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Let’s Talk Strategy

@ 11:18 am

“it is utterly useless for us on the outside, who buy and sell comparatively small blocks of stock, to conjecture about what “they” are doing.   We cannot know what the insiders intend to do, but we can see their orders on the tape when they execute them.   That is why my plea is for everyone of us to have no mere opinions of his own, but to allow the actions of the market to tell him what is passing.”
(Humphrey B. Neill, Tape Reading & Market Tactics, 1931, New York: B.C. Forbes Publishing Company; 14th printing, 2003, Vermont: Fraser Publishing Company)

When Nicolas Darvas was interviewed by Time Magazine in the early 60’s and it came out that he made almost 2 million dollars in the market in 18 months (while he was dancing around the world!), he noted that he read and reread Neill’s book (along with Gerald Loeb’s).   Neill’s book has been reprinted many times and I happened to find it on the shelf of my local Barnes and Noble store.   Neill dedicates his book, “to my losses, with a deep appreciation for the experience and knowledge which each loss has brought me.”

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The 10,000 Bounce

@ 11:27 pm

"Just when you think you have the key to the market, someone changes the locks."

So Dow 10,000 held.  This number means so much to people that had it simply given way quickly, we probably would have been hit with a climactic sell-off that would have ended the decline.  But we did not.  The Dow had fallen from 10,507.97 to 10012.36 in only 6 days.  Does a 200 point rally nullify a 500 point decline?  Is this a bottom? 

To me, little has changed. The market is still in a down trend.  The Dow would have to close 300 points higher for me to start to consider the bull case. Yes, even in spite of Yahoo and Google, the exceptions that prove the rule. I did not stop out of MHS, my lone holding, today.  The  new high index I described yesterday climbed from 12 to 28, still a paltry number of stocks that traded at new highs 10 days ago and closed higher today than 10 days ago.  After earnings season is over there will likely be a lull during which traders will focus again on inflation, recession, deficits and the Fed.

I have been using the term bear market–and this habit is dangerous.  It is much safer to say that the market is in a down trend.  Once I choose to use terms like bull or bear market it influences my judgment and it leads to predictions.  For example, if one labels the market as a bear it implies that it should last a certain amount of time that bear markets typically last and end in a certain way.  One tends to marry a scenario.  I may hang onto this scenario in order to be right (ego again).  Ever get so attached to a story  that you can’t observe what is actually happening?  It happens all of the time in the market.  People say things like, we should have a consolidation period followed by a rise or fall,or the market needs to rest.  The talking heads do this every day when they pontificate about what should unfold.  (So did I, when I said above that the market will enter a lull post-earnings.)

But I try not to predict.  I analyze the current market trend.  Are we rising, declining or stable or is it impossible to discern.    Right now, I believe  the trend is still down.   I never know how long the trend will last.  When my rules and indicators suggest a turn, I can turn on a dime and slowly wade back into the market on the long side. There is plenty of time to catch the real rockets after they have left the launch pad.  More on strategy this weekend.

Please continue to send me your questions and comments.  I value your support.

STOP THIS MADNESS

@ 11:23 pm

I exited the market in the fall of 2000.  I became incensed  as the NASDAQ was falling over the next 2 years and the media pundits were telling  us to buy and hold and to go after the bargains.  Day after day they were wrong and yet people continued to listen to them.  I remember one adviser who recommended Exodus Communications when it was down to 65 from the 80’s, and continued  praising its virtues all the way down until the company was finally de-listed.  And yet this person had the nerve to come back each week and opine on the market and to offer his picks.  The tragedy was that many persons lost their savings and their plans for early retirement. 

So has anything changed since then?  Today, in spite of the strong downtrend in the general market, the media gurus of the day are looking for safe stocks to buy–the few defensive stocks that will hold up.  Maybe they would lose their audience if they came out and told people to sell their stocks and stay in cash, never mind sell short.  They just keep telling us to look for the safe stocks–the needle in the haystack. But the bear devours everything before it is through.  Why do they insist on fighting the trend?  I certainly will not–the decline continues.  Over the years I have noticed that the market seers do not declare a bull or bear market until about 6 months after it has begun.  The NASDAQ topped out in January and the DOW in March.  When will we hear the first declaration of a bear market from the talking heads?  Stop this Madness.

My short positions made money today.  The housing stocks continue to crack.  This is probably just the beginning.  My lone long, MHS, did not hold up well today.  I may be stopped out tomorrow.  Over and over, I learn that to fight the trend is folly.  Don’t buy stocks now–any stocks.  I am mainly short and in cash.  Nothing feels better than to be in synch with the trend.

My primary trading strategy is to buy growth stocks trading at or near new highs.  I rode Yahoo up 100 points on two occasions and sold out above 400.  I buy high and sell higher.  But a hard lesson to learn is that the strategy that does beautifully in a bull market fails miserably in a bear market.  (Check out the book by Nicolas Darvas, How I made………, for a nice description of this phenomenon.) A good indication that things are souring is when the types of trades I have been profiting from suddenly produce a string of losses.

There are several other indicators that tell me when my growth stock strategy is unlikely to work.  First of all, if there are not at least 100 stocks on the NYSE or NASDAQ that are making new 52 week highs, the market is not strong enough.  These days, new lows are more common than new highs–a very bad sign.  Second, IBD (Investor’s Business Daily) publishes a chart each day of  the IBD mutual fund index.  This index tracks the performance of 23 growth mutual funds.  I have found that if this index is below its 50 day moving average, then I cannot make money trading growth stocks.  In other words, if the pros running these funds cannot make money I will not.  These managers are the ones who drive these growth stocks higher with their huge resources.  Currently, the IBD index is below its 50 day average and even in jeopardy of penetrating its 200 day average.  (The 50 day moving average is simply the average of all closing prices during the past 50 days.  It changes or moves each day as a new close is added and the oldest close is dropped.)  As of Wednesday, the index was down 6.15% for the year. In this climate do we really want to risk our money buying growth stocks?

I have also used TC2005 (go to Worden.com to learn about this impressive charting program) to compute a new index of the strength of stocks that are hitting new  highs.  I scan each of the 4,000 stocks in my stock universe (active stocks trading above $5) and count the number of stocks that hit a new 52 week high 10 days ago that have closed today higher than they closed 10 days ago when they hit the new high.  If stocks that hit new highs cannot continue rising, the future for new highs is bleak.  When I first computed this index in March, I found that over 100 stocks met these criteria.  Today, there were only 12 stocks out of 4,000 that hit a new high 10 days ago and closed higher today than 10 days ago.  With odds of 12/4000, why would anyone seek to buy stocks that are hitting new highs with the expectation of seeing them climb higher? I will continue to compute this index and report on any significant changes.

Before I close, let me share with you my thoughts about another ploy for scaring people from getting out of the market.  Ever read those analyses that say that if you were out of the market during the "X"  days of biggest gains, you would have missed most of the bull market move.  I think most people accept this logic at face value.  But I think it is absurd.  For example, say the market climbs 100 points in one day and you were out of the market.  The market could decline and retrace much of that move  on the subsequent days or weeks, when you could have bought in.  You did not necessarily lose the full 100 points.  Furthermore, given that we cannot predict the market’s daily moves, who in  the world would be so unlucky so as to miss all or most of the days of big moves?  I stay out of the market during times like these or go short.  There is always time to catch a genuine bull move.  Am I missing something here?

Send me your comments and questions. 

Extraordinary response–thank you!

@ 12:15 am

The response to my first two posts has been unexpected and welcome.  Thanks to a link from a most valuable investing blog (www.thekirkreport.com), I received over 1400 hits Tuesday.  Some emails/comments asked for more trading details.  That will come as I become accustomed to this medium.

I have found that the daily news breaks cause only minor effects on the market– temporary deviations from the market’s trend.   So I do not pay much attention to tonight’s earnings announcements from INTC and YHOO.  Yes, we may get more of a bounce in the techs, but still within a solid downtrend.  A 56 point rise after a 400+ point drop in the Dow is quite puny and reflects a sick market.  The DOW could rise another 300 points and still not break the downtrend.  The NASDAQ composite would have to rise to 2,000 before I would begin to question the bear trend. 

After the market confirms a real turn, there is plenty of time to get on board with buys.  We are interested in a trend that lasts months not days.  I don’t let the pundits scare me into the market prematurely–there is plenty of time to ride a real bull. The successful traders say there is a time to be out of the market–why trade long before the market meets my conditions for maximum success.  Real bottoms typically take time to form with at least one re-test of the lows.

So, right now I am sitting with puts in stocks in housing, auto-related, employment related and mortgage related industries.  My puts are good through June or beyond, so I can wait for the decline to resume.  (I buy deep in the money puts so there is little time premium to pay, but more risk.)

XMSR is looking sick to me—maybe the decline in car sales will hurt their subscription growth.  I originally bought XMSR when it was $2/share and traded it several times.  The company still has no earnings. (I don’t have a position in it now.)

Because I swim with the tide, I should own no stocks now.  However, I could not resist nibbling on a drug store stock (MHS) that has been hitting new highs. I think new medicare prescription benefits will take effect early next year.  Perhaps MHS and LDG are benefiting from this.  I set a close stop one point below my purchase price–I know the odds against a long profitable rise are against me.  In a weak market traders take profits quickly, thus truncating the rise.

I have no reluctance to take quick small losses.  I make a purchase and set a sell stop and forget it–take the emotion out of it.  Every loss brings me to the next gain.  It took me 30 years to get to this point.  Trading is about making money not being right.  A big ego gets in the way of successful trading.  More on all of this later.

Thanks for listening.

Put me on, IRA

@ 10:46 pm

Well, the market didn’t collapse today.  So what. Did you really think it would just tank like it did in 1987?    Most people hope it is over, and think that a further decline is not justified by the state of business, and especially, with all the bargains that have now materialized. However, the market always goes further than everyone thinks is justified–up or down.    This bear has plenty of time to smell the roses before it hibernates again.  It will take its own time.  Especially ominous–the short term interest rate index I follow jumped today–as much as it did when this rise in rates began in the first week of January.  Is something going to convince the Fed to become more aggressive?  Stay tuned.

Experienced traders do not care which way the market goes, as long as it moves in a trend.  Do you really believe the old adage, "Don’t sell America short?"  While the market spends most of the time going up, when we can buy stocks, why not profit in those periods of decline, when we can sell stocks short?  A good bear lasts 10 or more months and prices decline quicker than they go up–fear is quite a motivator. Why play only one side of the game.

Selling short scares people.  You ask your broker to borrow someone elses shares so you can sell them at the  current price.  He puts the proceeds in your account, but you can’t touch the money until you give back the shares you borrowed. When the stock falls, you buy the shares back at the lower price and give them back to the broker. You, however, get to keep the difference between the price you first sold the shares at and the subsequent buy back price (sell short at 80, buy back at 70–you make $10/share). What scares everyone is the idea that if the stock rises, you have to buy it back at a higher price and the price could theoretically go to a gazillion.  However, when you own a stock, the most it can fall is to zero.

Now, this fear of an infinite loss from a short sale is unrealistic.  When you buy a stock at, say 50, you place a stop order to  automatically sell your shares and "stop your loss" at an acceptable price, say 48.  If the stock falls to 48 you get sold out and take your loss.  You just reverse this for stocks you have sold short.  Sell short at 50, place a stop order to buy if the stock rises to 52.  Either way you have a strategy in place to limit your losses.  (Note, if the stock gaps up or down–jumps up or down in price and skips over your stop price–you may have a larger loss than your stop order would indicate.)

Now, to sell short I must trade in 100 share blocks in a margin account.  Margin, because the broker will charge me interest when he lends me the shares to sell short.  But I can’t trade on margin in my IRA account.  However, some brokers allow customers to trade options in an IRA.  Enter the Put option, IRA. 

A put option gives me the right to sell 100 shares to someone at a set price for a set time.  Thus, if I think stock XYZ, which is trading at 50 is going to decline, I could purchase a put option to sell 100 shares of XYZ at 50 (or 55, or 60 etc.) good for a few weeks or months.  I could then buy the stock, if it declines, to say, 45 and put them to someone at 50.  But I do not have to purchase the shares.  If XYZ declines, the put option (which trades like a stock on the option exchange) will increase in value and I can sell the option at a profit.  But if XYX rises, I can sell the option at a small loss or let it expire worthless.  Either way, if the stock rises, the most I can lose is the cost of the option.  So much for the myth of the infinite loss from selling short.

I can even buy put options on the stock market indexes (QQQQ, DIA) or ETF’s, if I think we are in a bear market–all in my IRA.  I cannot possibly cover all of the ins and outs of options here.  I am just trying to whet your appetite and show you how I profit from a declining market.  For a primer on options go to the learning center at www.cboe.com.  I disregard the media pundits looking for the rare rising stock to purchase and bet on the many stocks that are declining.