"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

Thursday, June 30, 2011

June 29 Intraday Market Snapshot: Potential Rising Wedge Formation

Keep an eye on the Russell 2000 intraday chart: it might be forming a bearish rising wedge at a major Fibonacci retracement. Also, relative strength was lagging a little bit yesterday. A test of the 800-level would be healthy, though, and potentially setup a swing play on the long side.

Swing Trading Uncle Russ: Sit and Wait

You might recall my post from June 7, where I started discussing swing trading the Russel 2000 index. I suggested to close shorts at the lower bound of the channel. So what should be the next move for a swing trader? Here's the current chart:


Obviously, the Russell is about to touch the upper channel boundary. Therefore, it is really about time to close index long postions. Also note that uncle Russ is running into overhead resistance, which is coming from the declining trend line. At this point, however, I would not reverse the postion and go short: relative strength vs. the S&P 500 has been positive and the intermeditate trend, measured by the 20 day MA is about to turn up. So doing nothing and wait for a pullback is propably the best bet at the moment.
Note that I still own a portion of my small cap index long (TNA) in the Covestor Model Portfolio. However, I'm on the way out and will determine when to sell it based on the 30 min intraday chart.

Wednesday, June 29, 2011

My Most Important Trading Rule

Take a look the chart of St. Joe Corp., a stock I shorted in May/June. I guess price action appears to be quite bearish and if you are short your natural thought would be to hold this thing until it goes to zero:



If there is one lesson I learnt while studying the markets during the last four years it is this one:

Price is ALWAYS coming back to its moving average. ALWAYS
(as long as the company is not Lehman Brothers :-))

So now look what happened with JOE:


You would call this rule "mean-reversion" if you want to sound a little bit more sophisticated. Once you understand that, it becomes much more easy to take profits into strength (on the long side) and to not chase stocks when they moved too far. It took me a while to figure that out, not so much intellectually but rather emotionally. It'll help to look at these charts from time to time to keep emotions in check when the heat is on.

The Current Hit & Run Market Environment

Traders usually like trending markets with smooth pullbacks for buying opportunities. A " perfect" textbook-like  market (which probably doesn't exist anyways) would offer declines in the area of 30 - 50% of the original up move. So if stocks would rally 10%, they would decline maybe 3%.
Unfortunately, the current market environment is different and investors need to adjust their short-term trading styles to this "hit-and-run environment". Basically, there are no shallow pullbacks. You are either in or not. Take a look at the recent runs of the Russel 2000:


More or less off the bat, the Russell rallied between five and 10 percent in 2011. No base building, no textbook-like reversal candle. Note that the latest run is getting into the "danger zone" where we would expect a leg down if the pattern we have seen this year holds.

The down-legs have been of the magnitude of four to eight percent:


Trading this environment profitably is extremely difficult and requires to
  • go more or less "all in"  after strong down moves and quickly close positions (or even go short) after (or better during) the up-leg
  • not chase stocks if they get away from you
  • look at 30-min charts because it is easier to spot reversals intraday
  • maybe even don't trade, the choppy can wipe you out. There will be an easier environment in the future. I promise.

Tuesday, June 28, 2011

June 27 Intraday Market Snapshot: Still Trending Up

On Monday, the Russell continued its way up. End of quarter window dressing might be the tune and selling into strength is probably a good exercise these days.

The index ran into some resistance around 805, but overall small caps continued to act stronger than S&P stocks. At this point, the Rus has formed a trend channel. The next leg up will determine if the rally is gaining strength or loosing momentum. I would bet for the later one, but as always be open for everything. Positive news from Greece could trigger a nice pop, though.

Monday, June 27, 2011

Intermarket Theme: Food & Beverage Stocks

Food and beverage stocks have outperformed the S&P since February. I take the Powershares Dynamic Food and Beverages ETF PBJ as sector proxy. Despite the general market weakness, PBJ is still looking quite bullish:


It is quite obvious why the sector outperformes: declining commodity prices lower input costs of companies like McDonald's or Starbucks (both companies are BTW included in the ETF).

The link is to commodity prices is quite strong as the following chart shows:


PBJ tended to outperform in the last years when DBA, the Powershare Agriculture Fund, declined. So if you intend to invest into e.g. McDonalds, you also want to take a look at DBA.

On a side note, I'm not investing into PBJ because the fund is very thinly traded. Covestor has some liquidity rules, which I have to follow.

Silver: a Potential Volatility Breakout to the Downside

One of my favorite trading setups is a "volatility squeeze", where prices move in a narrow range after violent moves. When prices not only break important levels but also expand volatility again, a volatility breakout occurs.

Silver prices look like creating such a setup and Bollinger Bands started to expand in the last week. I wouldn't be surprised to see the metal trading below $30 in the coming months. I therefore shorted Silver in the Covestor Model Portfolio last week.

Sunday, June 26, 2011

A Positive Sign: NASDAQ/NYSE New High/Low Divergence

For what it's worth, there actually is a bullish sign for stocks out there: the "NASDAQ New 52 Week Highs - 52 Week Lows" is showing some positive divergence with respect to the Nasdaq Composite Index itself. It seems like the sell-off has been loosing steam during the last two weeks:


A similar situation occurred at the NYSE with a small difference: the divergence started to show up a little later and has set up just in the last days:


I wouldn't aggressively go long based on this observation, however, it's a little piece of information in the n-dimensional investment/trading puzzle. Let's keep watching...

Saturday, June 25, 2011

VIX Demystified: The High Correlation with the ATR

The VIX is often described as a somehow mystical indicator, which "measures the expected market volatility over the next thirty days" (Wikipedia). Calculation of the VIX is quite complex and basically a weighted blend of various S&P 500 option prices. The indicator is often used to gauge fear of market participants.

In my opinion, there is nothing magical about the VIX. It only measures short-term historical volatility and you could use the Average True Range (ATR) instead. If you don't believe me, take a look at the following chart, which assembles the VIX and the 3 day ATR of the S&P 500:



The spikes and decay periods are nearly identical and both indicator are showing almost perfect correlation. What does that mean? Fear is not only characterized by a high VIX number, but can instead be measured simply by a high daily range of the S&P. The ATR correlates to the VIX much better than the simple index standard deviation.

Commentators (including me) discussed the low VIX readings during the last month. They could instead have  just concluded that prices have declined on a low daily range.

Wednesday, June 22, 2011

June 22 Intraday Market Snapshot: Now Things will get Interesting

As mentioned in my post on Monday, I expected a market bounce, led by small cap stocks. Frankly, even I was surprised by yesterday's strong price action. I keep focusing on uncle Rus since the Index outperformed the Nas and S&P (lower pane of the chart) this week and keeps leading:

 After yesterday's strong move, things will start to get interesting from a technical point of view: the Russell 2000 ran into a major resistance zone as defined by the Fibonacci levels. Price momentum is positive, though, and we'll have to see if there is enough fuel to push the index through these levels. For the next days, I wouldn't be surprised to see a re-test of the rising 5 day moving average, which could be a nice entry point for additional long positions. 
Longer term (beyond end of quarter window dressing) I'm sceptical of the rally. Various bloggers and full time traders I'm following are planning to go short again when momentum fades. However, a quick strong move to the upside in the next two days would prompt many traders to modify their short selling plans.

Tuesday, June 21, 2011

A Trading Lesson from Lululemon, Coach and Tiffany

Currently, I have three luxury retailer stocks on my watchlist: Lululemon, Coach and Tiffany. It is amazing to see how their charts are correlated to each other on a intra-day basis. It almost doesn't seem to matter which stock to trade in the short-term:


However, strength in one stock can also indicate potential future strength in another stock, which is what happened today: LULU was leading not only the sector, but the entire market. Tiffany was lagging in the morning but played catch up in the afternoon:


Plotting similar stocks on one chart can reveal interesting opportunities or support bullish/bearish trading decisions.

Covestor Model Portfolio Commentary: From Cash to Long

I maintained a bearish stance during the first half of June and played the market predominantly from the short side. Recently, I had been taking profits and increased my cash position to over 80%.
Yesterday marked a significant change in my short-term trading strategy. I closed an index short position (TZA) and went long various strong momentum names in the Covestoor Model Portfolio. I acknowledge that this is still a weak market and I don't expect to hold these stocks for a long time. Various factors suggest that we could see a bounce for a couple of days:

- The technical picture of the Russel 2000 looks short-term positive if important resistance levels can be broken.
- Some indicators (not all!) suggest a very high level of negativity in the market, which is usually the base for an oversold bounce.
- The markets ignored some positive surprises in economic indicators last week. Participants seem to focus solely on Greece. Greece is still a risk factor before the confidence vote and I might put up some hedge later today.

Russell 2000: Short-term Bullish

Small Caps underperformed during the recent market decline. The short-term picture of the Russell 2000, however, suggests a bounce for a few days in my opinion. The 30 min chart shows that the index ended its series of lower lows and lower heights:


The 5 day moving average even started to rise in the last days. There is also a nice momentum divergence when looking at the MACD filter. The critical level to break is 790 in the index futures and it looks like the Russel could take out that resistance this morning.

The daily chart is looking interesting as well:



The 200 day moving average offers a natural region for a bounce. It will be telling to watch the chart in the next weeks, because prices will be squezzed between the falling 50 day and rising 200 day average.Short term upside potential  is therefore limited from the technical standpoint.

Thursday, June 9, 2011

Keep an Eye on Oil

Crude has recently been showing some strength despite all the negative headlines and declining equity markets. Oil had been highly correlated to US stocks for the last two years. However, Crude has been outperforming the S&P 500 since March and held up quite well recently despite economic slowdown fears.Obviously, geopolicital issues, such as the failed OPEC meeting, are supporting oil. Current prices offer a nice entry point for swing trade on the long side:

Wednesday, June 8, 2011

Jim Cramer: "Too many bulls in the market"

Last night, Jim Cramer argued that there are still too many bulls in the market. How does he know? Here are some charts that support his point:

1) The VIX ("Fear Index") is still at a relatively low reading. Let's start talking about fear when the index spikes above 30:


2) The Equity Put/Call Ratio is nowhere near historical panic levels:


3) The McClellan Oscillator is at -44. In case of panic, the indicator can easily move below -100:


The absence of fear is the reason why I shorted the Russel 2000 yesterday after the release of Bernanke's speech.

Tuesday, June 7, 2011

Swing Trading the Russel 2000: What to Do Now?

In the current market environment, I like to swing trade the Russel 2000 Index from the short side. Small caps should underperform their larger peers in a weakening economy. The strategy is fairly simple (in essence discussed by Alexander Elder in his books): we go short when the index rises above the declining 20 day moving average and cover the short when price moves towards extremes, indicated by moving average envelopes. In the case of the Russel, I'm using 3.5% as width of the channel. So based on that strategy, it is time to close the short position, which I plan to do in the next days:


Disclosure: Covestor Model Portfolio is long TWM

The Market Transition of the Last Six Months

Markets don't roll over all of a sudden. Transition periods often indicate major trend changes. The behaviour of individual sectors in the last six months nicely demonstrated that process:

Phase 1: Everything is moving up. Looking at a sector chart from the beginning of this year shows how broadly the rally actually was. Defensive and non-defensive sectors participated in the rally:


Phase 2: Non-defensive sectors weakening. Serious cracks started to occur in April. Energy, Financials and Basic Materials started to decline while defensive sectors kept rising. Sector rotation driven by the smart money turning defensive.


Phase 3: Everything is moving down. These developments occurred in the last weeks. Even the defensive sectors cannot hold up. The market decline is broad based and it could take some time for a significant change in sentiment:


I'm always surprised that defensive sectors are supposed to be a protection during bear markets. It is my observations that Consumer Staples, Health Care and Utilities usually also decline. The reason why institutional money piles into these sectors is because they have no other choice: Mutual funds cannot go into cash and they are not allowed to go short either (Actually, I don't understand what's the point of Mutual Fund is if they have very limited degrees of freedom. But that's a different discussion). In any case, the individual investor obviously has a huge advantage because nobody cares if he is in 100% cash.

Monday, June 6, 2011

Recent Dollar & Gold COT Data

It's about time to check what large Future traders ("smart money") have been up to in key markets. Some interesting divergences have been showing up:

The US Dollar:

The majority of large traders was short in March and started to unwind positions since then.The divergence sent an early warning signal and the Dollar bottomed at the beginning of May. Traders even turned more bullish during the recent rally. I would have expected an increase in short positions in the last weeks in the light of Dollar weakness. Obviously, the smart money expects that the May lows will hold going forward. Should the US currency indeed reverse and put in a intermediate term bottom, implications for US equities and commodities would be on the bearish side. I would keep this chart on top of my watchlist.

Gold:

Large traders expanded their long positions in recent weeks, However, given the fact that Gold trades almost at May heights, a notable divergence could develop. The smart money has been reluctant to pile into Gold after the sell-off, which matches the decreasingly bearish bets on the Dollar.

Silver

Silver is looking even more dramatic than Gold: the rally in May was used to further wind down long positions. However, the overall net long position of large traders is now a at a multi-year low (not visible on the chart). Similar readings have historically been associated with bullish turning points.(Remember: identification of divergences and extremes are usually key to interpreting all kinds of financial data & charts)

Disclosure: Covestor Model Portfolio is long DGP

Sunday, June 5, 2011

Android vs. Apple iPhone/iPad: Who will Win?

It looks like the mobile computing market will be a battle of two titans: Apple and Google. Here's my thesis: if Android looks to become the winning system, Google's stocks should also outperform the stock of Steve Job's company. Granted, both enterprises apply different business models: Apple makes money selling hardware and apps though iTunes, Google's earnings are based on ad sales. Still, their stocks should reflect relative success of their platforms. So far, the winner seems to be Apple:

AAII Sentiment Indicating Complacency, Not Bearishness

The latest AAII bullish sentiment reading came in at 30.2%, a very low level. Apparently, a small number of individual investors currently feels bullish. Various sources in the Internet take this extreme reading as a short term positive for stocks based on the contrarian view. Looking at just the bullish reading unfortunately only tells one third of the story (I understand, it makes great headlines for retail investors). , AAII tracks three numbers: the share of investors who feels bullish, neutral and bearish.

Here are the readings for each category of the last two and a half years:

Bullish sentiment is in fact at a level, which has been a relative low point:


However, the neutral sentiment is also at record levels, so a large number of investors have no stance on short term market direction:


Finally, the share of investors who feel bearish on equities. We have seen much higher readings in the last two years:


Summary: not many feel bullish but also not many feel bearish. Based on these numbers, there is not an excess of pessimism in the market. I would even argue for a high level of complacency among investors, which I think would have rather bearish implications.

The latest development in the VIX supports that point: despite volatile declines in the market amid negative headlines, option premiums are obviously still at very low levels: