Flying Over the Cuckoo’s Nest

MARKET WRAP UP 06/09/10

After hitting a late morning high of 1077, the S&P 500 fell apart into the close to finish off 0.59%, at 1055. As I have noted in my previous posts, the raw emotions of many traders come to the forefront when we see price action like this.  The punishing downtrend that we have seen for weeks on end causes many traders to hope that they can buy stocks at the exact bottom, and make a huge score. When we finally see a relief rally, it is usually fast and furious, as shorts are squeezed, and bulls pound their chests in victory. However, when the rally falls apart quickly, the tables turn yet again, and the bulls find themselves quickly underwater on their new long inventory, and the bears scramble to reinitiate shorts.

Of course, all of these emotions are not constructive.  While it is tempting to think of trading as a test of one’s intestinal fortitude, it is important to remember that we are engaging in a complex mental exercise here. Any aggression that you show as a trader should be in a very well thought out and controlled manner. Leave the street fighting to others.

As the updated and annotated daily chart of the S&P 500 illustrates below, we continue to chop and flop around our key 1040-1050 zone. As I have noted before regarding key reference points, the longer that the market spends at these levels, the more likely it is that the support will fail.  What you are looking for are buyers stepping up with conviction, and greedy shorts paying the price for pushing their bets too far. From the action that we saw today, that kind of bullish scenario has yet to materialize. In order for me to get involved again on the long side, I am going to need to see that happen.

Thus, keeping a heavy cash position and an open mind are still the best ideas that I have.  Note that taking a pass on trading in this type of environment has the added bonus of viewing the action in an objective way. Having a healthy frame of mind and a healthy confidence level are essential in all forms of gambling.  Make no mistake, trading IS gambling, as we are betting on outcomes that have yet to be determined. Instead of denying that fact, a better strategy would be to embrace sound gambling concepts. A market like this will punish you for overtrading, fighting the trend, and any lack of discipline whatsoever. Novice traders will likely learn those lessons the hard way. Many other traders, however, have enough experience to the point where they think they are untouchable as far as bearing the brunt of the market’s force. They think they can manage their way out of any corner, no matter what they did to put themselves there.  In short, they allow their emotions, hubris, and machismo to overtake them, and they are essentially outthinking themselves.

You don’t make that same mistake.

[youtube:http://www.youtube.com/watch?v=A4JtI-g7rvw&feature=related 450 300]

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Days like today bring out the real biases in many market players. Within the context of a sharp downtrend, we saw a fierce selloff last Friday and Monday, only to stage a late day rally yesterday.  Today, we are solidly up 1% across the board.  The steadfast bears are pounding the table, calling this a fool’s rally that will soon fall apart. On the other hand, the perma bulls are out in full force, declaring this the true bottom.  Needless to say, there is a lot of emotion in the air.

What I find has worked best for me in these kinds of situations is to block out all of the noise, and look at the facts. We are still in a steep downtrend and have done lots of technical damage on most charts. However, we did become oversold, and as I noted a few days ago, a bounce was to be expected.  To me, the crux of the issue is determining how sustainable the rally is.

I am looking for continued buying on strong volume, which should help to firm up damaged charts (on a daily time frame) across the board. That metamorphosis takes an awful lot of heavy lifting, and the institutions are the ones with the resources to do so. Moreover, the nature of a sustainable uptrend is that you will be able to spot good entry points, based on an occasional low volume, orderly pullback.

Of course, none of this could materialize, and we could easily roll back over and make new lows. So, although I am sacrificing the rewards that come with precisely timing an inflection point, I am negating the substantial risks that are associated with picking bottoms.

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At the poker table, if you can pick up a “tell” on another player, you will be privy to information that can give you a greater edge in your decision making process.  Suppose that you are holding a good, but not great hand. You are against only one other player in the hand. You had been playing with this particular player for several hours.  You notice that when he has a weak hand, he does not mind joking around in a casual conversation with the players around him during the hand.  However, when he was a really great hand, he becomes very serious, and blows off any small talk because he is focused on the action at hand.  You can now use this information to form a more focused and cogent analysis before making a decision.

The same strategy holds true in the stock market.  If you can isolate a few corners of the market that have been giving off tells as to the next big move of the broad indices, you will be working smarter.  While hard work is necessary, it is not sufficient to crushing the market. You need to have a laser-like analysis, in terms formulating your strategy.  Be precise!

Thus, I will offer my two best tells for the current market.  The first one is $FCX, a stock I have talked a lot about recently. We know that they are a well run mega cap copper, gold and molybdenum miner.  Despite the recent “death cross” on the chart, the stock was THE tell today, as it was up the whole day, well before the broad market decided to turn green in the final hour. Pay attention to my commentary on the chart, seen below.

My second tell is the Japanese Yen.  While everyone is watching the Euro, do not forget that the Yen carry trade has been the premier vehicle for much of the risk appetite we have seen for many years now.  The Yen has had an inverse relationship to the performance of risky assets. Oh, and for all of you “flash crash” deniers out there, look at what happened to the Yen on May 6th of this year, and you can go shove your fat finger up a pencil sharpener.

MIND YOUR TELLS!

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MARKET WRAP UP 06/08/10

With their backs pressed hard against the wall, the bulls managed a nice rally into the close today, as the S&P 500 finished up 1.10% to 1062.  Despite the fact that the Nasdaq and the small caps finished slightly in the red, the bulls won the day. More importantly, they have momentarily halted the bears’ stranglehold on the price action.  It is a real plus for the bulls that the volume today was the strongest bull volume that we have seen in two weeks. It is also crucial to note that the 1040-1050 zone has proven to be support once again.

With all of that said, the bulls are going to need much more than one solid day to turn the tide. A deeply oversold bounce does not an inflection point make.  While many traders were eager to rush back into the market with their bids today, throughout this downtrend we have seen several promising one day bull victories that ultimately fizzled out in a speedy and violent way.  As the updated and annotated daily chart of the S&P 500 illustrates, the bulls could bounce a bit more from here, but we would still be in a steep downtrend (see below).

The real issue is this: Whether you have already defined yourself as a trader, or whether you will let the market define you.  If you choose the later, you will be insufficiently focused in your trading style and, simply put, you will be a long term money loser despite any short term luck.  If, on the other hand, you have defined yourself as a daytrader, swing trader or long term investor, you should know exactly what you are looking for in terms of the various opportunities that the market presents.

Many unprofitable traders figure that they will just do whatever makes money, whether it be intraday scalping, or buying and holding a blue chip company forever.  What usually happens is that they try to daytrade a stock, only to see it become a losing position.  They then average down into the position as it falls, and figure they will turn it into a swing trade.  Before long, they become frustrated and either sell at a huge loss, or continue to average down out of stubbornness and turn it into a longer term investment.  Even if they happen to turn a profit on that given trade, they have let the market define them.

You want to specifically avoid this type of situation as a trader, especially in the current volatile environment.  While bull markets may be forgiving, corrective markets will punish you for any lack of discipline.  As you know, I have defined myself as a swing trader. I fully recognize that I have missed countless shorter term opportunities, in terms of intraday or one-two day trades. In retrospect, I should have been more aggressive to the downside, as I took off all of my short exposure back when the S&P was above 1100.

My main focus right now is respecting the fact that we are in an unhealthy, choppy, news driven market full of broken charts on heavy selling volume.  I want to, above all else, preserve my capital for a better setup down the road.

Who knows? It may very well happen sooner than you think.

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Can’t help themselves the whole way down, baby….

[youtube:http://www.youtube.com/watch?v=u0PUrNwvvBk 450 300]

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On the back of two ugly down days, the S&P 500 is up a few points headed into the afternoon.  The Nasdaq is lagging, and is actually down 0.80% at the time of this writing.  Days like today illicit a very dangerous emotion from traders—HOPE.  Hope may work very well on the political campaign trail, but in the stock market, trading based on hope is one of the oldest sucker moves around.  It is often said that bull markets climb a wall of worry, while bear markets slide down a slope of hope.

We could easily rally a few days from here, as we are short term oversold. So, adding short positions at this point is probably not correct. However, the very nature of a countertrend rally is that it is short lived, regardless of how exuberant it may seem.  The great thing about the stock market is that, unlike in baseball, there are no called strikes, to quote Warren Buffett.  If you believe, as I do right now, that the risk/reward profile of putting cash to work is unfavorable, then your best move is to patiently wait for a better pitch.

As you know, I have been watching $FCX as my tell for the broad market.  It is up nicely today, over 4%. However, if you look at the daily chart, you will see that it is way too early to declare any kind of inflection point.  What you want to see is a few more days of price stabilization combined with heavy buying volume.

I know that this kind of market, as well the cautious nature of my posts, can be frustrating for many of you who are growing impatient. All I can tell you is that as soon as we find ourselves in a healthier market, I will be eager to post as many favorable setups as I can.  Conversely, should we get a multi-day low volume bounce from here, I will look at the short side should we break down again.

[youtube:http://www.youtube.com/watch?v=eKsXQq02dsw&feature=related 450 300]

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