March Madness

While people are experiencing March Madness for the NCAA, the market has also been going crazy. We have finally started to see some consistent movement to the upside and some of it has come in very large movements. Nearly a 7% move on monday as the treasury announced it would purchase bad assets from banks.

My risk management and long bias has served well in this environment and the market is acting like it wants to move higher as well, if it holds the 800 level I think we will reach 850 in a short time. I currently have a 67% gain on the year, which monetarily isn't huge since my account got fairly depleted last year but my trading and discipline has done very well this year, letting winners run and taking profits at targets and cutting losses. The key now is to again maintain and try and keep producing positive returns consistently, this type of performance is likely not very sustainable but even if I can do 5% gains a month for the rest of the year I'll double my account.

I would like to see a solid test and hold of 800 then a resumption of the trend upward and I will look to take more risk to the long side. If we start to see improving economic conditions not to mention better than expected earnings we could see this rally continue for a while. Is it a bear rally? Technically yes until it exceeds the previous relative highs of 1650, it doesn't matter to me, you have to ride them while you can. Increased patience is probably one of the other big factors to the recent success, waiting for the good entry points. We'll see what happens going forward but if I remain smart and disciplined and patient I should actually have to owe money to the government at the end of the year, who would have thought that was good? ;-)

March Maintenance

My bullish bias has played out well this week so far. I have had some positions in relative outperformers such as FCX and AMZN. On monday at almost the exact low I sold puts against the FAS( 3x bull financial etf), this was simply good timing but also a good trade from a logic standpoint. Financials were severly oversold, the FAS was trading at $2.50, and I was able to get .60 a contract for a march 2.50 put that is right at the money. Volatility was insane at 340%(not too insane since it is 3x) so I have the likely hood of volatility decay on my side as well as time decay AND the fact that I literally have limited downside at this point. I sold 20 contracts so my risk to reward 3:1, generally the opposite of what you want but in a naked selling scenario you generally have much larger risk. The other appealing thing, and the only real time you should sell naked puts is when you are comfortable owning the stock and having it put to you. I would have been fine having the stock put to me, I would have a cost basis of $1.90 at a likely low and significantly oversold market level. All of these things put the probability of immediate or future success in my favor.

I have tried to lighten my bullish positions and have scaled out of FCX with a target price of $37 in the short term to unload my remaining 2 contracts. I have found that scaling out is a very helpful method to control emotions and let winners run. It allows me to lock in profit and not have as large of account swings to the downside when stocks pull back. Depending on the price action I will wait for a pullback and look to get back in to FCX as I think it's longer term target is likely $45 in the next few months. My target on AMZN in 75 now that it has finally broken out of its 60-65 range, however I am holding shorter dated options so if it has much trouble getting above 70 I may get out and roll into a longer dated option on a pullback.

I took a new position in CHK today, as I think natural gas should be close to a short term bottom and if we start to see an uptick in prices I think CHK could see a significant move upwards. It broke above resistance at 15 so hopefully that will continue. Oil got creamed today after a bearish inventory report but if it can stabilize and start to move up again that should help the energy sector and my position.

Tomorrow is the hearing about mark to market accounting. My guess is that nothing actually happens, or if something does happen the reaction is muted given we have had such a run up into it. Most financials are still in longer term downtrends at resistance after these large moves up. Either way I am not very concerned with my FAS position, it is highly unlikely the stocks re-trace their entire amount in 7 trading days but it is of course possible since they moved up this much in only 3. Like I said I am fine taking delivery if it comes to that. I would almost prefer a pull back so I can get into some of the stronger names, I will likely look at MS if it pulls back.

Even though everytime I say this I immediately get smacked by the market gods but I currently now have a nice positive return for the year after the most recent move, now it is a matter of maintaining it with risk management and patience to wait for the good entry points.

Will It Ever Stop Going Down?

I was asked in an interview whether I was bullish or bearish on the market(best question ever in an interview). I generally like to just say ( or think) I am risk managed. I had made the statement that I don't necessarily think that the S&P was going to go to 600 or lower, however I don't believe anything is out of the question so you must continue to manage risk appropriately. I said people think that this time will be different than before and I said that seemed to be a stupid assumption, this time could actually be worse given all that is happening so if X happened because of Y before, why would you assume Z would happen( if Z is better than X) given the same input.

Do I think the bottom is in? We won't know that til it happens but I think it is much closer. There doesn't seem to be the same panic there was back in october and november which is good but still hasn't stopped the grind lower. We are about 55% off the highs, if we see another 10% downside I would be very comfortable committing long term capital to the market. The reason being that the average bear market has gone down about 50%, I would say this scenario is worse so a 65% decline would not be out of the question. Do I still think there is less downside risk than upside potential? Of course, but the thing that must be considered is time. There is unlimited upside (theoretically) and in my opinion probably a maximum of 20% more downside. We have to determine whether this is acceptable risk for our required return. If our time horizon is one year and we think MAYBE there is 20% upside over the next year is it a good trade if the risk to reward is 1:1? No. If you assume in 10 years we'll be back at the highs, is a 55% return good for 20% downside? maybe. Being young I have the advantage of time, I like to focus on more shorter term trading but for longer term investments in other portfolios I think it would be smart to put a portion to work. Generally I disagree with averaging in but there are some potentially "attractive" buying opportunities people are simply too scared to jump in, if you retire in a few years that is good to be scared but if you retire in 20 you are an idiot.

I myself am still beating the market but am down 4% to the markets 24% YTD, obviously I'd prefer a positive return. Right now there looks to be some positive things happening in the market. Commodities and commodity stocks seem to have bottomed, they are higher than the panic lows of october and november. Gold is not above 1000, and we are much lower than in october and november. Copper is moving higher which is a great global economic demand indicator. It could reverse but so far it has bottomed and I think a break about 1.71 would signal further upside in materials, crude oil is holding up as well.

As crude holds up, the energy sector is severly oversold which generally points to a short term and potentially long term recovery. Bullish percent figures are in the single digits. Same goes for financials. There is the hearing about changing mark to market accounting, if that happens and they pass a measure to alter it this could spark a rally that signals the bottom in the market. The idea is balance sheets would virtually improve overnight. I think the upside potential warrants taking some risk and I will be doing so on monday. That obviously doesn't solve all the economic problems it merely masks them to an extent however I think the ensuing rally would be hard to re-trace again without a lot more negative news. Plus there is so much bad news already built in to these stocks the downside is limited if it doesn't pass.

Another place I am looking is China, it seems to be holding up much better than the US, as evidenced by the FXI, we are at new lows and the FXI is significantly off of its lows and this relative strength could continue.

In the short term I am bullish given the significant oversold level of the market shown by the McClellan Oscillator and the bottoming formations in some leading indicators like commodities and long term treasuries. We'll see what happens, either way have to manage risk and diversify.

A Glimmer of Hope?

Yesterday we had a fairly decent snap back rally in stocks. It came out that apparently bank CEO's and executives were buying their own common stock. This is bullish in that it is likely the CEO's would not buy 11 million dollars(in one case) of common stock if it was going to get wiped out and go to zero. I would assume they know something we don't, however it hasn't been the case so far as they have apparently been oblivious to all the write downs as well. Regardless, this is a fairly positive sign and was taken as a positive by the market.

In addition to insider buying, we had Apple release it's earnings and blow them away. They blew away earnings in arguably the hardest quarter ever to sell high priced products. This shows that people are still buying high end electronics if the quality is good and that the consumer is not totally dead. I would like to be long Apple on a pullback for the longer term portfolio, the only question mark now is Steve Jobs which really shouldn't impact the stock but does so I have to be cautious. I will start to look at the financial statements and do some analysis on cash flows and make a determination.

We have a couple more important earnings releases in MSFT and GOOG. MSFT disappointed and announced job layoffs. GOOG reports after the bell. My guess on Google is that they beat expectations simply because if people are staying at home more due to the economy, they are likely on their computers more giving them more revenue in ads and search. Just my hunch, they are hard to gauge without statistics.

We also had jobless claims and housing come out today both worse than expected. I would argue that new housing permits going down is a positive since we need to get rid of excess supply to have a chance of housing prices stabilizing and improving. Jobless claims higher than expected is definitely not a good thing and will be one of the key metrics moving forward. However, we have to look at the market reaction after another initial sell off the market has recovered a lot of the losses as of this writing. The more bad news that comes out and gets discounted and the more we hold the better is the case for a bullish bias. We are currently in deeply oversold levels so I would think a rally is coming at least back up to the 860 level in the S&P 500 would be my guess. If we get good news out of the Obama camp and some positives in earnings this could be the catalyst.

I currently have no positions, I only have a 1% gain overall for this month however that is compared to a nearly 8.5% decline in the S&P 500 so I am still having decent outperformance relative to the major averages as of late. My only position is long the Euro which is somewhat a long stock play. If stocks do rebound we will likely see the Euro move up, oil move up, dollar move down. Treasury yields have also made a higher low and exceeded their prior high which I would think is also bullish for stocks as people get out of the safety of treasuries. TBT could be one way to play this trend.

In general, we can't have a sustained rally without financials participating. The banks that have held up better and made smart aquisitions will likely be the leaders coming out of this. U.S. Bank still has positive earnings to report, although the street didn't like the results they have avoided the massive write downs of others and will likely be a great company to own going forward. Wells Fargo and JP Morgan also made some smart moves and could be good plays.

So far 800 has held on the S&P in the face of nasty news, combined with the oversold level in stocks it supports a short term rally however I don't want to get too aggressive, patience has been working very well as of late so I am going to wait for confirmation before making any moves. At some point the market has to start discounting a recovery but I don't think we are quite there yet, possibly around March I think we could see signs of improvement, but again I'll wait and see.

New Year, New Ideas

So as the new year rolls in I am trying to learn new things that I find interesting and that could help me become more profitable. I have still maintained my relative out performance as of late, in the past 3 trading sessions I have been +4%, 0, +1.5%, the thing that is annoying is that on the flat day, I would have outperformed by 1% had I not taken a losing day trade on the futures. But I can't be that upset, i limited my loss at 1% and it could have gone in my favor and given me even better performance.

I had the privilege of speaking with Eric Utley who is a day trader and one of the two guys who runs Trading Addicts along with Jeff Kohler. I always enjoy hearing about real world experience, even if it is just to hear that they too take losses and make mistakes. He seems to wait around A LOT for a trade but said that he has a win % of 70%. I would wait around all day too waiting for those types of entries, I just wish I knew exactly what he is looking for that is such a high probability to him. If I knew I was taking a trade with 70% probability I could easily be mentally prepared for a loss knowing it was a minority of the time.

So I ran into a friend who is also into trading and he told me about an automated trading program for forex. I have always had an interest in these programs but it seems like unless you are at a hedge fund like Renaissance Technologies your program likely doesn't work. So far this program I paid 139 for doesn't work at all, luckily I am only using it on a demo account so it isn't real money being lost but I did lose 139 in paying for it. Supposedly there is a 60 day money back guarantee so I'll just go that route.

But besides that it seems like you should be able to automate trading which could be very handy if you work a regular job and at the same time had a program making you money. I am on a forum that is dedicated to these programs and most the things I see I laugh at. They have so many indicators and lines all over the place which I don't use. All I use are support and resistance lines, VWAP and sometimes pivot levels. It seems like if you have a profit and loss system that has a positive expectancy and a fairly simple order entry you could make some money. Of course much smarter people than myself have likely thought that too. Apparently the winner of a programming competition that turned 10k into 130k in 3 months has phd's in math and physics and his programming is based on Neural Networks so I am fairly disadvantaged. However as I have watched these programs run on the demo accont most of their entries are down right stupid and are at places where I definitely would not have manually taken a trade.

My idea would be to use a simple system that detects a trend change intraday based on say a 1m or 5m trend then compare it to the 30m trend and only go in the way of the 30m trend. Or just do a system based on a daily chart and trade the changing trends. The other more complicated system that I have an idea for would be to detect flag formations on various time frames and then take a trade once it breaks one direction or the other. You can see this happen on charts decently often, if you could determine with decent accuracy a flag and a break and use a stop loss of less than your profit you could possibly have a long term profitable system.

For example, say it is forex, and you have a flag that is about 50 pips in height, generally this is a continuation pattern and a break signals a resumption of trend for at least the height of the flag. Lets say I think it generally continues for 2x the height of the flag and once it breaks the flag it should not re enter the pattern, so I give it a stop loss of say 10 pips and my target is 100 pips. That means I could be wrong and get stopped out 90% of the time and still make money. Of course if I got stopped out 90% of the time I'd want to see if I was getting a lot of false signals or if my stop loss was too tight, but the point is theorteically in the long run it should make money. If you were able to be correct and reach profit 30% of the time you would make 230 pips of profit every 10 trades, depending on lot size and frequency that could be a lot of money.

We'll see if I can program these ideas into reality because it seems like people much smarter than myself can't do it but I will learn a great deal in the process and who knows maybe I'll come up with something. ;-)

Relative Outperformance

From the end of November to December has been a much better time than the rest of November. I am still recovering from the very tough trading times from September-November but December has been an encouraging sign and something I hope to continue for the future.

From November 27th to now we are almost completely flat. In that time period however I have achieved about a 20% gain. That seems great, and it is relative to the index but still doesn't put me in the black unfortunately. There are some great lessons to learn. Staying hedged and scaling in and out of positions worked very well. Taking profits quickly was the better strategy during the volatility so it made trades only about a 1:2 risk to reward ratio but holding longer would have resulted in giving back the profit all together.

One example is Apple, I sold some Dec 90 puts and already owned some April 09 calls, the stock went up to 102, which should have been bullish but it ended up finishing at 100 unable to break 102. I sold my calls and bought back my puts at 102, which proved to be very good because the stock is now trading at 90 today for option expiration. This worked because others had the same mentality, people are looking for quick profits and are not fully convinced of any sustainable rally without seeing better economic data.

Buying at support and selling at resistance has been the name of the game so far. Patience is the other key that has been highlighted. If a certain stock gets away from you, let it go, it will pull back, or if not there are plenty others at lower risk entries to be able to manage. In this time I have gone with smaller position sizes as well.

Going forward I think in the short term if the S&P gets above 920 we will go to 975-1000 in short order. Until that happens I will stay fairly neutral. I am looking to get long the Euro as I missed the run from 1.26-1.47 which was frustrating that I didn't buy the breakout at 1.30, I wanted to wait for a retest but that never came. Again the good lesson here though is patience, had I bought in at 1.47 assuming it goes non stop I would have been killed as it has pulled back significantly to 1.39. My hope is that it flags here and finds support then continues and I will buy the continuation or low risk entry at support and start with a small position and add as it goes in my favor.

With all the things the government has done and with Obama coming into office I am hoping that will calm the market more and we have easier trends to follow, obviously it has already helped with the VIX collapsing lately(of course with expiration). I will wait till after expiration to make some moves with options since they are generally cheaper on monday following expiration.

I am keeping in the back of my mind that we could see a significant rally into year end as people try to improve their books and the market panics higher as people don't want to miss the move. We'll see what the market shows us.

EMH: Fact or Fiction?

As the impending doom of the CFA Level 1 test date approaches my review of the material has prompted me to talk about Efficient Market Hypothesis. In the texts they outline 3 scenarios, weak form EMH, Semi-strong form and Strong form EMH. It is humorous how the text essentially says if EMH holds then no single person can really earn above average returns on a risk adjusted basis. At the end it basically says there is conflicting information.

The odd thing to me is how it barely touches on market psychology and behavioral finance when I think that is the more relevant factor that drives markets. The amusing thing to me is when they compare fundamental analysis to technical analysis and how they seem to be mutually exclusive. I always take fundamental analysis to be the more "conservative" discipline however when it is examined more closely how conservative is it? In addition how much different is it to technical analysis? The reason I say that is because no matter what you are doing, either fundamental or technical analysis, it involves two things: speculation and confirmation.

In fundamental analysis, which is supposedly more conservative you are speculating about future earnings and future cash flows of a company and hoping past performance is repeatable. Then you wait for confirmation at earnings time, whether it has an upside suprise or a disappointment, then everyone scrambles to readjust their outlooks and price targets. Earnings is apparently the number one reason for stock appreciation. Analysts themselves are generally fairly poor at determining future earnings. Hell, I got much closer than most on my Apple estimates and I had yet to learn anything about future cash flow discounting, WACC, etc... I think also some studies have shown that analyst ratings are a 50/50 shot at best, which makes me wonder what they are doing. Some of that could be political or business reasons, which obviously shouldn't factor in.

I guess the point I am trying to make is that how can a market be efficient when it is supposedly being efficient based off of speculation and incorrect information in the first place. Yes, once news comes out it is fairly quickly adjusted to, but it is adjusted to again based on speculation and the psychology of investors and traders that push stocks up or down.

Technical analysis is not without its drawbacks either however I think now more than ever it has been shown to be more useful than fundamental analysis. Someone may have sworn that GE was a steal at 18.50(which has acted as long term support so that lends support to the argument). However, the bottom line is everything is driven by supply and demand, if that level no longer holds because demand is not there then clearly people don't think it's cheap or want to buy it. Forced selling and uncertainty about earnings threw any type of speculation on future earnings and "fundamentals" out the window. In that scenario all you can do is watch price and volume movement and wait for things to stop going down. Obviously once things do stop and there seems to be price stability either people now find that stock attractive to buy or new news came out to make them buy it. Either way it doesn't matter, what does matter is that you now see the demand there.

The above example also lends credence to behavioral finance or how market psychology effects things. An efficient market would never have bubbles and subsequent bursting of those bubbles. However the fact is that there are bubbles and they overshoot on the upside just like they do on the downside. Take oil for example, it got to nearly 150, now its down at 50, it's actual fundamental supply and demand is likely around 75, but again you have speculators trying to gauge how bad the recession will be and large hedge funds that were far too leveraged and overweight oil and had to get out. The Oracle of Omaha Warren Buffet thought GS was a screaming buy at 120, he must really have liked it at 55 too. The market is driven by fear and greed and you constantly see things get mispriced because the market is either too fearful or too greedy.

The last thing I want to ponder is the matter of self fulfilling prophecies. Whether it is a GS analyst saying oil will go to 150, or a price pattern, some things just seem like they just get the market to buy into it so it happens regardless if it "should". I was told a statistic(that I need to verify) that head and shoulder patterns complete close to 90% of the time. So even if I am going only off technicals I remain curious as to why the pattern forms and why if it does form should it automatically increase as high as its pattern past the neckline? I have to guess that some of it is just because people think it should do that, it does. Same thing with fibonacci retracements, IMO they have absolutely no basis for working because you can chose a high and low wherever you want and they may or may not line up with support and resistance, but if everyone uses them, they work. My opinion is that most traders use rules and price targets and possibly the lines themselves when trading so they appear to work.

Self fulfilling prophecies are again a market behavior and could be exploited for above average returns if they work. I have to assume they are for the most part self fulfilling because I don't think that as a stock confirms a price pattern like a head and shoulders all the analysts following the company immediately agree(or just before it happens agree) that the stock is under valued by the amount the stock "Should" increase according to the pattern.

Anyways, those are my thoughts. EMH is mostly fiction in my opinion, I wish I had a true way to profit from these opinions but sadly I am sure they are nothing new. What the CFA books did show is that to consistently earn above average risk adjusted returns you just have to trade off of inside information, no big deal LOL.