Tuesday, February 28, 2012
The situation looks quite similar: fewer and fewer stocks kept drifting higher after the initial oversold burst. Here is the problem: in 2010/11, it took two more months of rallying before the negative divergence finally played out and stocks sold off. The same could happen now. It is impossible to pick the top and we will wake up one morning and stocks will gap down significantly. What do you want to do until then? Sell everything and watch from the sidelines? Hard to do psychologically. That's why I like mean reversion type swing trading, because I "buy the dips and sell the rips".
There is one difference, though, and this is why it is more likely that we will see higher prices in my opinion: sentiment is not overly optimistic. The indicator I'm following is the equity put/call ratio.
I'm using a 10 day moving average to smooth out the volatile daily data. As pointed out in earlier posts, the ratio is oscillates in certain domains. During bull markets, the p/c ratio moves between 0.5 and 0.7; during bear markets, general investor mood tends to be more pessimistic and values range between 0.65 and 0.9.
We are currently transitioning from a bear to a bull domain and the ratio is at 0.65, a little bit at the pessimistic side. Unless my assumption is false and we are indeed still in a bear domain, the equity put/call ratio has more room to fall. Note how sentiment became overly bullish during the final phase of the 2010/2011 rally and the ratio dropped below 0.5.
As usual, this is not a necessary, just a possible condition for short-term declines.
I call it the Double Dip Momentum play: the stock is in momentum mode, outperforming the broader market. At one point, the stock sells off on high volume, but no major news. A weak rally follows, thus creating a short-term bottom (Point 1). The second leg down is important: if this move is weaker than the first decline (weaker in a sense that the stock declines less rapidly, but also on less volume) it shows that sellers are running out of steam. At that point, it is only a question of time when buyers will step back in. Once the second short term bottom is put in ("double dip", Point 2), I buy.
Flotek Industries (NYSE: FTK), a stock that is currently part of the Covestor Model Portfolio, is a perfect example of the setup:
Another nice feature in the case of FTK is that the stock briefly broke short-term support around $10.75. A failed breakdown is another bullish sign and I have another setup in my playbook, which trades these patterns.
Note point 0 on the chart: this is where a "breakout trader" would buy the stock. I have not found any statistical advantage in trading these breakouts, especially when they come without major news. I'm only willing to trade them on headlines, which really shift the underlying fundamentals.
Monday, February 27, 2012
Even though the number of events is small, the findings suggest that the momentum effect is at work.
Friday, February 24, 2012
The markets tend to surprise the maximum number of investors. So what could they do now to follow this rule? The obvious price action for the S&P 500 is to fail at long-term resistance around current levels. A more surprising patten would be to break out to new hights, thus signaling a new bull market and suck in more investors from the sideline only to reverse higher and set up a "bull trap".
I do not say this is the most likely scenario, but a trader has to be open to every possible outcome. At least from the sentiment standpoint there is more upside potential: major psychological indicators are in the neutral zone because prices consolidated "under the hood" in recent weeks.
My portfolio is positioned on the long side, so I am obviously bullish as well. However, I would start taking profits when markets break out to new hights.
Thursday, February 23, 2012
A look at the daily chart reveals what might had happened: beginning of February, small caps moved vertically and actually gaped up. A classical exhaustion move? I guess we will know soon, but I would keep an eye on the Rus and increase short exposure when the index closes below 810:
Disclosure: Covestor model is long TZA
Here is my approach: since I don't care about fundamental supply/demand relationships, I like to look at price itself and focus on whoever is currently outperforming the other. The following chart is the price of Gold divided by the price of Silver. When the curve is rising, you want to be on Gold wagon; otherwise, Silver might be the better investment. Both metals are of course highly correlated. Obviously, Gold had outperformed his less expensive peer from August 2011 until January (red line). In 2012, however, Silver took the lead. At this point, it is not clear, who will lead us higher. It looks like Gold could make the race, but I would keep watching this chart and then decide which direction to go:
Here are just three examples: Cisco, Regional Banks and Ecolab. The funny thing is that these stocks/ETFs operate in entirely different sectors.
Friday, February 10, 2012
Tuesday, February 7, 2012
February will be challenging for short term traders because the market could drift higher for some more days or weeks: they need to sit tight and not get sucked into the market, which can also mean temporary underperformance if one is not 100% invested.