Why I’m shorting McDonald’s

 

It seems almost impossible to imagine that a company the size of McDonald’s could in fact, vanish…or is it?

First though, some disclaimers.

  • I’m a fast food eater. I grew up with McDonald’s in my life, but my parents recognized the value of balance, and so eating at McDee’s was a ‘sometimes’ treat, not an ‘everyday’ treat.
  • I’m not a born-again vegan with a raging hard-on against the satanic fast food industry and a single-minded desire to change everyone’s eating habits; I still eat the occasional fast food, but some time ago, McDonald’s ceased being my go-to choice.
  • I’m normally just a charts guy. But every once in a while, a story appears that catches my interest on a few levels, so I start to look a little deeper.
  • I could be totally, completely, utterly wrong here. Which is why I use stops, but more on that in a minute.

McDonald’s has been on my radar for a while now, but what finally nudged me over the edge to get into the trade was seeing one of their new TV commercials last night. It was for some wrap thingy (maybe only available here in Canada, who knows), but the 30 second spot screamed of a company frantically trying to reinvent itself. The product looked odd, which is not an appealing quality, and certainly didn’t leave me wanting to try it.

Case #1. The numbers:

Now, I’m not going to painstakingly break down the latest $MCD earnings numbers for you here. There are enough people out there doing that already, and doing a far better job of it than I ever could, at that. McDonald’s reported for the quarter on the 22nd, and it missed on both earnings ($1.40 versus $1.44 estimated) and revenue ($7.18 billion versus $7.29 billion). It’s feeling the pressure of lower sales in both the US and Europe, and perhaps most disturbing, it’s offering little in the way of positive guidance for the remainder of the the year. And this is not a new development: the company has struggled with their  numbers since 2012. One gets the impression that every quarter the board probably feels like a grade 8 student schlepping home with a poor report card, bracing for that conversation with the parental units. The company is facing increased pressure from, quite frankly, better tasting competitors. Those competitors include Chipotle Mexican Grill, which interestingly, McDonald’s once owned 90% of; “once owned” being the key phase there. D’oh! Which brings us to…

Case #2. The food:

Consumer Reports latest food survey had McDonald’s burgers rated 21. Out of 21. So, last, basically.

http://static3.consumerreportscdn.org/content/dam/cro/magazine-articles/2014/August/CRM_Consumer_Reports_Taste_Champs2_08-14.jpg

That’s not good. At the end of the day, even if it’s fast food, people want to at least enjoy the indulgence. And clearly McDonalds isn’t delivering.

What more is there to say?

Case #3. The chart:

(click to enlarge)

MCD July 2014

$MCD has had an undeniably strong run since 2003, as this weekly chart shows. But that trend seems to be wavering. The double top that formed with the peaks of April 2013 and May 2014 is easy to see. While that strong uptrend hasn’t yet been broken, it is weakening. With the double top comes an obvious stop loss point – a break above that would nullify this short idea.

There are clearly cracks in the armor of this monster company. Calling for it to vanish completely sounds a bit silly, until you start to ponder the larger question, which is: Is this a business that would get off the ground if it were started today? I think the answer to that is no. And the problem is, despite their attempts to reinvent themselves, they are still McDonald’s. Brand recognition is a powerful thing, but in this case, that may not be a good thing.

I’ll leave you with one final thought. Sometimes big companies do in fact just go the way of Blockbuster (see, there’s an example right there). Remember Compaq? MCI WorldCom? How about Arthur Andersen, a company that ran from 1913 to 2002, and employed over 80,000 people?

Think McDonald’s couldn’t just vanish? Ask yourself if your life would even skip a beat if it did. Would anyone’s?

 

Radio Silence

One of the great joys of being a free-thinking, independent investor is the ability to change direction on a moment’s notice.

Fish+cartoon

There’s no committee formation, no focus groups, no proposals to submit. Be it an investment decision or a business direction decision, we’re free to make changes. Now, they may not ultimately be good changes, but as my dad used to say to my mom on our summer vacation roadtrips, “I’m not entirely sure where we’re going, but we’re making great time!”

Despite my lack of updates and posts, I am still trading, and slowly adding quality positions as I find them. I didn’t make a conscience effort to stop posting, it was just the result of Life, and time getting away from me momentarily. And then an odd thing happened – there was a sense of peace that was actually kinda nice.

Some traders find it a challenge to stick to their trading plans, and for them, posting is a fantastic way to self-impose accountability: If you post that you’re buying a stock at $25, and your stop is at $20, then you are far more likely to stick to that stop and not sell out early…or worse, not sell at all.

Others post to share their trading experiences, both the good and the bad, in the hopes that others may learn.

And some post simply out of ego.

I suppose I post out of some sort of combination of all three.

In any event, what I’ve noticed is that by trading in silence, my trading has not suffered, and in fact I believe it has improved. And I measure that improvement not solely based on percentages, but also the bigger, tougher questions: am I following my own rules? Am I taking quality trades? Am I practicing discipline? What about patience? And I believe I can give myself high marks across the board by that yardstick.

I recently re-read Nicolas Darvas’s book, and though I’ve read it a number of times over the years, each time I read it (or any book, for that matter), I tend to get something different out of it – likely because each time I read a book, I’m in a different frame of mind, with different questions bouncing around in my head. This time around, I was more interested in his battle with “noise”. He needed to trade in silence, without constant, streaming input from other traders, brokers or excessive market data. And that resonated with me.

We go through phases, I think, and at the moment, this is “radio silence” phase for me – certainly not a permanent disconnect, just a break. I still privately correspond with several of the wonderful peeps I’ve met through Stocktwits, Twitter and this blog, but for now, the public stuffs will be minimal. I may even look to post more non-market related material.

I think sometimes we (and by ‘we’, I mean ‘I’) tend to get too focused on the details and fail to see the forest for all the trees. A step back, to regroup in silence, can be a healthy thing. I rarely look at my accounts during the week these days, and in general, spend about an hour or so on the week-end reviewing positions, and scanning for new ones. I don’t need to look at things every day because I have stops in place, and my trading platform will email me price alerts as they’ve been set for existing positions. If I don’t get any emails, that means there’s not much to look at.

I guess that’s what Darvas was trying to explain – ooooh! Now I get it….

0_0_0_0_250_262_csupload_43612477

$BBY strangle…redux

Back in March 2013, I did a post on strangles, and in it I detailed a long position strangle I did on $BBY. The trade was profitable, but admittedly, if you pull up the chart you can easily see it had much more room to run. Moving on!

We all know the Best Buy story, and how it seems unfathomable in this day and age that such a behemoth of a walk-in retailer can still exist. And yet it does. But I’m a chart guy. Mostly. The stock took a wallop (that’s a highly technical analytic term) back in January, and has been moving sideways ever since.

To be clear…I HAVE NO IDEA WHERE THE STOCK IS GOING TO GO….

And as always, I have zero idea where any stock is going to go.

At the moment, the options market is pricing in a 21% move in BBY by January 2015 expiration.

Sidenote: For those not familiar, that figure is arrived at by adding the cost of buying an ATM Jan ’15 call, and an ATM Jan ’15 put, in this case that’s roughly $6.20 combined, therefore for that position to break/even the stock would need about a 21.5% move by expiration date.

To me, given the historical pricing of the stock, given that the position would have 8 months to play out, it makes it a reasonable trade. Others may very well disagree. My thesis for buying the strangle back in January 2013 was that in my opinion, the company was unlikely to not undergo some sort of major corporate shift, or at least have that potential shift factored in by the market within 6 to 8 months. And at this point, I have a similar impression once again. I think a minimum 21% move by then in either direction is reasonable.

I’m not betting the farm on this trade; I’m treating it like any other trade, which means sizing it accordingly. I may in fact average into (not ‘down’, ‘into’) this position gradually.

Weekly chart, click to enlarge

BBY June 2014 strangle

 

 

 

Trading update

Last week I started deploying some cash back into the market.

I’m looking for high quality set-ups where I have an edge, and am being terribly picky about them.

At this point, I’m still 95% cash in one account, and 88% cash in another, with a total of 9 positions, the latest was a short on $PNRA this morning (I posted the idea, just not the trade itself. My stop is a close above $159.18, for those interested), and that is my only current short. I don’t think it’s cool to post my holdings with my entry prices now, as I didn’t post them when I took the trades, but I will at least run down the tickers here:

Long positions:

$SPY

$WFC

$RAD

$FLEX

$CSCO

$DOW

$TWTR

$DD

Short positions:

$PNRA

I’m sure the $TWTR position will raise an eyebrow or two, but it’s a risk-managed trade, using longer term calls (LEAPs), sized appropriately, and my current stop is a close below $29.51, the all time low.

So that’s where I’m at. I’m in no rush, and will add trades as I find them. I’m looking at multiple time frames, and in the vast majority of cases, using ITM LEAPs.

Be picky, be patient. It’s your money on the line.

Do you know your stock’s moving average?

Moving averages are a pretty common technical indicator. Everyone is familiar with the 10, the 20, the 50, the 200, and I use a few of those for my weekly trading system. But there is another moving average that is worth considering – the moving average for each stock. I’m not the first to bring this up (as I’ve mentioned before, none of my methods are original, they’re cobbled together from a wide array of sources), but I think it’s worth mentioning here.

Arguably, each stock is unique, and will behave with a certain about of independence, regardless of the noise going on around it. Take a closer look a stock, and you’ll notice something – it will likely have a unique moving average that it generally respects.

So let’s look at an example: $TNA

These are 5 screen shots of the TNA daily chart from 2009 to present, using the 105 period simple moving average.

Click to enlarge each

TNA5

TNA4

TNA3

TNA2

TNA1

It’s important to remember that I tend to think of moving averages as “areas” as opposed to lines drawn on the page with a number 2 pencil; sometimes they do act like distinct lines in the sand, but often it’s how the stock functions around them that is the greater tell. Additionally, it’s important that this isn’t used as a sole reason to enter or exit a stock, but used as simply another tool in the toolbox, and in conjunction with your overall trading strategy and plan.

I would encourage you to pick a stock, then adjust the moving average, and see what you notice. You might be surprised what you find.

Oh, and sometimes the moving average the stock chooses to follow IS the 10, or the 20, or the 50; and other times, you have to hunt a little for it.

 

 

 

 

 

 

 

Thoughts On Paper Trading

 

trading cartoon

I can’t think of too many careers where you would perhaps take a week-end course, maybe read a book or two, or watch a youtube video, and then come Monday morning, begin a retina transplant/proceed with opening remarks at a bench trial/draw up blueprints for an office tower/or replace the motor mounts on your family’s 2011 Dodge Caravan.

And yet in essence, that’s sadly what too many budding traders and investors do every week. Years ago, in a roundabout way, it’s what I did as well. Doh! I also tried to ‘play mechanic’ on my poor unsuspecting 1978 MGB at one point, but that’s a different story.

This is a career just like any other, and takes time and tuition from those that sign up.

There’s a school of thought that before putting real capital at risk, it’s best to paper trade first. I think paper trading has a place, and we’ll get to that in a moment, but for the purposes that most use it, there’s another approach to consider.

I’ve never been in combat, nor shot a live round at another human being, so I can’t presume to know what that feels like, or the emotions that go with it. Somehow I don’t think hunkering down for a week-end viewing marathon of Generation Kill cuts it. However, I have played a game or two of paint ball, and I assume that for as much as paint ball can get the heart racing, it feels substantially different when real, unforgivingly lethal, munitions are being propelled towards you with extreme prejudice.

Flight simulators have come a long way, and pilots are now able to practice flying, take-offs and landings at a plethora of real-life airports under every imaginable condition. A valuable and needed tool to be sure, but I’m guessing there’s a difference between sitting in a simulator showing nasty weather and an ill-lit runway, and coming into JFK in the middle of a February night with the sleet outside hitting your windscreen sideways, and 200 souls on board that don’t have the foggiest notion how to fly a Boeing 777, entrusting you to touch down safely. This, you’re thinking, is the real deal.

While actual lives may not be at stake when trading, the health of your finances – and possibly your loved ones – is most definitely on the line.

All of which is to say, that while paper trading may appear realistic, there’s no substitute for having real money on the line. You WILL feel and respond differently when the numbers are not simulated. So is paper trading a waste of time? Is there an alternative? Doesn’t it still kinda hurt to get hit by a paintball round? No, yes and most definitely.

First let’s look at where I think paper trading can be useful. If you’ve developed a system or a plan (and you should) and you know what needs to occur to get you into a trade (and you should) and know before entering a trade what your stop is/what would need to happen to prove your trade won’t be profitable (and you should), and you’re looking for a way to test what percentage of the time the strategy gives a negative result, then have it. It can be very useful in determining a failure rate.

What paper trading cannot do well is tell you how profitable a winning trade could be. And the reason is because in most cases, traders will react very differently under “live fire” than in a simulator. They may take profits too soon, let a winning trade turn into a loser, ignore or override their exit strategy because “this time it’s different”, the list is endless. Any trader that has watched the P&L in their trading account when a trade works violently for or against them knows what I’m talking about. And if it’s a new strategy, God help them.

So what’s the solution?

Trade real money.

Now, that does NOT mean that you take a 500 share position in $BAC on your next trade signal. What I would suggest instead, and what has worked well for me in the past, is to take a 5 share position. That’s right. 5 shares. Which in this case, would be about $75. Seems ridiculous, doesn’t it? But here’s the thing: the first objective this covers is that it gives you the ability to test your system, using real money, in the live market. If your system doesn’t work with 5 shares, it certainly won’t work with 500. But if it does work with 5 shares, then there’s a good chance it will work equally well with a full sized position (whatever that may be for your account). The second objective this addresses is it allows you to trade with just a hint of “live fire” coming at you, but not enough to either mortally wound your account, nor enough to distract you from the real objective..which is testing your strategy. Heck, buy 1 share if that’s all you need. If your system calls for you to sell half your position at a specific target, then buy 2 shares so you can do so.

Even though it’s a small amount of money, it will still give you a much better feel for not only how your system performs in real time, but how you as a trader react to what is happening before you.

Depending on your brokerage account and situation, there may be a concern that trading fees will make this an expensive exercise. I would argue that choosing to immediately go live with full sized trades and an untested system, has the potential to be far more costly, and potentially crippling to an account. Spend a little, to save a lot.

And this isn’t silly – no one is watching you, and quite honestly, no one cares. They have their own problems. Trading is about putting egos aside. If you had never worked out before, but read a Muscle and Fitness magazine on the week-end, would you march over to your fitness center on Monday, slap on a weight belt, stack both sides of the bar with plates and dead-lift the weight of a Smart car? Think you’d be back for more on Tuesday?

By the same token, what you would want to do is start small, and slowly work up with progress and confidence, getting your body used to working out, using real equipment, and a real plan.

personal-training

 

 

 

 

An update, and a trade post mortem

It’s been almost a month since I went to cash.

At the moment, I have a couple of shorter term swing trades on, but essentially I’m very much cash-heavy. I wait now patiently for the market to once again favor my preferred style of trend trading, and in the meantime, I keep the lights on by scalping quick trades intra-day.

The only way to have longevity in this business is to be trading with an edge. A “hunch” is not an edge. A “feeling” is not an edge. Having a trading plan (regardless of your time-frame), having a risk management strategy, and having self-discipline – those are edges.

My comfort zone is trading off the weekly. It’s where I feel most at home and in my element, and that’s been the case for most of my investing/trading years. I’ve spent time developing and refining that process and I now have a bankable edge.

Where I am most out of my element is day-trading. Which is not to say I can’t day-trade, or that I’m not successful at it, just that it’s not my preferred arena. And that became ever more apparent to me this week. Yes, the week was a profitable one, but that does not mean that each my trades were good trades.

Just because a trade was profitable does not necessarily mean it was a “good” trade. Conversely, just because a trade was not profitable, does not necessarily mean it was a “bad” trade.

A “good” trade is one where you adhered to your trading plan, employed a solid risk management process, and used discipline to execute it all…regardless of the outcome. In fact, having a profitable trade where you did not stick to your rules is quite dangerous: It teaches your brain that bad habits and sloppy trading will be rewarded, which might be true for a trade, or two, or three, but it won’t work over the span of hundreds of trades.

And so in the spirit of openness, self-flogging, and hoping others learn from my errant ways, I bring you my last trade of the week, on Friday.

My day-trading system gave me a clear short signal for $SPY about 40 minutes into the trading session, which I took (check). I took the right trading size (check), entered my hard buy-stop order (check) at the right price (check) and should the trade work, I entered my hard order to cover half my position (check) and at the correct price (check!).

And then I waited.

It didn’t take long. About 15 minutes later, the trade worked in my favor, and my buy order to cover half my position filled. At that point, I followed my plan, which is to then raise my stop (lower it, in this case, as I was short) to break-even. Now, no matter what, the trade is a profitable one based on the first half that was covered.

So far, so good!

And then the wheels fell off the bus. The plan is to then patiently ride out the second half, taking as much profit as possible (or get stopped out), before I get a signal to close the trade. But I didn’t do that. For whatever reason, I chose to cover the remainder far sooner, thus not capturing the bulk of the potential gains. Now, sometimes the trade reverts, and I’m stopped out, and there are no further gains to capture. But the risk/reward of this strategy only works if I have the patience to find out.

Think of it this way: If you risk $1 to make $0.50, that’s a terrible risk/reward ratio that will ultimate send you to the poor house. You would need to be successful twice as often as you’re not in order to simply break even, never mind actually make money. Bottom line is, you don’t want to risk more than you could potentially make.

In my trade example, I risked $1 and ended up making $1.25 on the trade (not literally – I’m using these numbers for ratio purposes), which while profitable and more than my initial risk, is still poor, if you extrapolate that over hundreds of trades with a 50% to 60% success rate. Had I stuck to the plan, I would have made $2.75 on this particular trade, which is nearly a 1:3 risk/reward. Ultimately, I think anything with an average of more than 1:2 is in the ballpark.

But the larger issue is why did I not adhere to my plan, and why did I close the trade early? To answer properly would turn into a small novel. I have no difficulty at all following my trend-trading trading plan and system to a ‘T’. It’s when I’m outside of that comfort zone that I can be far more prone to a lack of discipline. It’s a work in progress. It’s a weak spot for me, which I recognize and am working towards. It doesn’t happen all the time, but it shouldn’t happen any of the time. For me, the steps I take to work on it include a lot reading, especially chapter 2 of Mastering The Trade, by John F. Carter, an excellent read on the psychology of trading. Because the problem wasn’t with my system, but with my mind.