Where are we, market-wise?

This is the 30-minute bar chart of SPY (the S&P 500 ETF) since 5/2 (click to enlarge).

So basically, for all the gyrations of the past few weeks, we're pretty much where we were almost 2 months ago. The market has been trapped in a 149-154 range.

The orange line is the 20-day simple moving average, a very useful measure of the intermediate-term trend. It has started, for the past 2 days, to turn down which is a fairly bearish sign (again on an intermediate-term basis, not a long-term basis).

The 149 support level is therefore all the more important. If it breaks, the fall will be nasty and quick and I don't see it stopping before the 200-day moving average at around 143.

Great read on the Toro's Running of the Bulls blog on "sub(merging) prime". Get ready for some real fireworks this time. Apparently, the ratings agencies are the ones who will emerge as the real villains in this whole mess. They have been using Monte Carlo simulations to rate those toxic CDOs and as any reader of Nassim Taleb will tell you, Monte Carlo lulls you into forgetting the possibility of a Black Swan-type of event.

And I thought lower rates meant a higher stock market!



Every day the market has been down the past 2 weeks, we were told it was because rates were going up. There goes that theory. Today, 10 year rates went down 25 basis points while the Dow went down 185 points. As most so-called expert explanations in the media, this one is not worth much. Same with the dubious relationship between oil price and stocks or dollar and stocks. You can make the case (as I do sometimes) that, over the long term, such relationships/correlations do exist but not day to day.
On the other hand, one very significant relationship today was the fact that Google went up 2% with a market down 1.3%. Google closed at a new all-time high and I would expect it, after this mighty show of force, to keep going up. I will be posting an update on GOOG in absolute as well as relative terms shortly.

The trading person's contrarian

Tim Knight, founder of Prophet.net, a very serious trader and the author of one of the best trading blogs out there, is of a bearish bent most of the time. He has therefore been used (with some success I must say) as a contrarian indicator by a few wily traders. Two weeks ago, for example, after the market rolled over following the lead of treasury bonds, he was jumping up and down bearish and utilizing his sentiment as a contrarian indicator paid off. Now the situation is very different. Yesterday's action was, to say the least, very preoccupying for the bulls. They're all afraid to even think about it let alone utter it, but the expression "double-top" is on their mind. Yet Tim, as his entry yesterday indicates, is only "cautiously bearish" and his sentiment is imbued with new found humility and all sorts of caveats.
That, my friends, is problematic for the Tim contrarians out there. Is it time to be the contrarian's contrarian?
Market action today and tomorrow should go a long way in answering this question.

J.C. Penney in trouble?


This is the daily chart for J.C. Penney (click to enlarge).
This could be a head and shoulder pattern in the making in which case an initial target would be something around 65. This chart does have many bearish things going for it (or against it if you're bullish-minded). A solid support at 75 was broken, the 200-day moving average (which often acts as support, as it did in mid-May) was broken decisively and both the 20-day and the 50-day moving averages are trending down.
I would advise caution though (as in: don't go and short 10,000 shares right this second). The 200-day has not started to turn down yet, the RSI is at potential snap back level and the 75 support is still within reach. So there could be some sort of rebound. Ideally, and to get deeper and deeper into the details, JCP would rally back to a turning 200-day Moving Average and then head back down again. I'd give the odds at 50/50 of JCP breaking here for good vs having a last gasp. So I'm short a little with a stop at 76.20.

The Stock Market on borrowed time?

I mentioned John Murphy and intermarket analysis before. This seems a good time to dwell on the subject a little bit.
Intermarket analysis involves the simultaneous analysis of the four financial markets: currencies, commodities, bonds and stock. J.M. uses chart analysis extensively to that end.
It's noteworthy that, according to intermarket analysis, near the end of an economic expansion, for example, stock prices and commodity prices are usually strong, while bond prices are weak, a situation not unlike the one we have at the present time. Bonds peak before stocks do while commodities peak last.
Bond prices have an impressive record as a leading indicator of the economy, although the lead time at peaks can be quite long. Stocks and commodities also qualify as leading indicators of the business cycle, although their warnings are much shorter than those of bonds.
Bonds turn first (17 months in advance on average since the 1920's), stocks second (seven months in advance on average) and commodities third (six months in advance).
Now, what this is telling me is that, should this bond dowtrend continue, the stock market would be on borrowed time. How much time would obviously depend on many factors such as the willingness of the Fed to cut rates, the state of the Chinese economy, etc... But in light of all this, it wouldn't be altogether unreasonable to consider late 2008 a possible danger zone for the stock market.

Very enjoyable read on the dk report. Besides being exhaustive and to the point (and bullish), it has that California laid-back quality to it.

Another piece on quants, this time in Barron's. Time to short quants? The usual spiel about how quantitative analysis is now mainstream and gets inspiration from evolutionary biology, signal-processing techniques, etc... An interesting bit about how the best protection against a market crash would be a contract based on the maximum drawdown of the S&P 500 index as opposed to a put option on the index. It would basically be equivalent to a trailing stop and would theoretically be better than both a put option on the S&P and a call option on the VIX (very unpredictable). This maximum drawdown contract would need to be traded actively though.

Interesting Barron's this week, I must admit. How about this gem of a comment by none other than Mister Bond King himself, Pimco's own Bill Gross:
"If [the Chinese] are not going to be buying Treasuries, maybe we should be unloading some of ours before they unload some of theirs".
Which means that Pimco has been actively participating in (causing?) the bond destruction of the past two weeks.
He decreased the duration of his bond portfolio because:
"it is safer to analyze what the Fed might do than whether and what the Chinese might buy."
Maybe he should emulate commodity investor Jim Rogers who not only hired a Chinese nanny so that his daughter (and presumably himself) can become a fluent Mandarin speaker, but is planning to move to China.

For those technical analysis bashers and denigrators out there, this week's economist published a chart under the heading: Trend-breaking - US ten-year Treasury bond yields, identical to the one above (which I took the liberty of re-creating on Tradestation).

You'll notice the bearish falling channel being broken this week, which might indicate the end of the downtrend in ten-year bond yields and maybe the start of an uptrend (although it's too early to tell). The reference to trend-breaking in the title could not be more explicit. This, ladies and gentlemen, in the main article of the Finance and economics section of this most eminent of mainstream magazines is technical analysis at its most basic (and most effective), namely trendline analysis.

The myth of the rational investor has been thoroughly debunked over the last decade by, among other people, behavioral financiers and neuropsychologists. In this week's Economist, another myth comes under attack, the myth of the rational voter. Many political scientists believe that the wisdom of crowds phenomenon helps the best candidate get elected. Basically, if ignorant voters vote randomly, the candidate who wins a majority of well-informed voters will win, with the "ignorant votes" cancelling each other out. The Economist begs to differ, why? Because ignorant voters do not vote randomly. They, surprise surprise, fall prey to biases that make them systematically demand policies that make them worse off, therefore proving they are not rational.

Four biases have been identified:
1) People do not understand that the pursuit of private profits often brings about public benefits and as a consequence have an anti-market bias.
2) They underestimate the benefits of interactions with foreigners: they have an anti-foreign bias.
3) They equate prosperity with employment rather than production: a make-work bias.
4) They tend to think economic conditions are worse than they are: a pessimistic bias.

Doesn't that sound like the platform of about every politician you know?

I don't have anything original to say about yesterday's 187-point explosion in the Dow but will refer anyone who's interested to a great summary on "The dk Report" blog.

What I do want to post however is an update on the TLT chart. In a previous post , I mentioned the 82 area as a possible target for this down move. TLT did reach 82.20 2 days ago before strongly rebounding yesterday all the way up to 83.76. But now I'm not so sure that was the end of it. TLT got so thoroughly and rapidly destroyed the last few days (and Treasury bond rates in reverse, of course) that one cannot be faulted for thinking this just the initial (impulsive, to use Elliott Wave terminology) move of a much greater (higher degree in Elliott Wave speak) down move. I realize this somewhat contradicts another previous blog entry about how a broken downtrend line in the 10-year rates does not necessarily translate into an imminent uptrend, but I just want to stay open to the possibilities.

Oh yeah, and don't forget to CLICK ON THE CHARTS to enlarge them and have any kind of idea of what I'm babbling about. A black background for charts is not that great when they're in reduced size but I believe them to be the best in original size. Anyhow, that's the template I use for trading.

Maybe I should change the name of this blog to Death of a Trader. According to this Reuters article, most traders will be gone by 2015, replaced by powerful algorithms and other black box trading systems. The so-called algo-wars are raging between hedge-funds hungry for an edge.....blah blah blah. I mean, read the article, it's interesting as a sentiment indicator.
In the final analysis, you still need a trader (at least one) to program those machines. Also, in a panic situation, you can bet that those "algos" will be overridden. Human emotion will never be completely eliminated from trading, nor would it be advisable that it be so.

Jack Nicklaus, the greatest golfer who ever lived (at the present time) said yesterday on the subject of loosing (emphasis mine):

"Why would you talk about it or even think about it? It only perpetuates the problem. I always knew golf was a sport in which if you were really good, you might win 10 percent of the time. If you were the best in the world and were really hot, you might win 20 percent of the time. So you are going to have a lot of disappointments. It goes with the game, so you just can't worry about it."

Much in there applies word for word to trading.

The more I learn about China's version of capitalism, the scarier it becomes.
In this week's Economist, Arvind Subramanian, an economist at the Peterson Institute for International Economics in Washington, DC, points out that China's ability to sustain its exchange rate stems in part from "financial repression and autocracy" (emphasis mine). Basically, China forces its domestic state-owned banks to buy its central-bank issued bonds paying only about 2% interest while it earns about 5% buying American Treasury bonds.
The Communist Party geniuses in charge of this probably figure they have subverted the underlying concepts of any market economy, namely the self-interest of parties involved and, at the stock market level, our old friends fear and greed. I wouldn't be surprised if some of them were convinced that no bubble exists at present in their stock market and therefore no crash will ensue: they will always be able to control investors' fear and greed. Needless to say, and many people all over the blogosphere have been saying it better than I, this will not end well.
The only thing is that I don't believe it will happen anytime soon. It might take a few years to play out.

According to this surprising new study, it appears that anger improves decision-making.
I can't say that it agrees with my trading experience. Anger breeds a desire for revenge and seeking revenge in the markets after a bad trade is usually one of the surest roads to ruin.
But I can see how low-level anger (how should we call it...irritation, aggravation) could focus the mind and help the trade-selection process. A moderately angry (quite the oxymoron) trader would presumably make fewer mistakes than a bored trader, one would think.

Very nice recap of the late 90's Nasdaq bubble by someone who obviously observed it up close and personal on The dk Report blog.
This is the comment I made regarding that post:
It's funny how, even though I lived (and traded) through it all, I don't remember it quite like it really was, particularly the last few months of the bubble. I think it's partly because, while the indices were going up, many stocks were cratering. Every day had its disaster du jour and the new all-time highs on the indices were but a footnote.

You've probably been hearing this a lot the past few days: the 10-year rate has broken a major multi-year downtrend. Some people say 15 years, others say 30. My chart (this is the monthly) shows a clean falling trendline dating back to November 1994 that has definitely been broken this week. I fully realize that we have to wait until the end of the month to pronounce the monthly trendline broken but still...
Now a mistake most people make (including me, all the time) is to automatically conclude that, since a downtrend has been broken, an uptrend is about to start. Which is to forget that a market can do something else besides going up or down, it can go sideways. After the dust settles (and obviously emotions are running high these days), we could be stuck in a 5%-5.50% range for many months to come.

Everybody knows that John Murphy's all-time favourite tool is the relative strength chart. Intermarket analysis being his main area of expertise, it's understandable. And even if one can easily fall prey to overusing and overanalysing them, relative strength charts (or ratio charts) can be very useful. Shown above is simply the daily chart of (GOOG divided by SPY) and what it shows is that even though GOOG is making new all-time highs in absolute terms, it is still trading below its all-time high on a relative basis. Therefore (and you know where this is going), it still has room to go.
Granted I do own a few shares of Google and I am thus a prime candidate for the very common "cheerleader bias" where one only looks for facts supporting one's theories. I would be worried about it if GOOG were in a free fall, which is not the case (fingers crossed).

GOOG launches into the stratosphere? That's what is commonly known as coil action.
The last time it did this, in October 2006, it went up 100 points.

Here's another possible breakout. EWJ, the Japan ETF, breaking out of a falling resistance line. You'll notice the gently rising 200-day Moving Average (blue line on the chart that I really thing you should click to enlarge and have a better view. Have I ever mentioned the fact that a chart is worth a million words?)

Boy was I wrong about TLT. What I thought was a failed Head and Shoulder turned out to be only a "complex" or "irregular" one (the right shoulder had an added bump if you will).
In any case, according to my "calculations" (very subjective of course), this should take us down to the 82 area. Got short some here at 85.6, atrociously late of course but isn't it always the case when you're caught wrong-footed?

GOOG still going. Shown above are the 30-minute and daily charts (click to enlarge).
While the first one shows a continuing uptrend, the second adds the bullish fact that a falling resistance line was decisively broken in the last few days. Bigger, better things should follow.

And now....the musings part of the blog.

I'm reading this book on commodities by Jim Rogers. Nothing to write home about but something he said about the required character traits in a trader resonated with me.

Three main things he says:

1) be absolutely candid about your own attitude toward risk

2) have the ability to admit your mistakes

3) be willing to stray from the herd.

They don't sound like much at first but when you think about it, the reason why these traits are so hard to have and/or acquire is that they run counter to peer pressure, the strongest of pressures. We're pressured since a very young age by "our peers" to:

1) show we can "do it", "take it", "handle it" whatever "it" is

2) never explain, never apologize: it's a sign of weakness

3) be a team player.