and it is certainly not fun for those who trade without a solid foundation of knowledge, but most investors find the world of options to be a never-ending source of fascination, new ideas, and yes, just plain fan. But ultimately, if must never be forgotten that failure is not fan, and in order to ultimately succeed in your options trading, you must apply discipline and focus."
Bemie is a tour de force within the advisory industry. What began as two employees working out of a kitchen, has grown into one of the financial advisory industry's largest and most reputable operations. The services offered through his company are diverse, and cater to a wide spectrum of investors.
He provides specific trading services ranging from a daily "contrarian" e-letter, an ongoing blog offering updated daily commentary, the long-running monthly The Options Advisor newsletter, and ongoing portfolio development services focused on stocks, ETFs, and short selling candidates. One particularly intriguing service for those who are not comfortable with undertaking many trades is his Power Stocks, which focuses on just two primary recommendations a month.
His website is such a wealth of data ranging from advisory services, educational sections, and webcasts and podcasts, that I could barely scratch the surface in this review explaining the various "options" that he offers to investors and traders.