Archive for October, 2008

Everyone has been calling for a bottom all week.  As I have mentioned in prior posts, that is a very difficult game to play.  You know that you’re in a bear market when you look at the tape with the market down 250 points and you say to yourself, “not too bad”.  In a relative sense, that was fairly accurate this week.  Right now, it seems to me that it boils down to essentially two things. 1) unfreezing the credit markets and 2) getting the housing market in gear.  Ara  Hovnanian the CEO of HOV was on CNBC and talked about a long term capital gains tax credit to the tune of 15K and a 1.5% rate subsidy on home loans for buyers willing to venture into the housing market. I agree that we need to provide a short term incentive to get buyers into the game.  I know it’s more subsidy but I feel that it’s better than the alternative. The G7 summit is meeting this weekend to hopefully coordinate an effort to bring stability to the global credit markets.  I believe the bullish move the last ½ hour of trading today was short covering in anticipation of positive news coming out of that meeting.  No one wanted to be short ahead of those talks.

             From reports on Friday after market close it appears that the G7 is taking unprecedented action to stem the tide of the financial crisis.  According to reports, “they will be taking decisive action and using all available tools”

 

From a technical perspective, the DOW at 8000 should show some support.  The DOW formed a Hammer type candlestick pattern today (Friday).  It wasn’t classic but what that indicates is that the market closed well off of its lows on big volume.  That shows me that there are more bulls entering the fight at this level.  If 8000 does not hold, we could easily fall to 6500-7000 support from late 2002 and early 2003.  If the market interprets the decisions out of the G7 meeting as positive and the LIBOR spread decreases, we should see the credit markets open up and that would be very positive for the stock market.  If that happens, we could finally see some relief in the markets.  I am not sure that it will be sustainable, but we could have a positive move for much of the remainder of the year before losing momentum.  I see 2009 as sideways to down for the longer term.  Robin

The week began with the greatest single day point drop in Stock Market history.  WB was taken over by C (that later changed as WFC stepped in later in the week), however, the story of the day was the House not passing the bailout package with the DOW settling with a loss of 777 points.  Tuesday was “dead cat bounce day” as the DOW bounced back up on lower volume.  The credit markets remained frozen evidenced by record LIBOR rates.  The DOW finished up 485 points.  Wednesday saw ADP down and ISM with record lows.  Hope springs eternal as the market battled back to close only 19 points down in anticipation of the passage of a modified bailout package.  Thursday was down 348 points on the DOW despite the Senate passage of the bailout.  The day was shrouded by a host of bad economic data and sentiment that the package may be too little too late.  The SEC extended the short selling ban until midnight  on Wednesday October 8th.  Friday was all about the House vote on the reworked bailout bill.  The market was up handsomely early despite a pathetic non-farm payroll number.  When the dust settled and the bill passed, the DOW ended the day down 157 points.  Amidst all of the WFC stepped in to scoop up WB from C in a pre-market bid for the troubled bank.  The indexes didn’t do well this week with the DOW down 818 points, the SPX down 114 and the COMPQ down 236. 

We have to go back to July 2006 for support at 10173 and then the trading range of 9500-10000 from 2004-2006 and 9000-9500 from 1999-2002 which should be major support.  If those levels are broken, the next stop will be 8000.  We didn’t get the brief bullish pop I was expecting on the bailout vote.  I believe had the vote passed on the first attempt, we may have seen a small and unsustainable move to the upside.  As I have mentioned in previous posts, there are still major headwinds ahead.  I see a market that will go sideways to down over the next twelve months with brief periods when we will experience bear market rallys.  Watch support and resistance level and read how the market reacts at those levels.  I will give you my interpretation as it happens.  I anticipate the markets becoming more rational when the impact of the cash infusion hopefully takes effect.  I went to primarily cash with a few short plays before the meltdown so I fared well.  I will be back in when sanity returns. 

See INDU comments.  Support at 1086 from april 2005 and 1012 from August of 2004.  If those levels are broken, we have a free fall to 712-736 from 2002-3.  Strong resistance at 1252, 1278 and 1320.

Support at 1900 from July 2006, the 1832 form April 2005 and 1726 from August 2004.  Then all the way down to 1244 and 1054 from late 2002 and early 2003.  Moderate to strong resistance.

It does not matter if you know all there is to know about stock selection.  Strategy mastery is not the most important skill to possess.  You will be out of the game in short order if you can’t control your money. Money management is probably the most important skill a trader can have yet it is the most overlooked.  Last week we talked about ”The Power of Diversification” and the benefits of getting broader market exposure by not placing all of your eggs in one basket.  This week we’re talking about money management, the importance of position sizing and strategy diversification.

                The size of your account is a factor that will dictate how you will allocate funds.  It may sound counter intuitive, but it may be necessary to take more risk with a smaller account.  A $5000 account that is diversified and invests in a minimum of ten stocks at $500 a position will find it difficult to minimize the effect of the bid/ask spread and commissions.  This is known as “slippage”.  Although one needs to always be aware of slippage, it has less of an impact on larger accounts as a percentage of the portfolio.  Smaller accounts will return smaller absolute dollars even though the percentage return may be reasonable.  If you are generating a reasonable percentage return you must not be tempted to implement riskier strategies in order to achieve larger absolute dollar returns with a smaller amount of capital.  That type of thinking will lead to ruin.  Larger accounts have the luxury of more flexibility in strategy choices, position size and diversification.  Your risk tolerance will also play a role in the amount that you allocate to each trade as well as the strategy that is applied. It is necessary to master and implement strategies that you are comfortable with.  You should have strategies that can be applied to an up, down or sideways market.  The next important step is to define the goals for your account(s).  Your goals will dictate how you will trade the account.  You may be trading for monthly income in one account and capital appreciation in another.   A qualified account may be traded differently that a non-qualified account (IRA vs. regular account).  Retirement investing in an IRA may be approached more conservatively that a non retirement account and tax considerations may come into play.

                OK, with all of that said, what about money management.  The following are guidelines to keep in mind:

·         Diversify with multiple positions

·         Preserve capital

·         Don’t load up on one stock

·         Keep some powder dry/ cash reserve

Strategy diversification is important in my trading system.   The reason is that strategies have varying degrees of aggressiveness and not all are appropriate to apply based upon market conditions, risk tolerance and position sizing considerations.

·         I always keep 20-25% of my portfolio in cash for contingencies.  The remaining 75% is usually allocated as follows:

·         40% Collar trades

·         20% credit Spreads

·         10% Debit spreads

·         5% directional plays

Collars are very conservative as are credit spreads (the way that I do them).  Debit spreads are more aggressive and directional plays are high risk. 

If you use stops, you should factor your maximum risk for each trade.  I personally rarely use stops but rather, I hedge my positions with options.  I will risk no more that 2.5% of my entire portfolio on any one trade.  It’s important to understand that the amount of money traded per position is not the same as the risk amount.  If I had a $100,000 account and I bought 1000 shares of a $21 stock and in addition bought a strike 20 put for $1.50, my risk is $2.50.  (the difference between the $21 stock and the 20 put plus the cost of the put at $1.50 equals a $2.50 risk).  That would represent my maximum risk for this trade which is 2.5% of $100,000.  The risk in this example works but I have applied too much of my capital to this one trade which will not allow me to properly diversify.  My cost basis in this trade is $22,500 which is too overweighted on this one play leaving only a balance of $77,500 in my account to invest in other positions.  I hope you are grasping this concept because it will be the difference between success and failure.  Ok, that’s it for this week.  If any of you have have subjects that you would like for me to address just leave a comment here on this post.  See you next week.  Robin

ECONOMIC REPORTS

MONDAY 10/6

None

TUESDAY 10/7

FOMC Minutes, Consumer Credit

WEDNESDAY 10/8

Pending Home Sales

THURSDAY 10/9

Initial Claims, Wholesale Inventories

FRIDAY 10/10

Export Prices ex-ag, Import Prices ex-oil, Trade Balance

 

 

EARNINGS OF NOTE

MONDAY 10/6

None

TUESDAY 10/7

AA, SWY, ZZ, YUM

WEDNESDAY 10/8

COST, HELE, MON, RT

THURSDAY 10/9

CVX

FRIDAY 10/10

GE, INFY, NFLD

 

We are not out of the woods by a long shot.  As I have mentioned in previous posts, there may be continuing issues with consumer credit, commercial real estate and car loans.  The housing crisis is going to take a while to resolve as well.  Hedge funds could experience massive redemptions as they continue to underperform.  Those dollars leaving the market will create continued selling pressure and a falling market.    It seems like we are all trying to pick a bottom and the market isn’t ready.  We can never tell the market what to do, we just need to read the messages that it is sending and react appropriately.  From a technical perspective, I always determine probable targets based upon support and resistance levels.  I look for confluence and volume at those levels to gage whether or not those levels will hold.  Look for narrow range trading days as represented by DOJIs and Spinning Tops at those crucial levels.  When you see those candlestick signals at support and resistance, especially on diminished volume,  it is an indication that the move is running out of steam and an eminent reversal may be about to occur.  Well, what a week this has been.  One for the record books that’s for sure.  Stay alert and you will benefit nicely.  Bye for now.  Robin