"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

Tuesday, November 20, 2012

Silver Looks Good, But...

Yesterday, I increased my long Silver position after the prices confirmed a recent swing low. Long term charts look extremely bullish and one could argue that the metals (Gold as well) are resuming their long-term uptrends:

I'm more cautious: one has to be careful to not interpret too much into a chart. The human brain is great when it comes to pattern recognition, but it can also trick you and let you see things where there is nothing. Confirmation bias is one of the biggest enemies of a trader.

Here is a daily Silver chart with just a one year of price history:

I would argue that Silver is still in a trading range and as long as prices do not trade above $37, I would be careful arguing for a resumption of the long-term uptrend.

Since I have a position, I plan to take partial profits at the top of the range and then see how prices act from there. Will aggressive sellers emerge or will price stay at the top of the range or even blast right through it? I can't and don't have to predict what will happen, but I still can make money on this trade.

Monday, November 19, 2012

Did We Just See the Beginning of a Year-end Rally?

The good news first: this could be the beginning of a year-end rally. The market has to speed up since 2012 will be over in six weeks. (already got Xmas presents? (-: )

Last Friday was clearly a reversal day from the technical point of view; seasonality is positive (Thanksgiving week, if you don't believe me, subscribe to quantifiableedges.com) and sentiment has been so negative that it was positive for stocks.

Now here comes the bad news: if you are a short-term trader and want to go long here, you are too late. As can be seen from the following chart, the S&P 500 is already almost at the 38% retracement level, so reward/risk is not favorable anymore. Better to wait for a successful re-test of the lows at this point.

As for the Covestor Model Portfolio, I went long last week and only slightly increased exposure this morning. A lot depends on if stocks can hold gains in the afternoon.

Saturday, November 17, 2012

An Aggressive Trade: Long AAPL

One of the 12 setups in my playbook is the "One Day Reversal". Apple showed this pattern on Friday, so I took a long position in the Covestor Model Portfolio. This setup is a pure mean-reversion trade (most of my setups are actually combined momentum/mean-reversion structures) and is easy to recognize: the stock manages an intraday reversal on high volume after a major decline. The edge from this pattern lasts for just a few days, so this is a very quick and also aggressive trade. AAPL did setup in an almost textbook-like fashion, so I couldn't resist taking a position:

Thursday, November 15, 2012

How to Trade This Market Now

So, we finally got the first sign of capitulation yesterday. That's good. Should you go long now to participate in a potential rebound? I would (and will) be careful. Let me explain:

One of my favorite short-term market breadth indicators is the McClellan Oscillator, which closed at -87 yesterday. Historically, these levels have been followed by some sort of rebound. Take for example the situation, which occured in May this year:

Stocks rebounded 2.3% in the week after the selloff. Running some statistics over a couple of similar events shows a relatively high win rate (check earlier post about the topic here). The problem is the outlier ("black swan event"), which happened in August 2011: the S&P dropped another 6% after low McClellan readings:

These are the situations, where pure play mean-reversion traders like Niederhoffer blew up. The right way to handle these situations in my opinion is to simply not be greedy and too aggressive. Close the shorts at this point, take the gains and do NOT go long. A better trade is to wait for the rebound and re-short again or wait for a reversal day. In this case, however, one needs to choose a fairly small position size due to the high volatility.

Don't try to be a hero. Just try to survive.

Wednesday, November 14, 2012

Swing Setups: MS & AOL

I wanted to share two swing setups that are currently on top of my watchlist. Due to the currently mixed nature of the markets, I'm looking at both: the long and the short side.

AOL had a nice breakout after earnings. Of course, trading breakouts directly is not a high probability move unless associated news is game-changing. Statistically, most breakouts fail. A better way is to trade the pullback after frustrated smaller players closed positions and professionals took profits into the news.

AOL has lost almost 15% since the beginning of last week and price is approaching potential support levels. The trade at this point is to go long on a trend change on the lower time frame. $39 is the critical price level to watch:

Note that I'm already long AOL in the Covestor Model Portfolio since I'm trading the declining negative momentum, which is very aggressive.

Short MS
This is a classical "Anti" trend change trade (Adam Grimes for reference): an impulse move on November 7 after the election initiated the setup. Since then, MS consolidated in a tight range. Again, the trigger is a potential breakout on the intraday time frame. $16.3 is the level: 

Friday, November 9, 2012

How Volatility (Sometimes) Precedes Declines

I find the relation between realized volatility and price change an interest topic. I had been writing about volatility earlier, but the market just recently gave us an example of this notable phenomenon: volatility sometimes leads price action. 

I like to use the Average True Range (ATR) as an expression for volatility because it is such a direct measure. As one can see from the chart below, the ATR increased while the market transitioned from up- to downtrend in April as well as since October this year. It is almost like the market seems to get more nervous before the decline actually happens. Technical analysts sometimes talk about a "change in market character". Volatility can be a variable to quantify that change:

A couple of earlier posts about the topic:

VIX Demystified: The High Correlation with the ATR
Decling Volatility: A Bullish Sign? 
Market Bottoms: Amazing Parallels 
What Volatility Pre Clustering is Saying About the Stock Market

Visualizing the Loss of the QE Drug Effectiveness

As can be seen from the following chart, each rally since the market bottomed in 2009 became weaker and shorter. While the first run lasted over a year and prices gained over 80%, stocks managed to gain only 16% from bottom to top in 2012 during a four months rally:

It might be not hard to figure out what that means: the QE-drug is loosing its effectiveness. See my previous posts (here and here) for more on the topic.

What the Fading QE Theme Could Mean for Stocks

In my October 11 post („Crash Ahead?“) I argued that stocks had been driven in the last years by investors's hope for additional money printing. If the crowd would start to realize that additional QE would not help, this drug would stop working and stocks could move significantly lower: 

"What worries me most is the underlying theme: QE 3 has been sold aggressively by institutional players and even though an old Wall Street lesson says "never fight the Fed", I wouldn't bet the bank on it. What if the driving theme becomes the thought that more QE doesn't help? The Economist summarizes in its latest issue: "Central bankers alone cannot save the economy. It is time for politicians to pitch in." 

The market got another data point to support the „fading QE theme” this week: obviously, investors are expecting more printing as can be seen from rising Gold prices. The metal gained around three percent this week since the election. Stocks however lost four percent during the same period. 

From a trading perspective, I am 20% short (actually 60% through leveraged ETFs) and I’m hoping for capitulation to close these positions and maybe even go long at that point. Unfortunately, we are not there yet.  

Disclosure: Covestor Model is long TZA, FAZ

Thursday, November 8, 2012

3 Bullish Sectors Still Looking Bullish?

Yesterday before the open, I argued that Industrials, Financials and Consumer Discretionary stocks were looking bullish.  Are they still doing so after the sell-off?

Let’s take XLF as an example. The picture is not negative yet on the weekly chart since price still moves in a consolidation structure. However, support around $15.50 needs to hold. Otherwise, price would have failed at the long-term resistance. From failed moves come strong move:

The lower time framer looks much more concerning and is indicative of a potential trend change:  classical technical analysis would identify completion of a “head and shoulders pattern”. It will be important to see if any follow through occurs today or tomorrow:

In any case, I believe that the lower time frame leads here and I went short Financials yesterday morning and reduced long exposure by closing various positions. The Covestor Model portfolio took a two percent hit yesterday, but is still ahead the S&P 500 for 2012.

Most concerning, even after yesterday’s decline, is the fact that markets are not really oversold yet: I’m still looking for more extreme readings in the sentiment indicators I’m tracking.

Discosure: Covestor Model Portfolio is long FAZ