Prepare for the Nightly News

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MARKET WRAP UP 01/10/11

After another morning gap down, the spirited dip-buyers arrived once again, as the S&P 500 closed down just 0.14% to 1269. We continue to see the 1262 area act as a key support zone, with 1276 above serving as resistance. Overall, today was a rather slow day of trading, with not much momentum of which to speak. Despite AAPL printing all-time highs (Disclosure–I am long AAPL), it was tough to get excited about aggressively buying or shorting any areas of the market in particular.

The AA earnings tonight kicks off another round of nightly news over the next few weeks. That old phrase of “buy the rumor, sell the news,” is sure to be tossed around. Indeed, many stocks have seen a tremendous run up over the past few months. Of course, the reason as to why they have marched higher is something with which the financial news media is perpetually fascinated. From my vantage point, the importance of the underlying reasons for stocks moving higher is significantly outweighed by the actual price action and volume. After all, the big funds ultimately control the direction of the market. Whether they view a given earnings report as a catalyst to sell, or an excuse to take profits on even a pretty good report, is irrelevant to me.

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Many traders often improvise their strategy on how to navigate earnings season. So long as you develop a style of risk management that you are comfortable with, there is nothing wrong with taking a case by case approach. However, for the purposes of this post, I thought I would detail my strategy for a certain stock, of which I currently have no position.

We all know that AA (Alcoa or pocket aces) reports earnings after the bell today to kick off the season. So, let’s take a look at whether it is worth holding, buying, shorting, or leaving alone leading up to it.

On the weekly chart above, quite simply we can see the tremendous run that the stock has had off the summer double-bottom. Moreover, Alcoa is now quickly running into a well-defined area of resistance from January, 2010, just above. Thus, in the short-term (days, a few weeks), the risk/reward does not justify allocating fresh capital to the long side here, regardless of the actual earnings.

Now, as far as whether to hold an existing position into earnings, I believe that the stock is much more susceptible to a gap down than a gap higher due to the distinct possibility of aggressive profit-taking on any, and I mean any, slight disappointment in the earnings report. So, I do not think holding a sizable position through earnings is a good choice.

The next option is to position yourself for Alcoa to pullback after tonight. While this strategy makes sense for a few technical reasons, a few of which I outlined above, the fact remains that the stock is still in a very powerful and steep uptrend. Overbought can become even more so during a powerful uptrend. Although extended here, just because a stock is not a good buy does not make it a great short.

The above analysis leads me to conclude that your best bet is to fold pocket AA into tonight’s earnings report and take a pass on playing it, save perhaps a few exotic options strategies for advanced options traders. Earnings season for conservative swing traders is not a particularly fun time. We are dealing with more external variables than usual with a direct effect on price action and volume. Taking a pass on earnings plays is not a sign of trepidation. Rather, is a perfectly acceptable risk management strategy for traders who want to have staying power in this business.

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I originally posted this video for members inside 12631, which is a premium service affiliated with The PPT, last Tuesday, January 4, 2011. Click here for more details.

In addition to what I say in the video (my notes have been copied and pasted into the body of this post below the video), the basic idea I present is to not get too caught up in buying a stock solely because it is a takeover play. You will want to be sure the price action is still in your favor, as well as a myriad of broad market factors I outline in the video. Otherwise, you are left holding a perennial takeover candidate that is “always a bridesmaid, never a bride.”

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

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ANATOMY OF A TAKEOVER PLAY

1. Where Are We in the Cycle?

–> Easy Money/Cheap Borrowing Costs For Private Equity Firms

–> Firms Have High Levels of Cash re: M&A

–> Confidence Coming Back After Bear Market to do Deals–Recall 2008

Leads to…

2.  Which Sectors are Seeing the Most M&A Action?

–> Energy Sector Has Seen Deals Over the Past 18 Months

–> Technology Names are Perennial Targets/Sector Always Active

–> Financials Now Look to Be on Radar as Well (re: “The Fly”)

3. GOLDEN RULE FOR TAKEOVER PLAYS:

–> THOU SHALT OBEY THE “SISKEL TEST”–Gene Siskel (Siskel & Ebert)

—> Film Satires/Slapstick Comedies (e.g. “The Naked Gun” “Hot Shots”)

—> Would You Still Find the Joke Funny if You Had Not Seen the Film Being Spoofed?

—> Applied to Stocks: If Firm was Not Takeover Target, Would You Still Have Bought?

4. Examples: $ATHR, $BRCD, $HAIN, $NUAN

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MARKET WRAP UP 01/06/11

In front of a much-anticipated jobs report tomorrow, today’s price action was overall relatively tame, as the S&P 500 finished down 0.21% to 1273. While many of the large cap technology stocks once again performed admirably, there was distinct weakness in the commodity and retail areas, namely in the silver and rare earth miners. That type of contrasting action reinforces my working thesis that we are seeing a rotation of capital by the big money.

Regardless of what the actual jobs number is tomorrow, I will be watching closely to see if the hedgies and large fund managers use it as an excuse to continue to redeploy capital as they see fit. Just as we have seen the market buy stocks in the face of poor economic data, we could just as easily see a much-improved employment report as an excuse–not a catalyst as many macroeconomic traders claim–to further take profits in retail and commodities and move to other areas of the market.

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MARKET WRAP UP 01/05/11

After another morning move lower, the bulls pulled off an impressive comeback to close the S&P 500 at multi-year highs, up 0.50% to 1276. In keeping with the rotation theme that I discussed yesterday, we saw the commodity sector lag, while financials and large cap leaders in the technology-dominated Nasdaq thrived. Moreover, the underlying action in terms of individual breakouts holding was more impressive than what we had seen earlier this week.

With the National Football League playoffs kicking off this weekend, now would be a good time to discuss the power of home-field advantage. In football, playing a big game on your home field can have a material effect on the outcome of the game. As an example, you have your own fans vastly in the majority in the stands, screaming their heads off in your favor. The fans are the proverbial “mob,” displaying everything you would expect to see with mass psychology at work. When they scream loudly to try to disrupt the opposing team when they have the football and are on offense, the roar of the crowd will only grow louder each time the opposing team fouls up. The fans’ success reinforces itself. It is only when the opposing team scores several touchdowns to put the game out of reach does the crowd truly quiet down, as making noise no longer has the effect it once had.

Applied to the stock market, the bulls undoubtedly have had the home-field advantage since last September. In order for the bears to quiet the bulls, they will need to disrupt the “buy on every dip” mentality. Thus, topping is often referred to as being a process. Since we know that buying the dip has been a strategy that the market has handsomely rewarded for over four months now, it logically follows that those who have been successful following this strategy will not give up so easily. Instead, they will need to be disappointed several times—much like the hometown fans in the football stadium–before they give up and quiet down.

Accordingly, as a rally matures, rather than immediately leave equities we see capital rotate from sector to sector before it eventually leaves the market for a correction. The timing of this process is extremely difficult to forecast and is, indeed, often much more damaging to a jaded veteran trader’s portfolio than picking a bottom during a downtrend. Hence, the best strategy remains one of carefully riding along the pockets of momentum that remain, closely following where the big money is flowing.

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MARKET WRAP UP 01/04/11

The new year has certainly brought back some intraday volatility that we have not seen in a while. Early in today’s session, it looked like we were on the brink of a much steeper pullback, with commodities leading the way down after a series of nasty reversals from yesterday’s breakouts. However, the bulls were able to get their act together to muster a late day push to finish the S&P 500 down 0.13% to 1270. While commodities and many small cap stocks were weak, some of the larger cap names attracted capital, namely $AAPL $AMZN $DIS $GE and $PFE. Whether we see a further rotation out of the commodities as well as the higher beta names and into larger, more value oriented issues will be a key “tell” going forward. Adding to the case for a rotation into safety was the “hanging man” candlestick printed on the S&P 500 today.

In Japanese candlestick terminology, there is no difference in appearance between a bullish hammer and a bearish hanging man. Both candles feature a long shadow with the real body at the top of the candle, and basically no upper shadow. After a steep downtrend, we call them “hammers,” to illustrate the possibility of the bulls hammering out a bottom and reversing trend. After an uptrend, however, we call it a “hanging man,” to denote the idea that perhaps the bulls are losing the momentum and leaving it hanging out to dry. Either way, we are going to need to see some follow-through to the downside before we can call any type of major reversal here.

Moreover, despite the ugly red candles printed on the daily charts of the leading indices and sectors, we have not seen yesterday’s multiple breakout points breached yet. Thus, like it or not, we are going to need to be as agile as ever and ready to change our market posture at a moment’s notice.

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