2011: Hedge Funds in Review

Investors are aggravated. You’re aggravated. The whole world is aggravated.

And, well… we’re sorry for that.

Investors like you pulled more than $9 billion out of hedge funds in October alone — more than triple the $2.59 billion outflow in September.

Failing fund managers, much like the ones you entrusted thousands of dollars with, are telling customers:

“We are disappointed and we apologize. [This] was the worst in the firm’s 17-year history. As the year progressed our assumptions proved overly optimistic and net equity exposure too great.”

The above quote is from John Paulson, the same guy who reported these Q3 2011 numbers:

• Paulson Advantage: -32.57%
• Advantage Fund: -45.35%
• Credit Opportunities Funds: -19%
• Credit Opportunities II: -15.31%
• Paulson International Ltd: -10.40%
• Paulson Partners LP: -9.89%
• Paulson Enhanced Ltd: -22.41%
• Paulson Recovery Funds: -31%
• Paulson Gold Funds: +1%

This downward performance trend becomes a bit more apparent once you look at his competitors’ performance. 

Just about every hedge fund lost their investors gobs of money.

• Pimco’s Bill Gross made a huge bet against U.S. Treasuries this year. He was wrong.
  
  
• Fairholme’s Bruce Berkowitz’s investment in banks was a bad bet. His Fairholme fund dropped about 30% this year.
  
  
• And Legg Mason’s own Bill Miller stepped down from the Legg Mason Value Trust Fund.  Another fund he runs is down nearly 34%. 

They Were Wrong

Europe was a disaster this year. Hopes for a solution came and went. America was fighting off a depress, err, recession. Occupy Wall Street was camping out all over the country. John Corzine can’t find billions of dollars. 

Gold and silver ran to record highs. Housing still didn’t find its bottom. Hopes for QE3 sent the market rocketing, only to peter out in the months that followed.

Here we are, hugging the same flat-line we started 2011 with…

It’s been quite a year to forget.

Getting it Right

But for some, it’s been one of the greatest years on record. 

Friedberg Global Macro is up some 54% this year with bets that markets in India and Brazil would fall, European banks would crash, and U.S. Treasuries would rise. The firm now believes, as do we, Europe is headed for a massive credit doomsday, and that we’re all headed for a global depression.

Tiger Global is up 40%, betting with early stakes in Facebook and LinkedIn.

And I’m up more than 22% on the year.

You see, while hedge funds were struggling to keep their heads above water, my average for the year is close to +22% with closed positions.

In fact, I’ve closed more than 42 winners and only 10 losers since August 2011.

Two Smarter Ways to Trade: Part 1

Let me break down the chart below in two parts: the first six months of 2011 and the second half of 2011.

It’s a variation of the R-4 Trigger system.

In the first few months of 2011, we simply profited from the wild upswing in the market. This was confirmed with positive reads on moving-average convergence-divergence (MACD) and directional movement indicator (DMI).

But note what happened every time the MACD/DMI red line crossed above MACD/DMI, coupled with an overbought read on Williams % Range: the market sold off.

We didn’t have any significant Bollinger Band crossovers at the time, but were still able to go by MACD, DMI, and W%R reads.

In mid-March 2011, we got a major Bollinger Band move below the lower band. Once we got confirmation from MACD, DMI and W%R, we went long…

We went short again at the beginning of May 2011 when a death cross doji popped up above the upper band. 

We got red line dominance in MACD and DMI and went short:

It got even easier to call tops and bottoms when we’d get “candlestick dips” above or below the bands, coupled with MACD, DMI, and W%R. 

• At the start of August 2011, we called the bottom.
• At the end of August 2011, we called the top.
• At the end of September 2011, we called the bottom.
• In October 2011, we called the bottom.
• We were able to call the November 2011 top and the December 2011 bottom.

Going into 2012, though, we agree with Friedberg Global Macro.

We also see a massive credit doomsday for Europe. We’re all headed for a global depression, which means you want to stay away from stocks.

Stocks won’t protect you in 2012. But options will, as we profit from market downside…

Two Smarter Ways to Trade: Part 2

The beauty of my R-4 Trigger system is that it can be used with both stocks and options. 

“Ian, I’m still having a hard time with options. How do I open a position? How much do I risk? Sorry if these are stupid questions for you. I just want help.”

To open a position, you simply want to “Buy to Open.” Once that is established, you want to choose how many contracts to buy. Keep in mind that every 1 contract carries 100 shares of a stock.  

That’s where the fun starts…

Say you wanted to buy a put contract in Green Mountain (GMCR). You would still “Buy to Open.”

Now let’s say you believe GMCR will fall to $48. You could either short GMCR at $48 with 100 shares, costing you around $4,800; or you could buy a put contract at, let’s say, $4 a contract — which would cost you $400 per single contract.

If the trade doesn’t go your way, you can “Stop Out” just as you would with a stock. Or, if you’re happy with gains, you can simply “Sell to Close” when you want to close it out.  

The nice thing about options is that the risk is decreased. You’re risking less money than you would with a stock.

Will we have losers? Yes. Will we have winners? You bet.

Here’s the thing: Options can offer you the same safety and security that a stock can offer. It all depends on the time frame behind your choice of option.

As for how much to risk, never risk more than you can afford to lose. Never risk the house. Always play it safe, always play it smart.

This is not the market to risk too much on.  

To be honest with you, when I first started trading options 10 years ago, I thought it was difficult and confusing.

But after the first few months, I had a handle on what I was doing — and I found it very rewarding…

When we called the top of subprime, for example, we had readers walking with hundreds of thousands of dollars when Countrywide fell apart and Bear Stearns exploded.

Options are where the money is.

If you have a question, don’t give up on options. Feel free to ask us anything, any time.

Hope you and your families have a great holiday season…

Stay Ahead of the Herd,

Ian Cooper

@IanLCooper on Twitter

Ian Cooper has been trading stocks and options for 12 years. He contributes options, stock, and energy commentary to Wealth Daily, Wealth Wire, and Options Trading Pit. He’s the Coach behind Options Trading Coach, a beginner’s guide on how to trade options. Ian teaches thousands of loyal subscribers the many ways to be profitable from options rather than simply buying stocks alone. For more about Ian, take look at his editor’s page.