Market Monkey

July 27th

A few weeks ago, I mentioned that short selling is at record levels and any "half-decent bit of news could see a bout of short-covering".  With earnings season upon us and the market "expecting things to be lousy…any upside surprises might spark some buying".

That turned out to be an understatement.  Financials have been on fire since Wells Fargo produced better than expected results last week.  Add in a plummeting oil price and the market turnaround is complete, with traders pushing prices higher for the first time in weeks.

Unless you're short, that's good news.

I'm short.

The last few months have made for damn frustrating trading for this poor monkey.  Broadly speaking, my market calls have been right but I've been early in my timing.  When the market was flying higher in May, I was making the bearish case and scaling into shorts.  I eventually got stopped out for small profits just as the market turned around and went dramatically south without me.  With the Dow dropping like a stone and every quantitative and technical indicator suggesting a near-term bounce was imminent, I started nibbling on the long side.  I took three long Dow bets in a matter of weeks, with all offering early profits before fizzling out as shorts drove the market lower.

I got sick of bottom-fishing, as I'm sure many others did.  Quant trader Rob Hanna (www.quantifiable edges.com) mentioned last month a couple of mechanical bottom-fishing strategies that had produced a 100% winning ratio over the last 15 years or so.  That record was lost in July as the market kept going lower.  With the market refusing to behave, I decided it was safer to short any bounce rather than pick a bottom. 

Pity.  With the Dow rising by over 800 points in little over a week, I'd be sitting pretty now. 

Instead, I'm short, having scaled into an position at an average price of 11,497.   I wish I'd waited a while longer before going short - the market has shown a real character change over the last week.  On Tuesday, for example, indices were due to open almost 1% lower after Apple tumbled 10% in after-hours trading on account of disappointing earnings guidance and American Express and Wachovia weighed in with further earnings misses.  That meant I was up 400 or so and looking good for more.  I should have brought my stop up to break-even at that stage.   Instead, the market turned around and finished strongly higher.  By Wednesday, I was down almost a grand on the trade, bringing my account balance well below 20k and in the red for the year.  Not nice, not nice at all.

The Dow pulled back from there but I'm feeling pretty iffy about this trade and am tempted to exit if a chance appears.  Sure, I'd be shocked if this was anything other than a bear market rally.  The credit crisis is far from over and the US economy is likely to get a lot worse before it gets better.  Still, that doesn't mean that the Dow isn't capable of going much higher in the near-term.  The March lows are around 11,750.  The next obvious resistance area is around 12,000 (50-day average).  With a position worth almost 60,000 - more if I continued to add - any such rise would be nausea-inducing. 

A number of things are bothering me.  One, the market rallying in the face of bad news.  Two, the V-shaped bottom carved out by the financial sector and the huge volume accompanying the move.  I was expecting an oversold bounce but this one has been absolutely fierce and strongly suggests that the recent lows mark an intermediate-term bottom.   Three, despite tumbling in price, some technical measures suggest oil is not even oversold yet and may be headed for further falls in the coming weeks.  Good for equities, bad for Monkey.  Finally, the biggest rallies can come in bear markets and with short interest still at elevated levels, this one might have more gas in the tank.  It would have made more sense to start scaling into shorts around the 11,700 level.   

Of course, fear is a stronger emotion than greed and it's possible that I'm focusing too much on the dodgy aspects.  Still, this trade has tickled my insides more than I'd have liked.  One to watch.       

Weekly profit/loss: -€402
Overall balance: €20,163

July 20th

"Wild day in the markets as the DJIA turned around a few times closing down 100 with a 300 point range".  That's how one trader and blogger (www.dayshark.blogspot.com) described the action on a particular day recently.  Instead of updating his blog on a daily basis, he'd have been as well off cutting and pasting from the above sentence every day.  It's been pretty wild alright, and choppy as hell. 

On Thursday of the previous week, we see the Dow plunge 200 points late in the closing day only to regain 150 points in the last hour of trading.  The following day sees the Dow sink almost 300 points lower than the previous day's close ('the world's coming to an end!', traders cry) before regaining almost all of those losses in a couple of hours ('no, it's not!').  If that's not mad enough for you, the Dow then sinks almost 200 points ('uh, looks like it is coming to an end after all') in the closing stages of the session.

Monday morning, markets open higher on news that the government is about to prop up Fannie Mae and Freddie Mac.  Yippee!  To the moon, baby! 

Well, not really - Jim Rogers tells Bloomberg Television that the plan is an "unmitigated disaster" and he's not covering his shorts, no sirree.  The market decides things aren't so sunny after all and the Dow promptly drops over 200 points in the morning to briefly pierce the 11,000 level before bouncing after lunch to close above 11,100.  Manic as the Dow's action is, it's an oasis of calm compared to the financial sector, which experiences its worst one-day decline since 1989.  Fannie Mae, which opens 30% higher and peaks at $13.50, ends the day in the red.

Tuesday morning sees the banks get hammered once more.  Fannie heads down to $7.  The Dow says farewell to 11,000 in prompt fashion, heading quickly down to 10,800.  Longs are getting creamed, shorts are kicking butt.  Then the price of oil starts to fall precipitously.  No-one's quite sure why but traders don't care and pile back into equities, sending the Dow 300 points higher and back above 11,100.  Shorts are getting creamed and longs are kicking butt.

Until the last hour of trading when the Dow sinks 200 points.  Now longs are getting creamed and shorts are kicking butt.  Again.

Wednesday morning.  The Dow dips in early trade before bouncing at 10,900.  It goes on to bounce 300 points off its low and financial shares enjoy their biggest gain ever.  Shorts are getting - well, you get the picture. 

Volatility is good for trading, but it's nice if there's some rhyme or reason to the action.  When day trading, I like to short bounces to resistance and buy pullbacks to support.  That doesn't work when trading is as chaotic as it's been this week. 

Two trades, two losers.  The first looked like a great entry as I shorted what I took to be a dead cat bounce on an obvious downtrend day for the Dow.  I was up a few quid and left my screen for twenty minutes, coming back to find that the market had blown right through my stop and way beyond.  'Flip me', I said, or words to that effect, 'what the hell has happened?'  Turns out that a rumour was doing the rounds that the Fed was ready to provide a rescue package for Fannie and Freddie.  Even worse, the Fed wouldn't comment on the rumour and the Dow later surrendered most of its gains (of course, the rumour turned out  to be true in the end).  Too late for old Monkey. 

A similar trade a couple of days later.  Monkey shorts a bounce only to get blown away from the very beginning.  I was at my screen this time and went into damage-limitation mode, placing a limit order to sell if price came back near my original entry.  It did and I got away with a tiny loss.  I steered clear after that because I just couldn't get a handle on the action.

Where do we go from here?  My opinion is unchanged - irrespective of the awful headlines, we're overdue a decent bounce but that bounce should be shorted.  In the meantime, there should be plenty day trading opportunities from both the long and the short side - just don't expect it to be all plain sailing.

Weekly profit/loss: -€326
Overall balance: €20,565

July 13th

The banks are being slaughtered.  Markets are falling all across the globe, with the ISEQ in absolute freefall as it drops by 8% in a matter of days.

Just another standard week in the stock market then.

We're used to the selling at this stage.  In the US, the media has been droning on about how 'the bear is back', with the S&P and the Dow having officially crossed into bear market territory over the last week (a fall of 20% from peak to trough).   What did they think had been going on over the previous months?  Any donkey would know that global markets long ago crossed the threshold from 'correction' to 'bear market'.  There's an old saying that bull markets have no resistance and bear markets have no support and we've been seeing that for some time now, as traders fail to be tempted by lower prices.  Still, the extent of the recent selling has been notable.  As trader and blogger Rob Hanna puts it, the "recent downtrend has shown persistence to a degree rarely seen since the 70's."  That might puzzle readers who note that markets have dropped by just 20% so far, a far cry from the 50% drop seen during the 2000-2002 bear market.  Back then though, we got sharp reversals and snapback rallies.  Even weak markets are meant to bounce on occasion. 

Not this time.  Rallies are lasting a day but no longer.  Despite my bearishness, I've been expecting some sort of bounce and was hoping to nibble on the long side this week.  I didn't bother.  After being stopped out of last week's long bet (small profit overall), I stayed on the sidelines.  Like the aforementioned Hanna, Brett Steenbarger (traderfeed.blogspot.com) is a fine quantitative analyst and his recent posts convinced me to steer clear of longs for now.  Despite being "at oversold levels that have been associated with market rallies", the Doc points out that "we're seeing an expansion in the number of stocks making fresh 52-week lows" and have had "more stocks making 20-day lows than 20-day highs for 20 consecutive sessions."  When markets bottom, you tend to see divergences and a "narrowing of participation to the downside".  Instead, the opposite has occurred.  Worse, we've had "a grinding decline rather than a sharp panic".  Polls of retail investors shows bearishness but no headlong, paniced rush to the exits (Steenbarger points out that such polls tend to show pessimistic spikes at market bottoms).  Equity put/call ratios are similar. 

Market action on Tuesday and Wednesday was reflective of the current environment.  I wrote last week that "short interest is at record levels so any half-decent bit of news could see a bout of short-covering".  On Tuesday, oil fell by almost 4% and Ben Bernanke reassured investors that the Fed remains committed to financial stability and might continue emergency lending to banks through 2009.  That paved the way for a rally of sorts, but a muted one (the Dow gained 152 points).  Some shorts might have taken profits, but most were greedy for more.  The next day saw no follow-through, with the Dow failing to get past minor resistance at 11,400.  That emboldened the shorts once more and the market sold off heavily in the afternoon, with the Dow losing 236 points.  Note that there was no major earnings or economic news.   Markets are meant to bottom when they fail to drop on bad news.  Dropping on a no-news day certainly isn't a good sign.

We're heading into earnings season, which might offer some hope to beleaguered longs.  Clearly, the market is expecting things to be lousy, so any upside surprises might spark some buying.  Still, it's probably best not to hang around in such trades.  Take profits promptly and use any rallies to refuel on the short side.  Over the last few weeks, I've taken three long bets that have offered early profits.  They quickly fizzled out.  Methinks the market is telling me not to hold out for top dollar in such cases.  If short, let your profits run.  If long, take your profits and skedaddle. 

Weekly profit/loss: -€51

Overall balance: €20,891

July 6th

You've got to be impressed by the bears.   Every time you think a bounce is coming, they re-emerge, pounding equities into the ground.  It's not pretty if you're a long-term investor (not me), and it's damn annoying if you're a short-term long who keeps seeing his profits disappear (eh, me) but it's impressive nonetheless.

Markets have been really slapped around over the last few weeks, frustrating several well-timed long entries on my part.  A few weeks ago, I scaled into a Dow position at an average of 12,180, saw it promptly rise to12,350 before the grizzlies roared and stopped me out below 12,000 - a 1500 turnaround that had old Monkey fuming. 

Days later, another technical buying signal flashed as the Dow traded down to 11,750 .  Within hours, we were up to 11,900, I was up a modest 300 and hoping for some more.  It didn't happen and I had to settle for some small change in profits as the bulls ran for cover once more.  A massive fall followed, with the Dow losing over 350 points in a single day and the Nasdaq dropping a full 4%.  I wasn't so dumb as to go bottom-fishing that day.  In fact, I'd have made a mint if I'd been able to trade that day (we won't go into the details on that score).  Strong trending days, whether to the upside or the downside, are the easiest days to make a day-trading bundle.  It broke my heart to look at the intra-day charts after the event, with several low-risk/high reward short trades presenting themselves.

Anyway, I went long on Tuesday with the Dow trading at 11,180.  That was pretty much the bottom that day, a hugely volatile day that saw the markets swing all over the place before ending the day at 11,380.  I sold half here and brought my stop up to breakeven - there was some minor technical resistance at 11,400.  Besides, I was tired of giving up my profits and was pretty eager to book some gains.  Still, I was expecting a further rise - Tuesday's action looked like a near-term bottom to me. 

Briefing.com's Scott Smith thought similar but added some words of caution.  "When you get a key reversal day like we just had, if the action can't show signs of a continuation higher and holding strong by midday, it often will wind up failing during the afternoon as a) longs give up hope and b) sellers regain control."  That's what happened as markets sold off late on Wednesday.  I'm still in the trade - just - but am more than a little irked that my profits have halved, yet again.

The S&P and the Dow have now closed below their 10-day moving averages for 20 days in a row.  The financial sell-off has been twice as long, with two bank ETFs closing below the same level for 40 days in a row.  Rob Hanna (www.quantifiableedges.com) says that he has been "unable to find any other ETF that has ever traded below its 10-day moving average for 40 days...the persistency of this sell-off is quite incredible."

Indeed it is.  I think a bounce is probably near, but we might see some fearsome selling in the meantime.  Wednesday's sell-off suggests that the shorts aren't finished yet.  Volatility is picking up and we might need to see a capitulation day to wring out the remaining longs.  I notice that Barry Ritholtz's research firm (www.bigpicture.typepad.com) is expecting "a bounce, similar to January, only not as strong or long-lasting."  Ritholtz tends to be very bearish so that's quite a notable call.  Short interest is at record levels so any half-decent bit of news could see a bout of short-covering.  We saw that on Tuesday after General Motors produced awful figures that were not quite as awful as some had feared, prompting the market's late rally (it all fizzled out the next day, of course).

Anyway, I'll likely be looking for long entries over the next week but I'll be picky about it.  Like I say, I wouldn't be surprised to see a wash-out day pretty soon.  Any bounce is unlikely to be a long-term one.  This is a bear market, no doubt about that, so traders will be looking to sell the rallies.