Monday, July 04, 2011


Here is a chart of the Bernanke 500 and it shows one reason why obvious trades usually do not work. I wrote in here many times that the most obvious trade of all time was to short the indexes when QE2 ended and that was why I did not expect a decline at that time. You can see here how negative the sentiment got right into that time frame. All the small investors who are seemingly almost always wrong at the turns, got really negative about 2 weeks before QE2 was due to end. Large declines do not happen from these types of situations. Everyone had already sold.

There are several reasons why obvious trades don't work. However, defining what is obvious is the key to using this logic to ferret out bad trades. If you are Stevie Cohen, an obvious trade to him is one that should always be done, since his track record shows that he is the best trader in the world. When I go through my setups each day, there are obvious trades with my indicators. These are trades I always do. They are obvious to me, but not to others. What I define as an obvious trade, is one that the general public who is un-sophisticated, perceives to be an obvious trade. We can measure that by Sentiment, by watching the Small Specs in the COT report, or we can use common logic. In the above case we had 2 of the 3, with the Small Specs being absent.

You can see via the chart that the Sentiment had gotten very negative as I mentioned previously. The common logic part of this was not quite as straight forward. I am sure there are some people out there that have no idea what the government is doing to manipulate prices right now through the Fed actions. However, I did have a friend call me a couple of weeks ago that had never asked a question about the markets ever, asking me what QE2 was and what the end of it meant. He had heard it mentioned on a radio show while he was driving around, and it was positioned as a dire instance and he got a little rattled. I told him exactly what I have been saying in here, that on paper it could be bad but it was so obvious, that I did not think it would be. There are always anecdotal things you can point to that should be the tie breakers with such things, but it does get a bit subjective if you get too deeply involved with that. By anecdotes, the Gold market should have topped 2 years ago, so they are not always valid. This trade in the indexes may not have been obvious to everyone.

Why did this event fail to ignite a decline? First, so many sellers were already short going into it as evidenced by the Sentiment numbers. Second, the Bernankes were still above their 200 day moving averages. If you combine these two, they make for an ideal buy point not a sell. I was aggressively long across the board due to this as I showed some of the trades I had on. I still needed a trigger to get me in, I would not have gone long just based on some opinion supported by a few squiggly lines. My short term indicators did trigger buy signals last week and when they did I took them, pretty simple. I would have taken them anyway, but I went a little more aggressive knowing the trap was set for the suckers.

Here is what I think the biggest problem with obvious trades are, if you knew all the real facts, they would not be obvious. The orchestrator's of this move knew full well that there was a good probability the market could fall sharply once the fuel was turned off, maybe they did not turn it off? Maybe behind the scenes they actually did some things even more pronounced to give the markets a nudge? The Fed has been very actively involved in the markets for years, it was only recently they openly announced their intentions to elevate stock prices. The legend of the PPT was not born out of an explicit public statement, it was through behind the scenes operations. I did not look to see if POMO operations were heavy last week. If they were that would be one thing that might have helped any short sellers to be cautious. That is the point, we will never have perfect information, there is always something else to know.

Obvious trades for the most part do not work because those that think they are obvious, do not have all the facts.

I made over 25k last week because the long side was obvious to me.

I may not have had all the facts, but I had enough of them right and more importantly, followed my rules. I have cautioned people over and over that trading off your opinion is very difficult to do. The one advisory service I have told you I am trying out is an example of that. I read them just to get the gloom and doom side of things, they definitely deliver that. I would never make any of the trades they suggest because they are all based on large scale macro economic analysis, and the timing of the entries is just awful most of the time. They trade a 25% stop. A trade requires that should not be done, pretty simple. What kind of timing does it exhibit if you have to use that wide of a stop? They recently put on a short Euro position based on fundamental analysis of the big picture. It is certainly hard to argue the logic of that analysis. However, that trade is getting whacked right now, just awful timing on the entry. It could still work with a stop that big, anything can happen, but you have to have such small size that a recommendation like that is not worth much.

If your style is to trade based on this type of analysis, I would suggest a couple of things. First, leg into the trades since odds are you are going to be wrong on the timing most of the time. Fundamentals play out over months and years, not days. The fade the end of QE2 could still be the right trade, it is too early to tell from a macro point of view, only one day has been concluded. Second, try and find something that dials in the timing on a shorter time frame. This will at least stop you from getting run over in the near term like the previous example in the Euro. If you are doing all those things and shorted the indexes last week and lost, no big deal. You have followed your rules and it is time to move on to the next trade. No matter how you trade, you will take losses it is part of this business.

What is the next trade?

If we use the forecasting tools analyzing the prior times when Sentiment and the Advance Decline line have looked like this at the same time you can see it forecasts a rally continuing here on to new highs. I have looked back at all the prior occurrences this found, every single one of them showed a rally. One of the problems with the forecasting software is that you can look at countless numbers of combinations of things and get all sorts of results. You can almost create your desired outcome. This is why I mentioned several times, that these forecasts are not the end all. For example, the next chart is the same thing done on just price alone, it is the same chart I showed last week, we just now have a finalized bar for the week.

Here you see an entirely different picture. I had mentioned that the recent decline had broken enough where my indicators showed we had shifted to a down trend, and rallies should be sold. That is based on just price bars alone. So you can see we have conflicting information here, what to do? We have a bar pattern that is bearish and fundamentals that are bullish.

Nothing is the answer!!!!! We are at an inflection point. If we continue up as the first forecast shows based on sentiment and Advance/Declines, then I will look to buy the first pullback once my weekly turns back up. Until that time, if I get a daily sell signal that lines up with the weekly down projection, I will take that. Until one of those two things happens, I will do nothing and look elsewhere. Discipline is what will keep you moving forward, and lack of it will doom you. If you are hellbent on just trading the Bernanke's only, you are on your own. I had a period in my life where I did that and it was the most frustrating period I have ever had. The indexes are so manipulated, they are the hardest markets to trade consistently.

If I had to weigh the Advance/Decline importance vs just the price bars alone, the Advance/Decline wins. That is a big picture fundamental and when you see it as strong as it has been for the last couple of months which I have pointed out several times, the market is going to follow that course most of the time. On a short term basis you could view this last week as a climax, and a selling opportunity. I d not like to step in front of things like this but there are others I know that do and seem to do ok doing so. Maybe there is a short term sell, but I don't see it here other than whatever might setup as a day trade tomorrow.

It appears for now the risk on trade is back meaning everything is going to rise together once again. However, I am on the lookout over the next week or two to see if a retracement sell across the board sets up. There will not be an I told you so now, that was last week. I am not sure of the direction here but am leaning upwards.

Happy 4th

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