Monday, December 31, 2007

December 2007 Rewind - Santa's Folly

Apparently Rudolf got lost this year as the vaunted "Santa Claus Rally" became "Santa's Folly." Indeed, with the S&P 500, Dow Jones Industrials and NASDAQ 100 cash indices falling -0.86%, -0.80%, and -0.20%, respectively, the equity markets put in their poorest December performance since 2002.

Although there were more positive days on balance throughout the month, the markets could never quite get over their collective disappointment with the Federal Reserve's mere quarter-point rate cut on the eleventh, and fears stoked by former Chairman Greenspan's subsequent stagflation warnings. Apart from that, the typical positive holiday seasonality and pervasive sovereign fund acquisition news were simply overcome by a barrage of further subprime writedowns, mixed retail sales reports, geopolitical events, heated inflation readings, and tepid home sales news.

Interestingly, Large-Cap and Growth stocks continued to outperform this month even as the Small-Cap and Value stocks overwhelmed the indices into the red. On this New Year's Eve with all the volatility of the second half fresh on our minds, it is easy to forget that the major indices still managed to close ahead on the year, as follows:

2007 Index & ETF Returns (excluding & including dividends):
  • SPY (S&P 500) +3.5%/ +5.2%
  • DIA (Dow Jones Industrials) +6.4%/ +8.8%
  • QQQQ (NASDAQ 100) +18.7%/ +19.0%

And now we have a full 250 trading days ahead of us to celebrate in 2008. Cheers!

The Style Box below was calculated using the following PowerShares™ ETFs: Small-Growth (PWT), Small-Value (PWY), Mid-Growth (PWJ), Mid-Value (PWP), Large-Growth (PWB), and Large-Value (PWV).

The Standard & Poors 500, Dow Jones Industrial Average and NASDAQ 100 may be traded through ETF proxies, including the SPY or IVV, DIA and QQQQ, respectively.

Sentiment: Negative
Volatility: Moderately High (VIX 18-25)
Direction: Lower

12.31.07 - The only thing...

... to be enthusiastic about today's market action is the relative strength we are seeing in the Financial Sector (XLF). Maybe that will lead the overall market somewhere more positive by day's end.

Interesting barbell forming in the 2008 Market Opinion poll on the right. We traders certainly do have our opinions, don't we? Have you voted yet? Better yet, take a minute to post a comment with your prognostications!

Trade Idea Result: Lastly, if you were in one of the India Country ETFs (IFN/INP) for a possible bounce trade on a geopolitical over-reaction rational, it might be time to take profits on that trade, which is now up just over +4% since I posted the idea a few days ago.

12.27.07 - India Fund Opportunity?

3:32PM CST UPDATE: Throw away at the close. No big surprise and possibly the first tradable "on-sale" pricing of the new year. Worst December in five years? Have fun and be safe tonight -- Let's HAVE A HAPPY NEW YEAR!


Friday, December 28, 2007

12.28.07 - Nuetral Day... far... Tick and A-D lines essentially flat -- constructive, I suppose, but looks like we could be slipping here. Europe is holding up relatively better. The TNX (ten-year note) is getting pounded. Boy those new homes numbers were bad; really killed what could have been a nice bounce day going into New Year's Eve. Meanwhile the Chicago PMI came in strong, go figure.

12:00PM CST UPDATE: Yup, the market has deteriorated and now is around S1. Volume is extremely low. May hold around here. As a side note, I noticed that the Sentiment signal triggered long yesterday. I'll be thinking about taking that at the close or on evidence of a reversal, which is nowhere to be be seen as of now.

3:00PM CST UPDATE: Sort of a go nowhere day after all. Speaking of which, looks like Monday is a full-trading day after all. See you then.

Thursday, December 27, 2007

Grading 2007 Risk/Reward across Sectors & Styles

Even the casual investor couldn't have missed this year's financial news focus on "Increased Volatility" and "Split Markets." Exchange Traded Funds ("ETFs") provide us with an easy tool to take a deeper look into these headlines across both Sectors & Styles alike.

In this regard, the table below catalogues total returns and historic volatility across 14 Select Spider-Sectors and six PowerShares-Style category ETFs, as ranked by their respective Sharpe ratios:

As a brief reminder, William Sharpe's ratio is one of the simplest measures of the historic risk/reward characteristics of a security's return series, as follows: (Total Return - Risk Free Rate)/ Standard Deviation of Returns. Yes, there are fancier, better measures than this out there these days, but the table above tells our two stories quite nicely on its own; thank you very much!

Looking across the select ETF categories, the two headline saws become most apparent. First, volatility increased dramatically in almost every ETF category, in some cases nearly doubling between the first and second halves of the trading year.

Second and equally dramatic was the much ballyhooed split-nature of returns. Not surprisingly, Energy (XLE) and Metals (XME) led the pack here, with Financials (XLF) and Homebuilders (XHB) bringing up the proverbial caboose. Similarly, Large- & Mid-Cap Growth ETFs (PWB/PWJ) ranked the leader board throughout the year, with the Small- & Mid-Cap Value ETFs (PWY/PWP) generally taking it on the chin. In case the increased volatility wasn't a strong enough "tell" for you, split returns like these are not characteristic of a healthy bull market!

The scatter plot chart below takes our analysis up a notch, showing a slight inverse linear (albeit dispersive) relationship between positive total returns and relatively lower historic volatility:

Note: Volatility is presented highest to lowest.

The Metals & Miners (XME) complex located in the upper-left hand quadrant above was a bit of an outlier last year, posting both strong returns and relatively higher volatility.

As you develop your investment allocation plans for 2008, perhaps you will consider the persistence of these risk-reward characteristics through time, as well as the possible linear relationship between the two elements of Mr. Sharpe's equation.

12.27.07 - India Fund Opportunity?

I just heard Bob Pisani on CNBC "predict" the creation of several hundred new ETFs for 2008, including an India fund. I guess he has never heard of the NYSE's IFN, or Barclay's INP.

These are both down big-time today on the neighboring Pakistan/Bhutto news. They seem to have bottomed for the day and could be good buys as they still rank highly on most relative strength screens.

Back in the USA, the building negative economic news has finally come home to roost, at least for the day. Note the divergence between the slope of the Cumulative Tick and the actual prints... I "predict" that next Tuesday will be the first day of the New Year!

3:15PM CST UPDATE: Too much for the markets to digest to hold it together, albeit on light volume. Only one and a half trading days left in the year... doesn't look good! Watch India overnight and in the morning to consider nibbling around the edges. It could take a while for that news-cycle to play out in terms of geopolitical risk identification.

PM UPDATE II: For the record, this post was put up nearly a full day before CNBC thought to comment on the very same thing. Interesting how news and commentary filters out these days.


Wednesday, December 26, 2007

12.26.07 - Leaders Weakness

The so-called "leaders" (Financials - XLF, Transports - IYT and Semi-Conductors - SMH) are all showing more relative weakness than the major averages belie. Overall a flat, low-volume market. What did I expect the day after Christmas? Speaking of which, hope yours was terrific!

Nothing to show today so far... oh how I hate sideways markets -- you just know they are going to break one way or the other. Technically overbought, but now we have year-end to consider. Have you voted in the right hand side-bar poll yet? Didn't think so... come on gang!

12:15PM CST Update: Little break-out to the upside about 45-minutes ago. Cumulative Tick has turned positive and "leaders" making a come back, but still down.

Trade Idea Result: I should also update the Market Sentiment long signal noted last week on the 19th. It closed-out two days thereafter for a hypothetical +2.0% gain. Had you continued to hold through today, you obviously would have done better yet.

12.19.07 - Bad News Saturation?

Monday, December 24, 2007

12.24.07 - "The Only Gift Worth Possessing"

Markets are up nicely on MER news and holiday cheer. Some short-term overbought signals starting to trigger. I'd consider hedging, but don't fight the tape -- especially this week. In answer to a Wall Street Journal article today... enjoy your time with friends and family! - Jeff

Happy Holidays!


Saturday, December 22, 2007

2008 Market Prediction Poll

It won't be long before the primaries take over the news cycle. Why wait to vote? Make your prediction of the S&P500's 2008 performance on the right-hand sidebar now!

Post your prediction as a comment below to win a prize this time next year!

Friday, December 21, 2007

12.21.07 - Flatlined

First, yes, I retitled and final edited the article below to make it "cuter" for republication. Strong consumer spending has us up nicely on the day, but now the market is essentially flat and financials are pulling back slightly. Yes, this could keep going through the end of the year, but do keep an eye on it and consider a stop loss at yesterday's close.

PM UPDATE: Enjoy your weekend!


Thursday, December 20, 2007

Stagflation: A Christmas Carol Warning

Former Federal Reserve Chairman Alan Greenspan sounded a lot like Jacob Marley's Ghost from The Christmas Carol last weekend, warning how we are seeing “the early symptoms” of stagflation.

That’s right, the only word whose first letter strikes more fear into the heart of investors than the dreaded “R” word. Mr. Greenspan was behind the curve with his chain rattling on this one though; Mr. Bernanke’s Federal Reserve has been essentially saying the very same thing since mid-summer with its statements stressing concerns over higher inflation and slower growth ahead.

Most investors understand that growth is good and inflation is bad. For the newly initiated; however, this article explores at a very high level how this intuition is pedantically grounded in valuation theory, and why stagflation is truly an asset killer to be feared on the level of Scrooge's ghosts!

First, however, a couple definitions:

  • Inflation – Consumers experience inflation as rapid price increases relative to their purchasing power. This can be caused by several means. In the example du jour, strong demand for an oligopolistically controlled productive resource, read energy, pervades corporate cost of goods sold. However, for that cost increase to spread, note that firms must be able to pass it along to willing consumers.

    For these reason, most argue that true inflation must ultimately be supported by an expectation of more to come along with the injection of liquidity into the monetary system.

  • Growth – Expansion of corporate free cash flow, defined here as cash flow available for payment of debt, dividends and reinvestment. On an aggregate level, such growth is thought to be bounded by a nation’s gross domestic product.
The following sections discuss the effect of stagflation on several major asset classes, including Bonds, Equities, Commodities and Real Estate.


In many ways, bond pricing is the easiest to get one’s arms around, so let’s start there. The simplest model for bond pricing looks likes so:

     Bond Price = Coupon Payment/ (1+ Required Rate of Return)

Because coupon payments are fixed, the higher the required rate of return, the larger the denominator and therefore the lower the price. Bond investors require compensation for inflation expected over the life of the bond. Therefore, as this expectation rises, so does the required yield and price drops.

As for growth impact, required yield also factors in firms’ ability to repay their debt. Slowing growth may increase the perception of repayment risk, further increasing the required yield and thus reducing price.


The basic model for stock valuation is fairly similar to bonds, except that it cues off of sustainable dividend potential and considers future growth, as follows:

     Stock Price = Dividend/ (Required Rate of Return - Growth Rate)

Or, put another way in terms of dividend yield:

     Dividend/ Stock Price = Required Rate of Return - Growth Rate

Focusing on the right side of the equation, note that whether rates are stated in real or nominal terms, the spread remains the same. Inflation cancels out! On an asset class level; however, we have to consider a different dynamic. For this perspective we need to look back to bonds and the idea that investors have a perennial choice among the two classes. The much debated “Fed” model for aggregate equity market pricing takes this choice into account, as follows:

     Market Price = Aggregate Dividend/ (10-Year Treasury +
         Equity Risk Premium)

Above we learned that bond prices quickly factor in inflation expectations. As bond yields rise relative to stock yields, demand for stocks as an asset class declines and, as the theory goes, so does price. Presto, inflation plays a role and a destructive one at that!

Several economists feel this has more to do with a growth effect whereby potential dividends are pressured during inflationary spikes as the costs of production rise faster than they can be passed along. Either way, the result is the same. Speaking of which, and back to the original stock pricing model, we see that growth is deducted from the denominator. The smaller the growth rate, the larger the denominator, and, once again, price declines!


Commodities are thought to be tied more directly to Economics 101 - Supply & Demand pricing. It is much easier in this arena for producers to timely pass along cost increases. Take a look at food these days. Up to 40% of the retail cost of food is comprised of energy related components. Is it any surprise that prices at the grocery store have risen so quickly?

In this way, so long as they don’t rise so quickly as to squelch demand, commodities are thought to be largely insulated from inflation. The good news here is that everyday investors now have unprecedented access to this asset class through new ETFs such as iShares GSCI Commodity-Indexed Trust (GSG) and Deutsche Bank Commodities (DBC). Be advised; however, that gold no longer falls as strongly into this category as it once did. Nonetheless, it is still regarded as a good crisis hedge.

Real Estate

As my great grandmother said many times, "They aren’t making any more land!" Due to its intrinsic value, like commodities, residential real estate is also thought to be fairly well insulated from inflation. By the same token, as we have been recently reminded, demand may be squelched if borrowing rates to obtain and hold the asset rise too quickly.

Commercial real estate falls into a bucket somewhere between residential real estate and equities, albeit with a much greater emphasis on its ability to generate operating cash flow.

*     *     *     *
In his recent remarks, Mr. Greenspan pointed to rising import prices and declining productivity as offending tell tail signs of the “S” word. In fact, both CPI and PPI were recently reported to show extremely high year-over-year changes. At the same time, this week’s Philadelphia Federal Reserve and Conference Board leading economic indicator appear to reaffirm growth concerns.

On the other hand, a recent productivity report showed good strength, consumer spending remains high, and current market worries have yet to express themselves in measured GDP. Also, at this point in the cycle real estate trends are deflationary and jobs, although weakening, remain at historic levels.

Over time, markets tend to self-correct. A low, yet stabilized dollar may soon make our goods and services look relatively attractive to the rest of the world, keeping employment and earnings high. Witness all the sovereign fund investments reported of late.

A long enough period of stagflation almost always precedes recession. You can almost feel the tension in the Federal Reserve's statements as it rides the tightrope of its dual mandate to restrain inflation while supporting jobs. As we head into 2008 and in the spirit of the holiday, let’s hope for Mr. Bernanke's sake that Mr. Greenspan’s warning, like Marley's to Scrooge, is cautionary at best. The last ghost of Federal-Reserve-Chairmans-Past we want this economy visited by, is Mr. Volcker's.

Nothing ever changes, Hilarious!

Thank you Brian for the link below! I'd bet alot of investors wish they had the last two months of their equity back!

This whole sub-prime mess reminds me so much of the S&L debacle I was involved in cleaning up 16 short years ago. Nothing changes much... If anything, I'm surprised the real estate cycle lasted as long as it did.

On the more serious side, if you are interested in an introduction to tape reading, Brian's daily blog is a super place to start.


12.20.07 - Can't Catch a Bid

All the comments from yesterday still hold. The day isn't over, but this market can't seem to catch a bid and this range is becoming dull.

Still, somewhat higher highs and lows have occurred over last several days. Maybe well see a mid-day recovery ala the recent pattern. Hope springs eternal this season!

12:53PM CST UPDATE: Promise I didn't know that pop was going to happen, nor had I seen any evidence of it right up to my post. No, I can't take credit for that one. What is it they say about rather being lucky than smart? Take it easy, Tick and A-D still negative.

1:42PM CST UPDATE: Hey, what do you know, back up to the five-day moving average on the SPY. Watch the rising VWAP as potential pull-back support/ trailing stop level. Still lots of "technical" resistance potential around here, but we've tested this often enough, maybe, just maybe it will break this go around. One thing is certain, tomorrow's expiration day will be quite a trip.


Wednesday, December 19, 2007

12.19.07 - Bad News Saturation?

Today's action gives me the feeling that the bears sense that all the bad news that's out there has more or less come out and it may be time to cover for now.

This morning was looking very constructive IN SPITE of more "bad news" until the longs decided to play whack a mole with their best positions to take money off the table. If we can hold this dip here and reinstill some confidence in this constituency to let profits run, maybe we'll see some more upside progress.

Overall, slope of Tick and A-D are flat, which at this point is good.

PM UPDATE: Another good intra-day call. If only I could do that every day... Stellar Nike and Oracle earnings after the bell. A slew of additional "go-long" signals have triggered, including the revised Sentiment model. I'd just like to see some more conviction and follow through here... it's a bit of a worry.

Tuesday, December 18, 2007

12.18.07 - Sell the News?

A heavy sell program hit the tape about half an hour ago (see the large dashed green spike). This time it was met with some buying and the Cumulative Tick and A-D slopes appear to have flattened.

This could indicate an important level of support, but trend is still down so wait for more confirming strength and a reversal out of bonds before considering buying in for a bounce trade.

1:10PM CST UPDATE: Did you catch it? Important break through the VWAP and now test of the pivot. I'd like to see bond rates rise a tad indicating potential rotation "into risk."

1:23PM CST UPDATE: We are getting that rotation along with more volume than we've seen in a few days. Shorts are covering and money is going to work. Bullish Hammer. Each upward thrust typically will be associated by a leveling, or shallow pull-back in time, which is usually buyable. Speaking of which, please don't forget to trail stops!

1:55PM CST UPDATE: Bounced down off of R1 (dotted blue line). Look for support back at the pivot (dotted yellow line) else consider exiting if you are just a scalper. I don't think it's done yet, though -- but -- as always, respect price.


Monday, December 17, 2007

12.17.07 - No Respite

Persistent negative Cumulative Tick and A-D lines. Large-cap Tech is being especially hard hit: selling the winners over growth concerns? Certainly Financials are holding up relatively better: a rotation in anticipation of a sector bounce? The markets are technically oversold, but... there are too many buts!

Friday, December 14, 2007

12.14.07 - Pivot Resistance

The SPY is finding resistance at its daily pivot line (yellow dotted line). Relatively constructive considering the inflation confirmation though.

"Looks like" the market "wants" to be finding a bottom around here going into the end of the year, but we are so news driven and volatile it's hard to be confident in that assessment. Maybe the shorts will start covering next week going into expiration day to lock in gains.

Cumulative Tick and A-D Line slopes are flat to negative. Not much green on the screen in any investment category today.

WEEKEND UPDATE: I don't necessarily give a lot of weight to the last hour sell-off on accord of the day-of-week, Friday. Note how much volume has dropped off in-spite of the downward-vol and how we are almost back at the -62% retracement off the highs. In spite of the extreme negative reaction to the Fed announcement, the lows from that day have not seen a major violation and now we are in the final weeks of the month, December no less, not to mention leading into option expiration week. Is it possible that a bit of the selling we have been seeing has been tax motivated?

I'm no huge bull here, but I wonder just how much is and how many more shoes are going to fall off the "millipede" (to quote the "Oracle") at this point going into mid-January? Sentiment is SO negative. Goldman reports next week... smartest guys in the room?

Thursday, December 13, 2007

12.13.07 - Mixed News Day

So Lehman beats and retail sales look good, but wholesale inflation runs hot largely due to energy costs. Energy is a tough nut: it both drives inflation and yet can moderate economic growth of its own accord. That has got to put the Fed in a tough spot since it's not the type of inflation it can easily fight: market forces driving energy consumption are now at a global level. I'd therefore think the first-order concern would be the growth impact here, but hey, I'm no economist.

Price-wise we are retesting yesterday's lows, but without yesterday's strong trend action. Asia and Europe sure didn't get us off to a very good start. Speaking of which, overnight performance of the foreign markets is the very first thing I look at every day. A good practice.

Cumulative Tick isn't looking very good, I'd look for the slope to change and a break of the VWAP before I'd consider a long bet. We are essentially within the next level of retracement "support" in the SPY $146.50-$147.50 range.

1:20 PM UPDATE: Transports pulling hard starting about an hour ago. Money is either coming out of long-term bonds or a premium (edit: discount) is being paid... If the former, where is it going? Short-end? Would have expected a bigger equities pop otherwise. [OK -- Bit slow on the uptake on this one, it's an inflation repricing.]


Wednesday, December 12, 2007

Thank You!

With Christmas fast approaching and Hanukkah underway, I just wanted to say "Thank You" for all of your kind and supportive emails and comments over the course of the first three months of my journey into the "blogosphere."

That said, I would like to encourage posting/ commenting directly to the site going forward to better exchange ideas and share insights. However, I only ask that you establish a Google identity to avoid SPAM postings to this site. Otherwise, I promise I will post anything relating even remotely to the posted article, (constructive) criticisms included. That's what it's all about.

Sincerely, Jeff

Fed-Day VIX Option Trade Result

Last week Wednesday I pondered a long $VIX.X option trade to capture noise around the Federal Reserve announcement. I naturally thought I would report on that trade idea result today.

Excluding costs, if the hypothetical trade had been put on this Monday afternoon and taken off at yesterday's close after the announcement, it would have generated about +13.7% (corrected). Not too shabby.

Nice Move

12.12.07 - Slow Bleed...

Cumulative Tick and Advance-Decline line slopes are negative. The financial sector is being sold off/ shorted, pushing down the S&P500. Took some off at the open myself... guess I wasn't the only one. Back to looking to SPY $149 for support -- respect the trend though.

Tuesday, December 11, 2007

12.11.07 - Yippie-Yeah - 25bps All Around!

How do you spell that? Took off some of those hedges. Remember that the market typically takes an hour or more to "decide" what it all means. And you were wondering where all this mythical volatility was hiding?

P.S. - I will be looking for support just under/around SPY $149. Just exchanging IMs with J.W. speculating whether the Fed was able to respond to much of the negative news out just this week versus Mr. Market's always current expectations.

P.S.S. - Looks like I had a limited imagination yesterday because that statement isn't making anyone happy. Note the limited Window cut too.

P.M. UPDATE I - Well, more of a move than certainly I had expected and a one way trade at that, which is somewhat unusual. This is still a very tricky environment, although today did "feel" (both intuitively and quantitatively) like an overreaction to me. Yes, I also "felt" alot better about my hedges by the end of the day as compared to yesterday!

P.M. UPDATE II - What's this on CNBC after the bell about 4:55pm CST... a "secret" Fed source says that they are still considering "other means" of addressing the liquidity problem? Hmmmm. It is true that very few banks have been using the Window... Well, tomorrow is another day - as always - we will see.


Monday, December 10, 2007

12.10.07 - Bit of a Dull Day... spite of the early grind higher. It is difficult to imagine a bad result tomorrow:

50 Bps - Hallelujah and off to the races (but watch out for a hangover next day -- wow things are that bad + already short-term overbought). Dollar down, oil up.

25 Bps - Economy must be doing alright after all, and hey, it is the Holidays.

Zero... hmmmn, not going to happen. Famous last words? Maybe we'll get more at the Window. I'm still mostly hedged (and hating it). Good luck tomorrow, play the noise if you must and are quick on the draw. Volatility is the only certainty for the day.

Sunday, December 9, 2007

Market Sentiment System Revisited - Part I

Last month I posted a two-part article building on the always excellent work of Dr. Brett Steenbarger of TraderFeed fame. The article presented an outline for an intermediate-term Market Sentiment-based swing trading system incorporating the observations of Dr. Steenbarger. As background, links to the article follow:

Part 1Market Sentiment Oscillator

Part 2Sentiment Trading System

With the closing of the open trade referenced in Part 2, I thought I would post the results of that hypothetical trade and revisit the original system to see how it might be improved.

First, November's trade opened on the 5th when the ten-day oscillator first fell below 0.995, and closed on the 30th when the 2-day RSI exceeded 90 for a total of 18 open trading days. This was about seven days longer than the average trade, as previously tested back through January 2003 (about 1,240 trading days).

Using the S&P500 (SPY) as the trading vehicle, the maximum drawdown of this trade would have been -6.1%, the worst of the entire test period. This comes as no surprise, as the test period represented a remarkable bull recovery right up until the recent stall. Nevertheless, due to the strength of the end-of-month bounce, by exit day the trade was down by only -0.7%.

This is the general nature of the trade: buying on extreme weakness in measured sentiment, and selling into price strength. However, as I wrote, "this simple system can generate long holds during very rocky times...." This trade was certainly no exception!

Second, the lesson to resolve was clearly how to avoid getting in too early. In this regard, I decided to take a closer day-by-day look at the ten-day oscillator in conjunction with the absolute value of its underlying indicator, as follows (the x-axes indicate days prior to exit):

As shown above, like many technical indicators, the best time to take the trade signal is when a divergence between the oscillator and its underlying value is observed, suggesting a change in momentum. Had the hypothetical trader waited for such a divergence to occur on or around the mid-point of the trade window, as indicated by the originally specified system, a significantly better result of +2.1% to +4.9% may have been achievable (see end-of-day bars -10 and -7, respectively).

Visually reviewing prior open trade periods, I made similar divergence improvement observations. This inspired the following rule modifications:

Buy – Buy the SPY at the close when (1) the oscillator has fallen below 0.996 during one the prior three days, and (2) the two-day RSI of the SPY is below 50. These rules are somewhat looser than before, but two additional criteria are added to pinpoint a potential divergence point, including: (3) the oscillator must be higher than its lowest close within the last three days; and, (4) the underlying indicator must be lower than its highest close within the last three days. In other words, the oscillator must have potentially bottomed, and the underlying indicator must have potentially topped.

Sell – Sell after the earliest of the following: the oscillator reaches 1.01, the 2-day RSI of the SPY exceeds 90, or twenty days has passed. This is the same as before.

During the test period, this modified system would have generated a 53% gain before trading costs with 28 wins out of 31 signals (90% wins/ average +1.7% gain), and was invested 21% of the time for an average hold period of eight days with a maximum drawdown of -4.3%.

These results demonstrate the desirable attributes of a lower drawdown, a higher win rate, a shorter average trade duration, and less total market exposure as compared to the system's first iteration. Indeed, the most recent November trade would have recorded a +2.3% gain. Even better absolute results may be garnered by waiving the higher oscillator criteria (rule #3) and just waiting for a confirmed capitulation of the underlying absolute indicator (total gains of 65%). These results challenge the total gains of the SPY over the same period (+79%) with substantially less market exposure.

This analysis is still "Level 2" at best, and more work is required before I would consider the system tradable per se, including a parameter sensitivity test. In a later article, I will also take a look at how the system might be used, if at all, intraday.


Friday, December 7, 2007

Financial Services Downgrades Losing Impact

Financial Services continued to be downgraded heavily this week -- yesterday's slew of Merrill downgrades being just the latest. Talk about being late to the game and calling the kettle black!

Below is the six month chart of the Ultrashort Financials Proshares (SKF)(moves -2X). Notice the head and shoulders formation, and more importantly, the lack of downgrade impact as the ETF has backed off of its highs. At its peak, SKF was up nearly 70% this year -- now it's closer to 30%! Could we have seen a bottom in this sector Mr. Paulson? What say you Mr. Bernanke? Hmmn?

P.S. - I will post the long promised Market Sentiment System revisit over the weekend. Yes, that VWAP study is yet to come. My guess is that it only works during the strongest of persistent-trend volatility days. Why? By the time you have observed the reversal and take the next bar, the edge is likely gone. That's not to say I assume it will be an absolute bust. Let's wait for the numbers to tell the story.

P.S.S. - What, you are thinking about going (double) long! Try UYG. Sometimes I just find it easier to turn things upside down! Be careful, still tricky out there.


NASDAQ100 Up 7% in 10 Days: What Happens Next?

As of the time of this post, the NASDAQ 100 (QQQQ) has rallied more than 7% during the past ten days. Quite a "V" bottom, and a rather rare one at that. In fact, this last occurred in April of 2003. I ran a quick scan of the last ten years to see what happens over the subsequent five trading days when such fast moves of equal magnitude occur.

Of the 66 instances, 38 were negative (58%) for a total loss of 62% (average loss of -0.93% per instance). The chart below shows the equity curve of the hypothetical trade back through December 1997 (about 2,500 trading days):

In spite of the average loss over the period in its entirety, you can see how the trade was actually positive on balance during the heavy upward momentum "bubble" period through the Spring of 2000 before it devolved into a pattern of sharp-bounce breakdowns during the bear market period that ensued.

This month is typically bullish and has brought relatively good news. The Federal Reserve's decision next week will certainly dominate trading for the rest of the month. While many of the major indices are back at prior highs (save the subject of this study), volatility has increased significantly since this past summer, not unlike the 2000 transition period.

At the end of the day, how you view this study thus likely depends on which type of environment you believe we are in.

UPDATE: For a good second interpretation of the recent surge, read this TraderFeed article on new highs. I always advocate looking at multiple indicators to get a true read on the market. Price is just one, and as you can see above, in this instance its interpretation is indeterminate.

Thursday, December 6, 2007

Daily View - Look out above!

Technically an exceptionally strong day thus far. Clearly lots of hope riding on non-farm jobs tomorrow. Also, it looks like rate cut expectations and Washington's rate freeze are supporting a rotation into Financials in-spite of industry downgrades.

Nonetheless, it's nice to have broken that recent high with broad participation and great Tick strength. Transports are not doing quite as well, however, nor are interest rates confirming a trend-wise rotation into risk. Furthermore, whereas yesterday we were in a virtual "no man's land," we are once again headed into possible resistance above (see prior downtrend line, high-level Oscillator cross, 50-Day MA, and 62% retracement).

Fulfillment of the Market's hopes could easily pierce this (though it is a bit of a long list). Consider hedging as/if we hit that target area (say SPY $150.25 to $150.75), but I wouldn't try to pick a top just yet.


Wednesday, December 5, 2007

12.05.07 - Nice Move

Nice move and our fund took a small leveraged position at last night's close on the weakness, so all the better. We are back at the 50% retracement though; consider a loose trailing stop with an eye towards that rising VWAP.

1:30PM CST UPDATE: So did you trail a stop? I realize I looked neutral to bearish yesterday. My intraday comments are often based on discretionary/personal technical observation -- by day's end we had a quantitative buy signal. The day isn't over yet.

2:50PM CST UPDATE: Nice bounce back up off of R2, but now we are back at that area of concern. Yes, we got it twice. May be we'll be "in the clear" until Fed day (CNBC talking head speak), but you know there will be volatility ahead of the real jobs report and actual decision/event day. I still tend to think that if the VIX continues to collapse, there will be a decent short-term trade there on the $VIX options contract.


Tuesday, December 4, 2007

12.04.07 - No Motivation to Buy

Always tempting to fade the gap, and it looks like that was the morning trade, but I'm just not feeling any motivation to buy.

Cumulative Tick is flat lined, Semi's and Transports are pulling, but Financials are going nowhere fast and the five-day moving averages are again headed flat to southward.

The S&P500 may look more attractive around the twenty-day moving average in anticipation of a long Fed trade in a week or so, though a volatility/VIX option play may be more in order.

For today, keep an eye on that daily S&P VWAP to see it holds and whether the TNX keeps rising and/or the Financials decide to join the party, indicating a possible move back into equities after this as yet mild pullback.


Monday, December 3, 2007

November 2007 Rewind – The Write-Down Elevator Ride

Mortgage bank subprime write-down news and reoccurring recession fears predominated the trading environment this November, together pushing the major U.S. equity indices into their largest monthly decline and second “official” 10% correction of the year.

Over $80B in cumulative subprime write-downs have now been announced, with wide-ranging predictions of another $100B to $300B yet to come. Meanwhile, the White House revised its 2008 Gross Domestic Product growth estimate downward from 3.1% to 2.7%. November also found oil on the verge of breaking the psychological $100 per barrel mark, stoking consumer spending fears that were all too well confirmed by sentiment readings at multi-year lows.

In a more positive vein, the broad stock market declines and weak dollar proved too tempting for a number of sovereign wealth and private equity funds to pass up. Most notably, the Abu Dhabi Investment Authority took substantial, albeit non-controlling stakes in Citigroup (C)($7.5B) and Advanced Micro Devices (AMD)($0.7B), while Citadel made a 20% investment in E*Trade Financial (ETFC)($2.6B).

Together with an all out promise from Messrs. Bernanke and Kohn of further Federal Reserve rate cuts ahead this December, a put was effectively placed under the market, supporting a significant bounce going into the final days of the month. In fact, the magnitude of the S&P 500's final four-day rally had not been seen in over four years time. What is it that they say about the largest bounces occurring in _ _ _ _ markets? Grrrr!

By the end of the month the S&P 500 and Dow Jones Industrial Average were down 4.4% and 4.0%, respectively. In contrast, and unlike last month, the technology heavy NASDAQ 100 showed relative weakness, down 6.7%. While that effect was likely an attempt to fund margin calls and rotate into oversold financials, recession fears had an especially strong impact on Small-Cap stocks, which were down 6% to 7%. Meanwhile, the ten-year note ended the month below 4%, its lowest level since 2005.

In spite of this traditionally bullish season, I am concerned that should we see another test of the recent lows, whether it be this month or early next year, a more substantial breakdown may ensue. Let’s hope for the bulls that this volatility elevator slows and climbs more steadily upward this month. Happy Holidays to you all.

The Style Box below was calculated using the following PowerShares™ ETFs: Small-Growth (PWT), Small-Value (PWY), Mid-Growth (PWJ), Mid-Value (PWP), Large-Growth (PWB), and Large-Value (PWV).

The Standard & Poors 500, Dow Jones Industrial Average and NASDAQ 100 may be traded through ETF proxies, including the SPY or IVV, DIA and QQQQ, respectively.

Sentiment: Negative
Volatility: High (VIX 17-31)
Direction: Lower

Rising 5-Day MA Providing Support

Still catching up from last week's trip (back late last night) and need to get November's "Rewind" out, not to mention my fund reports.

The rising 5-Day Moving Average of the SPY appears to providing support. Although the cumulative TICK is positive, it seems weak and there is very little trend strength either way. Nonetheless, we are seeing a pattern of higher lows and highs here, which is constructive. We will see.

We are just under the 50% retracement on the first trading day of the month. Getting more short set-ups than longs at this point... Oil has got to be helping to sustain the gains here. Also, have you looked at the ten-year note lately? It's well under 4%! Although small-caps have been taking it on the chin, this has got to help at some point, although I suppose LIBOR is more relevant in this regard. As a last heads up, I believe the Sentiment trade from (too) early last month finally closed out Friday.

Apologies for the random walk, more when I have caught up.

Thursday, November 29, 2007

Travel Days & Consolidation Patterns

I will be traveling today and tomorrow on business. Constructive day. It will be interesting to see what Mr. B has to say tonight. Stay tuned next week for the promised VWAP study and an update on the Sentiment Measure.

Best, Jeff

PM UPDATE: I noticed this evening that a good number of fellow 'bloggers' are skeptical of the rally based on volume. That's fair enough, but be advised that relatively low-volume, narrow-range days subsequent to a big move off of a bottom, such as today, can also constitute consolidation days before another big leg higher. That plus end-of-month and December seasonality could spell a positive day tomorrow. Again, listen to Mr. B tonight for a read on the AM; respect price action; and trade well.

FRIDAY AM UPDATE: Nice pop; I'd trail a stop.


Wednesday, November 28, 2007

Federal Reserve Trial Balloons?

Compare and contrast today's Fed official statements with yesterday's:

Today (WSJ) - Though a repricing of risk "is not surprising or unwelcome," [Vice Chair]... Kohn noted that wider credit spreads and tighter credit standards "would make some types of credit more expensive and discourage some spending, developments that would require offsetting policy actions, other things being equal."

Yesterday (RTT) - ...Philly President [Plosser] explained... “It is important to recognize that the Federal Reserve cannot resolve this price discovery problem,” he said. “The markets will have to figure this out. Arbitrarily lowering interest rates or providing liquidity to the market does not provide the answers the market seeks. Indeed, in some circumstances, lowering interest rates may prolong the painful process of price discovery.”

Ever get the feeling the newly "transparent" Federal Reserve is floating trial balloons? What a difference a day makes! Go back over the last several months of Market Rewind month-end summaries. Irrespective of the occasional off-beat governor comment to the contrary and boxed policy statements, the Fed has consistently maintained throughout this disruption that they will "act as needed according to the data."

Here is a mid-day chart. The Dow has already hit its 200-day moving average. Cumulative Tick is strong, though trend strength is flattening out. Look for some prospective volatility around the Beige Book release.

2:50PM CST UPDATE: Nice. If you happened to have put on a long position when I mentioned the intra-day pullback was overdone yesterday mid-afternoon, you closed out today with a 4%+ gain on the SPY. I'd expect some follow-through by the end of the week on month-end buying, but personally used the opportunity to take some risk off the table. Hope it was a good day for you.


Tuesday, November 27, 2007

Brighter Days Ahead?

After reviewing recent price action, including yesterday's institutional throw away at the close, and contrary to my last remark, I am now more convinced that we are close to a near-term low here that will be buyable going into the new month.

Most compelling, I had very few stock pull back buy signals today, indicating that the stocks hardest hit most recently held their ground yesterday in spite of the significant damage done to the indices.

Perhaps the sovereign fund investment in Citi and oil price declines will provide the catalyst. Buyers just need a reason to step in here and scare the shorts a bit for a multi-day rally to ensue. After that, I have to say that I have drifted into the bearish camp. What took me so long -- probably as sure a sign of a bottom as any!

1:45PM CST UPDATE: Wow, made it all the way to 1:30PM to start selling in earnest. Adjusted TICK and Advance-Decline line remain stubbornly positive. Leaders still showing relative strength. Only two of nearly 100 pull-back buy orders have executed. This is overdone.

2:45PM CST UPDATE: How was that for a timely call! I wouldn't be surprised to see a run back up towards the 200-day moving averages/ short-term RSIs in the 80+ range from here. After that...

Monday, November 26, 2007

What I Track Intra-day

Here is a look at the various windows and indicators I track over the course of a day. Other indicators are more end-of-day in nature: more on these in later posts. I have another window that provides a view of various time frames as well. What do you track intra-day?

Interesting news on retail sales (Day After Thanksgiving +8.3%), from the Saudis (production increases) and Federal Reserve (liquidity infusion) today. The markets look morose and certainly very oversold in both price and time here -- but the primary down trend is quite obvious and the morning gap puts us at the top of the channel. Have I mentioned how I hate flat/narrow ranges (back through 10:00 am CST)? They can break hard and it's a tough call directionally here.

There is usually an end-of-month upside bias and negative sentiment seems quite overdone very short-term here in spite of the serious economic conditions we may be facing, but note how many of the seasonal patterns are failing. Nevertheless, it would be "nice" for the bulls to minimally see a higher low put in today.

3:03PM CST UPDATE: Ugly -- The SPY bounced down hard off of its declining VWAP and never looked back, forming a bearish engulfing bar exceeding last week's lows. I now expect further declines at least down to the August lows.


Tuesday, November 20, 2007

Turkey Talk

Light posting during Thanksgiving week at the in-laws. I think Citigroup (C) should get the Turkey-of the-Year Award for gobbling up more than its fair share of the news cycle this year. At down 40% on the year and 8% this month alone, it has certainly done wonders for the Dow, yesterday being only the latest example. Speaking of wonders, I "wonder" if Goldman Sachs would have issued that downgrade yesterday if alumnus Thain had taken the top job! Talk about being late to the game. Any other Turkey nominations? You sling 'em and I'll post 'em.

More in keeping with the season, it looks like we are getting a little recovery bounce at the open off of yesterday's damage down to prior lows. I don't have any stats on hand, but I've observed that the market often puts in a nice performance after "W" double bottom retests that hold over the next few sessions -- we'll see, I'm more skeptical than usual of late. I hope you all enjoy time with family and friends this week.

Friday, November 16, 2007

China - "A Small Setback"?

Thanks to John W. for sending me this link to The Economist. An incredible must read. Just when I finally went long again... still a relative strength play in spite of recent set-backs. That pairs trade mentioned last month has only gotten better since I last commented on it.

The Economist: A Small Setback

"In a little-noticed mid-summer announcement, the Asian Development Bank presented official survey results indicating China's economy is smaller and poorer than established estimates say. The announcement cited the first authoritative measure of China's size using purchasing power parity methods. The results tell us that when the World Bank announces its expected PPP data revisions later this year, China's economy will turn out to be 40 per cent smaller than previously stated.

This more accurate picture of China clarifies why Beijing concentrates so heavily on domestic priorities such as growth, public investment, pollution control and poverty reduction. The number of people in China living below the World Bank's dollar-a-day poverty line is 300m - three times larger than currently estimated."

November Expiration Friday & Holiday Effects

The Cumulative Tick slope turned positive in the mid-morning as the Dow bounced off of S1. Looks like we may retest the positive VWAPs around here though. Also, the often leading Semis, Transports and Financials are showing relative weakness. On the other hand, once again, in spite of the initial morning weakness, I have had ZERO stock pullback buys today. But, expiration days can be volatile, as you well know, and the day is young.

Next Monday marks the official beginning of the bullish season going into the new year. Taking that trade with the SPY has been positive in 9 of the last ten years (with only a small draw in 2003). QQQQ can be quite a bit dicier, albeit with higher aggregate returns. There is also often a positive Holiday effect that you may want to investigate going into the shortened Thanksgiving trading week. Just remember that with recent sentiment so negative, lighter volume could cut both ways.

That VWAP trade report may have to wait until next week, as I'm traveling this afternoon right after the close.


Thursday, November 15, 2007

This Picture Says it All

Keep an eye on these slopes:

Price Trend - Negative
VWAP - Negative
Cumulative Tick - Negative
Advance-Decline - Negative

How many S&P points do you think you would have gained trading on the slope of the VWAP (Volume Weighted Average Price) alone during the last month? I'll answer this question in my next post! Meanwhile, I'd "like" price levels to hold around here. Hey, hope springs eternal!

2:25PM CST UPDATE: Talk about risk aversion. Interestingly, I am seeing significant levels of "supportive volume" today (unusual volume spikes during price declines). Also, inspite of the large index declines, I have had very few stock pullback trades trigger, indicating that the stocks that have been hit the hardest over the last several sessions may have already bottomed for the near-term.

Wednesday, November 14, 2007

S&P500 Opening Gap still Holding

The SPY's opening gap is still holding, the five-day MAs have flattened or are creeping north, and the tick is hanging in there, which together I consider bullish. However, all else is looking neutral at best at the mid-day, but not bad considering all the position closing that is no doubt occuring.

In case you need reminding, we are still in a volatile time and this could break in either direction. Is this a low volume consolidation day for another leg up? A set up for a "W" bottom retest (hopefully with a higher low)? Would either surprise you? I am thinking you need to be open to either possibility with a prospective bias towards the latter.

3:10PM CST UPDATE: Another institutional "throw away" at the close.

Tuesday, November 13, 2007

Reversal of Fortune Breadth Call

Looks like the "Warriors" came out to play after all. The NASDAQ 100'S 4.23% gain on the day was solidly in the middle and double the median of the next-day-4-day-down stats posted yesterday. The vast breadth in reversal participation today (proprietary), plus options expiration week statistics (see Bespoke) suggest an edge on a momentum follow-through day tomorrow.

Volume was a tad light though and the trend is still down. Why do I have a feeling there will be an equal number of calls for a "bear trap" out there? At least there was no "throw away" at the close, although there has been a small give back in the after hours.


Leaders Participation

Tick is still strong, but the trend has stalled as the NASDAQ bounced back down off its five-day moving average. I'd like to see Transports (IYT) and Semi's (SMH) keep up with Financials (XLF) if this bounce is to hold.

I hate narrow ranges. Hopefully the VWAP for the QQQQ and 5-day MAs on the other ETF proxies (all breached today) will provide support. It's going to take more than this to inspire a true short-cover rally.

12:45PM CST UPDATE: There we go -- to the letter!

Short QQQQ/ Long SPY Trade Idea Result

Last Thursday under "just a thought", I casually pondered a Short NASDAQ 100 (QQQQ) and Long S&P 500 (SPY) trade based on their unusual divergence/ spread. I thought I would report on that trade idea result today.

Excluding costs, if the trade had been put on Thursday morning and taken off this morning with equal dollar weightings, the Long SPY side would have been down -1.7% while the Short QQQQ side would have been up +7.6% for a net gain of about +5.9%. As it turns out, there was plenty of opportunity to put the trade on Thursday after posting.

Looks like we are finally getting that statistically indicated (bear?) bounce. I imagine it will stick for all the reasons posted yesterday before the closing "throw away", plus the emphasis on some positive news for change. Keep an eye out on those declining 5-day moving averages as potential resistance though.

NASDAQ 100 Down 2 Days > 6%: What Happens Next?

Monday, November 12, 2007

Last Hour Breakdown...

Second day in a row and indicative of very negative market sentiment with traders not willing to risk the overnight, which typically pays a premium. VWAP did go negative around noon. That's what I get for "The Warriors" taunt link -- Respect-Price-Action!

Speaking of pain, take a look at E*Trade Financial Corp. (ETFC), minus 58% today on downgrade/ writedown news -- Ouch!

P.S. No, I'm not long ETFC!

NASDAQ 100 Update: Down Again...

This particular blog thread is getting dull (in fact, I will only bother to post it here), but to play it out -- here we go.

Downward momentum seems to be slowing, if not diverging on an hourly basis; short-term daily RSI is bottomed out; daily pivot S2 seems to be holding; Adjusted Tick is positive (see Steenbarger); the index is nearing in on a 62% Fibonnaci retracement; and the Financials and Transports are starting to pull on a relative basis (come on Semis). I know -- all technical observations that may amount to a hill of beans in this fearful, split market environment!

As of the time of this mid-day post, the NASDAQ 100 is down more than 10% from recent highs, including four successive down days cumulatively exceeding -9.75%. Again, going back through 1998 (2,480 market days) looking to see what happens the next day when:

(a) The index is down four days in a row; and,
(b) The sum total is less than (more negative than) -9.75%.

We find that of the 15 instances (note how this is becoming increasingly rare), 11 days were positive (+73%) for a cumulative next day gain of +37% or an average of +2.5%. The maximum next day gain was 10.0%, while the maximum loss was -9.7%. The specific instances and next day index change close-to-close (and VIX) are shown in the table below:

04/13/2000 -9.7% (29)
09/20/2001 -3.4% (44)
11/10/2000 -1.9% (29)
12/15/2000 -0.0% (27)
06/18/2001 +0.6% (23)
02/22/2001 +1.2% (27)
11/30/2000 +1.7% (30)
06/21/2002 +2.1% (27)
08/05/2002 +5.2% (45)
09/21/2001 +5.7% (43)
07/23/2002 +6.1% (45)
10/08/1998 +6.1% (46)
08/31/1998 +6.6% (44)
11/13/2000 +7.2% (29)
04/14/2000 +10.% (33)

Max. 10.0%
Min. -9.7%
Med. 2.1%
Ave. 2.5%

Today's VIX is straddling 30. Looking at just four successive down days irrespective of degree, there were 49 next day gains (+60%) averaging about +0.8%. I'm sure that I'm dating myself with this link, but remember this b-movie? The five-day MA is proving resistance here for the S&P 500; that taunt link is as good a jinx as any for another downside "outlier"!


Friday, November 9, 2007

NASDAQ 100 Down 3 Days > 7%: What Happens Next?

As one might imagine, the longer the duration of sell offs like these, the higher the odds of a mean reversion. Here is an update of yesterday's post. As of the time of this writing, the NASDAQ 100 (QQQQ) has declined more than 7.25% over the last three days. This last occurred in August of 2002. Once again, I ran a quick scan back through 1998 to see what happens the next day when:

(a) The index is down three days in a row; and,
(b) The sum total is less than (more negative than) -7.25%.

Of the 52 instances, 36 were positive (69%) for a cumulative gain of 93% (average of 1.8%). The maximum next day gain was 10.8%, while the maximum loss was -9.9%. Pretty hairy edge, if you can call it that.


Thursday, November 8, 2007

NASDAQ 100 Down 2 Days > 6%: What Happens Next?

As of the time of this post, the NASDAQ 100 (QQQQ) has declined more than 6% over the last two days alone. This last happened in August of 2002. I ran a quick scan over the last ten years to see what happens the next day when:

(a) The index is down two days in a row;
(b) The second day is down more than the first; and,
(c) The sum total is less than (more negative than) -6%.

Of the 38 instances, 24 were positive (63%) for a total gain of 56% (average of 1.5%). The maximum gain of 18.8% was set on 1/3/01, while the maximum loss of -7.3% occurred on 3/12/01. Talk about volatility! Next I loosened the rules, as follows:

(a) The index is down two days in a row; and,
(b) The sum total is less than -5%.

Of 103 instances, 58 were positive (56%) for a total gain of 55% (average of 0.5%). The maximum loss changed to -9.9%, which occurred on 8/31/98. A more thorough analysis might relate these statistics to the index's differential versus its 200-day moving average. I'm guessing that this wouldn't favor the current environment for the NASDAQ 100 with that index just coming off of recent highs. However, the picture may be quite different looking at the S&P 500, which has already breached its 200-day moving average. Can you say, "short QQQQ, long SPY?" Just a thought.

Speaking of which, be careful with the 200-day average of the S&P 500 having been breached out there gang. The behavior of the market can change dramatically when this happens favoring downside volatility.


Wednesday, November 7, 2007

Sentiment Trading System

In my prior post, I outlined a market sentiment oscillator building on work published by Dr. Brett Steenbarger. In this post I will present a hypothetical trading system based on that oscillator, as follows:

Buy – Buy the SPY at the close when the oscillator falls below 0.995 and the two-day RSI of the SPY is below 40. This criteria was met three days ago on November 5. Filtering signals when the RSI is high reduces total gains somewhat, but reduces returns volatility to an even greater extent by avoiding high level entries.

Sell – Sell after the earliest of the following: the oscillator reaches 1.01, the two-day RSI of the SPY exceeds 90, or twenty days has passed. It’s that last condition that gets me… this simple system can generate long holds during very rocky times, today being no exception!

During the 1,221 trading days back through January 1, 2003, this system would have generated a 52% gain before trading costs with 24 wins out of 28 signals (86%), and was invested 25% of the time for an average hold period of 11 days. The equity curve for the system is shown below:

During this same period, the SPY has gained about 76%. As nice as that equity curve looks (RSQ = 97%), I probably wouldn't trade the model because: a) I can’t promise based on my quick study that it is not "best fit" in some way; and, b) I have alternate systems based purely on price that I prefer. However, I find it to be an interesting concept worthy of further research. I also wonder if it holds any intra-day promise. If nothing else, I hope that you find it instructive and a nice distraction on this otherwise brutal market day.



Market Sentiment Oscillator

Earlier this fall, Dr. Brett Steenbarger of TraderFeed published an excellent series of articles outlining three market sentiment indicators based on inter-market ratios. The articles presenting the rational follow:

Gold as a Sentiment Measure for Technology

Using Sector Relationships to Catch Trader Sentiment

Global Performance as a Gauge of Trader Psychology

Intrigued and inspired by the good doctor, I developed a simple unified sentiment oscillator and trading system incorporating the core concepts from these three posts, plus an additional ratio relating the Dow Transports to the S&P500. The oscillator is calculated by adding the log ratios of EEM:SPY, XLK:^XAU, XLY:XLP, and IYT:SPY. A ten-day ratio of the result converts the calculation to an oscillator.

You will find that the oscillator moves fairly consistently between 0.99 and 1.01, which indicate short-term market despair and euphoria, respectively. Today's ugly market pushed this indicator down to .994. In my next post I will suggest a hypothetical trading system that employs this oscillator.

Thursday, November 1, 2007

November 2007 Monthly Pivots

Below are monthly support and resistance pivots for November. At the close of October, the indices sat just above their respective pivot points. Renewed credit and oil concerns have the indices challenging those pivots on the very first day of trading (sound familiar?), as follows:

S&P 500/ GSPC (SPY)-
Close: 1,549
Resistance: 1,570
Pivot: 1,538
Support: 1,506

Dow Jones Industrials/ DJI (DIA)-
Close: 13,930
Resistance: 14,193
Pivot: 13,872
Support: 13,551

Close: 2,239
Resistance: 2,262
Pivot: 2,194
Support: 2,126

Wednesday, October 31, 2007

October 2007 Rewind – The Fed Beat Rolls On

This October, a good deal of daily market movement involved speculation regarding the possibility of further Federal Reserve rate reductions. Once again, the Fed moved to the beat of the market and met expectations with a quarter point reduction in both the discount window and federal funds rates. At 4.5%, the funds rate now stands at its lowest level since January of 2006. In a likely nod to on going credit uncertainties and unprecedented real estate declines, the cut was made in-spite of continued dollar weakness, record commodity prices, and a strong third quarter Gross Domestic Product (+3.9%).

Although it was a rocky month, the rate reductions together with end of month buying, the passage of quarterly reporting jitters, and the reemergence of merger and acquisition news, all of the broader indices managed to close positively. In fact, in a wide divergence, the NASDAQ 100 had its best monthly showing in nearly two years (+7%). Interestingly, it was Internet stocks that led these gains as semiconductors suffered badly. Similarly, in-spite of all of the recent international large-cap talk, small- and mid-cap growth stocks were the big winners this month.

We may get a rate induced end-of-year earnings multiple expansion after all; we will have to see if $100 oil or the Fed's hints that it may be done for now take an eventual toll -- Happy Halloween!

The Style Box below was calculated using the following PowerShares™ ETFs: PWT (Small-Growth), PWY (Small-Value), PWJ (Mid-Growth), PWP (Mid-Value), PWB (Large-Growth), and PWV (Large-Value).

The Standard & Poors 500, Dow Jones Industrial Average and NASDAQ 100 may be traded through ETF proxies, including the SPY or IVV, DIA and QQQQ, respectively.

Sentiment: Mixed to Positive
Volatility: Medium/Reduced (VIX 16-22)
Direction: Positive/Split

Tuesday, October 30, 2007

China Pairs Redux

Recognizing that my last post was somewhat controversial based on commentary, here is a follow up article reporting how the hypothetical China Rebalancing Pairs Trade would have performed through yesterday's close: a) since posted on the morning of October 11th; and, b) since the FXI's short-term moving average first reversed.

a) Since Posted (10/11)-

> Short CAF/ Long EWH +14.9%
> Short FXI/ Long EWH -00.1%

b) Since First FXI 3-Day MA Reversal (10/22)-

> Short CAF/ Long EWH +8.0%
> Short FXI/ Long EWH +5.4%

These results assume equal dollar weightings and no commissions. A proposed change by the Chinese government to allow share classes to float together no doubt helped significantly. A few "comments on the comments":

1) Note how the use of the long/short combination reduced the risk of "being early" with this trade idea (FXI is actually higher since the 11th).

2) It is true that the CAF is a closed-end ETF trading below its NAV. It has been my observation; however, that such NAV mispricings often persist and shouldn't necessarily preempt a short-term trade backed by a well thought out rational.

3) Whether or not you agreed with the original rational, a good long/short pairing exhibits a highly correlated, mean reverting return series (i.e. cointegrated). This pairing fit the bill and paid handsomely.

Thursday, October 11, 2007

China Rebalancing Pairs Trade

As reported in today’s Wall Street Journal, late this summer the Chinese government announced a new policy permitting its mainland citizens to invest in Hong Kong equities. Although the specific timing remains unknown, this would be the first opportunity for mainlanders to diversify their equity holdings without obtaining special government approvals. In addition, the government is reportedly exploring easing restrictions on short-selling.

While the two markets are clearly correlated, as shown below there has been an obvious and widening gap in performance between them. A prospective rebalancing trade here using an ETF pair would be to: (1) go short the FXI (iShares FTSE/Xinhua China 25); and, (2) go long the EWH (iShares MSCI Hong Kong Index).

The CAF (Morgan Stanley China A-Shares) ETF is another short candidate with even higher returns year-to-date (+124%), but would make for a significantly less correlated pairing against the EWH (2007 correlation coefficient of 64% versus 87%).

I don't pretend to know the local investment psychology, but if I were a mainland citizen, I might think hard about diversifying my holdings after this year’s tremendous run, how about you?

FXI ~ YTD Return = 81%; P/E Ratio = 24.6; 20-Day Z-Score = +2.4
EWH ~ YTD Return = 39%; P/E Ratio = 16.3; 20-Day Z-Score = +2.3

Wednesday, October 3, 2007

Pivot Breakout

The market's blew right through the resistance pivot points on the very first trading day of the month. As a pivot primer, once "resistance" has been penetrated, it is thought to become "support" for subsequent pullbacks. The coming week will tell us whether or not this was merely a new quarter/month effect.

Either way, look for good support between the 10- and 20-day moving averages in the coming month for as long as they remain positively sloped. Obviously, earnings and any news impacting anticipated Fed actions will play an enormous role here.

Friday, September 28, 2007

October 2007 Monthly Pivots

Below are monthly support and resistance pivots for October. Currently, the selected indices each sit just North of their respective pivots going into the new month, as follows:

S&P 500/ GSPC (SPY)-
Close: 1,526.75
Resistance: 1,542
Pivot: 1,503
Support: 1,463

Dow Jones Industrials/ DJI (DIA)-
Close: 13,895.63
Resistance: 14,023
Pivot: 13,641
Support: 13,241

Nasdaq 100/ NDX (QQQQ)-
Close: 2,091.11
Resistance: 2,114
Pivot: 2,049
Support: 1,980

September 2007 Rewind - Ben's Emotional Rescue

This September, equities logged their best monthly performance since April, and their best September since 1998. Once again, Ben Bernanke and the Federal Reserve came to to our "emotional rescue" with a surprise 50 b.p. reduction in the Federal Funds Rate. The markets haven't looked back since (the Nasdaq 100 in particular), and once again the indices sit near their respective prior highs. Meanwhile, the dollar continues to plummet as commodities explode higher.

By the end of the month we were in a "bad news equals good news" environment, with every little disappointment signaling the possibility of further rate cuts ahead. Today, the Fed's William Poole threw a little cold water on that expectation, but that apparently is part of his job description. Looking forward, it seems to me that the market may be setting itself up for a small pullback presently based on the recent strong gains, increasingly negative news cycle, and local resistance at the prior highs.

The Standard & Poors 500, Dow Jones Industrial Average and Nasdaq 100 may be traded through ETF proxies, including the SPY or IVV, DIA and QQQQ, respectively.

Volatility: Reduced (VIX 17-28)
Direction: Positive

[Click to enlarge]

Xinhua China Index - Blowin' in the Wind?

The FTSE/Xinhua China 25 Index is up over 63% year-to-date and 21% month-to-date. Just as the index ascends new heights, I am seeing a disproportionate number of China ADR short setups. Where will the index head next? It is usually a very, very bad idea to fight such massive momentum. In addition, the country's long-term prospects certainly look good. That said, I have to think that the coming technical answer, my friend, is "blowin' in the wind."

The FTSE China 25 Index may be traded using the iShares 'FXI' ETF.