There are lots of reasons for a guy like me to stay primarily on the receiving end of trading advice, which is part of why this blog–and even my twitter posts, really–don’t, and usually won’t, offer any. Rounding up other people’s analysis is a better way of pointing the (slightly less fictitious, I must admit) reader to useful thinking.

But as I’ve been trading less and less, I’ve had lots of time think about just why I’ve been so carefully hedged, and even net short since the fourth or fifth week of the rally, and why it is that I closed out so many longs “before they ran”, and then Howard Lindzon’s great post this morning got me thinking about it some more, and so, in fine reflection of current market action, I managed to break through to a new realization using nothing but the ideas in my head.

Before I grace you with my revelations, a little background: my general position is one of skepticism. I am neither bull nor bear; out of October’s huge up day, I expected the rally now underway to emerge at any time, especially in the November and January attempts, and did not let go of a basically long bias until mid-February. By that time, even though I thought the market was oversold, I had digested enough information to know that the state of the economy was a lot worse than I had thought, even a few months before, and I was willing to accept that a severe correction was in order and underway. Very low index predictions I had once thought insane–say, Dow 6000–began to seem much more realistic.

This rally began, and I played along for a while, but the horrible news just kept coming. And it hasn’t stopped, by any stretch, as just about every link you can follow from this blog will indicate. (And the blog is mere weeks old.) By the end of March, there was an excellent technical case to be made for skepticism: the rally was gappy, jumpy, panicky; the dips were few, and bought immediately; the gaps up were many, and left unfilled; no support was building along the way; volume was not coming in. Increasingly, we were rallying off of… rallying. Not sustainable.

But there are always multiple technical cases to make, and this rally has ignored mine. Market chaos continues to act all organized, trending up pretty relentlessly. I wake up one day, find an old long position healed and profitable, and sell it into strength, counting myself lucky to have gotten out from under a bad buy I should have stopped out of weeks or months before. Then I wake up the next day, and find more strength, and feel like a chump.

Selling too early sucks, no doubt about it. Trading hindsight makes it especially painful–a parasite, because of the way a chart of the past pretends to reveal a pattern you should have seen all along. Of course, in real time, the pattern wasn’t necessarily there. Making the case after the fact is the bread and butter of technical analysis. I suspect that a poll of traders’ expectations at the end of March would not have shown a majority predicting the April we went on to have.

In any event, if you sell early to lock in profit, or get stopped out of a position that proceeds to run, you haven’t made a mistake, per se–you have effectively managed perceived trading risk. Your risk-management skills may be lacking, but that is a separate problem; at least you’re employing them. Not employing them in favor of tea-leaf reading is pure gambling, and either sets some foolish precedents by paying you off, or spanks you in the trading account to remind you not to gamble.

My big mistake wasn’t closing my longs–it was expressing my skepticism of the rally by adding shorts. Here was how my initial reasoning went: I had some longs left, I figured the rally would tire any day, and when things pulled back, I just wanted to be hedged. I chose weak names that had rallied hard, or weaker names that had trouble getting off the mat, and held them as portfolio insurance. A mistake that grew out of a previous mistake, which was holding onto losing longs too long, out of skepticism of the previous drop.

I hope you can see where I’m going with this. You might think that holding a losing position just causes you to put off an eventual loss. What I’m trying to make clear is that with a couple extra add-on thoughts, staying in a losing position can make you open a second losing position. This is precisely what happens when a trader “averages down” on a trade. You might think that because you’re trading the same name and lowering your break-even price, you’ve only got one position to manage. You’re wrong–you’ve got two, one hidden behind the other, and if the price of the name keeps moving away from you, you’re losing money on both.

My skepticism is not what hurt me here, though I jump up and down on it every day these days for keeping me out of some stupidly easy gold-rush trades. The essence of it is this: the proper trading position for a rally skeptic is cash, not short. And that’s the proper position for a crash skeptic, too.

If you disagree with market action, if you believe it cannot possibly continue, cash is the only defensive trading position. Whether short or long or hedged or condored or strangled or bungeed or expialidocioused, whether the market is crashing or surging or crab-stepping or cake-walking, if you hold a position you’re on the offense.

There is no way to “open a defensive position”, except against your own offense. Two offensive moves do not a defense make.