This week was a flat to slightly down week for me. Many of my shorts continued to show relative weakness, however this was negated by adverse movements in my commodity positions.
Reynolds American (RAI)
For my records, I did 3 trades this week. First was to sell APOL, due to my predetermined stop being hit, second was to get rid of MTD due to a buy out, and third was to short this stock below:
This week was a flat to slightly down week for me. Many of my shorts continued to show relative weakness, however this was negated by adverse movements in my commodity positions.
This week was a flat to slightly down week for me. Many of my shorts continued to show relative weakness, however this was negated by adverse movements in my commodity positions.
Moving Average Ribbons and Trend Following
Here is a chart that some may find pointless, while others may find valuable:
The very powerful Stockcharts.com allows you to create massive charts, which apparently, according to them, only about 2% of users take advantage of. This particular chart is 1600 x 989 pixels, and is the size I always use for my own personal analysis.
The very powerful Stockcharts.com allows you to create massive charts, which apparently, according to them, only about 2% of users take advantage of. This particular chart is 1600 x 989 pixels, and is the size I always use for my own personal analysis.
Malaysia iShares ETF (EWM)
The market rose quite sharply yesterday, which resulted in me getting squeezed on my many short positions. To help balance my portfolio, I wanted to add to my long positions, and give myself some protection should the market continue to rise.
To hedge myself, I could have simply gone long SPY or DIA, but I did not. Instead, I tried to find which world market was performing the strongest, and I went long that market.
I noticed that Taiwanese stocks were doing relatively well (EWT), also Chinese stocks (FXI), and finally Israeli stocks (EIS) showed strong relative strength. But the market that seemed to be outpacing everything else were Malaysian stocks (EWM):
As you can observe in the above chart, Malaysian stocks are not close to making new lows, while the DJIA and SPX are. I believe that going long the strongest market in the world, while short selling some of the weakest stocks I can identify, gives me an edge.
The next chart shows EWM divided by SPY:
As the above chart rises, it shows that EWM is rising faster, or falling less slowly than SPY. Of course, should this ETF lose its strength, I have a stop loss point to take care of it.
To hedge myself, I could have simply gone long SPY or DIA, but I did not. Instead, I tried to find which world market was performing the strongest, and I went long that market.
I noticed that Taiwanese stocks were doing relatively well (EWT), also Chinese stocks (FXI), and finally Israeli stocks (EIS) showed strong relative strength. But the market that seemed to be outpacing everything else were Malaysian stocks (EWM):
As you can observe in the above chart, Malaysian stocks are not close to making new lows, while the DJIA and SPX are. I believe that going long the strongest market in the world, while short selling some of the weakest stocks I can identify, gives me an edge.
The next chart shows EWM divided by SPY:
As the above chart rises, it shows that EWM is rising faster, or falling less slowly than SPY. Of course, should this ETF lose its strength, I have a stop loss point to take care of it.
Odyssey Healthcare Inc. (ODSY)
I have a buy stop set on this one. I don't like it at this price... I would prefer to pay over $12.00 a share.
Different Investment Styles and Trend Following
One characteristic of trend following trading that I find interesting is that the technique can be used on many different time frames, which means that many different types of investors can adopt a trend following approach.
For example, if one finds short term trading appealing, one can trade trends off a 5 minute chart. This approach used to be problematic, as profits tended to be negated by commissions, but with commissions so low today, I do believe that it is feasible.
Personally, I am more of a medium term trend trader that focuses on daily and weekly charts, and I find that this approach matches my needs in trading, but I would not say it is any better or worse than another approach.
Finally, on the other side of the spectrum, it is possible to be a very long term trend follower. This type of investor would most likely use monthly charts, and may only make a few trades a year.
In this post, I wanted to point out a very long term trend that is currently under way. It is the relationship between the price of Gold, and the value of the Dow Jones. I have been keeping my eye on this trend for years, and find it fascinating.
The chart below shows a 200 day moving average of the DJIA divided by the price of Gold going back 18 months:
As the chart declines, it is illustrating that as time goes on, the Dow is capable of purchasing diminishing quantities of gold. The chart also shows the result if one had gone long the Dow, and shorted gold - obviously a money losing proposition in this case.
The next chart shows the same relationship, but it goes back 10 years:
Another way to look at the above chart is to realize that in 2001, you could sell one "unit" of the DJIA, and receive over 40 ounces of gold. Today, if you sold one "unit" of the DJIA, you would receive less than 8 ounces of gold. I wrote about the reasons for this in another blog.
Finally, for the long term trend followers, we have the same relationship again, except going back 20 years:
As you can observe, the DJIA truly was the place to be invested from 1982 to 2000. A tremendous amount of wealth was created during this period, and I would even have to admit that a buy and hold approach would have been prudent during this time.
However, since 2000, we have seen a great tectonic shift take place in the market, a shift that has made investing in stocks a relatively unprofitable endeavour when compared to other asset classes.
For example, if one finds short term trading appealing, one can trade trends off a 5 minute chart. This approach used to be problematic, as profits tended to be negated by commissions, but with commissions so low today, I do believe that it is feasible.
Personally, I am more of a medium term trend trader that focuses on daily and weekly charts, and I find that this approach matches my needs in trading, but I would not say it is any better or worse than another approach.
Finally, on the other side of the spectrum, it is possible to be a very long term trend follower. This type of investor would most likely use monthly charts, and may only make a few trades a year.
In this post, I wanted to point out a very long term trend that is currently under way. It is the relationship between the price of Gold, and the value of the Dow Jones. I have been keeping my eye on this trend for years, and find it fascinating.
The chart below shows a 200 day moving average of the DJIA divided by the price of Gold going back 18 months:
As the chart declines, it is illustrating that as time goes on, the Dow is capable of purchasing diminishing quantities of gold. The chart also shows the result if one had gone long the Dow, and shorted gold - obviously a money losing proposition in this case.
The next chart shows the same relationship, but it goes back 10 years:
Another way to look at the above chart is to realize that in 2001, you could sell one "unit" of the DJIA, and receive over 40 ounces of gold. Today, if you sold one "unit" of the DJIA, you would receive less than 8 ounces of gold. I wrote about the reasons for this in another blog.
Finally, for the long term trend followers, we have the same relationship again, except going back 20 years:
As you can observe, the DJIA truly was the place to be invested from 1982 to 2000. A tremendous amount of wealth was created during this period, and I would even have to admit that a buy and hold approach would have been prudent during this time.However, since 2000, we have seen a great tectonic shift take place in the market, a shift that has made investing in stocks a relatively unprofitable endeavour when compared to other asset classes.
Adobe Systems Inc. (ADBE)
We finally received some meaningful movement in the market this week. Here are how the stocks in my portfolio reacted this week:
Short AFL -17%
Long APOL -2%
Short CEDC -31%
Short DOW -15%
Long HANS -4%
Short IP -11%
Long JBLU -27% (eliminated on Thursday)
Short KBE -17%
Short MTD -10%
Short TTWO -14%
Short VIP -14%
Long HBU.to +11%
Long HND.to +20%
Long K.to +2%
Long MRU/a.to -1%
Of course one week does not prove anything. My portfolio is also very much primed for downward movements in the stock market. Therefore, I will be inclined to add to my long positions on Monday in order to reduce risk.
I have posted a few long and short candidates that caught my eye today:
Short AFL -17%
Long APOL -2%
Short CEDC -31%
Short DOW -15%
Long HANS -4%
Short IP -11%
Long JBLU -27% (eliminated on Thursday)
Short KBE -17%
Short MTD -10%
Short TTWO -14%
Short VIP -14%
Long HBU.to +11%
Long HND.to +20%
Long K.to +2%
Long MRU/a.to -1%
Of course one week does not prove anything. My portfolio is also very much primed for downward movements in the stock market. Therefore, I will be inclined to add to my long positions on Monday in order to reduce risk.
I have posted a few long and short candidates that caught my eye today:
Autozone Inc. (AZO)
Notice how this stock is making a 52 week high, while the general market is making 52 week lows. This company must be do something right.
iPath Dow Jones AIG Cocoa Total Return ETN
There are now currently over 1,000 ETFs that any investor is able to trade in their brokerage accounts. Any new ETF that is introduced tends to be quite unique, as most markets and sectors already have an ETF covering them.
This is the case with this new fund, introduced last summer, which follows the price of Cocoa. As per the issuer's website, this fund is:
The chart below shows the funds performance since its inception in July:
Interestingly, Cocoa has been one of the few commodities (other than gold, and perhaps Uranium) that has broken its downtrend and has shown strength.
A commodity that shows strength in the face of a severe commodity bear market is something to take note of, in my opinion.
However, there are some issues with this fund, in my view. Firstly, this fund is thinly traded, so there is liquidity risk. Secondly, because this is an ETN, there could be potential counter-party risk, although this is probably unlikely.
This is the case with this new fund, introduced last summer, which follows the price of Cocoa. As per the issuer's website, this fund is:
intended to reflect the returns that are potentially available through an unleveraged investment in the futures contracts on physical commodities comprising the index as well as the rate of interest that could be earned on cash collateral invested in specified Treasury Bills. The Dow Jones-AIG Cocoa Total Return Sub-IndexSM is a single-commodity sub-index currently consisting of one futures contract on the commodity of cocoa, which is included in the Dow Jones-AIG Commodity Index Total Return
The chart below shows the funds performance since its inception in July:
Interestingly, Cocoa has been one of the few commodities (other than gold, and perhaps Uranium) that has broken its downtrend and has shown strength.
A commodity that shows strength in the face of a severe commodity bear market is something to take note of, in my opinion.
However, there are some issues with this fund, in my view. Firstly, this fund is thinly traded, so there is liquidity risk. Secondly, because this is an ETN, there could be potential counter-party risk, although this is probably unlikely.
DB Commodities Tracking Index Fund (DBC)
I spent years convincing myself that the fundamentals for commodities were strong. I now see why Ed Seykota uses the term "funny-mentals."
Another good quote that applies in this case is that "markets are 10% logical, and 90% psychological."
Another good quote that applies in this case is that "markets are 10% logical, and 90% psychological."
Horizon Crude Oil Bull ETF
I just can't stomach shorting oil at $35 per barrel, but I felt the same way at $40, $50, $60, and $70...
My fundamental beliefs, unfortunately, succeeded at colouring my trend following methodology, in this case. On the bright side, at least I never went long.
My fundamental beliefs, unfortunately, succeeded at colouring my trend following methodology, in this case. On the bright side, at least I never went long.
Cash is Not King
As the S&P 500 continues to grind sideways, I see a lot of debate on other blogs on which way the market will break. A common theme is to stay in cash until a move is made either up or down.
In my view, the S&P 500 is only one market amongst many. If this particular market is trading sideways, then I will trade something else. In my January 22 post, I mentioned that I was long gold and short natural gas. The reason I decided to put on such a trade is because gold was proving to be the strongest commodity, and natural gas was proving to be one of the weakest.
The chart below shows GLD (an ETF that tracks gold) divided by UNG (an ETF that tracks natural gas):
As the chart above rises, it shows that gold is outperforming natural gas. If you are long GLD and short UNG, you want this chart to be rising. This type of hedge has been quite profitable in the last couple of weeks; much more so than trading sideways in the S&P.
If you use your imagination, you can find many different profitable combinations. The chart below shows that you could have made a significant profit if you had bought oil shares, and shorted oil itself:
In addition, within the S&P 500, there will usually be sectors that are performing more strongly. I want to own the strongest sectors and short sell the weakest sectors. The next chart shows that biotech stocks are doing better than the market:
And, of course, there are opportunities always abound in the currency market. For example, the chart below shows that the Japanese Yen has dominated the British Pound in the last few months.
I don't know how much longer any of these trends will last, but I try to stay on as long as the trend persists, and exit only when I get my signal.
There are probably over 10,000 stocks, as well as dozens of commodities, currencies, and bonds to trade, which means that I really do not see the rationale for holding a significant portion of my portfolio in cash. There are always opportunities.
In my view, the S&P 500 is only one market amongst many. If this particular market is trading sideways, then I will trade something else. In my January 22 post, I mentioned that I was long gold and short natural gas. The reason I decided to put on such a trade is because gold was proving to be the strongest commodity, and natural gas was proving to be one of the weakest.
The chart below shows GLD (an ETF that tracks gold) divided by UNG (an ETF that tracks natural gas):
As the chart above rises, it shows that gold is outperforming natural gas. If you are long GLD and short UNG, you want this chart to be rising. This type of hedge has been quite profitable in the last couple of weeks; much more so than trading sideways in the S&P.
If you use your imagination, you can find many different profitable combinations. The chart below shows that you could have made a significant profit if you had bought oil shares, and shorted oil itself:
In addition, within the S&P 500, there will usually be sectors that are performing more strongly. I want to own the strongest sectors and short sell the weakest sectors. The next chart shows that biotech stocks are doing better than the market:
And, of course, there are opportunities always abound in the currency market. For example, the chart below shows that the Japanese Yen has dominated the British Pound in the last few months.
I don't know how much longer any of these trends will last, but I try to stay on as long as the trend persists, and exit only when I get my signal.
There are probably over 10,000 stocks, as well as dozens of commodities, currencies, and bonds to trade, which means that I really do not see the rationale for holding a significant portion of my portfolio in cash. There are always opportunities.
Kinross Gold (K.to)
This Saturday I have identified 3 potential long candidates. They are all Canadian, and I think that they are all natural resource related stocks. I purchased some shares in the stock below, Kinross Gold, on Thursday.
For Americans, Kinross Gold trades in New York under ticker symbol KGC. If you have access to both exchanges, and if you are unsure if you want to hold your shares in Toronto or New York, I would recommend reading this article.
For Americans, Kinross Gold trades in New York under ticker symbol KGC. If you have access to both exchanges, and if you are unsure if you want to hold your shares in Toronto or New York, I would recommend reading this article.
PowerShares Double Short Base Metals (BOM)
This is a fund that performs inversely to an index that tracks the price of aluminum, copper, and zinc, by a factor of 2 to 1. So, for example, if the price of these base metals fall on average by 2%, then this fund should rise by approximately 4%.
With the price of base metals crashing over the last 8 months, this fund has done quite well. As a trend follower, I try to keep my eye on as many sectors and asset classes as possible so that I can spot profitable trends.
I am willing to trade anything so long as that it is in a trend. It doesn't matter to me if it is the Japanese Yen, or US Treasuries, the price of Platinum, or anything else; if it is in a trend then it is on my radar screen.
Currently, I would not buy this fund, as it is trading below its 50dma. But I will keep my eye on this fund to see if the trend continues, or if there will be money to be made on the downside.
For more information, you can refer to the issuer's information page.
With the price of base metals crashing over the last 8 months, this fund has done quite well. As a trend follower, I try to keep my eye on as many sectors and asset classes as possible so that I can spot profitable trends.
I am willing to trade anything so long as that it is in a trend. It doesn't matter to me if it is the Japanese Yen, or US Treasuries, the price of Platinum, or anything else; if it is in a trend then it is on my radar screen.
Currently, I would not buy this fund, as it is trading below its 50dma. But I will keep my eye on this fund to see if the trend continues, or if there will be money to be made on the downside.
For more information, you can refer to the issuer's information page.
Mettler Toledo International Inc. (MTD)
What to short: MTDHow much to short: 46 shares (based on a hypothetical $10,000 portfolio and risking 3% on the trade)
Current Price: $61.68
When to cover at a loss: Based on the stocks volatility, my method says to place a buy stop at $68.24
When to cover at a profit: After a close above the 50dma
(Like all my posts, this post is for informational and record keeping purposes. It is not a recommendation to buy or sell any security)
Drawing the Lines on Bull and Bear Markets
When it comes to trading, I feel that it is important to always be cognizant of the long term trend of the market. Although all of the charts displayed in this blog so far have been daily charts, I do analyze weekly and monthly charts as part of the decision process.
In fact, when I take a position in a stock, I will prefer it if the stock's monthly, weekly, and daily trends are all in alignment. In my experience, this tends to increase the probability of a profit, and, more importantly, the magnitude of the profit.
The following chart shows how I define the long term bull and bear cycles of the market. The chart below is a monthly chart of the S&P 500, and goes back about 15 years:
The area in orange represents the 26 month moving average, and the area in blue represents the 9 month moving average. As you can observe, the S&P 500 has, like a giant pendulum in a clock, swung from bull and bear markets on several occasions in the last decade and a half. Needless to say, we are now in a bear market.
One thing I wanted to point out is that my use of 9 and 26 month moving averages is quite arbitrary. Those who think that they need to use Fibonacci numbers, or use some type of proprietary combination are on the wrong track, in my opinion. What's more important is that you have rules that you are comfortable with, and that you follow those rules.
The fact that we are in a bear market means that I will be net short stocks most of the time. I think this makes sense, since going long stocks in a bear market usually means going against the flow of the market, although there will always be stocks that will outperform the market.
Any buy and hold, long only type investor runs the serious risk of severe capital depreciation in this type of market. I feel that going with the flow of the market instead of buying and hoping that markets will eventually rise over time is a more logical approach. I am confident that this blog will illustrate this over time.
In fact, when I take a position in a stock, I will prefer it if the stock's monthly, weekly, and daily trends are all in alignment. In my experience, this tends to increase the probability of a profit, and, more importantly, the magnitude of the profit.
The following chart shows how I define the long term bull and bear cycles of the market. The chart below is a monthly chart of the S&P 500, and goes back about 15 years:
The area in orange represents the 26 month moving average, and the area in blue represents the 9 month moving average. As you can observe, the S&P 500 has, like a giant pendulum in a clock, swung from bull and bear markets on several occasions in the last decade and a half. Needless to say, we are now in a bear market.One thing I wanted to point out is that my use of 9 and 26 month moving averages is quite arbitrary. Those who think that they need to use Fibonacci numbers, or use some type of proprietary combination are on the wrong track, in my opinion. What's more important is that you have rules that you are comfortable with, and that you follow those rules.
The fact that we are in a bear market means that I will be net short stocks most of the time. I think this makes sense, since going long stocks in a bear market usually means going against the flow of the market, although there will always be stocks that will outperform the market.
Any buy and hold, long only type investor runs the serious risk of severe capital depreciation in this type of market. I feel that going with the flow of the market instead of buying and hoping that markets will eventually rise over time is a more logical approach. I am confident that this blog will illustrate this over time.
United States Gasoline Fund (UGA)
This week's ETF, ticker symbol UGA, follows the price of gasoline. According to the fund's site, it is designed to follow gasoline's daily percentage changes on a one to one basis. With an MER of 0.6%, it seems like a practical way for the average investor to acquire exposure to this commodity:
I have noticed that, for whatever reason, the price of gasoline is performing much more strongly than the price of crude oil (ETF ticker symbol USO), as the next chart shows.
What I like to do in my own trading account is to create hedges using two commodities. What I would consider doing in this case is buying UGA, and short selling USO. Doing so would allow me to profit in the event that:
Gasoline rises faster than crude oil (like it's doing now)
Gasoline falls more slowly than crude oil
Gasoline rises, and crude oil falls (ideal, but unlikely situation)
I have noticed that, for whatever reason, the price of gasoline is performing much more strongly than the price of crude oil (ETF ticker symbol USO), as the next chart shows.
What I like to do in my own trading account is to create hedges using two commodities. What I would consider doing in this case is buying UGA, and short selling USO. Doing so would allow me to profit in the event that:
Gasoline rises faster than crude oil (like it's doing now)
Gasoline falls more slowly than crude oil
Gasoline rises, and crude oil falls (ideal, but unlikely situation)
Mobile Telesytems (MBT)
What to short: MBTHow much to short: 60 shares (based on a hypothetical $10,000 portfolio and risking 3% on the trade)
Current Price: $18.57
When to cover at a loss: Based on the stocks volatility, my method says to place a buy stop at $23.56
When to cover at a profit: After a close above the 50dma
(Like all my posts, this post is for informational and record keeping purposes. It is not a recommendation to buy or sell any security)
Textron Inc. (TXT)
What to short: TXT
How much to short: 128 shares (based on a hypothetical $10,000 portfolio and risking 3% on the trade)
Current Price: $8.08
When to cover at a loss: Based on the stocks volatility, my method says to place a buy stop at $10.42
When to cover at a profit: After a close above the 50dma
(Like all my posts, this post is for informational and record keeping purposes. It is not a recommendation to buy or sell any security)
Accuracy Versus Expectancy
It might surprise a lot of people that the top trend following traders are only profitable on 35-50% of their trades. In my experience, many of those who start off trading look for a system or technique that will be at least 80% accurate, and I see many ads on the internet promising to fulfill this need.
Psychologically, this makes sense, as it is human nature to feel good after winning and to feel bad after losing. Furthermore, losses feel worse than gains feel good, to the point where studies have shown that it takes about 2.5 wins to offset the emotional pain of 1 loss. Thus trading tends to be a negative sum game emotionally.
But like I've said before, when it comes to trading, what comes to mind instinctively is often the incorrect thing to do. What top traders realize is that it is not how accurate your trades are, but how much you make when you win, and how little you give back when you lose.
In Jack Schwager's excellent book, The New Market Wizards
trend following trader William Eckhardt was quoted as saying:
On August 8th, this stock was identified by one of my scans as a potential short candidate. I knew nothing about the fundamentals of this company, but I did know that the stock was in a downtrend, so I took a short position at $15.00 a share.
Immediately after the trade was filled, I placed a buy stop at the level shown by the dashed line in the chart above. This step is essential for keeping all loses acceptably small in the event the trade does not work out (which happens often).
After about 5 months, here is how the was the trading:
I covered the short position on January 5th, 2009 after the stock rose above its 50 day moving average. The decision to cover caused me no consternation, as I was simply following my predetermined rule.
Now, to be clear, this type of trade is not a typical trade for me, and I am not some sort of genius for picking this stock. A profit of this magnitude may happen 5% of the time, but they do happen, and when they do, they cover the cost of all your small losses and more.
Psychologically, this makes sense, as it is human nature to feel good after winning and to feel bad after losing. Furthermore, losses feel worse than gains feel good, to the point where studies have shown that it takes about 2.5 wins to offset the emotional pain of 1 loss. Thus trading tends to be a negative sum game emotionally.
But like I've said before, when it comes to trading, what comes to mind instinctively is often the incorrect thing to do. What top traders realize is that it is not how accurate your trades are, but how much you make when you win, and how little you give back when you lose.
In Jack Schwager's excellent book, The New Market Wizards
trend following trader William Eckhardt was quoted as saying:...The problem in a nutshell is that human nature does not operate to maximize gain but rather to maximize the chance of gain. The desire to maximize the number of winning trades (or minimize the number of losing trades) works against the trader. The success rate of trades is the least important performance statistic and may even be inversely related to performance.
To help solidify the concept of how accuracy is not required for successful trading, let's go through an example. The following trade is a trade I did with real money last summer that resulted in a profit of approximately 76%:
On August 8th, this stock was identified by one of my scans as a potential short candidate. I knew nothing about the fundamentals of this company, but I did know that the stock was in a downtrend, so I took a short position at $15.00 a share.
Immediately after the trade was filled, I placed a buy stop at the level shown by the dashed line in the chart above. This step is essential for keeping all loses acceptably small in the event the trade does not work out (which happens often).
After about 5 months, here is how the was the trading:
I covered the short position on January 5th, 2009 after the stock rose above its 50 day moving average. The decision to cover caused me no consternation, as I was simply following my predetermined rule.Now, to be clear, this type of trade is not a typical trade for me, and I am not some sort of genius for picking this stock. A profit of this magnitude may happen 5% of the time, but they do happen, and when they do, they cover the cost of all your small losses and more.
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