Commentary – Page 49 – Ivanhoff Capital

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?

monthly-performance1

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.