"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, April 27, 2012

Potential Swing Trade: WFC

Wells Fargo is a stock that I plan to swing trade from the long side. Let me run you through my analysis process for this trade, which should give a good blueprint of how I approach a trade.

I’m using a “Tripple Screen” system, which was proposed by Alexander Elder, which I modified to exploit the momentum and mean reversion anomaly (check out my overview here about the topic)

First step is to look at the weekly chart: the stock is in an intermediate term uptrend and about to break out of a long term trading range. Momentum characteristics have been positive. WFC not only outperformed the financial sector, XLF also has been outperforming the broader market during the last months. According to the momentum anomaly, this trend should continue, so WFC is the right stock to trade from the long side:

Next is a look at the daily chart to get an idea of the mean reversion characteristics: WFC just went through a consolidation phase (“reverted to the mean”) and is about to exit this phase. I want to buy close to the 20 day moving average, so that’s where the stock is trading right now.

Third step is to analyze the intraday action. There are two possible scenarios: WFC will either pull back (scenario 1), which then created the buying opportunity or break out of the recent trading range (scenario 2). Depending on these scenarios, I will determine the appropriate stop level in case the trade would go against me:

Scenario 1:
 Scenario 2:

Finally a sanity check on briefing.com: any upcoming event/news that could randomize price action? Most important is the earnings report date, since I do not buy a stock right before the event. WFC just reported on April 16, so no issues from that side.

Thursday, April 26, 2012

Today is the Day

It has been a strong two days for the markets and I start to see some nice setups on the long side. Have to be careful because it we are in the middle of earnings season and I do not get into positions right before they report. Major indices are now trading on top of their recent range and I'm still short small caps through TZA. I will close the position immediatly when indices brake resistance, though:

Today is the day where we either brake resistance and switch back to bull mode or bounce back into the range. Stay alert.

Tuesday, April 24, 2012

Last Man Standing: Consumer Discretionaries

A market top is often a process and not a singular event. Topping processes can be observed on major indices itself: the Dow, Uncle Rus and the S&P 500 seem to be building technical "head and shoulder" tops.

Another way to recognize tops is by looking at major offensive sectors. There are only six of them: Technology, Industrials, Financials, Basic Materials, Energy and Consumer Discretionary. Usually, not every sector tops out at the same time. Price action of the last months is a perfect example: Basic Materials was the first one recording lower highs in February. Energy switched into this mode in March. Financials, Industrials and Technology joined in April. Currently, Consumer Discretionary is the only sector which still trades above the 50 day moving average, it is the "last man standing". The question is: for how long? It will be crucial to follow XLY, the related sector ETF, in the coming weeks: these stocks will need to continue to act strong or another sector will have to take over leadership, potentially one that has been consolidating for the last months (XLB, XLE). What's currently leading are defensive sectors, which is not what we want to see in a healthy market rally.

My feeling is that it is just a question of time until the final (discretionary) shoe drops, but as usual: trade what you see and not what you think you will to see.

Saturday, April 21, 2012

Bear Flags and Wedges Everywhere

Maybe I'm getting a little paranoid here, but I see bearish flags/wedges en masse on this IWM chart:

Needless to say that the Covestor Model Portfolio is short small caps (long TZA).

Thursday, April 19, 2012

3 Possible Scenarios for US Stocks

There are certain times when market conditions are mixed and do not justify to go aggressively long or short. Independent traders, who do not make money by presenting commentaries on CNBC have the luxury to maintain a "I don't know which direction the market will go" stance and stay mostly out of the markets. Pundits like Jim Cramer could never say that. Right now, I do not have an edge in predicting short term market direction, but as usual, this can change any day.

At the current stage, we don't know if equities are topping out or just entered a brief correctional phase. Traditional chartists believe that market tops are rather processes than one time events. Things will get interesting during the next weeks: should stocks move sideways or even rise on weak volume, chances are that markets are indeed building a top.

Theoretically, there are three basic scenarios going forward:

  1. This was it: markets will rapidly move higher in the coming weeks on good volume with many participating stocks. I don't think this is the most likely outcome based on the short term action described above, but we have to be open for everything.
  2. Weak leg up: stocks will continue to rise in the next weeks, but this will be a weak move with less momentum and lower volume. Scenario 2 is the favorite outcome for the bears because it would offer a great entry point for short positions and would further add to the notion of an intermediate term market top.
  3. Another move down: a second wave of selling would be the favorite scenario for the bulls if this move shows the opposite of scenario 1: lower volume on the declining days coupled with less downside momentum. A rapid, high volume selloff could be positive as well, believe it or not: while tops tend to be processes, bottoms can be created on a single day.

I'm leaning towards further short term weakness (which doesn't have to mean that we are entering a bear market) for three reasons: intraday price volume action, increased volatility and market leader breakdown. Stocks have declined on higher volume when looking at e.g. 30 min charts, a bearish sign. In addition, the average daily trading range increased as well, which shows that investors have been getting more nervous. Finally, several market leading stocks experienced significant high volume declines. The stock of Apple Inc. being the most prominent example.

Overall, I'm taking wait-and-see approach before leaning aggressively to one side. As a matter of fact, the S&P 500 is still moving in an uptrend on intermediate time frames, so there is no point in going heavily short. I might do a few long or short trades, but markets have been getting volatile and one has to be careful not getting chopped into pieces.


Tuesday, April 17, 2012

Apple and Efficient Markets

So markets are efficient, right? Prices can't be predicted because all available information is built into them at any given point of time and additional news gets discounted immediately.

So if you believe in fully efficient markets, how would you explain yesterday's four percent drop in Apple's stock price on no news? Here is a entry from briefing.com:

"ISI Group says they are not hearing anything new or incremental for the weakness in AAPL stock (down over 2%, but up ~$5 from its intraday lows). They believe this could be a simple "collapsing" on its own weight given the ytd move (i.e., AAPL up ~45% vs. S&P 500 up ~10%)"

ISI calls it "collapsing". I call it mean reversion, a market anomaly, which challenges the thought of fully efficient markets and is one of the pillars of my trading strategy. I haven't traded AAPL this year. In fact, I missed the recent move up and I was waiting for a pullback opportunity. After some (market) stabilization, it could get really interesting to pick up some shares in the next weeks.

Saturday, April 14, 2012

IBEX: The Most Important Chart Next Week

The Spanish stock market has been a global market leader in 2012 - to the downside. IBEX, the Spanish stock market index, is in fact in free fall mode, rapidly approaching US Financial Crisis lows. At the current pace, it should take Spanish stocks just a couple of days to get there. Even though the chart looks like a mess, it is too late to go short based on risk/reward considerations. A weak bounce from those support levels, maybe similar to what happened at the beginning of 2008, would however mark a good entry point:

The Spain theme has the potential to drive down stocks globally, which is why I keep this one on top of my watchlist.

Thursday, April 5, 2012

AUY: a Failed Trade

Last weekend, I posted about my trade in AUY. Yesterday, I closed the long position with a small loss. The trade failed from a profit perspective, yet I'm OK with the transactions. It is absolutely important in trading to cut losses quickly. No second guessing allowed. Trading is a probabilistic process, I am aware that almost 50% of my trades fail. That's no big deal as long as the average winner is larger than the average looser. There is a significant random component in the market and one has to deal with it by executing disciplined money management.

However, there was one mistake in going long AUY last Friday: I ignored relative strength, which usually is an important component in my analysis process. Yamana has been underperforming the S&P 500 for weeks and didn't show any sign of improvements. Trading mistakes happen, which is why limited position size and predefined stop loss points are important.



Wednesday, April 4, 2012

Pullback Propability?

I'm surprised by the resilience of equity markets. Stocks recovered some of their losses after yesterday's post-FOMC drop. It is not only the action of major indices, also underlying strength of leading stocks, such as AAPL, CMG or ISRG, is impressive.

However, there is one fact to keep in mind: during the recent three year rally, the S&P 500 has pulled back to its rising 50 day moving average at three times each year. So what is the probability that the index will pull back at least once in 2012?

It is higher than 50%, which is why I'm very careful being too aggressive on the long side at this point.

Sunday, April 1, 2012

Why I Bought Yamana Gold Last Friday

Usually, I'm not a fan of individual mining stocks. Company value is strongly tied to the price of Gold, so why take on additional risk factors by buying the miners?

The technical picture, however, is very compelling: the Gold Miners sectors has been acting weak since last summer and latest price action suggests that bears are running out of steam. The price chart of GDX, the Gold Miners sector ETF, has been shaping up a bullish "bearish wedge" pattern. The structure might one or two more legs to go before being completed, but prices currently trade at the lower boundary of the pattern. Another leg up is in the cards: 

Yamana Gold (AUY) on the other hand has been outperforming the sector for the last one and a half years. The company has been the "best house in a bad neighborhood" if you will. Should price turn north, the stock can quickly run to the $18 level, a 15% gain over current price:

Disclaimer: Covestor Model Portfolio is long AUY