Market Monkey

25th May

The headline on last week's column read "There are worse things than a few extra dollars".  True enough.  There are better things too though, namely a fistload of the same variety.  Monkey should have had a bucketload this week, with the market behaving just as he hoped it would.  Unfortunately, profits were of a more modest variety, and it's all because the habitual bad time-keeping of overfed medics and, eh, a little forgetfulness bordering on the criminal.

Let's backtrack a little.  Recently, I've been scaling into my Dow trades, starting with a small position and adding to short positions at successively higher intervals.  Unlike stocks, indices rarely go up in a straight line, so such a strategy tends to be a profitable one.  I had a few hairy moments a few weeks back during a period of marked market strength but the inevitable pullback followed and I ended up comfortably in profit.  As I mentioned last week, my plan was to do the exact same this time around.  I'd already shorted at 12,940 and planned on adding to my position at approximately 100 point intervals (to be specific, at 13,040 and 13,130, the latter being a point of obvious technical resistance).

Circumstances dictated that I would be away from my computer for a few hours on Monday - an appointment with the aforementioned overfed medic (I wouldn't refer to his weight only for the fact that he didn't appear until 3.30 - quite a lunch break indeed).  To cut a long and rather tedious story short, hours passed and the computer wasn't turned on until late in the trading day.  The Dow had been flying it in early trade, hitting 13,135, but had headed south as the afternoon passed.  That almost exactly coincided with last week's swing high of 13,132 - talk about technical analysis made easy.  I had an order in to short at 13,040 (or so I thought) but had never gotten around to placing the second order.

I logged off, irritated as hell.  That irritation was notched up a rung or two the next day when I discovered that I had not, in fact, even placed the order to short at 13,040.  Don't ask me how I got it into my head that the order was placed - sometimes, you can confuse thinking about an act with doing it (it's not the first time this has happened to me - sloppy monkey).  Either way, I had missed out on two perfect opportunities to add to my position.

What happened next?  The Dow took a 200 point hammering on Tuesday.  I was stopped out after lowering my stop to lock in some gains.  Wednesday was no different, with markets plunging after the minutes of the latest Fed meeting showed that rate cuts are done and the economy is in the crapper (not the exact words used).  After six up days in a row, the market had seen all its gains wiped out in just forty-eight hours.

Total profit, €258.  What should it have been?  That's hard to tell, although my calculations suggest somewhere between €1500 and €2000 - a nice week's work.  The plan was to scale out of the trade, taking profits along the way but allowing the trade time to work.

Cribbing aside, I'm just surprised that it's taken the market so long to get to this stage.  Over the last month, it's been shrugging off bad news as if it didn't matter.  At 13,130, the Dow was just 7 percent or so off its all-time high - that hardly suggests that traders were pricing in a recession or continued credit crunch woes or declining earnings.  Fundamental misgivings aside, the technicals were screaming out for a pullback for some time now.  Quite a few people I know have turned bullish recently, forgetting that some of the strongest rallies come in bear markets.  Despite an almighty effort by the bulls, the 200-day moving average held them off.  You don't need to be a technical guru to see that the smart thing to do with an overbought index struggling with long-term resistance is to get short.

In all, it's been a mixed week.  Like I said earlier, my profits should have been way, way bigger.  Not only did I not end up with a decent position size with my Dow short, my order to short Ebay just missed out.  The stock made it to $32.10, just shy of its 200-day average - I was looking to short around $32.40, with a tight stop above $33.50.  It fell below $30 on Wednesday.  The consolation is that my timing was good in both cases and that my balance is itching upward.

Weirdly enough, despite my long-held bearish misgivings, I'm currently long, having caught a falling knife by buying the Dow in late trading on Wednesday.  It's been a long time since I was long a US index but, with the Dow having cratered over 500 points in just a few days, and with its 50-day average at 12,600, I thought it was worth looking for a quick oversold bounce.  I don't see myself scaling into this one - I still feel pretty bearish in relation to the markets and wouldn't like to get saddled with a large long position heading southward.  Similarly, I don't plan on holding out for big profits and plan on closing the position in the near term.  I'm expecting a one or two day bounce, but not much more.

Rob Hanna's backtesting (www.quantifiableedges.com) leads him to a similar conclusion.  He tested strong markets that suffered big two-day losses and found that there's generally "a brief bounce that quickly peters out", going on to note that he's "not seeing anything that would lead me to believe there is a strong chance that the selloff has completely run its course".

Weekly profit/loss: +€186
Overall balance: €21,417

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18th May

Another day, another dollar.  Not a lot of them, unfortunately, but there are worse things than a slow upward grind.

I made a few quid on a day trading Dow short earlier on in the week.  It went my way pretty early on, forcing me to lower my stop to lock in some profits.  However, I tried to give it as much leeway as possible in the hope that the downside move would continue.  As it happened, the market enjoyed a minor bounce, just about touching my stop before reversing southwards - beastly. 

It's always a bit irritating when a well-placed stop is triggered like that.  Mine was placed above an intra-day resistance point.  It's always pretty easy to decipher where traders place their stops.  Most of the time, placing one's stop just above resistance or below support will do the trick.  Often, however, you'll get a 'head-fake', where a quick upside move triggers a host of stops and buy orders (that is, orders to buy that are triggered above a certain price), only for the prevailing trend to reassert itself.  That's what happened in my case.

The same thing happened on a larger scale on Wednesday.  Naïve traders who jump on every breakout are puzzled by such moves, but it's part and parcel of the game, as Mike Seneadza's account indicates (www.tradermike.net).  "The NASDAQ spent a good part of the day hovering right around its 200 day moving average before popping several points above it. But that turned out to be a head-fake when selling kicked in at 2:00." 

It's easy to get frustrated if you're on the wrong side of such trickery.  Too many traders say, 'I shouldn't have bothered with stops, I'd have made money if I just winged it'.  Of course, they're in deep trouble when they go down that road - when a breakout is for real, the ensuing move can be a big one and the mother of all losses inevitably awaits.

So how do you mitigate against such moves?  One option is to apply a time filter as well as a price filter to your trades.  As I mentioned last week, the Dow briefly popped above its 200 day moving average but failed to close the day above it, thereby keeping me in my position and preventing a pretty large loss.  If you're day trading, a similar filter can be applied, although it would obviously have to be a much shorter time frame.

There are other options.  It's always worth keeping an eye on other indices for confirmation of the move.  On Wednesday, for example, both the S&P and the Dow failed to take out their highs from the previous week.  Nor did they manage to pierce their 200-day averages.  The NASDAQ's move was a solitary one, which increased the odds of a false breakout.  Secondly, trading volumes were conspicuously low in early trading on Wednesday, which again didn't augur well for a sustainable breakout.  The late day break to the downside was accompanied by huge selling, however.  By keeping an eye out for such matters, you can guard against your stops being triggered.

Besides all that, I'd never have considered buying the NAS on Wednesday anyway - it's far too overbought (up well over 10% in the last month alone).  Buying strength and selling weakness can work well on individual momentum stocks or certain commodities but it's a different story with indices.  Buying a strong index that dips is all very well, but buying a heavily overbought index hitting new highs is a different matter altogether.  It doesn't work (I've seen detailed research on the matter, so that's a fact).

Going forward, I remain bearish.  I shorted the Dow on Wednesday.  It had risen over the previous days and after rising by more than 100 points on Wednesday, a short seemed in order.  It would have been nice if I waited a little longer - the Dow stopped just short of obvious resistance at 13,000, which also marked its 200-day average.  That would have offered a superb place to get short, but I wasn't sure it would make it that far so I took a smaller position at 12,940.  At the moment, I plan on adding to the position in a similar manner to my recent short (that is, scaling into the position at staged intervals).  If no upside occurs, so be it - my current position still offers potential for half-decent profits.

My reasons for being short haven't changed.  We're still in a bear market.  Bear market rallies can be strong, as the recent one has been, but the overall trend is to the downside.  With all the indices currently hovering around their 200-day averages, the obvious play is to the short side.  Also, Brett Steenbarger (www.traderfeed.blogspot.com) has been pointing out that the recent moves to price highs not been a broad-based one - "a limited number of sectors have accounted for essentially all the strength", leading him to conclude that he "cannot imagine the market sustaining a significant bull move on such a selective basis".  Rob Hanna, whose research at www.quantifiableedges.blogspot.com is among the best I've seen, adds that he has been "seeing more and more bearish signs" and changed his near-term outlook to a moderately bearish one this week (he had been leaning to the bullish side). 

Still, there are bullish indications too.  Steenbarger notes an expansion of stocks hitting new highs recently, which is something I'll have to keep a close eye on.   

In all, I'm not expecting a collapse any time soon.  Volatility has dropped off significantly of late and I don't see the markets relapsing into panic mode in the next few weeks.  In fact, I wouldn't be surprised to see a range-bound market, where the 'buy low, sell high' mantra applies.  Besides the Dow, I'm also looking at shorting EBay around $32-33.  A long or two might be in order if things get a bit skewed to the short side.

Weekly profit/loss; +€136
Overall balance; €21,231

11th May

It's been a bit wild, baby.  The figures show modest profits for the week, although it didn't feel that way.  After staring into the abyss, Mr. Market took mercy on me and whisked me away to safety at the last moment, helping my account value turn up by a couple of grand.

Ok, abyss is a bit strong - at my worst point this week, I was down €1400 or so - ugly, but hardly the abyss.  Still, with a large short position going against me, it was sweat-inducing stuff - each 1% move in the Dow would cost me well over a grand, so the prospect of an ugly, ugly loss loomed large. 

Like I said last week, I intended scaling into my Dow short at successively higher intervals and was prepared to risk much more than on an ordinary trade.  After months of risking 2-2.5% per trade, with little to show for it, I was ready to up the ante.  Hence, my battle cry at the end of last week's column - "bring it on, Mr. Market".

He certainly did that.  Like a king angered by the provocations of a lowly serf, Mr. Market decided to give poor old Monkey a painful beating before this column had even gone to press (like the Lord himself, Mr. Market is obviously omniscient - he didn't even have to read the column).

I'd shorted the Dow a few weeks ago at the 12,800 and the 12,900 levels, with orders to add to my position at 13,000 and 13,100.  Both orders were soon triggered and I was down by almost a grand and a half.  With each 100 point move in the Dow being worth €800, the prospect of bigger losses couldn't be ignored.  I was prepared to give the trade wiggle room but I didn't want to let things get completely out of hand, so I resolved to add to my position one more time (at 13,200) and place my stop for the entire position just above that final add-on.

Thankfully, it didn't come to that - the Dow topped out at 13,132.

It's gut-wrenching to watch, of course, but I had been confident of a turnaround.  Yes, I'd been wrong in my positioning over the last few weeks - despite being overbought, the bulls were still calling the shots and driving prices higher.  Still, the Dow was up against its 200-day moving average, the first time it had challenged that juncture in 2008.  People had to take profits at some stage and this was the obvious place to do so. 

It's not uncommon for obvious support or resistance levels to be pierced on an intra-day basis but closing decisively above them is a different matter.  That's what happened the Dow, which failed to close above the 200 DMA, despite surmounting that level earlier in the trading day.  It's all very well to place your stop loss order under or above a particular point, but sometimes, it can be worth applying a time filter as well.  In this case, giving the trade a little extra time made all the difference.

Monday turned out to be a down-trending day and I was in profit by Tuesday morning.  I resisted the instinctive but ignorant urge to close out the position - if you're going to use wide stops or take a lot of heat on a trade, then you can't sell out at the first hint of a profit.  The market went as low as 12,850 - having shorted at an average of 12,964, I was now up almost a grand and had seen a €2300 turnaround in just two days.  It was time to tighten up my stops and lock in some profits.  I was stopped out of half of my position soon after.  I kept a looser stop on my remaining position, as I was hoping for further downside.  Alas, it was not to be and I said farewell to my three-week old short. 

The selling resumed on Wednesday, with the Dow suffering a one-day decline of over 1% for the first time in a month.  Pity I missed it, as I'd be sitting on some damn nice profits.  No point crying over spilled milk, however.

Despite my relief, it's hard to argue that this was a successful trade.  I ended up making €500 or so - a modest amount, especially considering the risk I took on.  Not only that, I was up by the same amount just a week or two ago, meaning that all that nervous tension in the meantime was for nothing.  Sure, it was exciting, but I've said it many times - trade for the spondulicks, not the delirium and the exhilaration.

Still, it was a defensible trade.  It didn't yield big bucks, but it might have.  I do think that scaling into index trades is a viable and worthwhile strategy.  Towards the end, if I'm honest, I'd have to admit that I was beginning to average down on my position as opposed to scaling in - a bad business, but allowable if you're experienced enough and if you limit it to index trades.  As I said last week, indices are more receptive to overbought/oversold analysis than individual stocks.  A stock can go to the moon, rising or losing 50% or more in a matter of days, but an index like the Dow will rarely go up or down in a straight line.      

On another note, I finally managed to end the week above €21,000.  My account has surpassed that level on countless occasions this year, only to invariably retreat in the coming days.  No big deal, of course, but it was beginning to irritate me.  Modest as my gains have been, the trend is up over the last few months.  In January, I wrote that anything less than 50% in a year is unacceptable.  That view is unchanged; watch this space.   

Weekly profit/loss; +€376
Overall balance; €21,095

4th May

Question;  When can a small loss for the week be regarded as a good thing?
Answer: When a quick downside move in the Dow sees your account swing €800 to the good and keeps open the possibility of bagging a grand or two.

Trading the Dow hasn't been riveting of late.  Volatility has dropped off and traders were playing a game of 'wait and see' in the days leading up to Wednesday's Fed announcement.  We finally got some decent movement when the decision came through.  When it comes to Fed days, we always do.  It doesn't matter how predictable an announcement may be (everyone knew a quarter point cut was coming) - the market always goes la-la anyway, as if some earth-shattering bombshell has been detonated. 

Doubtless, students of such matters will point out that the market is more bothered about the accompanying Fed statement than the actual rate cut, that it is trying to parse and analyse the invariably cryptic wording, hence creating uncertainty and volatility.  Fair enough. 

Either way, only a true thicko has their stop loss order placed nearby in the immediate aftermath of Fed announcements.  With markets gyrating wildly in either direction, it's almost sure to be hit.  Many day traders avoid Fed day altogether - the opening hours tend to be dull and the closing hours absolutely lunatic.  It's not ideal.

Anyway, I'm not complaining about the late-day downside.  After shorting the Dow last week around 12,800, I added to my position a couple of days later when it surmounted 12,900.  That meant that each 100 point movement equated to a €400 swing, which afforded the possibility of some decent profits.  Unfortunately, the bulls have stubbornly held onto recent gains and intra-day movements have been minor.  At one stage, I was up just over €500 on the trade and at another (Fed day), I was down over €500.  In between, it's been slow.   

Regular readers might note a change in my money management practices.  Ordinarily, I'd bring my stop up to the breakeven mark once a trade has moved sufficiently in my favour.  This time around, I decided to play it different, to up the ante a little bit.  I said recently that I'd prefer to find additional trades rather than increase the size of my individual bets.  Thing is, stocks are in earnings season, which is severely limiting the opportunities available to technical trading monkeys.   

I want to make some decent cash.  There's nothing intrinsically interesting about stock charts - I follow the markets because I want to profit from them.  Hence, I decided to bet bigger and adapt my usual trade management methods.

At the time of writing, I have an order to add to my position if the Dow clears 13,000.  That came very close to triggering on Wednesday (it's a pity it didn't, as I'd be nicely in profit by now).  Essentially, my plan has been to add to my position in 100 point increments.  If you're going to make a bigger bet, you may as well do so by scaling into an index trade.  Indices rarely go up in a straight line, unlike stocks.  Just look at Apple - over the last six weeks, it's gone from $120 to $180 with barely a pause.  Indices are much more receptive to overbought/oversold analysis. 

That doesn't mean that the Dow has to head south.  I could be wrong and it might continue it's upward ascent.  Certainly, Wednesday's late-day downside isn't a cause for complacency.  Rob Hanna (www.quantifiable edges.blogspot.com) writes that "the fact that it (the S&P/Dow) was up 1% shortly after the announcement and then faded late left many traders with a bad taste."  Unfortunately for shorts, Hanna's analysis shows that "a strongly negative reaction to a Fed announcement has typically been followed by a very positive next two weeks"  just as positive reactions tend to be followed by market weakness.  No joy on that front then.

Still, the S&P has been unable to close above resistance at 1400.  Price has made a big 'V' move into this area and really needs to rest/ pull back at this stage.  Also, my old pal Brett Steenbarger points out that the rally has been getting narrower, with fewer stocks displaying decent momentum to the upside.  The number of stocks hitting 52-week highs has been falling, even as price continues to rise.  Besides, despite the recent bullishness, markets remain below their 200-day moving averages.  Some of the biggest rallies come in bear markets, remember that.  In time, they peter out and the bears resume control. 

As for the fundamentals, they're lousy.  Fundamentals aren't much good when at comes to forecasting short-term moves, of course.  I'd have no hesitation in going long if I thought the technicals supported the bullish viewpoint.  Methinks that's not the case, however.

If the market stages a decisive breakout in the coming days or weeks, I might have to revise my position.  I'm prepared to take additional heat on this trade, but not an unlimited amount.  If the market broke 13,000, I'd be down €600 - no problem.  If it hit 13,100, I'd be down €1200 - eh, not so nice.  If it went to 13,200, I'd be looking at paper losses in the region of two grand.  Another 100 points and…

That's enough for now.

The above calculations assume that I continue to add to a losing position.  I've warned against the likes on many occasions and don't advise newbies to try the likes, I really don't.  There's a very good chance I'd pull the plug on this trade before it got to that stage.  Thing is, after months of responsible trading, I think I've earned the right to bend the rules a little.  Like I say, it might never happen - I might take profits if the market moves in my favour, or pull out if things get too hairy.  Or I might not.  Bring it on, Mr. Market.

Weekly profit/loss; -€102
Overall balance; €20,719