"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, July 31, 2011

The Friday Flash Crash and What it Means for the Markets

Markets are so focused on what's going on in Washington that real price action is muted. Last Friday morning, Financial REITs experienced a Flash Crash. Take a look at Invesco Mortgage Capital for example.

Friday, July 29, 2011

The Rare Breakdown of the Gold - Gold Miner Stocks Correlation

Gold and Gold Miner stocks are usually highly correlated to each other. This correlation recently broke down, as can be seen on the following chart (A):

Thursday, July 28, 2011

Market Commentary: What's the Theme Here?

Yesterday's sell-off had been triggered by the current US debt ceiling discussion, according to many commentators. However, I'm not really sure if there isn't another theme at play here.

Saturday, July 23, 2011

Market Commentary: I'm Bullish

I can't repeat it often enough: trading comes down to searching for extremes and divergences by exploring not only price action but also news, sentiment and fundamentals.

I feel there is a huge disconnect these days between headlines, investors' mood and the market value. This situation prompted me to put more money to work and go 100% long in the Covestor Model Portfolio last week. Let me explain:

Tuesday, July 19, 2011

How to Trade Apple Over Earnings

Assuming you are a short-term trader and you hold Apple today. Where's your edge going into earnings?

According to Bespoke Investment Group's earnings database, Apple's average gap up after earnings has been 1.93%, so it would make sense to hold the stock.

I see things a little bit different:

Sunday, July 17, 2011

Similarities Between Wine Tasting and Trading

I don't call myself a Wine Connoisseur, but some years ago I started to develop a preference for certain grapes and regions.

Sector Rotation: Defensive Sectors Loosing Strength

Corey Rosenbloom recently wrote in latest post "What is the Sector Rotation Model Saying in July 2011" that "the model continues to to show defensive/protective money flows, which casts a cautious tone over the broad state of the stock market."

I do not agree with him. Here is why:

Friday, July 15, 2011

Key ETF to Watch: US Retailers

Equity markets were showing some broad based weakness yesterday and even though the S&P 500 managed to stabilize above support around 1300, charts of many sectors are looking weak. I'm even not talking about Financials, but Semiconductors, Internet Infrastructure, Home Construction or Insurance ETFs are in fact trending south.

Tuesday, July 12, 2011

Covestor Portfolio Commentary: Turning Short-term Defensive

My trading philosophy is based on a top-down approach, where I constantly try to get a handle on current market characteristics, psychology and underlying themes. I'm using various tools to do that: technical analysis is one of them, skimming hundreds of headlines and blog entries is another daily task. So here is how I see the markets:

On June 29, I hypothesized that US stocks are currently in a "hit and run" environmen. The June rally as well as  recent declines support this thesis. Basically, the S&P is bound in a wide range between 1250 and 1350, give or take a couple of points. The only positive currently is the strength in so called Momo stocks (high beta momentum names): the prices of e.g. LULU, AAPL, CMG or NFLX did hold up fairly well in the last days. That's the reason, why I'm still long in some of these names and it would be a great opportunity to add to these positions once the market stabilizes.

On the negative side, market psychology seems to have changed significantly: Italy's sovereign debt is now all over the headlines and the markets clearly didn't expect the country to become an issue that fast: whenever the "unexpected unexpected" hits, markets are not prepared and sell off. The issue with Italy is a big story and there is a chance that Financials and the Euro stay under pressure for a while, which is why I went short the European currency using the ETF EUO and US Financials with the ETF SKF. Overall, my portfolio is still slightly geared towards the long side with an overall beta of 0.22.

Technically, the Euro is not a good position since the currency broke the important 1.40 support level against the Dollar this morning. A sharp technical move to 1.35 and after that to 1.30 could be the consequence.  For whatever reason there has been a strong positive correlation between US stocks and the Euro during the last two years, so a weak Euro would pressure equities as well.

Finally, the indices I'm watching (SPX, Russel & Nas) are approaching levels where they *should* rebound, based on obvious support (1300 for the S&P for example) or Fibonacci retracements. It will be telling to see how they act at these critical levels in the coming days.

Disclosure: Covestor Model Portfolio is long AAPL, LULU, EUO, SKF

Monday, July 11, 2011

Why is Portfolio Beta Relevant for Swing Traders?

I often see other investors posting their their cash levels on social platforms such as StockTwits. I have to admit I also did that sometimes. However, I would argue that these numbers are irrelevant and don't say anything about the bullishness or bearishness of the trader. It is almost like when somebody tells me a mean value. Averages are irrelevant without mentioning the standard deviation of its distribution, but that might be a topic for another post.
Swing traders usually hold a couple of positions and portfolio beta quantifies the overall risk. A trader can be 50% in cash but the portfolio might still show similar fluctuations like the S&P 500 if the positions are high-beta stocks, such as LULU for example. Or a trader can be 100% invested and portfolio beta is 0 because long and short positions are balanced.
I frequently calculate the beta of my swing trading portfolio and balance it with my market expectations. For example: after the recent rally in US stocks it made sense to bring down beta levels to around 1, which still means that my portfolio is exposed to 100% market risk (and return), even though I'm at 30% cash.
Another application of portfolio beta is identification of individual position risk. If the relative beta of a position is significantly higher than the average value, overall portfolio performance can be overly sensitive to the performance of that position. By replacing the high-beta contributor with a short position, overall beta can be reduced significantly if needed. For example: I'm long FCX, which is 12% of my portfolio but contributes 22% to my overall beta. I'm thinking of closing FCX and going short the Financials (XLF). This trade would cut my beta to almost half to 0.6.
Going forward, I will always post my beta when tweeting cash levels.

Friday, July 8, 2011

Apple Weekly Trading Characteristics: Maybe the Stock IS a Buy

Recently, I did a post on Apple Inc. where I explained why I didn't buy the stock so far. Well, if the daily chart doesn't look compelling, maybe the weekly chart can help:

Every stock has its own trading characteristics, Apple is no different. It seems to be typical for the stock to work through relatively long consolidation periods (red boxes) and an then suddenly start to build another leg up. Relative strength is important as usual: each rally was accompanied by superior performance vs. the S&P. There have been signs of RS in the last week. I speculate that this strength will persist and lead to a new leg up. Earnings, however is scheduled for July 19 and I usually don't like to hold a full position when a company reports. Now might be the time to buy Apple for a pre-earnings run and then take half off the table shortly before the release date.

Thursday, July 7, 2011

From my Mailbag: "I Missed the Latest Run!"

Here is a mail I recently received from a developing trader. I thought I answer it openly on this blog so that others maybe learn something too:
"Funny how you mention LULU because I have been watching that name and missed the run from the low 80s until now which is a bummer.  I guess I am wondering now at what time does it become a short??? 
With this latest run I am wondering when the market might turn...  I have for the most part missed this last bull run.  I felt that the news from Greece would have a bigger effect on the market but the market just shrugged it off.  I tend to be more of a pessimist than an optimist so hence I lean more towards the bear side than the bull side.  I think this personal bias is something I will have to overcome to become a better trader. 
Most of my gains this year have come from commodities.  I also had good luck with silver.  What a run that was.  Now I am unsure which way that will trade from day to day.  I have a little hesitation to jump into gold  here now.   I have found that AKS tends to swing pretty well on the charts and made some $$ there too.  My losses this year have come from TZA and VXX for the most part. 
The retailers continue to have a good run.  I am surprised at how these have shot up.  I continue to read the stories of the strapped homeowner so I am still scratching my head.  As, there are a record number of people in the US on food stamps."
And here is my answer:   
I understand your negative feelings about the missed opportunity in LULU but you have done some good things here, which shows that you are on the right path: first you are watching the right stock: half of the trading success is stock selection and LULU is definitively a market leader showing superior relative strength. Second, you didn’t chase it, which can be a common issue among new traders. Don’t be frustrated about the missed opportunity. I miss opportunity all the time (guess what, I’m currently NOT in NFLX, CMG, AAPL,…). A lot of times, trading means waiting. Waiting for the next setup to occur.

I would not recommend trading LULU from the short side. As a swing trader, just wait for a pull back and then get in. Always trade in the direction of trend of the higher time frame. The long term trend in LULU is obviously up. Trading countertrend moves requires a lot of experience and you need very accurate intraday timing to have a good risk-reward ratio. If you are not a full time trader and can follow prices during the day you have no chance. The only opportunity in the short-term could be if LULU would create a blow-off top, similar to what we saw recently in Silver (commodities in general tend to create these parabolic moves more often than stocks because its harder to attach a price tag to them). If you have studied the nature of blow-off tops in stocks (not commodities) then you might have the setup as part of your standard playbook.

In term of Greece, here is how I saw the situation: the headlines were negative but despite all the negativity (remember, Greece is part of a bigger picture, which includes Portugal, Ireland, Italy and the entire future of the Euro) the European currency acted quite stable and was trading above 1,40. Markets usually “buy the rumor and sell the fact” or on the short side “sell the rumor and buy the fact”. When markets detach from headlines and refuse to do what everybody expects them to do, there is usually a trading opportunity. Euro's price action showed me that there was some underlying market strength, which prompted me to go long. Try to listen to the markets. 

Congratulation to your Silver trade. However, it shouldn’t have come by luck. If you were just lucky, the trade won’t be repeatable. If the trade was a standard setup in your playbook, good. Actually, trading can be quite simple. I actually have a “bread-and-butter” setup (there are some derivatives and additional plays of course) and I’m just observing the markets every day to wait for the setup to occur. Over time trading has to become boring because you repeat the same thing over and over again and possibly wait a lot. That's ok.Welcome to trading. (Maybe that’s why I started blogging, so I have something else to do :-) )

Concerning VXX:
the VIX ETF VXX is a piece of garbage. Just look at the overlay of VXX and VIX:

VXX doesn"t catch the spikes at all. The only possible trade I maybe (and I really mean m-a-y-b-e) see is shorting VXX after spikes. Contango is one of the issues (I have no room here to explain what contango is, just google it).

Concerning retailer strength:
The market is a discounting mechanism. It doesn’t matter what happens today on main street (unless it is really the "unexpected unexpected"). It is all priced in. It is the "anticipated delta" that counts: if the market thinks there will be fewer people on food stamps in six months, markets go up today. Remember:“buy the rumor, sell the fact”.

On a final note: what works for me doesn't have to work for you and vis versa. If you biased more negatively in general, maybe you become just a better short trader than I am. The trick is to match your trading with how your brain is wired. A good trading journal can help finding that out.

Hope my comments made sense to you. Happy trading.

Monday, July 4, 2011

Why I Didn't Buy Apple During the Latest Rally

Apple had a nice run last Friday, gaining over two percent for the day. Time to get back into the stock?

Even though the company is on my watchlist, I didn't pull the trigger (yet). Granted, Apple is in a long term uptrend, but I want to see relative strength vs. the underlying index and so far the iPhone stock hasn't been able to outperform. Note how the breakout in March and September last year was accompanied by relative strength:

Earnings is coming up quickly in two weeks on July 19, so a potential pre-release (buy the rumors sell the fact) rally  would need to start soon.

Covestor Model Review - July

June has been a positive month for the Covestor Model Portfolio. I was very defensive in the first half of the month and used market weakness to close short positions in St. Joe's, LDK Solar and Ann Inc.
The market took a dramatic turn in the second half of June and recovered most of the month's losses. At the same time, I turned short-term bullish as well and started to engage in various long positions. It seemed to me that the market ignored positive US economic news and instead focused on global macro issues from the developments in Greece, Japan and China. Most of the sentiment indicators I am following signaled an excess of negativity of market participants, so I turned bullish based on the principles of contrarian thinking. If everybody expects prices to fall further, then it also means that these investors have already sold. Prices can only decline, when there are more sellers than buyers.
Going forward, I remain bullish and plan to expand my long portfolio on minor pullbacks. Earnings season will start after the July 4th weekend and a positive outlook of many companies could fuel the rally. Analyst expectations did come down in the last months and the stock market is about beating expectations.

The Value of Chart-based Trading Journals

Summer is a good time to focus on trading skills and look for areas of improvement. (actually, should be a continuous process throughout the year, but I assign a bigger portion of my trading time to skill development during these months).
I maintain three different trading journals and I would like to highlight one of them: my chart-based journal . The other two are a classic quantitative journal with P&L and all that good stuff as well as a weekly market snapshot journal.
Because I'm traveling quite frequently, I'm a truly "cloud-based" trader, who couldn't survive without Google Docs. My chart journal is actually a Google Doc presentation and the slides are snapshots of my trades with comments. Charts are taken from stockcharts.com and there is easy process to populate the slides. Whenever I enter a trade, I create a separate chart in a special watchlist and mark entry and exit points. Roughly three months after I closed the trade, the chart gets copied into the Google Docs presentation, which is a nice process by itself, because is forces me to review each trade after some time and see how prices developed after I sold. It is unbelievable, what you learn about your strengths and weaknesses.

For illustration, here are two recent trades. Let's start with a trade where I screwed up, Tata Motors:

There are always at least four entities on the chart: entries (green circle), exits (black circle, sometimes more than one if I scale out), a red line (initial stop) and comments of course. So which lesson did I learn from the TTM trade? The entry was pretty good: a volatility breakout play on the long side on positive relative strength. TTM had a nice run after my entry, but I didn't take profits! Usually, I'm at least selling half of my position into strength quickly after the entry. Second mistake: I closed the position near the 20 day moving average, which is more of a buy point with my strategy. I should have waited for another bounce to get out.
Third lesson learnt: TTM turned out to be great short play later on, because relative strength vs. the S&P 500 was deteriorating and a great setup occurred at the beginning of May. Always keep stocks you recently traded on your high priority watchlist for follow up plays.

Things become interesting when I repeat certain mistakes. The journal helps identifying these problematic behavioral patterns. Take this trade of Westport Innovations around the same time as an example:

Nice breakout play, took profits along the ride, which was good, but finally closed the trade into weakness, similar to what I did with the TTM trade. So now I have something to work on during summer through various exercises (e.g. mental visualizations).
Note that both trades had been profitable, however, they were not perfect trades. I don't judge the quality of a trade by the profits. Criteria is purely execution.

To conclude this post, let me highlight that I'm not making bad trades only. :-)
Here is a example of one of by best trades in the last months, long Silver:

Bought during consolidation and took profits along the ride. Only negative (if I really want to criticize something): I could have traded with more size at the beginning.(As you know, my favorite quote is from George Sorros who used to say "Why so small?" when one of his traders put up a position with not enough size)

I hope you now see the value of chart-based trading journals.

Happy Trading!