"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

Friday, December 30, 2011

Morning Briefing Dec 30

The rally keeps weakening: price divergence against MACD is showing that the rally is getting weaker. It would be surprising to see a breakout to new highs today. Any year-end window dressing move would be suspect. I'm not planning any additional long positions.

Thursday, December 29, 2011

Morning Briefing Dec 29

Yesterday's decline didn't come as surprise. Was the action just a consolidation move or beginning of a new trend? Hard to say at this point, prices need to stabilize today and tomorrow. It is still the end of the year and it is hard to read too much into the price action.

Wednesday, December 28, 2011

Morning Briefing Dec 28

The S&P is still in rally mode since the index has put in higher intraday highs since Dec 22. However, momentum has been weakening in the last days. This should not come to a surprise because there is some strong intermediate term resistance at 1265 in the Futures. It is important to watch the nature of a possible pullback: prices should consolidate in a tight pattern and leading stocks should continue to lead. However, should prices break through resistance on high volume, the S&P could quickly run to 1300 in the first weeks of January.


As for the Covestor Model Portfolio, I'm quite loaded with various long positions. Some of them (GCI, FTK) acted weak during the recent rally, so I will probably close them and wait for better opportunities. I still maintain some shorts (HPQ, GMCR, BBY, SLV). Best Buy is the stock I will possibly cover soon: there was no follow through after the earnings miss and prices seem to bounce from an important support level.

Don't take my long exposure as a bullish sign. It is window dressing season and Europe is in hibernation mode. I can't believe this topic is solved, expecting negative headlines to continue soon.

Thursday, December 22, 2011

Morning Briefing Dec 22

I suggested yesterday to wait for a pullback to determine if a series of higher highs and higher lows can be established. In fact, Futures pulled back right to resistance at 1225. Price action has been bullish so far and I we could see another strong leg up if prices can overcome resistance at 1245:


I added another long position yesterday, KeyCorp (NYSE: KEY). I like the relative strength of US regional banks. The market could run into major resistance soon around 1260, so I wouldn't add new long positions at this point and possibly shift into profit taking mode.

Why I Do Not Worry About BAC or ORCL

I received the following comment yesterday on on of my entries. I decided to answer with another post since I think it highlights some important points when it comes to technical trading:


"I know you focus on technical analysis only, but wondering about the MA thesis. Do you view it as a Financial play or a Technology play? If Financial, do you worry about BAC going down and implications on credit and debit card volume? If Tech, do you worry about ORCL-like results reflecting slower growth?"

My short answer is: no, I don't worry.

Actually, it doesn't matter if I worry about anything related to the markets. What matters is to figure out if the market will worry about the worries if you will. The term "worry" should not be part of the vocabulary of a short-term investor/trader anyways. I cannot trade based on emotions. It can only work based on a whatsoever analysis that you know gives you an edge in the market. Since I'm very short-term oriented, fundamentals don't matter anyways, but let's assume they would: I guarantee you that hundreds of bank/hedge fund analysts thought about ORCL earnings yesterday and what they mean for the economic outlook. Some, maybe many, of these analysts are much smarter than at least me. Plus: these institutions have access to much better information than I do. The result of these analyses is the current stock price (if you believe that markets are efficient, if you don't, fundamental analysis doesn't matter anyways). I cannot have an edge over these institutions by performing a better fundamental analysis or have a smarter thesis.

Another point: yes, ORCL earnings were bad, but I guarantee you that this didn't come as a surprise to some of the big guys. Just check how ORCL has been underperforming (even the Tech sector) since November. There were some massive insider sales in the last months, so chances are whoever sold yesterday, was the last one to sell and that's usually the retail crowd.

With respect to MA: look at the long term correlation with BAC: both are inversely correlated, so obviously. there hasn't been any implication for the last 12 months at least. Can that change? Of course. But the key to technical analysis is to use it reactively and not in a predictive way, so if correlations change, there will be enough time to sell or even go short. I doubt this will happen in the next two weeks, because that's the time frame of my trade.


Wednesday, December 21, 2011

Morning Briefing Dec 21

As I wrote yesterday morning, the downtrend in the S&P 500 decelerated over the last days. When Futures broke the descending trendline, prices took off. If you just trade the SPY, you had no chance of participating in the move when you didn't get long on Monday before the close. Strong moves come from failed moves and the S&P failed to break below 1200. That's what happens when only traders participate in the markets and everyone/every computer is following the same signals:


Going forward, we need to see if a new uptrend can shape up. The action yesterday was just a pop higher. Stocks now need to record a higher low in order to establish a trend. 1225 should offer support.

I did a couple of trades in the Covestor Model Portfolio and bought some momentum names. One example: Mastercard, which I intend to hold until $395:


Industrials are Leading

Believe it or not: Industrials have been leading the market higher in the last weeks. The chart of the related ETF XLI is showing some bullish signs: prices have not only been outperforming the S&P 500 since October, they are also in the process of setting up a bullish inverse head and shoulders pattern. $34.50 is the level to watch for completion of the pattern, which is just 3 percent away from current prices. XLI closed yesterday right between a "50/200 DMA sandwich", which cries out for a resolution. Keep this ETF on top of your watchlist:



Tuesday, December 20, 2011

Swing Trading Morning Briefing Dec 20

Downside momentum has been slowing during the last days: a bullish declining wedge pattern appears to shape up on the 60 min chart of the S&P Futures. In addition, divergence between price and MACD is indicating less selling pressure as well. 1200 is an important level for the index, so naturally I would expect some buying coming in. It is the end of the year and there are only eight trading days left. Maybe we'll see a little rally next week for some year-end window dressing. Volume is low so it is easy to kick around prices.


Closing or at least scaling out of short positions seems to be a prudent move. On the other side, I had to close a long trade in DY yesterday with a small loss because the stock hit my stop price. My shorts in XLF, BBY, GMCR, FXE and HPQ are doing well, but as I mentioned before I'll need to skim exposure this week. Don't forget that US stocks are driven by the Euro and there is a record amount of open short positions in the market. So any rumor could shoot the currency to the moon , which would also be bullish for the S&P. 

Monday, December 19, 2011

Swing Trading Morning Briefing Dec 19

We're seeing some buyers coming in this morning, creating a potential double bottom on the intraday chart of the S&P 500 Futures. 1220 is the critical level to watch. Also note how downside momentum became weaker since Thursday, indicated by the MACD divergence. Be careful with your short positions at this point. One could add to the longs if we hold above 1220-1250.


Sunday, December 18, 2011

How to Become a Better Swing Trader

Current markets are fuzzy and don't provide many tradable setups, so its quite dangerous to overtrade. A better activity these days is to focus on trading skills improvement. Here's a tip if you are a swing trader: watch the market overview videos of Adam Grimes, over at SMB Training. Even though the videos discuss past market action, Adam often highlights underlying techniques. I'm currently going through them and I find these videos quite helpful. Thx to SMB and Adam for putting them together.

Euro - S&P 500 Correlation at Record High Again

For a couple if weeks it was looking like the high correlation between Euro and US stocks was about to break down. Never count the chicken before they hatch: the link tightened again last week, SPY and FXE 10 day intraday correlation as been rising to 0.94 last Friday. Obviously, the European story is driving US stocks again, so every American stock investor is actually a Forex trader these days:







Friday, December 16, 2011

How to Trade the Collapsing Platinum/Gold Ratio

The Platinum-Gold ratio has totally collapsed in 2011. I'm not so much interested in the reasons for the decline, I rather like understand how to make money from current price levels. For those who are interested in fundamentals, here is a recent Financial Times story on the topic

Historically, Platinum has been more expensive than Gold for most of the time. Here is a chart of the long-term picture:


There have been only three periods since 1980 when Platinum was trading lower than Gold, so one might be tempted to set up a mean-reversion trade (going long Platinum/shorting Gold) .

I wouldn't initiate such a trade just yet. The ratio can fall further: it reached its record low in 1982 at 0.7, so that's over 20% lower than current levels. Also, the ratio can stay low for quite some time, maybe one or two years. For a long-term investor, this wouldn't be an issue, but for me it is. When Platinum prices turn lower, they can come down quite hard, like in 2008. The current price structure reminds me a little bit of that period.

I would (and I in fact will) use a simple technical tool and follow a 50 day moving average of the ratio. I want to see the average turning north before committing funds to this trade. There will still be enough time for profits. In 2009, it was even a better investment to buy Platinum without the Gold hedge, so this is a trade to consider too. So far, however, the 50 DMA is declining, which simply means to keep watching and waiting:




TAO: Keep This ETF on Your Watchlist

There has been news floating around in recent days about the "Chinese housing bubble". Nobody knows if the Chinese government will be successful to engineer a soft landing. In any case, the China Real Estate ETF TAO doesn't look too promissing and I would love to short this one. However, the fund is not liquid enough to trade it in the Covestor Model Portfolio:




Keep an Eye on the Financials

Some interesting price action in the Financials: technically, the XLF is in the process of setting up some sort of triangle pattern, which could mark a bottom for these stocsks. Relative strength also seems to not get worse at least. I keep watching this one, especially since I'm short XLF (through SKF):


Why Yesterday was a Weak Bounce

The S&P 500 gained 0.3% yesterday. The bounce was not only a weak one because of that number, defensive sectors have been leading while offensive ones (Technology, Materials, Energy) underperformed. Not something you want to see in a rebound. Note that this was not a trend just yesterday:



Swing Trading Morning Briefing Dec 16

I started the Morning Briefing yesterday by looking at the intraday SPY action. For some reasons it makes more sense look at Futures instead. There can be significant overnight action, which has the ability to change the technical outlook for the SPY as well.

As for December 16, the downtrend is still intact. However, prices are reaching an important level: should the S&P break 1225, the sequence of lower lows and lower hights gets broken and the market could work on a short-term reversal. In that case, a inverse head and shoulder could mark a intraday bottom. One wants to become more offensive and possibly add to longs on any pullback.

Any failure of 1225 would be a good opportunity to add to short positions as indicated yesterday.


Thursday, December 15, 2011

A Conversation with my Greek Business Partner

Yesterday, I was talking to my business partner in Greece and he told be stories about the country that make you think that politicians are so behind the curve.

He, let's call him Demetrios, is running an engineering company with ten employees. Yesterday, he received a letter from the Greek tax office and they asked him to pay 50,000 Euros in taxes for some profits his company made five years ago. The problem is: he doesn't have 50,000 Euros right now. Demetrios actually has to let some of his guys go to be able to keep paying the bills.

He also told me about a "new" government initiative to raise some cash by increasing/collecting property tax. What happens now in Greece is that people own real estate and suddenly have to pay taxes on it. OK, they probably should always have paid taxes a while ago, but the issue is that some of them don't have jobs anymore and are struggling to pay any bill.

Conclusion: politicians are dreaming if the think that they can balance their budget by raising taxes in a screwed up economy. Sooner or later, Greece has to default to reduce debt in my opinion. Color me bearish.

Strong Bank Stocks: Meaning Anything?

Financial stocks were outperforming yesterday. How much should we read into that?

The following chart shows the 30-day relative performance of major sectors vs. the S&P 500. While yesterday was a good day for bank stocks, it is difficult to see a larger underlying trend. It'll need more strong days before I'm ready to agree that Financials are out of the woods. What's rather eye-catching is the continued strong relative performance of defensive sectors such as Consumer Staples, Healthcare and Utilities.
Also interesting: relative performance of Energy and Basic Material stocks has been deteriorating for weeks. So yesterday's sell-off shouldn't have come as a surprise:


Disclosure: Covestor Model Portfolio is long SKF.

Swing Trade of the Day (Dec 15): CB

My favorite candidate for a swing trade on the long side is Chubb Corp (NYSE: CB). The insurance company has been showing good relative strength in recent weeks and could be benefit from a market bounce from oversold levels. Credit Suisse recently initiated coverage of the Casualty Insurance sector and rated CB as Outperform. Should CB continue to rise, the chart could create a bullish "inverse head and shoulder" pattern, which would mean that my initial price target of $70 is too low.


SPY Swing Trading Morning Briefing Dec 15

The 30 min intraday chart of the SPY is still looking bearish. Prices are have established a stable downtrend with lower lows and lower highs. A swing trader wants to take profits on the short side at the lower declining trendline. We had opportunities to cover some shorts the last two days.

If we see a one or two percent rally to the declining 5 day moving average, I might consider adding to the short side as long as downside momentum doesn't diverge: keep an eye on MACD. The divergence end of November indicated the upcoming change in trend and aggressive traders would have established long positions. So far, there is no divergence. Stay with the trend until it changes.


Another way to look at MACD is to watch out for extreme readings. In the last three months, the indicator's most negative values turned out to be below -1.5. Currently MACD is at -0.7, so there is potential for further declines. Also 120 seems to be an important area of support, so watch out for divergences at that level:




Wednesday, December 14, 2011

What's so Cool About the Golden Cross?

I did a little bit more work on the 200 DMA after my previous post on the topic. I have to confess, I was never a guy who was considering such a long term-moving average. I think this has changed as of today.
I ran a little statistics to evaluate how good signals form crossings above/below the 200 DMA turned out. In order to smooth the noisy daily data, I used the 50 DMA instead of daily data. Call me ignorant, but I figured that I was actually backtesting the famous „goldencross“. Well, here is why it is famous: I used daily closing data of SPY, the S&P 500 ETF since 1994, so a 15 year period. If one would have bought SPY on the day of the Golden Cross and sold the opposite signal („Death Cross“), 100% of these trades would have been profitable! Here is the complete signal summary:

 
I then moved on and tested the opposite: going short on a Death Cross and cover on a Golden Cross. This signal would have resulted in only 33 percent winning trades. Yet, results are encouraging. Profitability would have grown in the new millennium. The two trades in the nineties were not profitable. The average win was more than three times as high as the average loss, so the short-only strategy would have been profitable as well:

 

Conclusion:
100% win rate for the Golden Cross makes it clear why many institutions are looking at the 200 DMA. Using these signals result in a very simple but effective long-term trading strategy. Even short-term traders like myself can benefit because the indicator seems to make a good job defining bull and bear markets.  
BTW: The market just experience a “Death Cross” on August 17.

2008/2011 Watch: Perfectly Matching the Playbook

Technically spoken, markets are perfectly playing by the 2008 playbook. Also check out my post from mid November on the topic.

Today's episode: the 200 day moving average. Institutions are watching this indicator, which is why he is so important. Just like in June 2008, prices were touching the declining moving average and sold off afterwards. If equities keep copying the 2008 price action, keep your seat belts fasten. I keep focusing on short positions in the meantime.

Where is the Trend? SPX Intraday Action

The basic premise of technical analysis is that there are trends and they tend to persist once a trend has been established. Whether an analyst is using trend lines, moving averages or a MACD indicator, it all comes down to figuring out if there is a trend. Trends can occur on any time frame.

The latest price action of the S&P 500 is a good example. There is no trend on the daily chart, so no higher highs/higher lows or lower lows/lower hights:


The 30 min intraday chart looks entirely different with respect to trending conditions. Prices established an uptrend from Nov 26 to December 5, then moved sideways until December 6 and have established a downtrend since then. Very clean and textbooklike action:


The second step is to figure out how to trade the trend. Since markets are currently trending down a swing trader wants to establish short positions at the upper channel boundary and take profits at the lower trend line. Swing trading on an intraday chart would basically mean to not hold positions overnight. It would have meant to go short yesterday morning and cover in the afternoon. However, a swing trader, who operates on daily charts (like me) becomes a trend trader on the intraday charts.

A lot of investors/traders have been frustrated by price action in recent weeks. The trick is to find the right time frame, where trending conditions occur. If a trend cannot be identified, hold cash. Very simply.

Tuesday, December 13, 2011

Algorithmic Trading: How Humans Can Still Win

It is no news that computers are on a path to dominating trading activities. It is estimated that between 50 and 75 percent of trades are executed by algorithms these days. The $100,000 question is whether the human trader has still a chance to win in such an environment.

A recent UK paper gives a good overview of the topic. While the authors expect computer trading to increase in the next ten years, they also envision that human traders will still play, a role, although a smaller one, in the markets. One key aspect that comes to mind when studying the publication is time frame. It seems like the entire algorithmic trading discussion is centered on very short-term methods, such as high-frequency trading, and recently "news analytics" (a strategy, where algorithms scan the news for headlines and rumors and automatically act upon these information). So if the machines push into ultra-short time frames, humans have to move to lower trading frequencies where they face less computer competition. Intraday traders will probably have a hard time competing because they fight against one of the key strength of a computer: speed.

Computers became quite fast in recent years and academics are discussing when hardware will become as powerful as the human brain.

A quick comparison of processing power and memory: IBM's Watson, who competed in the "Jeopardy" game show this year, can operate 80 trillion floating point operations per second (80 Teraflops). Theoretically, the human brain is much faster with an estimated 100 quadrillion flops (100 Petaflops). The big difference lies in parallelization: the computer can use most of his processing power for a single task, the human is not only running more complex jobs (breathing, eating, typing,...) in parallel, he has also the unique capability to learn while he executes. Computers can't really do that (yet). In terms of memory, computers have been catching up: Watson has 15 terabytes of RAM, while estimates for the brain range from 750 GB - 6 TB.

One of the areas, where computers still have a hard time with is pattern recognition, although progress has been made in that field. I believe that the human trader has to focus on patterns when he wants to outperform  machines. Technical analysis can be part of it. Patterns can occur in news flow and the behavior of market participants. Markets always change, so recognizing this change (which is essentially a process of learning) leverages another strength of the human brain.

Here is an example: have you noticed the crazy price action in Silver this year?


This chart is very interesting and in my opinion perfectly shows how traditional technical analysis principles evolved in the light of algorithmic trading. When recognizing these changes, it is still possible to make money with Silver.

The first "technical event" was the vertical run-up in April, marking a classical blow-out top. It was easy to identify but a trader, who was long needed to sell into strength and couldn't wait for the eventual top to occur. In the new age of algorithmic trading, it is more difficult to recognize the final top itself. A technical trader would maybe watch out for some reversal candlestick pattern. In the case of Silver, you never got such a pattern. Instead, prices simply collapsed for three days. Classical technical analysis suggests waiting for a weak rally after the initial decline for a good shorting opportunity. In the age of algorithmic trading, there is no more time to do that, because every trader (computer) is trying to get out at the same time. You can still go short, but can't wait for the rally.

Then there was the second dump in September, when prices declined by 25% in just two days. The same pattern: no time to wait for a weak rally. You were either short or you were not. Technically, it was possible to recognize the weakening price structure days before the decline. In a computer-driven environment you can't chase anything anymore because risk/reward ratios become negative immediatly.

So how can a human trader win against the algos?

1) By lengthen the time frame
2) By focusing analysis on pattern recognition and learning mechanisms
3) By understanding how computer trading is changing traditional patterns




Wednesday, December 7, 2011

Are we Overbought Yet?

The McClellan Oscillator is becoming my favorite tool to evaluate overbought/oversold levels. Extreme readings tend to indicate major turning points (necessary, but not sufficient condition). +/-80 has been a level, where you want to consider to at least close long/short positions. Note how low readings set the stage for the November rally:

Current indicator level is around 20, so markets are far from overbought even despite recent gains. News from Europe later this week will be key for another leg up in US equities.

The Hidden Rally in Homebuilder Stocks

It seems hard to believe but guess who has been leading the market higher during the last two months: US Homebuilder stocks. Note how ITB, the ETF of that sector, has been outperforming the S&P 500:

Price-volume action has been extremely bullish since higher prices came in on above average volume.
Housing prices are still declining in the US, which can also mean that foreclosures are finally getting sold and bring down inventories. That's a positive for the market. It's important to keep in mind that housing stocks tend to bottom well before housing prices start to flatten out. As usual: the market is a discounting mechanism. Buy the rumor, sell the fact.

As for the Covestor Model Portfolio, I closed my TOL long position before the earnings report. However, I'm looking for getting back into the stock on pullbacks.

Monday, December 5, 2011

Should you Buy the Euro? What COT Data Suggests

As I keep preaching here on this blog: a trader essentially is looking for two different patters: extremes and divergences.

Bearish sentiment of Euro/Dollar currency speculators has recently reached extreme levels: Large traders accumulated a very high number of Euro short positions. The last time, Commitment of Traders (COT) data showed these readings was early Summer 2010. The Euro then reversed sharply and rallied from 1,20 to 1,40 in five months. I wouldn't be surprised to see a similar move if Europe can get their act together this week. Downside is probably limited due to the negative sentiment:


US Long Bonds: a Great Shorting Opportunity

US interest rates are at record low with yields below three percent. The longer term picture however looks quite bearish from a technical standpoint:


Price/volume action has been negative in recent months: higher prices in TLT came in on declining volume. Note how similar divergences let to intermediate term price reversals in recent history (Jun-Sep 2010, Jan - Mar 2011). A classical chartist would recognize a potential "double top" chart pattern in the making.

Last but not least, the latest COT action hints that large traders didn't buy into the recent November bond rally and actually increased their bearish bets:

  I am considering shorting long bonds soon through TBT, the 2X leveraged inverse ETF.

Oct 5 2011: The Day Steve Jobs Died and Apple Started to Underperform

Since Steve Jobs passed away, AAPL has underperformed important indices and competitors: the S&P 500, the Nasdaq and even Google showed better performance in the last two months. Not a good sign. Before investing into the stock, I would wait for relative strength to pick up again:



Friday, December 2, 2011

Declining Euro US Equities Correlation

Just an interesting observation: the FXE-SPY intraday correlation keeps declining. That's positive. It looks like the market started to focus on other themes, such as a strengthening of the US economy.