A Picture Paints A Thousand Words

Off to the left is the 30 Yr Bond Implosion. I have displayed standard deviation bands just to give a visual of how extreme this move has been, relative to recent action.

We are below the 3.0 band right at the moment, and as I type this, have a very weak overnight session going once again. Rarely does this market get extended to this degree in either direction. There is a gap down from 3 days ago that is unfilled so far.

There is alot of logic and math that will tell you that a reversion to the mean is imminent when these types of extensions occur. While this is true, they generally occur when a very strong trend is underway, and hence, you are fighting the trend playing for that reversion. My Short term bond trading system did generate a buy today, but has struggled recently during this down move. Most of my patterning is based on "normal" market action, and alot of the general rules go out the window when you get a move like this. You cannot pattern your trading activities for the once every 5 year occurence, or you will struggle most of the time. All that can be done is install strong money management techniques, so that you do not get wiped out when you get a move like this.

I do expect some type of reversion to occur, but it will setup a short entry if it does. This trend is very strong, and will not be easily reversed.

SEE I TOLD YOU SO
This is inevitably what the chicken littles are going to say after today. I did not imply from the last post that I was predicting this, only that this was a potential sign of trouble. Had I been trading from a short term perspective I would have been out before today, but I am not with stocks.

A sharp correction like this is scary and brings out the doom and gloomers. Maybe they will be right this time, we do not know at the moment. The precipitous drop in the bond market today once again shows its merit in directing stock prices. Notice how we have already hit the 2 standard deviations down level on this retracement, generally a good place to buy in an uptrend.

I am waiting for the COT report tommorrow to see how the real insiders have handled this. If they have scurried for the sidelines which I doubt, my model may generate a sell signal. Most of the stocks that I own have not fallen much during this drop, which is a positive, one has risen.

For now I say to stay the course on the long side, and if that has changed I will post something here.

S&P 500

I apologize for having been so negligent in keeping up here. I have been juggling alot of different things, and have had tremendous internet problems at my home. Satellite internet sucks for the record!

As you can see, the Jaws of Death have shown up for the stock market. This is a pattern that has led to many severe declines in the past, so why am I still bullish and heavily long stocks?

Notice at the bottom, the heavy long position the commercials have established. What I think will happen is that the rally will continue for awhile, the commercials will gradually shift away from the long side, and if this happens, yours truly will exit his longs.

The trick with this formation is that is sometimes can persist for a few months to 6 months before anything happens. As a result, for the time being, it is just watch this closely for signs that it is leading to trouble. Sorry for the poor spacing, Blogger is not in the mood apparently tonight to allow me to put spaces between the paragraphs.

Here is the close out of the short trade from the other day, exited on yesterdays opening for a nice profit. This shows that there is value in shorting at times against strong trends in short term trading.

Not all trades work out like this, but if you pick your spots carefully, you can succeed. As you can see from the chart there have been very few short trades my system has generated in the last 30 days, which is good. When markets run like this they are difficult to trade, because most of the time they trade a bit more two sided.

For the average investor, I suggest staying on the long side here, and buying pullbacks. Fighting a trend like this is a losers game over time. In my early days I used to fight trends like this all of the time, and learned from the school of hard knocks not to do it. I did do it here and profited, but I have 20 years of experience trading, which gives me a small advantage in picking my spots carefully.

If you choose to do it honor your stops and keep your egos at the door. When a market is running like this there is no telling how far it will go. It could stop tomorrow, or go for quite a while.

S&P 500

Here is the trade I currently have on for the S&P 500. As you can see it is a short position. I am bigger picture bullish, but that does not mean that short term sell signals cannot be taken. The recent COT report did show heavy long positions on this recent rally, which is very bullish larger picture for the market.

I do view any pullbacks as buying opportunities and I think those that are waiting for the big selloff are going to have to wait until the end of the summer. Predicting is a difficult undertaking for anyone, but that is how I see it at the moment.

This trade will be exited shortly as it is a short term trade and appears to be headed for a profit.

S&P 500

I posted a couple of weeks ago there was possible trouble due to weak bonds. As we can see, there has been some short term strength that has entered that market. This was the lone remaining shortcoming of the rally off the lows, that has now been resolved. I am aggressively long stocks from a couple of weeks back, when the short term trend down trend of bonds broke. I was waiting for a pullback, but decided based on the strong seasonal pattern, to pull the trigger and just add to my positions on any pullbacks.

I was concerned that the breakout that was brewing due to the small ranges I mentioned, would happen upward, and I did not want to miss it. We also have the commercials on the long side as well. We are hugging the 2.0 standard deviation band on the high side, which tends to happen during strong trend moves. This does tell us that we are short term overbought, but I would view dips as a buying opportunity for now.

We do have to keep a close eye on the bond market, which is showing some weakness as I type this. If we were to get a big drop there, it will undermine this rally at some point.

CRUDE OIL

For those of you that get my newsletter, the Crude Oil trade is summarized to the left. I had said to short it on 4/2/07 and exit when the percent R closed under 25. The entry was 65.10 and the exit was 62.01, a profit of $3.09/barrel. This yielded $3,090 per contract so I hope some of you did this trade. Things rarely line up as perfectly as that one did, so the trades have to be taken when they do.

STOCKS

Here is how we look on 4/11/07. Once again the resiliency of this election rally has asserted itself. My long term indicators have never gone away from the long side, so they indicate to still be long. We do have some possible trouble brewing with the Bond Market.

The Blue Line marks 30 yr Bonds, and as you can see, this market has had a sharp move down in the last 30 days. This happened while stocks rose nicely during this same period. These types of divergences often spell trouble for stocks. We are in the early stages of this divergence, but it is probably not a time for an aggressive long position without a pullback in price first.

Also note how the average daily range is getting quite small, indicating very little volatility. Generally, these conditions lead to breakouts in price, one way or the other. The commercials are still heavily long this market, so that is a positive. I am looking to enter this market on the long side aggressively, but not without some type of a pullback first.

S&P 500 The Latest

Here is the latest picture of the S&P 500. This weekly chart is nice to look at because it keeps things in perspective. You can see that prices have not really dipped much in spite of what some of the people calling for a crash have said.

The commercials have bought this little dip, which is bullish. However, you can see that my Magic Potion indicator has turned negative. This just stand alone is not enough to short the market on a larger scale, but it is reason to expect a sideways to down move here for a period of time.
Overall though, I do not expect to see a large break in the market until the end of the summer, but I am hoping for a dip in the next few weeks to load up on the long side.

I will need to see that bottom indicator turn green to confirm the upmove, which it has not done yet. My overall timing system does still say to be long this market, so dips are buys assuming that indicator goes green on them.

S&P 500 The Latest

Let's take a look at where we sit now with the S&P 500. If you remove the emotion out of the moment, you can see this decline has not been that significant. We have broken the uptrend, but we do not have a crash on our hands. You can see I had a short term buy yesterday that profited, being exited this morning.

I have drawn a red line down indicating the short term downtrend that we have established. Underneath this, under the blue line which is bonds, I have a red line indicating the nice uptrend we have there. At the very bottom, I have drawn a line that indicates we have had some commercial buying during this drop, this is what we want to see. Strong bonds and commercial buying, are both supportive of stock pricing.

The commercial buying is not at the level "yet" where it is strong enough to act upon. However, if this index gets over 80, that will change things a bit. As long as the bond market stays strong, and the commercials continue to increase their long side exposure, I am looking for a buy setup for a several month hold coming up soon. My large picture timing indicator has not flashed a sell yet, so buying dips is the call until that happens.

It would be nice to get one more sharp dip that has heavy commercial buying to set this up perfectly, but things rarely setup up in the optimal fashion. We may move sideways to lower for the next few weeks instead. Either way, I am looking for a buy spot.

Banking Stocks

Someone asked me to take a look at the Countrywide situation. I believe the thinking was that with the subprime mortgage overnight implosion, there might be a spillover effect.

First, for those of you who are reading my blog for the first time and or, are not current clients, I need to briefly explain how I trade so that you can view my comments in the right context.

My orientation to trading which has evolved over the last 24 years, is that I only take loaded or very high percentage trades. This is how I achieve an accuracy of 80% wins to losses. As a result, I establish criteria, and only go in when those criteria are met. This is not to say that there are not other ways to trade profitably, there are. However, to trade and get the results that I require, I need to have this level of discipline.

For stock trading, what I want to see is improving earnings for buys, declining for shorts. I also want low debt, or itleast a declining trend in debt for buys, the reverse for sells. I also want the seasonal tendency to be at the very least nuetral, not against the way I am looking. Then I want a pullback against the trend for entry. I do not care about what I call the "story." The story is the subjective situation surrounding the company that I may have an opinion on. Opinions are to suject to emotional influence, so I stay clear of them when trading.

Countrywide, if we use my criteria, would be a counter trend entry to the seasonal if it were shorted here, so that is not good. Debt is flat, but technically slightly rising, a negative. We are awaiting the recent earnings statement to see where that currently stands, that mark that as an unknown. Also, we are in a current retracement in a flat market, which is a better buy than sell in general.

In summary, this is not set up the way I require for a short entry. This does not mean that this stock will not go down, it is just not a short entry that I would take. If you are playing the story, you need to step in front while it is at a high level, here we are just in the middle of a trading range, so this entry has "poor location."

S&P Update

Here is how we look as of the close of Monday. We have continued downward even though we have had a couple of intraday snap back rallies that good day traders could have capitalized on. Most day traders lose money, so do not be tempted by that endeavor.

Notice the carrots on the chart which indicated potential signals. All of these signals (the last 3) were filtered by my secondary trading filters. We have been trading the bonds here the past week, but nothing has triggerred in the S&P.

I have been through too many of these to try and be a hero, I will take the signals when they come regardless of the market environment. If I do get any here, I will take them with half the normal size due to the increased volatility. I do hope for this decline to setup a rally in 30 - 45 days more or less.

I have highlighted the gap on the chart, because that is an ominous pattern. For this market to have gapped down, and not tested it, or even close in the ensuing days, does not speak well for the immediate future of this market. However, we are extremely oversold, so the odds to not favor shorting at these levels. Wait for a bounce to enter new short positions. We are likely to have volatile action in both directions, so honor your stops.

I do expect some further downside action, but I do not believe we are going to get a runaway bear market out of this due to the strength in bonds.

Where do we go from here?

I had mentioned that I would have buy signals for Wednesday, but none of them were triggerred, so I am flat(no positions). Today we come in with a gap down open following an inside bar with an up close.

Historically this has been a good buy pattern and poor sell pattern in general. However, none of my systems generated any buy signals, and in fact one generated a sell signal that was filtered due to the bullishness of the pattern. I want all the stars aligned, so nada for me today.

I do urge caution for those of you not to react too emotionally during these types of periods. Do not chase the market, and please trade smaller positions than your normal size. It is tempting to want to make a killing during a period like this, but more people blow up than make killings during market crashes. The worst thing that can happen is to bet the farm on one short position, have it pay off, and have a bad habit reinforced. Market conditions like this come around once a year for a week or two, so you can not pattern all of your methods on the rare occurences. Do not pyramid and press your bets. There are likely to be sharp moves up and down over the next week, and you can really get whipsawed.

The trend has changed here, but we are really overextended down right now, so the odds of a sharp bounce are high. You do not want to be short the farm when a 20 point bounce in the S&P happens.

What Now?

The big one that alot of people have been looking for finally happened today. You can see by the chart that alot of damage was done today. I would love to tell everyone I called this in advance, like last May.

However, that would be false. I had been warning that we were setting up a sell signal, but my large picture sell has not triggerred yet. After today, it will not ,simply because one of the components requires an overbought condition, which is now weeks away.

Days like today take on a life of their own, once the selling begins with this type of power all that you can do is honor whatever stops you have in, and let the action take place. Many reversals do happen after heavily negative overseas action like we had last night, so we cannot always know that this type of blowout will follow that.

If I had to guess what will happen next, I would guess the following. A little more weakness over the next few weeks. Then a bounce up that fails to make a new high, setting up a larger picture sell signal that syncs up with my timing indicator. There have been a few instances like this for those who get my newsletter, that were pointed out last month. This is only a guess, with no real basis other than just my years of experience, it may or may not have any value.

For those trying to trade in here, what I would suggest is to cut back your size to take into account the increased volatility that is likely to be here for a bit. Next, honor your stops and do not get emotional. We do not have many days like this historically, so the sample size is too small to have a reliable read on what will happen tommorrow. We are already very extended down, and historically 5 consecutive down closes in the S&P which we have had, have been good short term buys. I will more than likely be buying the S&P on Wednesday depending on what my systems tell me.

It is possible that this is an isolated event, but there are not many historical days like this that just result in things returning to normal right away. The strong bond market should provide some strength underneath this soon.

Still no Sell Signal

The end of last week refused to give the sell signal, so it is still a long side market. I am relieved simply because it would have had to have been ignored due to the seasonal up bias still in place. If we get one in March it will be past the filters for time of the year.

We may not get a sell signal, so there is no reason to be short until one develops. We have had a tremendous run, and the trend is up, so ignore the gloom and doom of the doubting Thomas types and stay with longs until we get something that says not to. There are some internal aspects that have weakened slightly, as you can see the commercials are mostly on the short side. As a result the base underneath is not as strong as it has been for the last several months.

All this really means to me is to not add too agressively to existing longs at this juncture. It does not mean run out of the market and hide.

Stocks Peaked?

Here is an updated view of my "Magic Potion" indicator. There is no magic to it actually, but just a goofy name a gave it to make fun of myself. As you can see it has returned to the green, indicating a buy. However, based on the computation of it, if prices stay where they are the rest of the week, it will go back into the red.

There was never an official sell signal generated during those 3 red bars because the other components of the timing system did not confirm it. They are all presently confirming any sell signal in the underlying, if the week closes with all of the components where they are as of this posting. It is February, so a sell signal now should just be used to get flat. In general we do not want to be aggressively short during the first two months of the year due to seasonal effects.

If march rolls around and the indicator is indicating a sell at that time, we will have something to act on. Until then, the trend is still up so no need to do any shorting.

S&P 500

Here we have an updated S&P chart. You can see where I exited my short trade from a few days ago on Mondays opening. This is exactly why I exit short term trades against the trend very quickly, had I held that position, I would be sitting on a big loss. The way I exited brought in a very nice profit of 13 S&P points.

I have written in my newsletter about my larger picture timing system that I have developed for the S&P. Although very close to triggerring a short sale indication, it has not done so yet. It will most likely be held off for itleast another week due to the rally in the bond market (red line).

I do expect this bond rally to slow down here and perhaps move back down in the next week or so, which might setup the S&P sell signal at that time. There are several components to that system, and most are lined up on the short side, but not all of them. Until it signals a sell, it is still green light to the upside, and exit counter trend trades quickly.

Shorting the Lenders

There has been alot of talk about shorting the lenders lately, so I thought I would devote a day to discussing this. Accredited Home Lenders is displayed over on the left. As you can see it has dropped from a high of 60.13 to a last trade of 24.50. It is clearly in a downtrend, yet if we look at the last 12 months earnings, we see a nice uptrend. Also, another filter I like to look at is debt. Their debt ratios are actually dropping.

Many people are expecting both the EPS to deteriorate, as well as the debt to increase, due to the difficult period that lenders in general are in.

However, as I have told people over the last 6 months to a year with the homebuilders, the balance sheets of most of these companies have very attractive ratios still. This does not make them prime candidates for shorting. I want deteriorating debt ratios, and declining earnings for stocks I am shorting, and the reverse for stock buy candidates. Further, this is a stock that has already dropped 60%, so although there may be more downside, the fat of the move is already over.

For those that cannot help themselves, and are dead convinced that the worst is just beginning, I suggest just waiting for 3 to 7 day reactions upward against the downtrends to taks short positions, or buy puts. Then hope the downtrend resumes. These little retracements visually look like flags, so we call them bear flags. I would start this process by looking at stocks that have increasing debt and declining 12 month earnings ( not just one quarter ). This will itleast line up the fundamentals with the "story."

For Sam, NFI has fallen way more than these others from 70.32 to a last of 15.96, too late there. NEW is the same story. AHM looks better as the 12 month EPS has declined and debt ratios have risen, and the stock has only dropped about 25% off the high. However, it is not in a downtrend yet. I would wait for a break, and short the first retracement of that one.

S&P 500

Here is an update of the daily S&P 500 chart. You can see my system has me short as of Friday's opening. This is a short term trade that will be exited on Monday's opening. My big picture timing system is ever so close to giving a sell signal now, it just missed on Friday's close.

Not to worry because most significant highs are not made in February, so we will probably go up itleast one more time. My short term signal was based on entirely different parameters than the big picture system.

Notice large divergence that continues to be in place with the Bond market below. This at some point is going to spell trouble for stocks, and it may already have triggerred something. The small graph at the bottom is just a moving average of the tick index. This is something I am playing around with, but have not really found any use yet for. It can be ignored.

The commercials have also gotten heavily short as of this last weeks report, so it is only a matter of time before a decline hits.

S&P 500

Displayed to the left is the weekly S&P chart. It may be tough to see, but the large picture swing system I have is applied to that chart. As you can see it had a long entry back in late August of last year, and is still long.

It is getting very close to generating a sell signal, but it has not done so yet. Very few market peaks are made in January or February, so there is no need to get excited and step in front of this trend. However, as you can see, the sharp downmove that the bond market (purple) has made recently, has set up a large divergence with stock prices. It is possible for these divergences to persist for a few months before stocks are effected. If this relationship stays like this, it is only a matter of time before we see a big stock market decline.