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2004 Or 2008?

Let us cut right to the chase. No one can deny that the market has been correcting for the past five weeks or so.  The real issue is whether we will stabilize and settle into some kind of broad trading range (2004) or whether we are on the cusp of a major breakdown (2008).

From my vantage point, at the heart of the answer is whether we will see another round of steep deflation, or instead whether reflation will continue. Seeing as I am skeptical of manipulated government data as well as dorky, lagging indicator economists, I would rather trust the way the market negotiates one stock in particular.

Freeport-McMoRan Copper & Gold Inc. (Public, NYSE:$FCX), is a prominent, large capitalization copper miner, as well as dealing with gold and molybdenum. They are a fairly well run firm.  Looking at the chart of the stock in multiple time frames, it has become apparent to me just how good of a tell–and leading indicator–the stock has been with respect to the broad market.  If we are going to have another deflationary crash, or instead will reflate (or inflate), this stock will tell us in advance, given its mining interests.

Thus, with the uncertainty and choppiness of the current market environment, I will keep $FCX on my screen, irrespective of whether I ever trade it.  As I am writing this, the stock is sitting on a significant support level. To break down through it would be a very bearish signal.

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Still No Cigar


The bulls showed some heart today, for the first time in a while, as they took the S&P 500 up 2.58% to close at 1098.  It always amazes me how sentiment amongst traders can shift so quickly in a volatile environment.  One day it seems like most traders are storing canned peaches, coffee, and unauthorized cinnamon in their apocalyptic storage areas, and the next they are looking to ride their newfound “momo” longs.   Even on huge up days like today, the fact remains that violent day-to-day price swings are friends of the bears, and not the bulls, as the market is reflecting the uncertainty of the current economic landscape.

Because of the continued wild price swings, combined with the fact that we are chopping and flopping around below the 200 day moving average on the S&P 500, I believe that the bulls have to overcome the burden of proof here.  One exuberant bounce does not an inflection point make. As usual, follow through is key.

Those of you who have followed my work know that I do not try to perfectly time bottoms and tops. Rather, I want to participate in the “meat” of the move. In other words, I am willing to miss out on the initial and final 10% moves of a trend, so long as I ride the 80% in between.  Frankly, I do not care whether that means I am going long or short.  The goal is to make money, instead of choosing a gang and stubbornly sticking with them.

Despite the big move today, the updated and annotated daily chart of the S&P 500, seen below, illustrates the still shaky backdrop for the bulls.

My final takeaway from the current predicament is that we are in the soup right now.  The 1100/200 day m.a. zone continues to be a key battleground area.  Buying and selling volumes have been declining over the past few days, so we are likely to see resolution one way or the other.  Both bulls and bears can point to solid arguments here.  Until this mess gets resolved, however, I will continue to sit in cash and let others do the dirty work for me, before allocating my capital.

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Stop losing your own, and other people’s money! Where’s your goddamned sense of pride?  Wait for the inflection point, and then ride the trend. Until then, there are worse things in life than sitting on a pile of cash, waiting to allocate it when the time is right.

[youtube:http://www.youtube.com/watch?v=67qEA0r5TDE&feature=related 450 300]

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The Story of Maximum Boom-Boom

A few years ago, I took a trip out to Los Angeles and found myself sitting in the best poker game I have ever seen, to this day. I was playing $100/$200 limit Texas Hold ‘Em at the Commerce Casino. To a person, the table was full of players not just playing every single hand they were dealt, but raising and re-raising with them on every single betting round.  Needless to say, they were playing very “loose,” and very aggressive.  In a full game (9-10 players) of limit Texas Hold ’em, very few starting hands show a large enough profit over the long run to justify playing very many of them.  You should be folding most of the hands that you are dealt before seeing the first three community cards.  The correct strategy is to be “tight” by only playing the best starting hands (pocket aces, KK, QQ, JJ, TT, Ace King suited, etc.) yet also very aggressive when you are finally dealt them.  Generally speaking, you want to be patient and then raise and re raise with big pairs, and big suited hands. Of course, you will play other hands, but only in select situations.

For the first few hours that I sat at the table, I felt like it was correct to fold every single hand that I was dealt. When the game you are sitting in is very aggressive, you should be playing even tighter than usual, as the variance–or volatility–of the size of the pots and your own price swings are exacerbated.  Beyond that strategy, however, I was so-called “card dead,” as I was consistently looking down at hands like 2-8 off suit. Because of how loose all of the other players were, it made absolutely no sense to try to bluff them with my horrendous cards, since they would not be folding.

Naturally, the players around me were oblivious to my absence from participation, as they were either drunk or in some euphoric state of degenerate gambling nirvana. At the risk of stereotyping, in poker you want to sit at tables with women and men wearing flashy jewelry.  You want to sit in games where people are boisterous, emotional and loud.  If they are drinking alcohol and/or have been playing for hours or days on end, all the better. You want to play with people who are having fun gambling, without too much regard for the math involved.

About two and half hours into my playing session, I looked down at the Ace of spades and the Ace of clubs.  I raised and got raised three more times to cap the betting action before we even saw the “flop” (first three community cards).  No one folded.  It was all nine of us in the pot for $3600 before the we even saw the flop! The flop came down 2-2-7, all of different suits. Understand that this one of, if not the, very best flops you can see when you are holding A-A in a wild game. I raised and re raised my hand until the betting action was capped.  No one folded.  The next card was a 6.  I bet, a middle aged Asian gentleman raised me and, surprisingly, everyone else folded.  I re raised, as I could beat many hands in this situation.  However, he kept raising me back until I just called. The last card was a 3.  There were no flush possibilities on the board.  I bet, and he raised again. So, I just called.  The Asian man turned over 4-5 for an unlikely straight, which he had caught perfectly on the fourth and fifth cards.

As he raked in the massive pot, he gave me a playful smile and screamed “maximum boom-boom!” in a thick Chinese accent, while pointing to my second-place pocket aces.  He had been screaming that little phrase after each big pot he won. I said “nice hand, sir,” while my stomach did a few somersaults.

I took a break and walked away from the table for a minute to collect my thoughts.  Should I leave the game? Well, I ran through a checklist of questions that I ask myself when considering whether to pick up my chips and leave.

How well was I playing?

I was playing very well, and  I was not tired nor making emotional decisions.

How good was the game in terms of potential profitability?

It was a great game with loose and careless players playing very poorly despite their aggression.

Before I asked myself any other questions, I knew I had to return to the game, so long as I did not surpass my stop loss. I noticed several of the regular, winning players were on the waiting list and looking eager to get into the game. Indeed, it was a great game.

A few more hours went by, and I was losing about $2,700.  Normally, if I lost my initial buy-in ($5,000), I would get up and leave, as a stop-loss. The casino would always be open, and I could come back the next day and start fresh.  A few of the crazy players were getting lucky, including Mr. Maximum Boom-Boom, and many of them were simply passing their money back and forth to each other with each crazy hand.

I wish I could give you a rousing finale to the story. But, there wasn’t.  I got dealt a few more quality starting hands and lost the hands, along with my buy-in.  I could have easily bought back into the game for another $5,000, but I knew I would be digging myself a deeper hole in the face of a wild game, with wild swings.  So, I stood up and I left the game.  The next few days on my trip I gradually won back the money I had lost. The games were tougher and not as juicy, so it was a slow grind trying to win.  It truly was an elevator down, stairs back up type of situation.

Despite the fact that I knew I was playing my cards in a way that was profitable over the long term, that night I had to respect the fact that short term luck can have a surprisingly heavy influence on any one poker game.

As much as I wanted to take the otherwise pleasant and funny Asian man’s money, to let my ego get involved would likely have been a costly mistake given the short term luck he was having, compared to mine.  It also occurred to me how ironic his little catch phrase was, as without any kind of stop-loss, you are destined to experience a maximum boom boom, in terms of your downside risk.  Just as in the stock market, your poker losses can mount up very quickly.

Despite the money that I lost, walking away from that juicy, stellar game remains one of the best decisions that I have made and am proud of.  Of course, I could have gone on winning streak and won tons of money that night. But, that misses the point.

As a serious stock trader, and a serious poker player, you are constantly trying to fight and minimize the luck that is involved, not embrace it. Luck is the ephemeral friend of amateurs.  If you find yourself in exceptionally volatile situations, of course you can gamble it up all you want. But that’s not the risk/reward profile you should be looking for as a serious trader.


In the current stock market in which we reside, many traders are disrespecting the short term luck involved.  Perhaps buying falling knives right now like $RIG, $BP and $APC will show a huge profit over the long run.  However, what usually happens is traders try to precisely time an inflection point, only to lose a quick 20% and sell out of their positions.  They sell out of both frustration of quickly losing money, and fear that their doomed stock will soon go to $0.

My point is that you always need to have an exit strategy in mind for any position that you take. Even if you do not place a specific stop loss, you should mentally have a price target in mind where you are explicitly prepared to admit that you are wrong and have made a mistake.  Note that this applies to long term investors as well, even if they had previously averaged down in a position.  At some point, you will be wrong.  Limiting further downside risk is an ever present issue in the stock market, if you want to live to fight another day.

Take, for example, the bulls who bought last Thursday’s 3% rally. We have now closed below where we were before that day started. Are they going to admit they were wrong if we keep seeing more selling? Each and every rally attempt we are seeing is being met with distribution.  I am going to respect that fact and, despite any oversold conditions, will sit in cash for now until I see a better environment to trade.

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Midget Bowling!

For quite some time now, I have noted the relative strength shown by the midgets, a.k.a. small cap stocks, since the middle of April.  As opposed to the broad market and countless other sectors and stocks, the small caps have yet to close below their respective 200 day moving average.  Historically, the transportation sector and small cap stocks are widely seen as leading/confirming indicators.  Thus, with both of those areas showing relative strength throughout this correction, I have been more apt to sit in cash than to put on short positions.

Excluding the fallout from the quagmire in the Gulf of Mexico via the attrocious performance of the energy sector, the small caps are notably weak today. As I am typing this, the broad indices are trying to stay green. However, the small caps are still one of the notable leaders to the downside today.  The intraday and annotated daily chart, seen below, should show that despite their relative strength thus far, the small caps leave much to be desired in terms of being a long setup.

Keep a close eye on the midgets for the rest of the trading session.  If they continue to roll over here, I suspect it will be a bad omen of things to come.

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Monthly Charts From Hell

Because I remain in 100% cash, I am constantly reevaluating my strategy for the sake of thoroughness. In my quest to look for reasons to get involved on the long side, however, I have come across several problematic monthly charts that I would like to share with you.  The charts seen below all involve bearish reversal patterns, particularly when viewed through the lens of Japanese candlestick charting.  The two patterns I would like to discuss are the shooting star and bearish engulfing reversals.

The “shooting star” is a type of reversal pattern that is made up of one candlestick with a small “body,”  a relatively long upper shadow and a minimal or absent lower shadow. Basically, the shooting star illustrates that the buyers have exhausted themselves via a blow off top.  The sellers then aggressively move in and push price down to where it was at the beginning of the month (on a monthly chart).  When seen after a steep uptrend, the shooting star should be taken very seriously.  A sharp gap down immediately following the shooting star helps to confirm the reversal’s validity.

The bearish engulfing pattern can been seen over two candlesticks, the first being white (or green, where the bulls won the month on a monthly chart) and the second one being black (or red, where the bears won the month with price finishing lower). The main idea is that the red candle is bigger than the green one, and thus “engulfs” it.  When seen after an uptrend, this pattern signifies that the bears were able to convincingly seize control of the price action away from the bulls.  The bigger the red candle is, the stronger the reversal.  As with the shooting star, the buyers had made a higher high in the beginning of the red candle, only to see sellers present themselves in a meaningful way and, unlike the shooting star, actually push price all the way below the low point of the green candle.  Also, as with the shooting star. follow through to the downside is key.

I have denoted the patterns in the following monthly charts, which include: $SPY, $COMPQX, $XLE. $XLI., $CREE, $VECO, $GMCR.

Note that there are still several arguments the bulls can point to as reasons to be optimistic, such as the fact that the hammer on the $SPX daily chart from last week is still valid.  Also, the small caps and transportation stocks have shown relative strength, and they are widely seen as leading/confirming indicators.  Moreover, after an historically weak month of May in terms of broad market performance, it is tough for me to become aggressively short right here, right now.

Thus, despite the troubling monthly charts seen below, I prefer cash at the moment.

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