Michael Arold

Why I'm Careful Right Now

2012-03-05T11:17:00.000+01:00

There is currently one reason to be careful when it comes to US equities and certain commodities: the US Dollar, which is usually inversely correlated to these assets.

The Dollar Index chart shows that prices are in a process of creating a "double bottom" chart pattern (red lines), which would be bullish for the Greenback. In addition, this bottom would mark a series of higher hights and higher lows since August 2011, so the Dollar is developing an intermediate term uptrend.

Even if you are "just" trading US stocks, it is important to follow these intermarket relationships. At the end of the day, it is all just ONE big trade.

Market Commentary March 1

2012-03-01T08:28:00.000+01:00

It was a very weak session yesterday. Even though the S&P 500 just lost 0.47%, more damage has been done "under the hood". A key index right now is the Russell 2000, which has been weak since the beginning of February. Small caps can be a good indicator of for the risk on/risk of trade. Fortunately, I build up a significant market short position two days ago by going long TZA The hedge was not enough to compensate all the losses from my long positions yesterday, but I expect further declines. At this point, they should be limited, so I wouldn't be aggressive on the short side. I closed most of my long positions yesterday, though.

A new short for me yesterday was BBY, which created an "inverse double dip momentum" setup from my playbook. I probably will discuss this play at a later post.

Silver got totally killed. I have a position, but I entered this long early, on January 17. I took profits yesterday and reduced position size by 50. Depending on the price action today, I might even close the trade entirely.

The market has some room to fall because it got too extended. Declines usually happen fast, so stocks could correct in just two or three days. The key indicator I'm watching is the McClellan Oscillator, which currently trades at -34. Stocks reversed during the last years at readings below -80.

Some Thoughts on Market Sentiment and Breadth

2012-02-28T09:32:00.000+01:00

I wanted to share two observations wrt/ current market sentiment and breadth: first of all, fewer stocks are participating in the rally, which is usually a negative sign. Take a look at the number of S&P 500 stocks above the 50 day moving average and compare the situation to the rally in 2010/11:

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.

Another Swing Trading Setup: Double Dip Momentum

2012-02-28T08:59:00.000+01:00

Here is another setup from my playbook. This is my second favorite behind the "Earnings Gap Reversal" setup.

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:

A classical chartist would probably identify a declining wedge pattern.

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.

What Happened Historically When the S&P Broke Out to New Highs?

2012-02-27T10:32:00.001+01:00

The S&P 500 is trading right below a 52 week high around 1350 and could break out to new highs soon. What did the index do historically when similar setups occurred? To find that out, I looked at new 52 week highs when the prior high was recorded more than four months earlier. I found five incidents since 1995:

At each of the events, it would have paid to buy: the rally kept going and the index traded higher four months after the breakout. In the cases when prices consolidated after the new high, it would have been a profitable strategy to buy into the consolidation.

Even though the number of events is small, the findings suggest that the momentum effect is at work.

How Could Markets Surprise?

2012-02-24T07:41:00.001+01:00

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.

What Happened to Small Caps on Feb 6?

2012-02-23T15:58:00.001+01:00

I do not have an answer to the headline question, but something happened. On this day, the Russel 2000 started to underperform the S&P 500. Small cap performance is often a good indicator for investor's risk appetite. Did someone flip the switch to "risk-off" mode?

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

Should you Buy Gold or Silver?

2012-02-23T15:33:00.003+01:00

Gold and his little brother Silver are making headlines again, so which one should you buy?

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:

Keep an Eye on This Pattern

2012-02-23T13:56:00.001+01:00

I recently came across the following pattern on a couple of stocks/sectors, which formerly had been leading the market higher: it is sort of a 3-push structure, with each new high coming in on a weaker move than the prior high. In addition, relaltive strength vs. the S&P 500 declined. I'm not sure if this is part of a regular consolidation or sign of a top. It might be an interesting short setup.

Here are just three examples: Cisco, Regional Banks and Ecolab. The funny thing is that these stocks/ETFs operate in entirely different sectors.

Feeling bored? Then Trade This...

2012-02-23T13:40:00.003+01:00

Greece was just "bailed out" and related stocks enjoyed a nice rally on the news. Since the dust keeps settling, it might make sense to short Bank of Greece again. The stock had a good 150% pop in January and broke out of a consolidation to the downside yesterday. The key with this trade is to apply strict money management and a) keep position size small b) follow your stop, which I would put at $3.7. So far I do not have a position, but might consider to take this trade. Volume has been massive, though, so downside potential could be limited.

A Short Term Portfolio Hedge

2012-02-10T09:55:00.000+01:00

This week, I put on a short-term mean reversion trade in order to hedge my long positions and reduce portfolio beta. Small caps had a parabolic move in recent weeks and I expect a minor pullback soon. The longer term trend is still intact of course and buying will probably pick up again at lower levels. I'm using TZA, the 3X inverse small cap ETF. I'm basically trying to benefit from a potential 2-3 percent pullback:

Challenging Weeks Ahead

2012-02-07T11:07:00.000+01:00

The 2012 equity rally has been relatively easy to trade so far and the Covestor Model performance shows exactly that: the account is up 8.5 percent for the year as of February 3. Unfortunately, the days of easy money are over in my opinion, at least in the short term. Equity markets are extremely overbought and the S&P 500 is reaching an important long term resistance at 1350. At this point, I would like to see a pullback to at least the 20 day or even 50 day moving average before committing more money on the long side. The market, however, will do its best to challenge investors and hurt the maximum number of participants. The best way for Mr. Market to do that is by actually breaking above 1350, trigger some buy stops and pull in the last non-believer. A similar situation occurred in October 2010 (see chart below): the S&P 500 briefly set a new high in a rapid move only to consolidate in the following weeks. It had been a weak move, though: the number of stocks above the 50 day moving average was smaller than a couple of weeks before the event. I would therefore follow stock participation and market breadth like a hawk in case we see SPX running to new heights.

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.

Why I am Long Silver

2012-02-01T17:00:00.001+01:00

I like Silver a lot these days and I recently added SLV to the Covestor Model Portfolio. Two reasons: Silver should be one of the beneficiaries of the renewed investor's speculation for QE3 as well as an attractive technical situation:

Essentially, SLV just broke out of a gigantic "declining wedge" formation, suggesting sellers are exhausted. The size of the wedge is fairly big: it took SLV over six months to create the formation. Edwards and Magee suggest that prices usually do not take off immediately after bullish wedges, so there is still time to get in or increase the position on pullbacks. In general, one has to manage position size especially with Silver because the metal can make very violent moves and the trade can raptly go against you.

Market Bottoms: Amazing Parallels

2012-01-25T11:03:00.002+01:00

It feels like Mark Twain was wrong when saying History doesn't repeat itself, but it does rhyme when looking at last three stock market bottoms - including the recent one. Repetition of this pattern is simply amazing:

There are three characteristics which played out almost the exact same way:

1) Duration - the entire process took around six months.

2) Failed test of the initial low, which also marked the start of the rally.

3) Declining volatility during the entire process.

The chart above also shows very nicely how volatility has been clustered in recent years. Volatility clustering is a known phenomenon/market inefficiency and I'm tempted to incorporate that into my trading (shorting the VIX at cluster peek? Needs more research/work before I'll implement it)

By the way, I didn't play this structure well when it first occurred in 2009, which was the only year where the Covestor Model Portfolio underperformed the S&P 500. However, in 2010 and 2011 I got much more aggressive on the long side when this pattern showed up, which is one of the reasons why the portfolio is up over six percent in 2012 so far.

QQQ at New Highs: Lessons from 2010

2012-01-23T16:28:00.002+01:00

The Qs are trading at new multi-month highs, which bakes the question if one should buy at this point. The Nasdaq rallied to new similar highs three times in 2010 and each time QQQ kept rising another six percent for the next couple of weeks. So going long this overbought market for a short-term trade might make sense.

Here is how it played out in 2010:

The situation today:

Interview with new RIMM CEO: Time to Short the Stock Again

2012-01-23T14:24:00.000+01:00

OK, he is a German dude, but after watching this interview below with the new RIMM CEO Thorsten Heins. I can hardly resist to start shorting the stock again. It seems like the company is living on an island and has completly lost sense of reality.

Some quotes and my interpretation:

"RIMM was small in the wireless arena and we have taken this to new highs."
Translation: We have done this in the past, but have no clue how to do this in the future.

"If we continue doing what we're doing, I don't see any problem us being among the top 3 going forward".
Comment: guys, you have to change something here. The German dude should be fired for this statement.

"At the very core is innovation. We always think ahead".
Comment: no, you don't. Otherwise you wouldn't have lost market share. Again: time to wake up, guys.

"Somethimes we innovate too much when building a product."
Comment: no, you don't innovate enough.

"We want to spend more time on prototyping, research and development while building the products."
Translation: our costs will go up, but you won't see new products for a long time.

"It's important that R&D is excited about our future."
Comment: well, at least you are obviously not in this video. How do you expect your people to be excited? (Excess excitement is a not key feature of Germans anyways)

"In my free time, I love to play with new technologies".
Translation: I have an iPhone myself.

What really scared the hell out of me was Heins' proclaimed future focus on the consumer market. Given the competion, I don't believe RIMM will be able to come up with a compelling consumer products. He also put a lot of emphasis on the Blackberry 10, which is supposed to be launched in September. Way too late, according to znet.com.

Here's the full video:

Bullish Put/Call Ratio Domain Change

2012-01-23T09:57:00.002+01:00

The equity put/call ratio is one of the sentiment indicators I'm looking at. Istead of considering absolute levels, relative extremes within their local domain are more important. I introduced the p/c ratio domain concept in an earlier post last year.

It looks like the ratio is about to move to a lower general level ("bull domain") again: when the ratio of the past 10 days averaged 0.65, prices tended to reverse in the short-term during the last six months. The zone around 0.65/0.7 might now become the "too pessimistic" level:

ORCL: a Typical Earnings Gap Play

2012-01-19T11:41:00.000+01:00

The "earnings gap play" is not my typical trade, but one of the setups I want trade more. The idea is to look at companies who disappointed with earnings and gapped down significantly. I buy when the stock reverses immediately after the report and tries to close the gap. I like this trade because I get the opportunity to buy the stock at a discount. Many investors got trapped on the wrong side and sold into earnings. They start to figure that they have been wrong so they start buying back the shares. Others might simply buy to do some dollar cost averaging on their long positions.

ORCL is a good recent example of this setup. I'm still long in the Covestor model portfolio, but the stock reached my target and closed the gap. I'll probably taks some (partial) profits today:

Disclosure: Covestor model is long ORCL

FCX: Tool Partial Profits

2012-01-19T11:25:00.002+01:00

I reduced size of my FCX position yesterday and sold some into strength. The trade is developing nicely, but the company reports earnings today before the open. I usually cut size prior to these events. In addition, FCX hit the upper channel boundary, which is where I try to sell anyways:

Disclosure: Covestor model portfolio is long FCX.

Silver Opportunity

2012-01-19T11:15:00.000+01:00

A nice technical trade is shaping up in Silver: the metal is about to break an important declining trend line and prices recently bounced from key support levels. The trade on the long side has a risk:reward ratio of 1:3 (stop @ $29, target @ $35). It's not shown on the chart, but 35 is also an important Fibbonacci level:

Disclosure: Covestor model is long SLV.

AAII Sentiment Survey: So What?

2012-01-18T15:06:00.002+01:00

Market pundits have been dissecting the latest AAII reading, which has been very high for the bulls.

Contrarians, such as Mark Hulbert don't buy the rally. If these "experts" would simply pull up a chart, they would quickly recognize, even without advanced quantitative analysis, that high bull readings did not have any predictive value in the last two years:

Even worse: you would have missed the entire 2010 rally, because bullish sentiment came in between 40 and 60 percent during the entire move (see chart).

What's Wrong with This Picture?

2012-01-17T10:35:00.001+01:00

The markets are doing funny things these days and when I get the feeling that somebody must be wrong big time when looking at key asset classes. Something is wrong with this picture:

Treasury yields are falling, which indicates a weaker economy ahead. The Euro is declining, which hints more weakness out of Europe. On the other side, Copper and US stocks have been rallying, indicating the exact opposite.

Whoever is on the wrong side will trigger a sharp move in the opposite direction. My feeling is that the bears are making a mistake. The Covestor Model Portfolio is positioned to the long side. Positive catalysts could be US earnings and China growth (positive catalyst China starting to ease rates this month). Market participants seem to favor these themes over the European debt topic. Keep an eye on FXI and commodities, which should outperform in this environment.

The Recent Decoupling of European and US Stocks

2012-01-07T22:00:00.001+01:00

I was surprised how much US stocks recently have been able to uncouple from their European peers.

However, when I looked at the combined chart for both markets I was even more astonished that this uncoupling has been going on for a while: the S&P 500 has been outperforming European equities since July. As a result, the S&P looks like being in a uptrend while stocks of the old continent are trading sideways:

German DAX' Today's Bullish Action

2012-01-02T22:11:00.001+01:00

The German DAX broke out of a symmetrical triangle to the upside today, which is very bullish.

Usually US stocks wouldn't care about what is going on in a tiny country oversees, but the European debt theme has been pressuring global equities in 2011. Relative strength has been positive as well so believe it or not, German stocks have been outperforming US equities since September. I'm actually considering going long the Germany ETF EWG.

Is it Time to Buy BAC?

2012-01-02T12:58:00.001+01:00

BAC has been one of the worst stocks in 2011 with a decline of over 60%. Headlines are still horrible and risks from Countrywide's mortgage business continue to pressure the stock.

Technically, though, BAC is starting to look quite interesting:

There is no question that BAC is still trending down, but it has been approaching the key $5 level in the last quarter and obviously some buyers have been coming in. Downside momentum has been declining as can be seen in the MACD-price divergence. In addition, volume action has been slightly positive. Finally, there are two declining wedges on the price chart, the last one was just recently completed.

Relative price strength vs. the S&P 500 is still negative, though.

The chart looks compelling, but I have a problem trading stocks of companies, which are engaged in major lawsuits. I know that technical traders should ignore the news, but there might be enough time to get into the stock after a positive outcome of the allegations.

Morning Briefing Dec 30

2011-12-30T14:41:00.001+01:00

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.

Morning Briefing Dec 29

2011-12-29T10:20:00.002+01:00

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.

Charts of individual names, however, are looking more concerning. The weakest sector was Basic Materials and charts of some names raise concerns. Take for example FCX:

The stock is about to break out of a symmetrical triangle - to the downside. Other stocks, which have been leading, are creating bearish rising wedges on their charts. One example is GLNG:

The best performing position in the Covestor Model Portfolio yesterday was the Silver short. I did not take profits yet since I chart is a total mess and there is still the potential for a big downside move.

Morning Briefing Dec 28

2011-12-28T12:16:00.003+01:00

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.

Morning Briefing Dec 22

2011-12-22T15:30:00.001+01:00

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

2011-12-22T09:55:00.002+01:00

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.

Morning Briefing Dec 21

2011-12-21T13:59:00.001+01:00

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

2011-12-21T09:58:00.001+01:00

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:

Swing Trading Morning Briefing Dec 20

2011-12-20T09:53:00.000+01:00

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.

Swing Trading Morning Briefing Dec 19

2011-12-19T10:59:00.001+01:00

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.

How to Become a Better Swing Trader

2011-12-18T12:37:00.002+01:00

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

2011-12-18T11:23:00.000+01:00

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:

How to Trade the Collapsing Platinum/Gold Ratio

2011-12-16T11:07:00.000+01:00

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

2011-12-16T09:47:00.000+01:00

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

2011-12-16T09:31:00.001+01:00

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

2011-12-16T09:27:00.000+01:00

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

2011-12-16T09:07:00.000+01:00

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.

A Conversation with my Greek Business Partner

2011-12-15T19:37:00.002+01:00

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?

2011-12-15T12:14:00.000+01:00

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

2011-12-15T10:01:00.001+01:00

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

2011-12-15T09:20:00.001+01:00

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:

What's so Cool About the Golden Cross?

2011-12-14T13:23:00.002+01:00

I did a little bit more work on the 200 DMAafter my previous post on the topic. I have to confess, I was never a guy who wasconsidering such a long term-moving average. I think this has changed as oftoday.

I ran a little statistics to evaluate howgood signals form crossings above/below the 200 DMA turned out. In order tosmooth the noisy daily data, I used the 50 DMA instead of daily data. Call meignorant, 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, theS&P 500 ETF since 1994, so a 15 year period. If one would have bought SPYon 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 signalsummary:

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

Conclusion:

100% win rate for the Golden Cross makes itclear why many institutions are looking at the 200 DMA. Using these signalsresult in a very simple but effective long-term trading strategy. Evenshort-term traders like myself can benefit because the indicator seems to makea good job defining bull and bear markets.

BTW: The market just experience a “DeathCross” on August 17.

2008/2011 Watch: Perfectly Matching the Playbook

2011-12-14T09:22:00.004+01:00

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

2011-12-14T08:07:00.002+01:00

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.

Algorithmic Trading: How Humans Can Still Win

2011-12-13T09:37:00.001+01:00

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

Are we Overbought Yet?

2011-12-07T12:43:00.001+01:00

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

2011-12-07T10:02:00.001+01:00

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.

Should you Buy the Euro? What COT Data Suggests

2011-12-05T13:14:00.001+01:00

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

2011-12-05T09:13:00.001+01:00

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

2011-12-05T08:26:00.001+01:00

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:

Declining Euro US Equities Correlation

2011-12-02T21:09:00.001+01:00

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.

2011 Linkfest: How I Trade

2011-11-30T08:12:00.001+01:00

I received a lot of positive feedback on my latest online model presentation. One question was about the trading tools that I'm using to determine turning points and market direction, since the Prezi was only meant to give an overview for investors, who are not deeply into technical trading concepts.

I could probably write a book to really explain my philosophy in detail. Unfortunately, I don't have the time for that. The following links to earlier posts might give an overview of my trading tools.

In a nutshell, it is a top down approach: first determining market characteristics, sentiment and direction. I'm applying various breadth indicators as well as a "holisitic view". Basically it's about pattern recognition on a macroscopic level. Trading comes down to searching for extremes and/or divergences.

The second step is the tactical approach on a individual stock and/or ETF level, which comes down to trading channels.

Links about general market direction & sentiment indicators:

Determining market turning points using the volatility decay concept

Recent volatility decay

Determining market direction: equity put/call ratio example

Example: understanding current market characteristics - the hit&run market

Determining market sentiment: VIX; McClellan, Equity Put/call ratio

Understanding market characteristics: analysing key sector performance

Evaluating sentiment using COT data divergences

Put/call ratio domain concept

Evaluating seniment: Copper, New High/Lows, Stocks Above 50 DMA, sector analysis

Links about channel trading on a individual stock level:

General channel trading approach

General selling philosophy

Trading (mean-reversion) rule: price almost always comes back to the moving average

PREZI Covestor Model Presentation

2011-11-29T09:10:00.001+01:00

I was experimenting with the PREZI online presentation tool last weekend and took the opportunity to create some "slides" discussing the philosophy behind the Technical Swing Covestor Model Portfolio:

Any feedback is more than welcome. I love the PREZI tool. In order to use it effectivly, you really need to forget everything you learnt about powerpoint.

Enjoy

How to Trade a Possible Bounce

2011-11-28T09:38:00.001+01:00

Furtures have been strong this morning on Italy bailout news. Since markets are heavily oversold, we might see a nice bounce, which still could be traded from the long side.

I would not focus on individual stocks, since correlations are very high. Instead, simply use a index fund for a swing trade for a couple of days. I'll focus on the Russel 2000:

As can be seen from the chart, IWM, the Russel 2000 ETF, has room to 70.5 from a Fibonacci point of view. Also, major general resistance starts in that area. Indices will possibly gap up a percent or two, but the tradable range spans around six percent overall. Stop below 68 could offer a compelling risk/reward ratio.

Unless headlines change until the US morning, this could be an interesting trade.

The Chart Every Equity Trader Should Watch

2011-11-23T10:33:00.001+01:00

Since we are all Forex traders these days due to the high correlation between stocks and the Euro, here is the chart that every equity trader needs to watch: the Euro intraday.

The currency has been consolidating for the last days in a tight range between 1.3450 and 1.3550. A move below or a above the range should trigger a major move in US stocks and determine short term direction. Unfortunately, the Euro is acting weak this morning, which translate into weakness in S&P futures as well.

Decling Volatility: A Bullish Sign?

2011-11-23T08:20:00.001+01:00

The market has lost abound five percent so far in November. Even though I more or less declared myself a bear with my prior post, I have to recognize some potentially positive developments: volatility has been declining in recent weeks. The situation reminds me of the 2010 summer decline:

The July - September bottoming process was accompanied by declining volatility as can be seen by looking at the Average True Range (ATR) and the VIX. The situation is similar now, the VIX could decay a little bit faster for my taste. In any case, I would be very careful shorting the market at this point.

As for the Covestor Model Portfolio, I'm currently short XLF and DB. I'm not really comfortable with these positions, so I will close them soon.

Is This 2008 Again?

2011-11-21T11:34:00.001+01:00

It is quite striking how charts are starting to look similar to the ones of the 2007/08 top. Here is what happened to the S&P 500 then and now:

2007/08:

2011:

I did a quick comparison of some basic "geometrical" characteristics of both events. These basic dimensions are so similar that its almost spooky. Similarities really should start to diverge from now on:

You might understand, why I'm not overly bullish these days.

Covestor Model Portfolio Update

2011-11-18T09:22:00.001+01:00

Yesterday was an important day from the technical point of view: major indices broke out of an important "symmetric triangle chart formation " to the downside. Classical chart analysis suggests significantly lower prices ahead. The best case scenario for markets and short-term traders like myself is a quick 2-3 day rebound, followed by a major drop. The rebound would create wonderful shorting opportunities and a weak rally would further confirm the valitity of the breakdown:

In recent posts, I was highlighting the declining correlation between weak Euro and US stocks as a potential sign that markets started to leave the debt crisis behind. However, I also presented that the high correlation was still intact when simply looking at the Financial sector, so caution was justified.

Some stocks broke out to the upside in the last days before reversing trend. I had been setting up various long positions. Two days ago, I started to close them because the markets simply acted too weak. I took a small loss in some of the stocks, but that's what traders do. By the same token, I got back into shorting GS and C while staying short the Euro as well. Mostly, though, the portfolio is in cash (80% to be specific). As mentioned earlier, a weak rebound would give me the opportunity to expand the short position. Should this rally not happen, well, then I at least benefit from the small short position.

From the sentiment standpoint, further declines are possible: many investors and fund managers were pulled into the markets, hoping for Santa rally.

A final word on Gold: I had been long since Oct 25 and closed the trade yesterday after taking partial profits along the way. Various pundits predict Gold to hit $2000 soon. The short-term technical pictures speaks a different language (worth a blog post I guess), which I could not ignore. I don't know the reasons for Gold's fundamental weakness yet, but the entire action reminds me of 2008, when the yellow metal also had a hard time despite its reputation of being a hedge during times of crisis.

Disclaimer: Covestor Model Portfolio is short C, GS, long EUO

Determining Breakout Direction

2011-11-15T06:46:00.001+01:00

In recent weeks, the chart of the S&P 500 has been forming a "symetric triangle" pattern. Direction of the breakout should determine the intermediate term trend:

One option is to wait for the breakout to occur and then trade in the direction of the trend. Another is to watch for early indications and then try to envision the likely direction of the break. Here is how I'm trying to do that:

Various market leading large cap stocks have formed a similar pattern as well, so they should lead a market breakout as well and might finalize the pattern a tick earlier than the general market. Here are some stocks/sectors I'm watching:

INTC is in the process of breaking out:

CAT already broke out:

This pattern is relativly easy to trade. The only caveat: everything seems a little bit too obvious at this point. The market usually tries to surprise the majority.

Euro Decoupling from US Stocks?

2011-11-14T21:00:00.001+01:00

I wrote a post the other day on the FXE-SPY correlation. Since the beginning of November, however, we have been seeing a slight divergence between Euro and US stocks:

In fact, the 130 period (10 day) intraday correlation has been declining recently. Three options on what this means: a) impact of Europe fading and US stocks can buck the trend, b) Euro is leading down (as it has been doing so in recent months) and US stocks will follow, c) nothing.

I'm in favor of option a) because US earnings season has been quite strong and might have been the catalyst for the intrinsic strength of equities.

Why I Would Still Buy MCD on Every Dip

2011-11-11T12:47:00.001+01:00

Here is some cool Peter Lynch type of research on McDonald's:

a new franchise recently opened close to our office and I couldn't resist to trying out today for lunch. Or at least tried to try it out. The place was so crowded around noon that I had to cancel the endeavor (I'm a pretty unpatient guy when it comes to certain things and I refuse to wait for a Big Mac for more than ten minutes). Before leaving, I took a snapshot with my Blackberry (sorry for the crappy photos, we'll talk about shorting RIMM in one of the next posts):

So I was still hungry and in fast food mode, so I went into Burger King across the street. Of course, I also took a photo, five minutes after the shot at Mc Donald's:

Obviously, the place was virtually empty and I could enjoy my Burger.

Germany is a pretty mature market and you would think that people here get enough to eat, but obviously a new McDonald's can still attract the crowd.

Burger King (BKC) was taken private last year. Here is what Reuters wrote on Sep 2010:

(Reuters) - Burger King Holdings Inc agreed to sell itself to investment firm 3G Capital for $3.26 billion, giving the No. 2 U.S. fast-food chain breathing room to fix its business and close the gap with leader McDonald's Corp.

"Close the gap with McDonald's"? If you look at my photos, it rather seems that the gap is widening one year after the acquisition. I keep MCD on top of my watchlist.

Lessons from the Latest Intraday SPY/FXE Correlation

2011-11-11T09:46:00.001+01:00

The Wall Street Journal recently discussed the high correlation between US stocks and the Euro. Effectively, every US equity investor is a currency trader these days. While the Journal highlighted the longer term picture using a 30 day correlation, it might be interesting to analyze intraday relations.

The following chart shows the recent 5 day correlation of the SPY and FXE ETF:

In the last six weeks, the relationship between Euro and US stocks has been getting even stronger, trading at a perfect 1.0 at certain times. Correlation breakdowns have been only temporary and for a short time. In fact, one can observe that stocks had only a chance to develop a sustainable rally when the Euro moved in the same positive direction: stocks rallied for a short time at the end of August as well as mid of September, but the Euro acted weak (Box A and B). During the October rally (box C), both assets gained in price.

An interesting situation occurred during the last couple of days (box D): the Euro has been acting significantly weaker than US stocks. So based on the observation of the last months, the strength in the SPY should not be lasting long. The Euro has to regain strength soon to keep US stocks at current levels. I would keep the combined intraday FXE/SPY chart of on top of my screen.

What's Up with Gold?

2011-11-02T21:30:00.000+01:00

Today, I increased my long position in Gold. Something is going on and the current price action offers a very attractive risk/reward profile.

After the sell-off in September, the precious metal has gained some strength and is currently trading around $1700. What's interesting is that Gold has some pretty strong support around $1650. Even more compelling is its recent strength in the light of a stronger Dollar, which hints some underlying bullishness (Gold is typically inversely correlated to the Greenback).

So here is the trade: long at 1700, target, 1900, stop 1650 results in a risk reward ratio of 4:1 (1900-1700:1700-1650). I guess I take that trade.

Disclaimer: Covestor Model Portfolio is long UGL

AAPL: Not Shorting Yet

2011-10-24T20:55:00.001+02:00

I have to confess: this morning, I wanted to post a piece about why I think AAPL is a short. The headlines today however indicated a sense of optimism about the possibility of an upcoming Apple TV. This sentiment could support the stock for a while and shorting is off the table unless I see relative weakness in the stock. Still, AAPL stays on my watch list for a potential trade to the downside; I'm not pulling the trigger yet.

How to find the next Green Mountain?

2011-10-17T21:32:00.001+02:00

Green Mountain Coffee sold off hard today after David Einhorn presented his short thesis. GMCR perfectly fit my criteria for a weakening stock, which is why I shorted the company in the Covestor Model Portfolio.

Unlike Einhorn, I did only apply very basic fundamental analysis. Most of my criteria are based on technical factors and general trading characteristics. If you want to find the "next Green Mountain", you cannot wait until the news hits like today. Fortunately, there are other signs to look for:

1) High Short Interest & Bullish Average Analyst Rating
It might feel strange to short a highly shorted stock, but academic research has shown that the combination of shorts and bullish analysts creates a positive edge on the short side. Rationale is that analysts are usually behind the curve and short sellers are rather sophisticated (you didn't hear me say "smarter" :-) ). I discussed this point in an earlier post.
Here is a scan I frequently use on Finviz.com to find candidates. Note that I'm looking for large cap stocks since I want to minimize takeover risks. I also need stocks that are easy to short, so again: large caps are the choice. By the way, GMCR still showed up on the scan this morning.

2) Momentum stocks
Next I'm eyeballing the charts: I want to find stocks that demonstrated sort of a toppy price action after a major run. GMCR was/is in the process of creating a "head and shoulders" top.

3) Entry timing
Finally, you need to time the entry of course. Since I'm a swing trader, I'm looking for a weak rally/consolidation after major declines. It is important, that the stock didn't break down yet. You want to be ahead of the curve before major negative news hits. This phase is probably the most difficult one for many investors since it often means to just watch the stock and learn to read its specific price action. At one point, you will notice that the stock doesn't react on positive news anymore: the big guys are using every opportunity to sell into strength. Actually, you want to see the stock to trade on weak relative strength against an underlying index such as the S&P 500. GMCR started to do that at the end of September.

So: who could be the next Green Mountain? Take a look at the scan I mentioned above.

Drum roll....

I would shoot for CERN. Not a perfect pattern, but good enough to keep on the watchlist.

QQQ: Should you Buy the New High?

2011-10-17T11:09:00.001+02:00

I asked the same question in my last blog post with respect to AMZN. The answer was that it wasn't a good idea from the risk/reward standpoint. Interestingly, the situation looks different when trading QQQ:

During the recent bull market, there were two occasions (April 2009, September 2010), when the Index emerged from a multi-month, high-volatility consolidation phase. During these events, prices kept moving higher for several weeks or even months without looking back. So if you believe that recent history will repeat itself, you have to buy at this point.

AMZN: Should you Buy the New High?

2011-10-17T10:43:00.000+02:00

AMZN has closed at a new high last Friday. Does it make sense to buy the stocks at this point?

To answer the question, look at what happened when AMZN closed at similar multi-week new highs this year:

Amazon is a leading (momentum) stock: as you can see, the company has been outperforming the broader market since April this year.
Black circles indicate these buy points. Green circles mark the swing high with percentage gain after the buy point. So that would have been your gain assuming you would have sold the stock at these points (which would have been highly unlikely because it is almost impossible to pick the top).
The red circles mark the maximum loss from the buy point.
Statistically, buying new highs would have resulted in a high win rate: 100% of the trades would have ended higher at one point four weeks after the buy. However, expectancy would have been negative, because the average loss would have been much higher than the average potential gain on this trade.
Bottom line: you can loose much more when buying new highs than what you can win: not a good trade.

Why I Might Short Silver but not Gold

2011-10-16T11:37:00.000+02:00

Very interesting developments occurred in the precious metals markets in recent weeks and they bake the questions if one should engage in Gold or Silver these days. Let's discuss the yellow metal first:

Even after the recent sell-off, Gold hasn't broken its long term uptrend. So from a trading perspective, I wouldn't go short unless I'm convinced that we have seen a "blow off top", which I'm not. The recent decline could present more of a buying opportunity. However, I would give Gold a little bit more time to digest the lower prices. Long term, fundamentals are still extremely bullish: in a nutshell, Gold tends to rise during periods of negative REAL interest rates which is where we are in right now.

Silver is an entirely different beast. Prices not only broke the longer term uptrend, but have underperformed Gold prices since the May sell-off. I believe that the current level present a nice opportunity to go short. Risk is clearly defined (as long as you trade futures) since I would put a stop around $34. There are some overnight gap risks when trading a Silver ETF, but you can accommodate to the situation by choosing a smaller position size.

Live Trade: Exit FDX

2011-10-05T08:41:00.001+02:00

I covered my FDX short yesterday morning with a 7.06% gain (discussed entry here). Prices hit the target at the lower channel boundary and reversed on the intraday chart. Since markets are deeply oversold and momentum seemed to weaken, I didn't consider scaling out of the position. Moving forward, I keep FDX on my watchlist to re-enter on the short side . Let's see how price will behave around $71.

Doug Kass Calling a Bottom Again

2011-10-04T11:07:00.000+02:00

Frequent readers of this blog know what I'm thinking about market pundit Doug Kass, a frequent CNBC guest who does not publish his investment track record. It was therefore difficult for me to understand how investors can even listen to him and other Fast & Mad Money talking heads (I understand now after reading more on the topic of crowd psychology).

Anyways, Kass has been calling a bottom again ("I believe that the lows of the year are in", Sep 26 2011). As discussed in other posts (March 23, 2010; Feb 7, 2011) , there is no statistical evidence that Kass' calls differ from random calls. In fact, we'll never forget his legendary call to buy Financials on Jan 14 2008.
Kass compares the current situation with the mood of the markets in February 2009.

Here is my comparison: one of the indicators I'm looking at is the number of new 52-week highs lows. In 2009, there was a clear divergence between price and the number of new high/lows: the the sell-off was loosing steam. The situation is entirely different now: there hasn't been any divergence in the last months. Also note that the number of new lows is not at extremes levels, compared to 2008/09. Based on this indicator, stocks have more room to fall in my opinion:

The only positive is that indices are approaching major support levels, but this itself does not mean we'll see a bottom. (It's like driving on a highway: the fact that there is an exit coming up doesn't mean I will take it. Only when I start using my blinker, you can infer that I might be willing to leave the highway.)

Intraday Volatility Rising Again

2011-09-30T09:17:00.002+02:00

Something has changed in the markets the last days. Intraday volatility, as measured by the 65 period (5 day) Average True Range, is on the rise again. To me, this means market participants are getting more nervous. Should this trend continue, I expect major indices will break out of their range soon. It's like a storm is gathering energy before the wind is starting to blow:

Live Trade: SHORT FDX

2011-09-29T16:20:00.001+02:00

I'm trying out something new: on an occational basis, I will highlight my (technical) rationale for individual trades. I will post right after I entered a position and provide updates in the following days on why I hold or closed the trade. These trades will be executed in my Covestor Model Portfolio and should give you a feel for how I buy and sell stocks.

Today, I shorted FDX. The stock is moving in a downtrend and has been underperforming the broader market for the last months. The trade is a play on the weakening global economy theme. Note that I usually try to identify driving themes and then select the appropriate stock/ETF to trade this theme. Here's FDX' chart when I shorted the stock this morning. Stay tuned for updates:

When Do I Sell?

2011-09-29T11:58:00.002+02:00

I was recently asked to explain my selling methodology. Let me highlight a couple of points concerning this topic.

First of all, I can't fully discuss selling in a blog post since I could easily fill a book with content. However, I can give you an idea about my methodology. In fact, it is not really my proprietary method. A lot of the aspects are taken from Alexander Elder's approach. I strongly recommend studying his work if you feel that the concept makes sense to you. I recently discussed how his ideas influenced my trading here.

I am basically a "channel trader", who is using EMA channels to determine exit points. The idea is to sell when everybody wants to buy or vice versa in the case of a short trade. The concept makes so much sense to me since I believe that you can only make money on the stock market by buying low (which by definition is when everybody is selling) and selling high (which means selling when everybody is buying). In order to implement this concept with technical trading tools, you simply need a moving average and channels, which reflect a positive/negative increment to the current average price. So conceptually. I'm trying to buy close to the moving average and sell close to the upper channel boundary in the long case. In addtion, I often scale out of positions, especially in strong markets in order to let profits run.

Here are two recent trading examples:

I bought AMZN on August 26. The stock was trading close to the 20 day moving average. I sold the stock three days later when prices touched the upper channel line. As you can see, I took out only a portion of the entire move, but that's ok. That's swing trading. I'm not trying to sell at the absolute top.

Another example on the short side: FST.
I shorted the stock on August 8, again, close to the moving average, the level of "normalcy" (Elder calls it "value") if you will. FST moved down strongly and I reduced position size by half two days after I shorted the stock. I finally closed the trade two additional days later when downside momentum deteriorated.

As I mentioned before, there are a lot of nuts and bolts to this technique and I highly recommend reading Elder's book The New Sell & Sell Short for more details.

Note that I was showing you two successful examples here. In reality of course, not every trade is succesful. In fact, there is a lot of noise and randomness in the markets so many trades (between 40 and 50 percent) will not work out and you have to sell with a loss. No big deal if you have good money management, though.

Covestor Portfolio Update: What Happened During a Brutal Week

2011-09-23T14:07:00.000+02:00

A quick update on what happened to the Covestor Model Portfolio after a brutal week for global equities. As I mentioned in my last monthly Covestor update, it was "time to focus on mean reversion trades": the S&P 500 has been in a trading range between 1100 and 1230 since the beginning of August. I have been trading the range with a bearish bias: going short at the top of the range, closing shorts and going modestly long at the lower levels. The strategy has worked out so far, the model portfolio is up almost nine percent for the month of September. It's a very short term oriented strategy and the trades barely lasted longer than three or four days. For example, I took various short positions last Tuesday (IWM, REMX, KOL, GS, VSI) and closed the trades fully (IWM, VSI) or partially yesterday (Thursday).The S&P closed at the lower end of the range. Does that mean it is time to go long again? I don't think so. However, adding to the shorts isn't a high probability trade either. Given the recent downside momentum, there is decent chance that stocks will build another leg down. In a highly volatile, news driven environment nasty short covering rallies can occur any time and it is mandatory to manage risk. I will keep raising cash if major indices continue to record new lows. My favorite scenario is a panic sell-off, because a reaction trade on the long side would offer a compelling risk-reward situation. Unfortunately, various sentiment indicators I'm following indicate that fear is not at extreme levels yet, so keep your seat belts fastened.

Pair Trading Ideas

2011-09-13T08:07:00.000+02:00

I like the idea of trading pairs in order to play secular industry trends while being market neutral. So far, I don't trade them, but I might consider setting up a model portfolio in the future after some more research.

Here are some interesting pairs:

Long Amazon, short Best Buy:

Long Dollar General, short Wal-Mart:

Long Apple, short Nokia:

Long Germany, short Italy:

Covestor Portfolio Commentary - Coming Next: Dow 10,000?

2011-09-12T10:33:00.001+02:00

Futures are down sharply this morning and stocks are a mess. Classical chart analysis suggests that the DOW could see a rapid move towards 10,000 within the next weeks. During August, a bearish "rising wedge" pattern shaped on the charts of various indices and a break of the lower pattern boundary, which we might see today, could move the Dow Jones to the next major support area around 10,000:

What does that mean for the Covestor Model Portfolio?
Last Friday, I closed all my long positions (most of them with a small loss) and opened various shorts when it became clear that the rally was over. In hindsight, it was not a wise decision to trade the rebound by buying into strong stocks. In bear markets , trading direction is SHORT, Period. The only exception is if markets experience capitulation and even then, going long requires a lot of experience and very conservative money management. So far, I haven't seen investors throwing in the towel, but that could change fast. Too many "momentum stocks" have been holding up quite well.

So going into the week of September 12, Covestor clients are short Italy (EWI), Financials (long SKF), First Solar (FSLR) and Netflix (NFLX). I keep the number of positions small in order to stay nimble. Correlation among stocks is high, so it saves time and commissions to focus on sector and country ETF's.
Should the markets indeed record new lows this week, I will gradually reduce short exposure and take profits into weakness.

Overall, I'm not sure if I should enjoy the latest developments because the Covestor Portfolio is doing well, or hope for a stronger market because my 401k is suffering. Unfortunately, the managers of the Fidelity funds I own haven't been able to record positive returns this year unlike me. I'm starting to ask myself why I still own them.

My Short Italy Position: a Classical Swing Trade

2011-09-07T10:30:00.002+02:00

Yesterday, I partially covered my short position of the Italy country ETF EWI. So far, this trade has been a classical swing trade and represents the"bread and butter" trade in my playbook:

EWI has been moving in a perfect downtrend while underperforming even the US markets, represented by the S&P 500 in the lower pane. The sell-offs came in on increased volume, a bearish sign. My general strategy is to sell short close to the declining moving average and cover when prices touch the channel boundaries, so yesterday was a day to take profits. However, I didn't close the entire position because downside momentum has been very strong in recent days. Price action today or tomorrow will determine if I finally will shut down the trade.

Disclosure: Covestor Model Portfolio is short EWI.

JOE: Potential Long Trade

2011-09-05T15:22:00.001+02:00

There are not may stocks I'm considering candidates for a long trade these days, but JOE caught my eyes.

St. Joe is a stock I was shorting a couple of times during the first half of this year. Recently, I looked at its longer term chart again and believe it or not, the stock might start to look like a long at this point. Let me explain:

When looking the price action the first time, one would say that the chart is mess: JOE is in a downtrend as defined by the declining 20 week EMA. Also, the stock has been underperforming the S&P 500 in the last five years, so there is no relative strength recognizable on the weekly chart.

What's intriguing, though, is that downside momentum is waning: the bears have been loosing steam in the last years, which can be seen by looking at the divergence of price and the MACD indicator.

Even more compelling is the volume action. The "Force Index" (basically result of price rate of change multiplied by volume change) also shows divergence: so volume on the downside is fading. The entire action is taking place at an important long term support level, $15.

Let's take a look at the daily chart:

Same divergences on the shorter time frame. The stock even slightly outperformed the S&P 500 over the last two months. I believe that somebody is buying here and the market doesn't notice yet because of current macroeconomic concerns.

What's even more compelling: JOE has a very high short ratio: it would take 32 days for the shorts to get out at the present volume, so the stock is a major short squeeze candidate.

I'm not pulling the trigger on this trade yet, but keep it on top of my watchlist for a potential turnaround play. All bets will be off if price breaks $15 of course.

What a Trader can Learn from NASA's Apollo Program

2011-09-05T11:18:00.000+02:00

(I apologize for the somehow geeky post, but sometimes the engineer in me comes through since aerodynamics was one of my majors at university :-) )

The other day I saw a fascinating documentary about the Apollo Moon program in the Sixties which reminded me of some important trading lesson.

During early development stages, rockets quite frequently blew up in the testing. Engineers got frustrated because there was intense pressure from Washington to move the program forward. According to Jesco von Puttkamer, who was one of the engineers, Werner von Braun was pretty cool about the failures. He kept saying that they were fine as long as they gained telemetry data during the test flights. These recordings helped them to find the source of the problems. Ultimately, von Braun's team succeeded, of course.

Trading is similar: some trades will blow up, it's no big deal. As long as the trader knows why, he is fine. There are two reasons why a trade can fail: number one is by design, the other one is by mistake.

The "failure by design" is nothing to lose sleep over: no trading strategy has a 100% win rate. That number will be somewhere between 40 and 70% depending on the strategy.

"Failure by mistake" is an issue and something every trader, even me, has to work on. Nobody is executing the perfect trade all the time, sometimes one is biased, sometimes one is not following his own trading rules. That's why it is extremely important to monitor one's trades as detailed as possible by writing a journal and collect "telemetry data" if you will.

Most important, though, is to be relaxed about it, like Werner von Braun. He probably would have been a great stock trader as well, but since he was a genius he would have excelled in every field. Geniuses tend to be multi-talented.

How Dr. Alexander Elder Inspired my Trading

2011-09-04T12:40:00.002+02:00

My current summer read is "The New Sell and Sell Short" from Dr. Alexander Elder. I have read his earlier books, but this one is a great refresher and expands on the shorting topic. In this post, however, I do not want to discuss the book but rather highlight, which elements of Dr. Elder's philosophy I have adopted to my trading.

Overall I have to admit that probably 80% of my trading style is based on Elder's strategy. I tweaked his approach here and there to fit my view of the markets. In a nutshell, the Elder approach is a swing trading strategy that buys stocks at value when they are close to a moving average and sells when prices are extended, which means that the stock is trading at a distance to the average. Of course, there are a lot of nuts and bolts to it, and I encourage aspiring swing traders to study Elder's work.When I read his books, the approach immediately made a lot of sense to me: buying at value and selling when everybody wants to own a stock seemed to be so logical. Also, the strategy is in essence a mean-reversion approach. Mean-reversion is a market anomaly, which has been observed by academic research.

Here are some of the Elder tools I'm using:

Trading on multiple time frames: making strategic decisions on the weekly chart, tactical decisions on the daily.
EMA channels on the daily chart to define value and over/underpriced zones.
MACD indicator to evaluate when a trend is weakening
Elder's Force Index to indicate when bulls/bears are loosing power
New High/Lows to evaluate market breadth
Money management rule: Elder recommends 2% of capital per position. I'm using 1%, though with a different technique to calculate stop prices.

Some tools I'm using in addition to Elder:

Relative strength against an underlying index. I want to own stocks that act stronger than the overall market. Relative strength can also show early warning signs when divergences occur.
Equity put/call ratio for a look into overall sentiment.
A different scanning process. Elder is starting with industry groups and then boils down to individual stocks. I run technical trend scans and look at the chart of every S&P 500 stock twice a month to find stocks which match the patterns in my playbook (believe it or not, there are just five patterns in my playbook. Ten, if you add the short side. Out of the five patterns, there are two major ones that I actively trade, the other ones are either "niche" patterns or still in the "development phase".
Scaling out of positions: it seems like I'm using scaling much more actively than he does. However, I'm still fine tuning this technique.
Modified risk and stop price calculation: since I'm trying to trade in the second half of the day and I'm not using hard stops, I need to incorporate the volatility into my risk calculation.

If you are looking at my standard daily charts, you can obviously find many Elder elements. Again, the major difference is probably the additional relative strength:

Note that I'm not using the Elder Impulse System, which is a different way of coloring the bars. Reason is that I want to limit myself in the number of indicators on the chart ("keep your chart clean") and I'm already at the maximum number of items that I feel comfortable with.

Overall, the Elder approach has greatly benefited my trading. Even though the strategy is relatively simple, it took me years to really learn it and to eliminate basic mistakes. Maybe that's the time it takes because there are many behaviors that need to sink in and become automatic in order to get constantly profitable. Even though I'm OK with my trading results, there is still room for improvement and there are several areas I'm currently working on.

Why I Don't Like Gold Miners (Yet)

2011-09-01T09:38:00.002+02:00

A fellow blogger recently commented on Gold Miners: J.C. Parets argued that stocks are poised for a breakout, based on technical conditions. I'm not (yet) optimistic for Gold stocks. A key parameter in my trading is relative strength and Miners have simply underperformed f Gold in the last months. One could argue that stocks are poised for a catch up move, but even in that case, the Gold Miners ETF, would outperform the yellow metal. Note how the last move in September 2010 was indeed accompanied by strength against Gold and the general market:

However, there is a positive sign today: GDX acted much stronger than the general market in recent weeks, so let's keep an eye on the GDX:GLD ratio to evaluate the quality of a potential breakout move. Frankly, there is no point in owning Miners if Gold is acting much stronger. In that case, own the metal instead.

Disclosure: Covestor Model Portfolio is long DGP.

Visualizing the Rise of Germany in Europe

2011-08-31T12:24:00.000+02:00

The following chart shows the relative performance of the Germany ETF EWG against the Italian EWI. I found it quite interesting to see how German stocks have been outperforming Italian equities for the last five years:

The combination offers an interesting pair trade if you believe that the economic differences will keep widening, which is what I think. An investor, who would have gone long Germany and short Italy five years ago would have raked in a 37% return without a single negative year, even during the financial crisis.The return for this year so far would be positive even though both ETFs are down for the year.

Disclosure: Covestor Model Portfolio is short EWI.

How I Trade Europe in the Covestor Model Portfolio

2011-08-31T11:50:00.000+02:00

Even though I'm short-term bullish (see my last post), I have a close eye on Europe. One of the positions in the Covestor Model Portfolio is a short trade of the Italy ETF EWI, even though I accumulated various long positions in US stocks during the last week.

Europe has the potential to kill the QE3-hope-rally in my opinion. As usual, I'm looking at relative strength against the S&P 500 and Italy doesn't look too good with this respect. In fact, the ETF didn't participate in the recent rally at all:

Unfortunately, Germany doesn't trade any better:

What really doesn't fit the picture here is the performance of the Euro, which held up quite well in recent weeks. Sorros was speculating about a "secret buyer" of the currency the other day. The question however is if we are seeing Euro strength or Dollar weakness. The later one might be the case:

Overall, I'm planning to stay short Italy until I see some relative price strength.

What the Lessons from the 2000 - 2003 Bear Market Mean Today

2011-08-31T11:01:00.000+02:00

My general investment hypothesis these days is that stocks entered a bear market. I'm not alone with this outlook: Peter Brandt, a very experienced trader whom I respect, talks about the same notion in his blog. Even though I agree with Peter's views, my investment conclusion differs. Some of the differences arise from the fact that he is a position trader who applies longer holding periods while I'm trading short-term swings.

My view is that even in a bear market there can be significant rallies, which are short-term tradable. Let's take a look at the 2001 - 2003 decline to illustrate the point:

Even though stocks clearly acted in bear market territory, the S&P 500 pulled off three 20 percent rallies over the two year period. If traders simply bought stocks right after the major sell-offs, they could have achieved significant returns even in a long only portfolio. Obviously, markets were volatilie over the entire period. I believe that we could experience a similar highly volatile pattern in the coming years. Holding short positions for sure makes sense, but investors might have to stay in these trades for several months while stocks are rallying - psychologically a challenge for inexperienced position traders.

The scenario is the reason why I took several long positions in the Covestor Model Portfolio last week. I believe that the bear market will continue, but right now investors are hoping for more QE3, which could fuel stocks for several months.

Finally, here is a similar chart for the most recent period. As you can see, volatility has indeed picked up in the last two years:

Volatility Cluster & Decay: Indication of Higher Prices Ahead?

2011-08-28T18:55:00.000+02:00

It is well known that volatility tends to form clusters over time. Adam Grimes of SMB explained the phenomenon in a very practical way here. Bottom line is once you have a volatility spike, large price moves tend to persist for some time. So you need to adjust your trading. However, that's not the topic of this post.

One observation I made during the last years (and I should quantify the these observations) is that the decline of volatility after a spike (I call it volatility decay), seems to be a non-exclusive criteria for higher prices ahead.

Take a look at the following chart:

Even though markets were initially not rising, declining volatility (measured by the Average True Range "ATR") declined during the bottoming processes in early 2009 and Summer 2010. As can be seen from the chart, the ATR has already started to move lower after the recent volatility spike in August. Does that mean the market reached a bottom? Maybe. However, volatility decay was more a process of months instead of weeks. So the development of the last days doesn't mean much. It is more important to keep observing the action: lower prices on declining volatility could be a bullish sign going forward.

The Two Waves of the August Sell-off and What They Tell us About the Markets

2011-08-28T18:19:00.000+02:00

I was analyzing August price action this weekend and found some very interesting points. When looking at an index chart (Nasdaq Composite in this case, but other indexes are highly correlated) we can identify two waves of selling so far. The first one obviously was much stronger than the second wave:

A remarkable divergence occurred when considering the number of new 52 week lows (lower pane). The Nasdaq Composite recorded new price lows, but fewer stocks obviously participated in the decline, a bullish sign short-term.

What's more interesting is to look at individual stocks. This weekend, I was browsing through all the charts of S&P 500 stocks and I found that it is possible to classify them into three basic categories:

1. The strong Comebacks

These stocks have rebounded strongly after the first wave. In fact, you wouldn't notice that there even was a second wave of selling in the market. Certainly, stocks in the defensive sectors are showing this characteristic. A positive is that some offensive names, such as AAPL can be classified in this category. To look for these stocks, simply search for names that trade above their 50 day moving average:

2. The Endangereds

These stocks didn't really participate in the second selling wave. However, they are in a dangerous position, because their charts are forming bearish continuation patterns, such as wedges or rectangles:

3.) The Loosers

The loosers fully participated in the second wave and recorded lower lows during the second half of August. To find these companies, I simply ran a scan for stocks that traded lower on Friday than 14 days ago:

The interesting observation is that every stock, independent of the category, sold off during the first wave. The market saw some sort of differentiation during the second wave. Obviously, the first selling was kitchen sink type action, maybe coupled with some forced hedge fund selling. Everything had to go. It seems like the market got more rational during the last two weeks and market participants tried to pick stocks, which were taken down without reason. The decline in new lows, which I discussed above support this point.

What does all that mean for a short-term trader?

One possibility could be to start buying category one members. However, stocks are still volatile and this is clearly not a bull market (group one is fairly small, especially when taking out Utility stocks). So I will look at cat. two and in particular three for potential short candidates. I'll keep an eye on the bearish patterns of the second group as an indicator where markets might be going.

Vacation Canceled: Back to Work

2011-08-18T22:17:00.001+02:00

Unfortunately, I had to cancel vacation this week due to a tragic loss in my family. The good news: I'm back to trading and the opportunity that presented itself during the last days was simply to compelling to ignore. Three days ago, I presented the idea of an intraday declining wedge on chart.ly. At that point, I started to set up short positions in the Covestor Model account. Since equity asset classes have been extremely correlated recently, I focused on individual sectors and took modest short positions in Basic Materials and Financials (XLF, XLB). In retrospect, I could have been more aggressive with my shorting since the markets presented an almost perfect setup. At least I'm happy to be on the right side.

So when will I cover the shorts? I believe we will at least test August lows again. That's when I plan to start scaling out. As usual, the plan is subject to change every day.

On Vacation the Next Two Weeks

2011-08-14T16:03:00.000+02:00

Since I will be on vacation (visiting family in Michigan) the next two weeks, the Covestor Model Portfolio is now doing the same and went to 100% cash. It was an important trading lesson some years ago to really not have any short-term trades running while taking time off or not being able to follow the markets all the time. Once we went on Summer vacation during earnings season and one of my stocks reported earnings and blew through the stops while I was laying on the beach. I tried to stay connected to the markets but believe me: it wasn't really a vacation.

The great Jesse Livermore stated: "Every once in a while you must go into cash, take a break, take a vacation. Don't try to play the market all the time."

I would add: there will always be new opportunities in the market. Who knows. Maybe Gold becomes a great short or whatever.

Yesterday's Reversal and Fibonacci Levels

2011-08-10T11:13:00.002+02:00

I'm not really using Fibonacci Levels to make trading decisions. However, I'm occasionally following the topic because it's quite fascinating.

If the market indeed bounced yesterday (and we would need to see at least one higher high/higher low week), it would have done so exactly at the 61.8% Fibonacci retracement level on the weekly chart:

Let's take this concept a step further and check how high the market could bounce based on Fibonacci levels:. As can be seen on the 30 min intraday chart, there is not much room: the first major retracement is at 1194 for the S&P 500 or 1.9% above yesterday's close. Given the current volatility, the market could reach that at the open. So trading a snap back rally really doesn't offer a compelling risk/reward ratio at this point:

Covestor Portfolio Commentary

2011-08-09T10:37:00.001+02:00

I'm posting portfolio commentaries a little bit more frequently here to keep Covestor clients updated in the light of market volatility.

August has been positive for the Covestor Model Portfolio so far. As of August 8, the model is up 4.6% for the months and is currently 72% in cash. Because of the high volatility, I'm holding only a few positions and focus the trades on ETFs instead of individual stocks. Equities are highly correlated these days, so holding single companies is a waste of time. I'm still in the process of winding down my only short equity position, Forest Oil (NYSE: FST), which obviously is showing a nice profit at this point.

Other than that, I'm trading leveraged ETF's on a very short time frame, holding the position for just one or two days. Any time, we could (don't have to) experience a sharp snap back rally. After the strong declines of the last days, however, every rally will be sold, so going long can only be a trade for a day or so.

In my trading model the markets are constantly switching between "mean reversion" and "momentum" domain, both require totally different trading approaches. The art of trading is to recognize the underlying domain and then invest accordingly. Momentum was the name of the game in the last weeks. Mean reversion will follow soon. I know hedge funds who play momentum- or mean-reversion only, which is not a long-term winning proposition in my opinion.

A new position this week has been Gold, which I trade as a momentum asset. I believe that the yellow metal could go parabolic at this point if the FED continues to pump money into the markets. We will know more this afternoon.

Equity Put/Call Ratio: Finally Investors Getting Bearish

2011-08-09T10:12:00.001+02:00

It sounds obvious in the light of recent stock market declines, but bearishness is finally showing up in the sentiment indicators I'm following. That was different at the beginning of the month if you remember my last post on the topic. The equity put/call ratio is now moving into "panic territory", which is good news.

Only caveat: I wouldn't go long yet because the ratio has now entered bear market domain. I discussed the domain concept in an earlier post. Basically, it means that whatever is considered oversold in a bull market doesn't mean oversold in a bear market. In 2008/09 the 10 day moving average of the ratio could easily move above 0.9 before a short-term price reversal occurred. As of yesterday, the reading was at 0.8:

Very Simple...

2011-08-05T16:36:00.001+02:00

It is 10:30 pm ET and there is nothing in the charts that suggests going long would make any sense. Very simple: as long as the SPY is trading below the falling 5 day moving average, you'll find me on the short side or in cash:

10%+ Declines: Not So Uncommon

2011-08-05T11:44:00.002+02:00

US stocks lost over 10% in the last two weeks. Reason for concern? Not really. As can be seen from the chart below, "10% bombs" have been not unusal in the last two decades. In fact, I counted eight events in the last 18 years; granted they have been unevenly distributed and seem to demonstrate cluster characteristics. It might be too much of a stretch, but one could argue that once a 10% drop occures, expect more to follow:

In any case, another "fat tail" just occured, which shows that the bell curve distribution used in traditional risk models is just BS.

Covestor Model Portfolio Commentary

2011-08-05T10:57:00.002+02:00

August 4 was a brutal day for the markets. Fortunately, I was positioned on the defensive side so that the Covestor Model Portfolio actually showed a slight gain for the day in the magnitude of 0.8 pct. Going into Thursday, I was 30% in cash, 25% long and 45% short.

Long and short positions:

On the long side, I was trading AAPL and Silver. The IPhone company demonstrated superior relative strength until Thursday and I hypothesized that the stock would benefit from a possible market rebound During the session, however, AAPL was not immune against selling pressure, which could indicate capitulation (positive for the markets) or (and that's the concerning part) forced selling by major institutions who need to meet margin and redemption calls. Forced selling was potentially a factor why Gold and Silver performed so badly. The later even lost over 7 pct on margin call fears, which forced me to close this position with a small loss.

On the short side, I owned (and still own) EWI, the Italy ETF and Forest Oil (FST), in which I took partial profits. The position in EWI was reduced last Tuesday. I did not completely close the shorts yet. Going into Friday's session, I'm 78% in cash, 9% long and 13% long.

I will further raise cash levels and AAPL will probably be the first position to go. The high expectancy trade is not to leverage up to play a possible rebound. The better option is to wait for the rebound and then short into the rally. This requires some patience, but if you are not a patient investor, you shouldn't trade anyways.

Some general comments:

Even though the portfolio obviously outperformed and shows a positive return, I am not satisfied with the performance. I was too biased the last weeks and focused on the debt deal discussion even though price action indicated that markets would focus on other topics soon. On July 23, I was still bullish and I ignored weakness in the Industrial sector. On July 28, I recognized the slowing economy theme and I went more defensive. In hindsight, I could have been way more aggressive shorting the markets. However, I think the Honeywell chart I presented is still valid, we just fell a bit more than anticipated. On the other side, I shorted Italy on July 27 because I felt that underlying developments were showing up in the news and charts presented a nice setup for a swing trade.

The high cash levels are a result from what I learnt in the last years. I started to trade at the beginning of the Financial crisis, which turned out to be a great period for a new trader to learn the game. (The worst period probably would have been during the Internet bull market in the nineties). The current market environment is not new to me so I'm quite relaxed about what is going on.

Will the market crash?

That's the 10 Mio Dollar question. I don't know. Nobody knows. When you argue from the fundamental side, you might say stocks are cheap, but there might be other forces at work right now, which control supply and demand. Most concerning to me: forced selling. A couple of hedge funds probably blew up yesterday. Mutual fund cash levels are at record lows. More redemptions or maybe a run on Italian banks and markets can decline even with sound Fundamentals. Machines are controlling the trading. Look at my post from last Sunday: there was a Flash Crash last week. I believe it could happen again. I wouldn't bet on it. It's simply unpredictable; therefore one has to manage risk.

Jim Cramer: no market crash
In the light of sometimes chaotic and unpredictable markets I personally find it dangerous when Entertainers such as Jim Cramer say that "current market action is not reminiscent of a market crash". Crashes are unpredictable and the right statement would simply be "I don't know", but obviously he cannot say that on TV. I wish he would publish his long term track record of (even better) sign up for a COVESTOR account so we can better judge his calls and I could compete with him. I like competition.

Investors Still too Optimistic

2011-08-02T10:04:00.002+02:00

Two of my favorite sentiment parameters are still showing that investors are not really concerned about the possibility of further declines, even though the S&P 500 is at very critical technical levels. Yesterday, the index barely made it to close above the 200 day moving average. The indicator is important because it often acts as a line in the sand for institutions.

The average Equity Put/Call Ratio of the last 10 days is at 0.645. Readings above 0.7 had been associated with major turning points in equity prices:

The AAII Sentiment Survey Bull-Bear Spread came in at 6.4% last week. I consider values below -20% to be indicative of too much pessimism:

The lack of concern last week showed that investors were expecting a positive outcome from the US debt ceiling discussion. They were not positioned for the case of lower equity prices.

Conclusion for the short term trader:

I wouldn't go long at this point to play a possible rebound. A positive risk/reward trading opportunity on the long side will occur when we see higher levels of pessimism. Until then: sit and wait. Of course prices could rebound right now, but that doesn't mean going long is a high propability trade.

The Friday Flash Crash and What it Means for the Markets

2011-07-31T11:42:00.001+02:00

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.

The stock was down 16% during the initial minutes of trading. Others similar REIT's didn't look better:

Here's the longer term chart for reference:

What does that mean? In my opinion, May 6 2010 can happen again. Be careful out there.