Don't trust V-bottoms

 

We finally managed to have two positive back-to-back days for the benchmarks. There are many stocks that bounced from oversold levels, undeservingly so. They climbed to their 50-day MA, where they will find major resistance. Why? Because most of the investors in these stocks are under water and they will sell as the stock climbs, effectively killing its upside potential. Look for V-shaped bottoms. They are destined to fail. They represent an important occurrence in trading: there is often a significant short squeeze before next major leg down. A real, healthy bottom takes time to form. It takes months of sideways action in a relatively tight range. This is an indication of accumulation. Take a look at the fertilizer producer MOS. Between October and February it mostly moved in the 30-40 range. Since January, it gradually started to build higher lows until it decisively broke  above the $40 level. Every retracement was met with support at the 50-day MA. This is a healthy formation. I do not imply that this was the ultimate bottom for MOS. In this market, anything is possible. Just pointing out, how a sound bottom is usually formed.


Don’t rush all in after two positive days. We are still in a bear market and most likely things are going to get worse, before they get any better. How long is this rally going to continue is anyone’s guess. I’d say it has the potential to go until the beginning of next earnings’ season, when we’ll hit the hard, cold reality again. In the meantime, you could grow your portfolio by being extremely selective and patiently wait for the right set ups to form. You don’t have to trade every day to be profitable. 

Is that enough market weakness?

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A snapshot of the monthly performance of stocks priced above $2 and with average traded daily volume of over 100k

We haven’t seen that much weakness in the market since Mid November last year. 1226 stocks were down more than 20% for the last month. This is an incredible destruction of shareholders’ wealth. So many different industries were affected, that it would be more beneficial to mention those that so far have managed the storm – Agriculture chemicals, Internet providers, Gold, Food processors, Semiconductors, Sporting goods, Wireless communications.

92 stocks have declined more than 50% during the last month vs only 7 up more than 50%. I follow this ratio closely as the market tends to turn when it reaches extremes. It has been there for the last couple of days, but this market doesn’t care about it and daily rewrites the history of all oversold indicators. Many expect (hope) for a bounce tomorrow.( Including me).

Other than 2 quick day trades in $UAUA( one short, one long), I sat on my hands all week. I have a bullish bias for tomorrow just because if you read the news you’d tell yourself that things couldn’t get any worse. They could and this is why I am still not willing to hold a position over night. I prefer to protect capital and live to trade another day.

In times like this, it is always useful to remember Paul Tudor Jones words about market extremes:

There is no training – classroom or otherwise – that will prepare for trading the last third of a move, whether it’s the end of a bull market or the end of a bear market. There’s typically no logic to it; irrationality reigns over supreme, and no class can teach what to do during that brief, volatile reign. The only way to learn how to trade during the last, exquisite third of a move is to do it, or, more precisely, live it.

10 Essential Trading Words

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1. Simplicity – have a simple, well defined way to generate trading ideas. Have a simple approach towards the market. You can’t simply take everything into account when you try to make an educated decision. Filter the noise and focus on several key market components. For me, they are relative strength and earnings’ growth.

2. Common sense – create a trading system that is designed on the basis of proven trading anomaly. For example, trend following in different time frames.

3. Flexibility – be open to opportunities in both directions of the market. Be ready to get long and short.

4. Selectivity – chose only trades with the best risk/reward ratio; stocks with the best set ups; it doesn’t make sense to risk a dollar to make a dollar.

5. Don’t overtrade – two or three well planned trades in a week (month) might be more than enough to achieve your income goals. Patiently wait fot the right set up to form and offers good risk/reward ratio.

6. Exit strategy – Always, absolutelly always have an exit strategy before you initiate a trade. Know at which point the market is telling you that you are wrong and do not hesitate to cut your losses short immediatelly. Don’t be afraid or ashamed to take a trading loss. Everyone has them. Just make sure that you keep their size to a minimum.

7. Let’s profits run – one or two good trades might make your month. One or two good months might make your year. Letting profits run is as important as cutting losses short. Bigger winners will allow you the luxury to be right in less than half of the trades and still be profitable.

8. Consistency – Stick to your method of trading ideas’ generation.

9. Specialize – Specialize in one or two distinct setups. It could be a combination of technicals and fundamentals, certain timeframe or special event as a trading catalyst, certain sector or trading vehicle.

10. Have a plan – Which are stocks that you will be paying special attention to – this week, today. Why those stocks? In which direction you expect them to continue their move? What will give you a clue for the beginning of the move? Follow them exclusivelly and enter without a hesitation when they give you a signal. Don’t  just wake up and sit in front of your monitor without having a clue what are you going to trade today.

Fast moves: TRA

 

 

TRA doubled since December 08 and rose 63% for the last month, which automatically put it in my watch list. I follow closely stocks that make 50% up or down moves in a short time frame, for which I consider a month or 20 trading days. I use a liquidity filter (average daily volume above 100k) and price filter (above $2.00) in order to escape from worthless OTC stocks.

50% move in a month is unusual and there is always a strong catalyst behind it. If you understand the catalyst, then you have better chance to understand the sustainability of the move. Many traders will consider 50% move in 20 trading days insane and will blindly short. Not so fast. A good number of those stocks have strong wind behind their back and continue to rise. I have seen stocks that rise another 50 or more percent after the initial big move.

Such types of stocks move violently and it is not wise to risk more than 0.25% of your capital on them. Always use stops. If you don’t know where you will exit in case you are wrong about the move, you are very likely to fail. Know at what point you are wrong. Remember, if you use stops, you are already doing better that 90% of the traders out there.

Certainly many on the stocks that appear on my 50% moves list are bouncing from their bottom after prolonged downturn. Such bounces are usually fruit of short covering and they are not sustainable. As a result, such stocks find strong resistance as their approach their 200-day MA and provide excellent short opportunities. Watch carefully for first signs of weakening of the trend and distribution.

In the case of TRA, the stock’s fast price appreciation was driven by a takeover bid in December. Last week it reported much better than expected earnings due to strong sales, which might add more fuel to its rocket. Last Tuesday it looked that the market was expecting this report and sold off the morning earnings’ gap. As a whole the first half of last week was charackterized by weakness in the fertilizer’s industry, which was likely the main factor that sent TRA from 25 to 22, later Wednesday afternoon. The stock managed to recover most of the move in Thursday. Friday, there was sideways action on much less than the average traded volume.

As a whole, the stock has been showing some signs of distribution lately and I would not get long before it manages for clear out 25.50 on strong general market. If you try to go against the trend and short TRA, good entry would be below 24.40 with a stop at 25.30. Target is 22.00. In this case, you will risk 90 cents to make 2.40, which is almost 3:1 reward to risk ratio. It is not the best risk/reward ratio, since the stop is relatively wide: about 3.7% of the stock price.Still  3:1 is better that 1:1. It doesn’t really makes sense to risk a dollar per share in order to make a dollar per share. Such type of thinking won’t get you very far. Your goal is to be immensely profitable, when you are right and to lose a tiny part of your capital when your are wrong. Remember, many of the best traders out there are right only half of the time and often even less than that.

 Risk 0.25% of your capital. If it is 100k, you will risk $250 on that trade. 250 divided by 0.90 will give you approximately 280 shares. 280 shares * 24.40 means that this trade will engage $6832 of your trading capital.

I will try to update several times a week with new trading ideas from stocks that have appeared in my “fast moves” watch list.

Have a great trading week

A smarter way to use leveraged ETFs

Double and triple leveraged ETFs were constructed to serve mainly as short-term trading vehicles. The reason behind is that they reflect the daily change in the underlying index (or basket of stocks).

Let assume that a triple bullish ETFs is promoted at the market with a starting price of $100. If the price of the underlying index goes up 10% for the day, the price of our leveraged beast will rise to 130 (3 x 10% x $100). If, on the very next day, the price of the underlying index drops 10%, the triple levered ETF should drop by 30% x 130 and to trade at 91 by the end of the day. The net result from those two trading days is 1% drop for the underlying index and 9% drop for the triple levered one. It is a simple mathematical rule. 10% drop in a price is recovered by 11.11% rise and 10% rise in price is erased by 9.09 drop. The levered ETFs are computed in a way that you might greatly benefit by this mathematical rule during certain market conditions.

November 2008 was the birthday month of triple leveraged ETFs. Two of the first were TZA and TNA, which were supposed to reflect 3 times the daily change in Russel 2000. They were both promoted at a price around $60 per share. Let assume that you were aware of the above mentioned mathematical rule and decided to short 50,000 worth of TZA and 50,000 worth of TNA in order to hedge your position. The net results is that you are short 834 shares of TZA and short 834 shares of TNA. Three and a half months later, the triple bearish TZA is traded at $56 and the triple bullish TNA is traded at 25. You decide to cover your short positions and in TZA you make $4 per share or $3,336 for the position; in TNA you make $35 per share or $29,190 for the whole position. The net result is $ 32,526 gain or 32.52% for 3.5 months. For the same period Russel 2000 is down about 16%.

This strategy provides best results and is safer to be used in range-bound markets, since more often retracements to a moving average will have higher depreciating effect on both levered ETFs. During periods of strong trending markets, the strategy could be detrimental for your portfolio if you don’t have percentage stops in place. Nothing goes straight up or down, but there are always exclusions and you should consider them in your risk management models. Chose levered ETFs that are well diversified, representing various sectors.