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Over at least the past two decades, the 20 period monthly moving average on the S&P 500 has been an excellent reference point for bull and bear cycles. When it is rising, you should generally be a bull for the foreseeable future, while you should be bearish when it is declining. When it smooths out, you should grow cautious and wait for resolution. As with all moving averages, it is important to note the slope of the reference point and not just whether price is above or below at any given time. Too often, traders completely ignore the former aspect, while getting caught up in the latter to their detriment.

Another important point is to keep the timeframe in mind for perspective, as multi-day or even multi-week trades can be made counter to the trend above. The 20 period monthly moving average analysis is extremely beneficial to your market posture during largely volatile periods of confusion. As an example, in the summer of 2010 we had a nasty 16% broad market correction. At the time, I posted a monthly chart like the one above over on Stocktwits, noting that even though the market was quite scary and sentiment horribly negative, all that was happening was a pullback to the still-rising 20 period monthly moving average. Note above that we found support right near that rising 20 period monthly.

Unlike the summer of 2010, when we never breached the 20 period monthly, this time around we did. That said, the moving average is still inclining (albeit at a lesser rate), which tends to bode overall quite well for bulls. Moreover, the buyers did an excellent job of quickly taking price back above it.

Based on prior market action, a longer-term bullish to bearish reversal should see the 20 period monthly moving average flatten out while price consolidates below it, before we eventually break lower. I am not impressed with the price action in the current market of late, but the bears still have plenty of work to do before I would say that we are back in a cyclical bear market.

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NOTE: This is worth posting at the beginning of every earnings season. It is as much a reminder to myself as it is to you.

 

[youtube:http://www.youtube.com/watch?v=xPcql4FuCK0 450 300]r
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With AA officially kicking off yet another earnings season last week, consider this a friendly reminder to check and then double-check your current portfolio holdings to see when they are scheduled to announce. As a relatively short term swing trader, I am almost always looking to significantly reduce or outright close a position into earnings. There are simply too many variables for me to have an edge.

Even if you have illegal inside information about what a particular firm’s earnings will precisely be (and would thus face the distinct possibility of winding up in a federal pound-me-in-the-ass prison, with no conjugal visits) there is still no way to know how the market will react. Stocks can just as easily sell-off on great earnings as they can on horrific ones, and vice-versa.

Technical analysis has its clear limitations in that it can only demonstrate what is currently known and knowable by the markets. To presume that charts can dictate everything into the future is pure folly. Trading IS gambling, as we are wagering on outcomes yet to be determined. Instead of running away from that fact, a better approach is to embrace sound risk management.

In sum, leave the heroic all-in bets on an earnings play to old men trying to recreate their youth as they imagine themselves as Steve McQueen in The Cincinnati Kid. For those of you who have seen that movie, they will likely face the same fate as McQueen’s character did in the end as well.

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At the end of the day, all we are doing in the stock market is wagering money on outcomes that have yet to be determined. If you insist on spending your time coming up with condescending, pre-packaged responses about how trading is categorically not gambling, then you are already battling demons that will eventually come home to roost. Trading is most certainly gambling, and so is investing for that matter. Even if you buy a stock for a dividend in lieu of capital appreciation as a long-term investor, you are gambling that the dividend is safe. I invite you to take a look back at history at how many firms cut or completely erased their dividend back in 2008, to illustrate just how much of a risk it is, even when it seems like the safest thing in the world.

Given that we are gamblers, it is especially illuminating in a market like the current one to see how traders react to adversity. Look at your local Twitter stream, and you will see traders trying to fade other traders simply because they dislike them. You will see others arguing against straw men, creating their own twisted reality where “everyone” expects a 2008 crash, so therefore they are bullish. Alternatively, you will see other traders arguing “everyone’ is bullish, so therefore they will press their shorts here (albeit with the wind at their backs). Of course, when “everyone” is fading “everyone” else, you really do not have the type of contrarian evidence that you look for at inflection points. Instead, you have noise upon noise.

In a market like this, you also see raw emotions come out. When the market is trending higher in a low volatility environment, it is very easy for traders to act like one big, happy family, save the few outcasts who short the uptrend all the way to the top. However, once the tide turns and volatility returns in a corrective market, most traders get bit–The only question is how much. If you take a lump early on in the correction/bear market, there is nothing wrong with cutting your losses and retreating to a highly defensive posture via cash for the duration of the volatility. For those who continue to trade these markets in an active manner, unless you have a specific game plan you are bound to lose control of your emotions. You simply cannot afford to lose your head. Imagine sitting at a poker table in person with nine of the traders you despise the most from social media. Imagine them getting lucky and winning a hand of poker against you, and seeing them smirk as they drag in your money and count it. How are you going to react? Will you throw your cards at the dealer? Will your berate the jerk who won your money and got lucky?

The first thing to remember is that you are here to make money without exposing your capital to undue risk. So, you should ask yourself whether you truly are, in fact, getting unlucky in the current market. If you honestly believe luck has nothing to do with it, and you are simply not adept to this type of a stock market, then there is absolutely nothing wrong with getting up from the table, walking away, and coming back later when the game conditions (stock market conditions) have changed. The next thing to consider is, supposing you are truly getting unlucky in this market, then will emotionally reacting by cherry picking a trader you dislike or think is weak to use as a contrarian indicator be an effective strategy? I view this type of a reaction as being the poker equivalent of throwing your cards at the dealer for losing a tough hand.

In the current market, we have seen unrelenting selling in many of the industrials, energy, materials, and financials. Indeed, that can be described as forced selling and capitulatory. I can certainly envision a bounce sometime soon, but it is likely to be much more of a function of exhausted selling than of “everyone” leaning bearish. In other words, since many traders appear to be focused on making bets based on sentiment, I am getting up and walking away from the sentiment game altogether, focusing now more than ever on price. Because when “everyone” tries to fade everyone else, you are left with an amorphous quagmire that is nothing more than a sucker’s bet.

 

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Knockin’ on Heaven’s Copper Door

Opening Heaven’s Copper Door

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I am eagerly anticipating the next season of Breaking Bad on AMC in July, which I consider to be the best television series in at least five years (Other shows not far behind include: Justified, Rescue Me, The Wire, Deadwood, Sons of Anarchy). Breaking Bad is set in modern-day Albuquerque, New Mexico, and centers around a high school science teacher who looks to make as much money as he can by cooking crystal meth for his wife and cerebral palsy afflicted son before he dies of cancer. Even though his cancer goes into remission, Walter White (played by Bryan Cranston) remains heavily involved in the meth business, dealing with assorted bad guys along the way.

What makes the show great is the level of sophistication of the criminals. This is not some formulaic show by any stretch, with mindless violence and writing that condescends to any thinking viewer. Instead, the writing and acting is focused on the subtle aspects about a criminal enterprise.

The following scene is from an episode late in season three entitled, “Half Measures,” Mike (played by Jonathan Banks–The right hand man of the head boss of the criminal enterprise) pays a visit to Walter White’s house to let him know that White’s cooking assistant druggie (Jesse Pinkman, played by Aaron Paul) needs to go, since he has been disrupting the operation with his erratic behavior. Seeing as White feels loyalty to Pinkman as the latter was his student many years ago, and the two have a long history, he is reluctant to sign his death warrant.

However, in what is one of the more memorable monologues in television history, Mike delves into his own background, before he himself became involved in criminal enterprises, in order to drive home a crucial point.

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[youtube:http://www.youtube.com/watch?v=arTnX8tF2_s 550 412]

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Jesse Livermore, arguably the greatest trader who ever lived, committed suicide after a long bout of depression. In his suicide note, he wrote that he considered himself to be a failure. This, from a man who was worth well over $100 million after the Crash of 1929 from nailing the short trade. Later in his life, Livermore broke his own trading rules at various times and endured massive drawdowns from his fortune.

Trading is a tough business for those of us who take it seriously. Even the best of the best routinely fall victim to the dark side of gambling. As quaint as it sounds, consistently surviving each trading session with your portfolio balance intact will put you well ahead of the game over the long run. Keep in mind, over a multi-year period over 90% of traders will be net losers. The biggest reasons for most of them losing are overtrading and routinely adding to losing positions. By far, the one technique that most traders fail to learn is that no trade is often the best trade. When it comes to the stock market, there will always be another opportunity, so a lost chance is not nearly as damaging as a loss in capital from overtrading.

Living to fight another day in the market and in life is something that Livermore forgot in the depths of his depression. You don’t make that same mistake.

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