Stansberry Research: Stansberry Research has made an art form out of “bad to less bad” trading. Can you define the term and walk us through how it works?
Brian Hunt: “Bad to less bad” is a phrase that Steve Sjuggerud coined years ago to describe extreme contrarian trading.
It amounts to finding assets that have been hammered for some reason… be it a natural disaster, a broad market selloff, or a long industry downturn… buying them after the market has bottomed… and making tremendous returns when a bit of normalcy returns to the market – or when conditions get “less bad” for the industry.
It’s the single greatest trading strategy on the planet.
Stansberry Research: How can the gains get so big?
Hunt: When an asset suffers a major selloff… or has suffered through an extended bear market… people say things are “bad” for that asset. Nobody wants to buy it.
Mention the asset to someone at a cocktail party and they will recoil in disgust.
You’d never see it on a mainstream magazine cover because the publishers know having that particular asset on their cover would gross out readers and potential newsstand buyers.
It’s around this time – when most folks can’t stand the thought of buying that asset – that it can start trading for less than its real, intrinsic value.
It will start trading for less than its replacement value.
For example, if most folks hate a particular real estate market, houses in that market might start changing hands for well below the cost it would take to build new ones. This is called “trading below replacement cost.”
In this kind of “bad” condition, you can often buy an asset for a third or half of its book value… because nobody wants to touch it. But if you step in and buy amidst the pessimism for 50 cents on the dollar, you can double your money if just a tiny bit of optimism returns to the market and sends the asset back to its book value.
Mind you, it doesn’t take great news to double the price of a cheap, hated asset… It just needs things to go from “bad to less bad.”
But the great part of “bad to less bad” trading is that because of the pessimism surrounding the asset, there is little downside risk to your trade. Everyone who wanted to sell has already sold. The selling pressure is exhausted. The risk gets “wrung out” of the trade.
Stansberry Research: It sounds a lot like the famous saying from banking legend Baron Rothschild… that to make a fortune you need to “buy when there is blood in the streets.”
Hunt: Exactly. It’s buying near the point of maximum pessimism.
Stansberry Research: It also sounds like the “bad” conditions can be the result of a short-term hit or the result of a long-term bear market.
Hunt: Yes. It’s important to keep that aspect of “bad to less bad” trading in mind. The bad times in a particular industry could be due to a disaster, like the Gulf of Mexico blowout in 2010… or because a sector has been mired in a long bear market. Short term or long term, the main thing here is finding potential buys in assets that would make the average investor recoil in fear or disgust.
Stansberry Research: Give us an example of “bad to less bad” trading with the long-term condition in mind.
Hunt: Let’s start with gold stocks.
Gold enjoyed a tremendous bull market in the 1970s… and reached a speculative peak in 1980. It then crashed and spent two decades mired in a terrible bear market. Gold fell from a peak of $800 an ounce in 1980 to around $250 in 2000.
The global economy generally did well in the ’80s and ’90s, so folks were much more interested in owning stocks and bonds than gold or gold stocks, which are typically seen as “safe haven” assets… They are seen as trades that do well in times of economic turmoil.
When an asset spends that many years in a bear market, folks “give up” on it.
In gold’s case, nobody wanted to own gold for more than 15 years. Nobody wanted to invest in a gold mine for more than 15 years.
Most folks just wanted a hot technology stock. There was extreme pessimism toward gold in the late 1990s and early 2000s. Everyone had sold their gold stocks. It was the definition of “bad.” Many gold stocks traded for much less than the replacement cost of their mines… or even worse, less than the value of the cash they held on their balance sheets.
In 2001, things starting getting “less bad” in the gold business. Gold moved off its bottom of $250 and climbed 50% in a little more than two years. These were the early years of folks flocking toward “real assets” like gold, silver, and oil in response to the declining U.S. dollar.
Gold advanced to $500 an ounce by 2006. It advanced to $1,000 an ounce by 2008. Gold stocks staged an incredible “bad to less bad” rally. Elite gold companies like Royal Gold (RGLD) and Goldcorp (GG) climbed more than 1,000% during these years. They were at depressed levels. When things got “less bad,” they soared.
Stansberry Research: How about some short-term examples?
Hunt: The March 2009 panic bottom is a great example. Back then, many folks were worried we were headed for the Great Depression Part II. Credit had seized up. Stocks, real estate, bonds, and commodities had all collapsed. It wasn’t just “bad” in most people’s eyes. It was “catastrophic.”
If you had stepped in and bought great stocks during this “bad” time – this time of blood running through the streets – you could have made 200% in a company like Apple (AAPL) in just a few years. You could have made 500% or 1,000% buying world-class resource stocks. You could have made 60% on a blue-chip company like Intel (INTC) in a little more than a year.
Everything was depressed back then… So when things got “less bad,” they shot higher like a coiled spring.
Stansberry Research: You mentioned that disasters can create “bad to less bad” opportunities. Can you give us an example of this?
Hunt: Well, the Gulf of Mexico disaster of 2010 that I mentioned earlier is a good example.
It was a horrible situation with the worst headlines an oil company could imagine. People died when the rig blew up. Thousands of barrels of oil were spilling into the gulf every day. The containment efforts were ineffective.
The market’s reaction to the whole thing was to hammer the share prices of many of the world’s best oil-producing and drilling companies. Even companies with modest business exposure to a drilling moratorium fell 50% in just a few months. BP (BP), the majority owner of the well, fell 55%. Transocean (RIG), the drilling company that owned the rig, fell more than 50%.
Drilling companies started selling for discounts to their book values… or absurdly cheap earnings multiples… like four or five times earnings. It was a “bad” situation.
But for investors and traders who know “bad to less bad” trading, it was an opportunity to buy great companies at discounted prices. Transocean rallied 90% off its bottom. BP rallied 80%. Again, these stocks were so deeply depressed by all of the negativity, they were like coiled springs… ready to shoot higher when things got just a little “less bad.”
Stansberry Research: It’s important to emphasize that you’re not saying you make the biggest gains as things go from “bad to good”… but “bad to less bad.”
Hunt: Exactly. Steve really drives this point home.
He points out that you make the really extraordinary gains just when a glimmer of light appears. Not when the whole sun comes out. You have to be willing to get in there and buy when it feels uncomfortable.
If you wait until the news gets rosy and people realize it isn’t the end of the world, you’re going to be too late. You’re going to miss out on the big, easy, early gains. You have to buy near the point of maximum pessimism.
Just thinking about buying something in a “bad” condition might make you feel sick to your stomach. But the seasoned trader knows this feeling is often a great buy signal.
Stansberry Research: It sounds like the danger here is buying something that’s “bad” and watching it get “worse.”
Hunt: Yes… That’s the biggest risk with this idea. A bad situation can get much worse. You can reduce the risk of loss with two things: waiting on a bit of price confirmation, and using stop losses.
When I say “price confirmation,” I mean that I like to see the price move just a little bit in the “less bad” direction. A plunging asset is like a falling safe. If you try to catch it in the air, you’ll get crushed. It’s best to wait for the safe to hit the ground.
I like to see the prices slammed to a bottom… then move just a bit higher from their lows. Maybe it’s waiting to see a 5% move off the lows… or maybe it’s waiting for the asset to reach a two-week high… or cross above a moving average. The key is waiting for the price to “confirm” your trading idea. This reduces the risk that you’re buying something in free-fall.
When it comes to “bad to less bad” trading on longer-term ideas – the buying of assets that have been in long bear markets – you also want to see some sort of catalyst on the horizon that will cause the bear market to end.
For example, the catalyst that caused gold to emerge from its bear market was a big decline in the value of paper currencies… and emerging buying power from Asian countries like China and India. You want a catalyst on the horizon to ensure that you’re not buying an asset that will just sit there and do nothing.
The other thing to remember when trading “bad to less bad” situations is to use a stop loss. This is a predetermined point at which you will sell a position if it moves against you.
Nobody is right on “bad to less bad” opportunities all of the time…
Using a stop loss ensures that you have a plan in place to deal with adverse conditions… and that over a lifetime of trading “bad to less bad,” you make a lot of money when you are right, and lose only a little bit of money when you are wrong.
Stansberry Research: Thanks, Brian.
Hunt: You’re welcome.
Sponsored Link:
In DailyWealth Trader, we have all the tools you need to start generating big
income from selling
options, including an extensive "training center" that houses thousands of dollars'
worth of educational
material... daily Q&A sessions... and a large video archive.
You can
learn more about
DailyWealth Trader right here.
Source: Growth Stock Wire