"Water shapes its course according to the nature of the ground over which it flows; the soldier works out his victory in relation to the foe whom he is facing. Therefore, just as water retains no constant shape, so in warfare there are no constant conditions."
-
Sun Tzu

Sunday, May 29, 2011

Next Week: Greece & The Dollar

As usual, the US Dollar will drive market action next week. The Greenback showed some decent weakness last Friday and in fact bounced off its latest 38.2% Fibonacci retracement. It looks like the Dollar is building another leg to the downside and running into the long-term (bullish) declining wedge:



Short-term however, the Dollar has good potential for further declines. The wildcard is Greece and we will see fairly quick next week how things play out. The situation is getting interesting fairly quickly (check out one of the latest post on zero hedge) and could pressure the Euro. My feeling is that most news are already priced into the markets, but we will see in the next days. Should the European currency not get kicked around too much, US Dollar weakness would probably benefit the Basic Materials and Energy sectors. In fact, these sectors outperformed the S&P 500 during the last week and should benefit from the developments in the Dollar:



Similar charts could be shown for Basic Materials as well as certain commodities such as Gold or Crude.

Bottom line: Obviously, I'm mildly bullish and will keep looking for LONG opportunities in sectors, which are sensitive to the Dollar. High on my watch list are APL, CLF, HOC, NSC and PDS.

Disclosure: Covestor Model Portfolio is LONG DIG, DGP

Thursday, May 26, 2011

Intermarket Thoughts: Dr. Copper - or is it "Dr. BRIC"?

One of the main drivers for Copper demand has been consumption from emerging BRIC economies. Therefore, Copper prices and the stock markets of Brazil, Russia, India and China have been strongly correlated with the red metal, as can be seen from the following chart:


What's interesting here is that the BRIC markets recently started to act weak before Copper began to struggle: BKF has been moving sideways since October 2010 and in fact broke their longer term trend line. So are the BRICs leading Copper prices down? A similar situation occurred at the beginning of 2008 (left side of the chart): Copper was still rising, but BRIC countries already began to weaken. I'm monitoring if history will repeat itself and if "Dr. BRIC" will predict "Dr. Coppers" actions.

Wednesday, May 25, 2011

Short-term Positive Dollar-Gold Correlation Creating a Trading Opportunity

Gold and the US Dollar are usually inverse correlated: when the Dollar falls, Gold has the tendency to rise. Occasionally, this relationship changes so that Dollar and Gold both show strength. I believe that markets are sending an important signal when Greenback and the Yellow Metal become positive correlated: they are indicating strong  underlying demand for Gold because the metal can buck negative pressure from the Dollar. What would happen if the Greenback would start declining again? The situation would create a positive force pushing Gold prices higher. We don't see this situation very often. The following chart shows that both assets moved in tandem only three times during the last ten years. Note that I was looking for periods that lasted longer than a couple of days with significant strength in Gold:


Here is where it gets interesting: Dollar and Gold have been positively correlated in the last days:


The duration is still very short in order to be comparable to the positive correlation periods of the upper chart. But I would keep a close eye to the developments in the next weeks.

In any case, current Gold prices offer a nice entry opportunity on the long side after the pullback.

Disclosure: Covestor Model Portfolio is LONG DGP

Tuesday, May 24, 2011

Dr. Goldman: Does the Stock Predict Market Direction?

I don't know why, but some investors consider Goldman Sachs a leading market indicator. In fact, there is a saying "as goes Goldman, so goes the market" (check out this 2009 Bespoke post on the subject). So let's take a look at how GS's stock price correlated to the S&P500 in the last five years:


GS "predicted the 2009 market low and 2010 "flash crash". Obviously, the stock has been underperforming in recent months. Will the S&P follow?
I would be careful with the conclusion since two incidents are statistically insignificant. It will be interesting to see, though, if "Dr. Goldman" is right this time.

Lesson from Recent COT Data Divergences

I like to use COT (Commitment of Traders) data as one of my analysis tools (Find some research on the topic here). The behaviour of "large traders" (the "smart money") is of particular interest.

Current market weakness has been preceded by divergences in many different markets. Even though prices where still rising, large trades where closing positions during the run-up:

Silver:


Russel 2000:


Crude Oil:


My favorite one: US Dollar (note how large traders where riding the trend down but starting the mid of March unwinding short positions. The development was the reason why I closed UDN in the Covestor Model Portfolio)


So lesson learnt here: follow the smart money.

Monday, May 23, 2011

The 2 Sectors Investors Need to Watch This Week

Market weakness started months ago in the commodity sector and spread to other industries in recent weeks. Two ETFs held up quite well so far, but recently developed some serious weakness, so I would keep them high on my watchlist:

Last week, the Retail ETF XRT completed a "bearish 3-push pattern", which is supported by a bearish MACD divergence. A similar structure occurred in other sectors weeks ago. Volume action has been quite bearish this month as well. The ETF might be a good shorting candidate with a stop at $53.5 and target at $49:



The last bastion for the bulls is the Semiconductor Industry. The ETF SMH is looking vulnerable. Further declines would set up a "double top", which ultimately could lead to a downside price target of $29, a 30% decline over current levels:

Equity Put/Call Ratio: The Domain Concept

The equity put/call ratio is one of my favorite short-term market timing tools. However, I look at the indicator a bit differently than other investors. Often, absolute boundary values are defined in order to determine if sentiment is too bullish or too bearish. For example: when the 20 day moving average of the ratio records higher than 0.7, a "buy" signal is generated. To be honest, I argued the same way in recent post. However, it is important to look at the longer term picture.

I'm stating the obvious here, but in general, investors are more bullish in a bull market and more bearish in a bear market. You can actually quantify this notion by looking at put/call ratios on a longer time scale:


The put/call ratio seems to oscillate in more or less constant domains for a certain period of time.
Note how the domain boundaries (0.5;0.7) worked perfectly during the recent bull market.  During the financial crisis however, the levels came in at (0.7;0.9). So whatever was considered overly optimistic during the crisis, had been a overly pessimistic reading during the current bull market. Before 2008, the levels were (0.6;0.75).
It is challenging to determine when markets are about to transition from one to another domain, which they obviously have to do from time to time. Ignoring the possibility of a transition process would totally kill investment performance, because investors would go long when they should be short. Predicting domain change might not be possible, but being aware of the effect can help manage risk.

Are market's in a domain change process right now? They might be. Applying simple technical analysis to the 20 day moving average of the put/call ratio can help to answer the question.

AAII Sentiment: Justifying Going LONG?

A widely followed contrarian indicator is the AAII sentiment survey. Latest bullish readings came in at 26.7%, which seams low (long term average is 39%, according to AAII. Would it be justified to go long based on the view that too many investors are negative on the stock market?

I don't think so. Let's discuss:

AAII publishes a bunch of numbers: investors, who feel bullish, bearish and neutral. The difference between bulls and bears is the "bull-bear spread" and I think this number measures actual bullishness much better than the bull number alone. But let's look at the recent reading for the bears:


The number is elevated in the short-term, but more or less average if considering the last five years. (Obviously, investors tend to be more bearish in bear markets. But that's a topic for another post). In general trading off (technical, sentiment or economic) indicators can be done in two ways: looking for extremes or divergences. Bearishness obviously isn't at an extreme and therefore not jusifying going long at this point.

Let's look at the bull-bear spread:


Similar picture here: the reading is low, but not at an extreme point, however, this could change quickly. A major sell-off could easily push the spread below -30% in the next two weeks. That's when you want to go long to play the rebound.

Conclusion: obviously, I wouldn't open new short positions at this point, but instead ride existing trades.

Friday, May 20, 2011

Relative Strength of Dividend Stocks

How do you know if the stock market is "strong" or "weak"? One of the indicators I'm looking at is the relative performance of Dividend stocks. When they outperform the broader market, I assume that investors are more risk averse and tend to buy "safe heaven" assets. One way to measure dividend stock performance is through the iShares DJ Select Dividend Index Fund DVY. Note how the relative strength of this ETF correlated with market weakness in the last two years. You won't see that my looking at DVY alone. But plotting DVY:SPY visualizes the concept:


Even though I'm short term bullish for stocks, the chart is supporting the opposite stance: Dividend stocks have been outperforming since February and are up over 10 percent for the year.

Sprint: My Favorite Chart These Days

Sprint's stock price is currently printing a wonderful chart. The stock is a classical turnaround play and the weekly pattern is showing a nice pennant structure:


From a technical standpoint, the stock could easily run to $7 and beyond, a 50% increase over current prices.

On a shorter time frame, S has been very strong in the last two months, also in relative terms, measured vs. the S&P 500. Volume action has been great as well, so I belive a breakout could happen soon:



A potential catalyst: Apple signing up Sprint for the iPhone. Rumors are already circulating.

Disclosure: The Covestor Model Portfolio is LONG S

Turning Slightly Bullish

The last weeks have been rough for the markets with very volatile action in some market leaders. Sector rotation was the name of the game in recent months. Investors moved into defensive sectors such as Utilities or Health Care.

In the last weeks, I have been bearish and accumulated various short positions in the Covestor Model Portfolio. I believe that stocks could actually have some upside from here. Let me explain:

The reasons for the decline are obvious: lower global GDP growth expectations, strengthening of the Dollar as a safe heaven asset, negative surprises of key economic indicators suggested that US growth is decelerating. These factors are probably priced in at this point. We can test this hypothesis by watching how markets react to upcoming negative news in the next weeks: losses should be limited.

There is reason for hope from a technical side. Some observations:

The Equity Put/call ratio is at a relatively high level, so investor sentiment is very bearish, which is actually bullish for stocks. Reading above 0.7 usually resulted in higher prices in the following weeks:


The S&P 500 might be about to leave its short-term downtrend. It has been a frequent pattern in the last years that the market rallied sharply after similar declines. Interestingly, BTW that these rallies happened in the second half of the month in March and April:



Copper is showing some signs of life: the metal is trading at the important $410 level. A break of that level would indicate that the Dr. is rather in a sideways period instead of a down trend. Watch the Copper/Gold ratio for indications of a trend reversal. The red metal has been a leading indicators for equities in recent years:


Finally: the US Dollar. There has been a strong inverse relationship recently to US Equities - Dollar goes down, stocks go up. This week, the Greenback found some resistance at 76, which is also an important Fibonacci level BTW. Should the US currency resume its decline, stocks might find new heights in no time. It might be compelling to even set up a US Dollar short position at this point:


In terms of equities, I can find many stocks, who actually did not break down in recent weeks, but have built a late stage base. Granted, probability for more strength after a late stage base is lower, but strong prices in the light of significant market weakness is a positive sign. Wynn Resorts is one example. There are a bunch of similar stocks on my watchlist right now:


What does that all mean for my portfolio?
First of all, I will reduce my short exposure by closing inverse positions, such as SKF or DUG. Next I plan to carefully add positions on the long side, probably looking for Technology stocks since the Nas has been surprisingly resilient. 

Monday, May 16, 2011

S&P 500: Better Bouncing Tomorrow

The S&P 500 should better bounce tomorrow, because the index will otherwise complete a quite bearish chart pattern, a "rising wedge" and also break the 50 day moving average:



I believe, though, that we will see further price weakness because the technology sector, the last bastion of strength, broke down today. We'll see. The Covestor Model Portfolio is positioned mainly on the SHORT side.

Introducing: Swing Trading Alerts

I recently started to summarize the key rationale of some of my trades on a single page and put it out as a pdf on Google docs. What I mean with "key rationale" is usually not an epic text about why a company is over- or under valued.Since I'm a short-term trader, I'm looking for various technical and quantitative factors that could influence performance in the weeks ahead. I will discuss these factors in a later post.

Often, these alerts are trades that I executed in the Covestor Model Portfolio, so it is just another way to follow, what I'm doing. The alerts, however, are just a sub-set of the Covestor positions.

The following link guides to the entire alert collection, so you can always see the entire set. Once a trade gets closed in the model portfolio, I will also change the name of the file in the list and add CLOSED +/-X% to indicate the performance of the trade. https://docs.google.com/leaf?id=0B10A-rrQWEvXYTc5ODg5MDYtMmNjZi00NjdmLTkyYjAtMTQ5NGY5MTkwZDY0&hl=en

I'm not sure, how these Swing Trading Alerts will evolve over time. They could migrate into a newsletter type publication. Currently, I see them as an educational tool for the novice swing trader who wants to learn how to set up specific positions and might be unsure if they should take a specific trade. Since most, if not all of these trades will be Covestor positions, my own money (the Covestor Model Account is linked to my personal trading account) is on the line as well, which makes a big difference. I do not know many newsletters, who have personal money in the stocks they recommend.

Swing Trade Alert #3: SuccessFactors, Inc.

Swing Trade Alert #3: SuccessFactors, Inc.

Swing Trade Alert #4: SHORT Apple, Inc.

Swing Trade Alert #4: SHORT Apple, Inc.

Wednesday, May 11, 2011

Apple: Trading Like the Sector

It's amusing to see how many investors slice and dice Apple's stock and the company's fundamentals. Remember that AAPL is followed by 54 analysts and 6945 investors on StockTwits. The question is if the company's Financials or stock technicals actually matter so much these days. The following chart shows  Apple's recent price action and the "Dow Jones US Technology Index", where AAPL's weight is roughly 14%. As a matter of fact, the iPhone maker is trading like the index (IYW is the underlying ETF):


The stock will become interesting for me again once it can detach from its Index.

Monday, May 9, 2011

Visualizing What Happened "Under the Hood"

It's my investment thesis that a lot of weakness currently occurs "under the hood" and doesn't show up in major stock market indices (yet). I compiled the following chart to visualize how various bearish factors accumulated throughout the year:


The underlying theme is obvious: Mr. market is discounting a slowdown of the global economy. One factor alone wouldn't be an issue, but the streak of events should raise concerns.

The market needs to show some strength, and should do that rather sooner than later. There is hope: Technology stocks acted strong the last weeks. They have the potential to lead the markets higher, so I'm watching the sector carefully:

Thursday, May 5, 2011

US Dollar Outlook

When it comes to the US Dollar, I can see analysts in two camps: one group is calling for an immediate rally to work off oversold conditions. After that, they expect further declines. The second camp is looking for further declines right away. It's interesting that both parties seems to predict a long term weaker Dollar.

From a technical perspective, the US Dollar Index has been moving in an accelerating downtrend for the last three months and is rapidly approaching the 20-year low around 72. It would be telling to NOT see strength around that level:


But even if the Greenback experiences some sort of bounce, the longer term outlook remains questionable:
BespokeInvestment Group published a quantitative study he other day suggesting further intermediate term weakness after strong significant declines.

The Dollar would need a catalyst in order to gain strength and I cannot see one coming up. Basically, there are only three possible modes: the Greenback could strengthen because of safe heaven buying or because the outlook for a stronger US economy improves.Third, the Dollar could strengthen because other currencies weaken.

Let's look at these scenarios:

1) Safe heaven: at least during the recent Japan catastrophe, the Dollar did NOT show strength, which suggests that the US currency hasn't been considered a safe heaven. So I conclude that this catalyst mode will not materialize in the short-term.

2) Stronger US economy: economic indicators recently kept signaling weakness, US Treasury Yields are dedlining. Mr. Bernanke is expecting further weakness. Unless upcoming job numbers surprise, I do not see a catalyst here as well.

3) Weaker international currencies: most major central banks are in tightening mode, which obviously supports there local currencies. The only potential catalyst could come from Europe or to be more specific: from Greece or Portugal. However, I'm surprised of Euro's strength in the light of negative headlines from these countries. My feeling is that Germany's economic strength is actually trumping negative headlines from smaller countries. Keep in mind that Germany's economic output is ten times higher than Greece's GDP. So who cares about Greece?

In summary, I cannot see a major catalyst for the US Dollar coming up, which is why I'm actually shorting the Greenback. I recently reduced my position to take some profits, but would increase again on rallies.

Disclosure: Covestor Model Portfolio is long UDN

Wednesday, May 4, 2011

XLE: Very Clean "3 Push" Reversal Pattern

XLE is showing a very clear "Three Push" reversal pattern (check out Corey Rosenbloom's discussion of the pattern).



The same pattern can be found with other sectors/ETFs (e.g. IWM). However, it's standing out most clearly with the Energy sector fund.
The more interesting question is how to trade it. I already set up an initial short position on the inverse ETF DUG and plan add on completion of the pattern. In terms of targets, the 200 day moving average is lining up nicely with important Fibonacci retracements, so I would expect a decline of around 12 - 20% in the non-leveraged ETF:


Disclosure: Covestor Model Portfolio is long DUG.

Some Things I Currently Don't Like...

... when it comes to equities:

Dr. Copper who had a good track record in the last three years in predicting equity moves has been weak recently:


Fewer and fewer NASDAQ stocks have been participating in the rally in the last months:


Fewer and fewer S&P 500 stocks have been participating in the rally in recent months:



Leading sectors, such as Energy, have been showing technical weakness:



Momentum stocks are struggling:


Defensive sectors have recently been acting strong: 

...but maybe I'm just paranoid and we see some normal sector rotation. In any case, market characteristics have changed. As long as the Dollar stays under pressure, everything is fine, I guess.

Tuesday, May 3, 2011

How to Trade Hostile Takeover Bids

Traders occasionally get lucky and one of their holdings catches a hostile takeover bid. (Lucky unless the bid was anticipated of course). What should a trader do when a bid is announced? Take a look at the following two examples:

NYSE Euronext:
the company received a bid last February 9 from Deutsche Boerse. I argue that it would have been wise to sell the stock on the day of the announcement. It took two months for a competitive bidder to emerge. During that period, the stock lost 10 percent of value due to concerns that regulators would veto the deal. Even after NASDAQ came out with an alternative offer, NYX had a hard time so far closing above $40:



Potash Corp:
The company received a takeover bid by BHP Billiton on August 17 2010. Prices traded flat in the following months because the merger had to be approved by shareholders, who requested a higher price. Mid November, BHP withdrew the bid claiming they were not able to satisfy regulator's requirements. Interestingly. POT's price rose after BHP's withdrawal because the entire sector had moved up in the meantime:

Conclusion, based on these two anecdotal events: if you own shares and a hostile bid emerges, sell. If you don't own stocks, don't chase price (which is generally a good advice anyways).

Silver: Shorting a Possible Top

Yesterday morning, I closed the long Silver trade with at small loss. Price action suggests Silver saw a "blow out top", which is usually followed by a rapid decline. I'm considering setting up a short trade. SLV could rapidly decline to levels around $32 - $36. In this case, price wouldn't even violate longer term trend lines:



In terms of risk/reward, here is how I would structure the trade:
Assumed sell price (short): $42
Stop: $45
Min. target: $36
Risk/reward: 2