Cynicism Helps When Trading Do-Nothing Markets

The late John Scarne, legendary card manipulator and gaming wizard, used to tell a story about how he and his pal, heavyweight boxer Jim Braddock, walked into a crooked card game and won a pile of money.

Knowing that they were being cheated put Scarne on his guard, and he lost no time taking countermeasures to ensure his and Braddock's great success that evening.

Whenever it was Scarne's turn to deal he went to work, peeling useful cards from the bottom and even the middle of the deck. At one point, in full view of all, he surreptitiously stacked the cards while shuffling them, allowing him to deal Braddock a hand that beat a tableful of exceptionally good hands.

Scarne surely would have feasted if he'd lived long enough to play the stock market over the last six months, since the game has been dominated during that time by thimble-riggers and keister bandits who would not think twice about bankrupting some widow or stealing from an orphan's college fund.

With stocks locked in a range, seemingly unable to go much higher or lower, Wall Street's wolves have set upon an unwary flock of short-term traders with unusual voraciousness, jacking shares up and down with the skill of a carny man working the roly-poly board.

It is in times like these that cynicism and street smarts can help the day trader and active investor eke out gains in a do-nothing market.

I forecast here a few months ago that the stock market would go nowhere for a while, and that is essentially what it has done. The S&P 500 index is trading about where it was in April, and so is the Dow Industrial Average.

Now I expect share averages to trend lower into year's end, but not by much. My target for the S&P 500 and Dow Industrials is about 5 percent below current levels, and 10 percent for the tech-heavy Nasdaq 100 index. The respective lows would be 1,425 for the S&P, 11,100 for the Dow and 3,600 for the Nasdaq.

With little opportunity for portfolio gains if I am right, investors seeking to tweak their yields up a notch might want to consider using 10% or so of their assets to trade actively in and out of stocks, indexes and options.

If so, here are some tips to avoid getting fleeced. They come from long experience in the trading pits and from close observation of certain patterns that keep repeating themselves amidst the current tedium.

My short list:

* Visualize the competition. If you would not sit down at a poker table with a bunch of guys who smoke cheroots and wear $2,000 lizard-skin boots, then pick another game.

* Forget everything you may have learned on CNBC about what causes stocks to move up and down, because it's not "fundamentals" that drive them. In fact, most of the time shares fluctuate at the pleasure and discretion of institutional heavies whose skill at manipulating the fear and greed of others would make Machiavelli weep for the little guys.

* Trade against the trend whenever possible; that is the most effective way I have found to limit risk to pennies on the dollar. There is a saying that "the trend is your friend," but for short-term traders the opposite often holds true: the trend can be viciously erratic and harshly punitive for those who seek comfort in traveling with the herd. If it were otherwise, millions of speculators would fearlessly jump on "obvious" rallies or declines and ride them for big, easy gains.

* To accomplish the above, find a trading system that will help you pinpoint rally tops and retracement lows. There are dozens of such systems that are easily learned, and even a novice can use them well enough to stay a few crucial steps ahead of the crowd.

* Use the leverage in puts and calls whenever possible by purchasing options that are far enough out-of-the money to be selling for $100 or less. Stick with the near-term expiration at all times, since longer-term plays are a sucker's bet, akin to making an even-money wager that Jeb Bush will be President in 2012.

* Never trade options without using "contingency" orders, such as, "Buy four December 60 calls for 2 3/8 or less, provided the stock is trading 53 1/2 or higher." If you do not understand and employ such strategies routinely, you are no more likely to make money with options than the blackjack player who always splits fives and doubles down on hard sixteens. Incidentally, I have found only one broker in the country who understands and accepts contingency orders -- a Chicago firm, Benjamin & Jerrold Discount Brokers. * The tech-heavy Nasdaq 100 futures are a favorite vehicle of traders who want action, but they move like the critter in "Alien," lulling the unwary before disemboweling them. By no means should you trade puts and calls on this vehicle, since they are as close to a criminally rigged game as any I have observed in thirty years of market-watching.

* When a particularly strong stock gets socked for a sudden 10-point loss, keep in mind that the illusion of weakness has been deftly engineered by shakedown artists. Typically, they have just unloaded shares into a steep rally and wish to accumulate more stock at lower prices before repeating the cycle. The bunco artists who move the shares of Merrill Lynch around like Pak-Man are among the true masters of the game, and you can learn a great deal just from watching their swoon-and-recover antics.

* Unless you are the kind of skiier who takes double-diamond trails on the first run of the day, avoid trading in the opening hour. This is breakfast time for the pros, when they make waffles, sausage and hash out of retail customers.

* Don't swing for the fences. This market probably isn't going to spectacular new highs or lows any time soon, so keep your expectations within the 10-15% price band that has by now become routine for cyclical swings.

The rules I have spelled out above work for me, but you can probably come up with equally effective ones by watching the markets closely for at least a few weeks. Trust your own observations, since they are capable over time of identifying patterns and idiosyncrasies that even the pros don't necessarily see and can help you to turn a profit.

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