Alex Roslin's Financial Stories

Banks and Crude Charts Look Hot, But Housing Still a Drag

2009-06-18T14:52:00.001-04:00

By Alex Roslin

Investor's Digest of Canada

June 5, 2009

Markets have been on fire since their March lows, but they’ve climbed a classic “wall of worry.” Bearish sentiment is so strong that many investors and analysts are convinced the rally can’t last and we are about to see a monster selloff—perhaps taking markets below the March lows.

Even the “smart money” large commercial hedgers are highly pessimistic. Starting in late March, they’ve built up huge net short positions in S&P 500 futures and options—a sizeable bet that the market would fall.

As of mid-May, all this worry has been terribly misplaced. Stocks have shot virtually straight up for two months. The S&P/TSX composite index and S&P 500 both gained 35 percent since early March, while the TSX capped financial services index flew up an extraordinary 59 percent.

The phenomenal gains are clearly bullish, but how can we tell if the rally has legs? Could this merely be a massive “sucker rally” that traps unsuspecting investors just as they tiptoe back into the markets?

An important exercize worth doing regularly is to step back and look at the longer-term weekly and monthly charts to put things in proper perspective—and see where we might be headed. These charts are telling us some interesting things.

Many market sectors have gone a long way toward repairing the damage they suffered during the Crash of ’08—but some haven’t and remain highly dysfunctional. Especially well-positioned right now are Canadian financials and crude oil; but housing remains a worrisome underperformer.

The charts also show that many sectors are headed into potentially dangerous territory. We might see a sideways consolidation period at best—or, at worst, the long-expected selloff. Below are some highlights based on my interpretation of a chart-reading system developed by renowned analyst Tom DeMark. (Google “Tom DeMark” to learn more.)

Broader market

The S&P/TSX composite index has been a big winner lately, benefiting from its commodities focus. Its rally since March has powered the index up handsomely, but now, the index has stalled below a key level of resistance at 10,312 on the weekly chart. This is where there’s a Tom DeMark Setup Trend (TDST) resistance line dating back to the beginning of an uptrend that started in 2005.

Also a concern: the TSX completed what DeMark calls a Sequential Setup without breaking out above the 10,312 level. (A Sequential Setup is nine consecutive days of closes higher than the close four days before.)

Under DeMark’s theory, this suggests a rally that has possibly exhausted itself. A rally that doesn’t break out above a TDST line before completing a full Sequential Setup has a good risk of facing strong headwinds.

The plus side is that, in the event of a selloff, the TSX has solid support at 9887 (the highs of early Nov. 2008) and 9267 (the highs of early Jan. 2009) on the daily charts. These levels could contain any correction that does take place. A stop could be placed below these levels.

The most bullish development would be for the TSX to shrug off these factors and keep muscling upward above 10,312. That could spell lots of additional upside. Watch this line carefully.

The TSX can be traded with exchange-traded funds like the iShares S&P/TSX 60 Index Fund (XIU) and the 200-percent leveraged Horizons BetaPro 60 Bull Plus Fund (HXU). A bearish bet can be placed with the 200-percent leveraged Horizons BetaPro 60 Bear Plus Fund (HXD).

Within the TSX, Canadian banks have been some of the most remarkable performers. The S&P/TSX capped financial services index has broken up beautifully above resistance on both the weekly and monthly charts (around 141 and 137, respectively). These areas should provide solid support in the event of a broader market selloff and can act as stop levels. Next resistance is still far above current prices. A TDST resistance line appears on the monthly chart at 185—which means potential room for nearly 30 percent more upside.

Less happy is the action in housing. Despite spectacular rallies since March, Canada’s iShares Canadian S&P/TSX Capped REIT Index Fund (XRE) and the U.S. HGX Housing Index have both stalled in their uptrends before coming anywhere close to resistance on the weekly and monthly charts. Since housing is at the root of our current mess, this sector’s weak charts probably spell trouble for the market rally.

Commodities

Crude oil saw a vicious correction last year but might now be among the best positioned commodities. In mid-May, it rose up smartly above resistance on the weekly and monthly charts around $57. The caveat is that lots of additional resistance exists on the weekly chart that could trip up crude. Be ready for lots of volatility. Next weekly resistance levels to watch are $62.43 and $73.48. Crude is tradable with the 200-percent leveraged Horizons BetaPro Crude Oil Bull Plus Fund (HOU) or the United States Oil Fund (USO).

Copper has soared 65 percent since March, but, much like the TSX, it has bumped up against resistance on the weekly chart. This comes just as copper has finished a full DeMark Sequential Setup. Support on the daily chart exists at 196, so this would be a logical support and stop level in the event of a selloff. A sustained rise above weekly resistance at 220 would be supremely bullish for the metal—and the entire market, as copper is a bellwether for the economy. (Copper can be traded with the iPath Dow Jones-AIG Copper Total Return Sub-Index ETN, symbol JJC.)

Emerging markets

Emerging markets are blasting off. The iShares MSCI Emerging Markets Fund (EEM) has exploded up through resistance lines on the weekly and monthly charts (at 30 and 29.50, respectively). Those levels should serve as support (and potential stop levels) for any selloff. And despite a 55-percent rally since March, EEM has its next serious level of long-term resistance at around $49—meaning nearly 60 percent of potential upside above the current price. Emerging markets are tradable with the 200-percent leveraged Horizons BetaPro MSCI Emerging Markets Bull Plus Fund (HJU).

Gold Gets Its Groove Back For Now

2009-05-06T10:49:00.002-04:00

by Alex Roslin

Kitco.com

As stock markets fly up from their March low, gold has slowly wilted. Even a decline in the greenback hasn’t returned bullion’s shine. Gold seems to have met solid resistance around $1,000—the level it hit in Feb. 2008 and again this past February before taking serious tumbles.

Could this be what technical analysts call a double top—a bearish formation that usually leads to a major selloff? Or are the gold bugs right to say gold is about to explode because of the oceans of central-bank liquidity being mainlined into the financial system?

The questions are especially important as gold has recently tended to move in the opposite direction to the stock market. So if the equities rally is for real, will this spell trouble for gold bulls?

We can find some interesting answers hiding in some little-known derivatives data that comes out once a week in the U.S. government’s Commitments of Traders reports.

I know, I know—talk to most people about derivatives and you’ll see eyes glazing over and hear the sound of snoring. Well, get another coffee because this data tells us where the big players in 100-plus markets are parking their money.

And in the gold market, things seem to be looking up—for now. My trading setup based on the COT data gave a bullish signal for gold bullion for the open of Monday, April 27. It had been in cash before that for 11 weeks.

The signal is based on a couple of key developments in the data. Firstly, the so-called large speculators, who tend to be wrongly positioned at key market junctures, have recently gotten quite bearish on the prospects of the yellow metal.

In fact, starting in early March, the large specs sharply reduced their total open interest (long plus short positions). This caused them to fall significantly below a long-term moving average I’ve developed to track where they stand compared to recent data.

Meanwhile, another positive development has occurred in the large spec net position. It has remained in a highly pessimistic posture since last August. That, of course, is also bullish for gold bugs. We want to get long when the dumb money hits extremes of gloom.

And last August, the wrong-way large specs hit a historic peak of bearishness that they have yet to really reverse. In fact, the week of Aug. 19, 2008, saw them get more bearish in their futures and options net position as a portion of the total open interest than they’ve ever been since the beginning of the data, relative to their moving average.

Since then, it should be said, the large specs have gotten somewhat less down on gold. But they haven’t gotten anywhere nearly frothy enough by historic standards to jeopardize a gold rally. That was even true during February’s spike past $1,000.

My trading setup based on the COT data works by combining two signals and taking positions in bullion when they agree. The first signal is fades the large spec total open interest in gold; the second fades the large spec net position.

I’ve found through lots of backtesting (including Monte Carlo tests and detrended price data for you stats enthusiasts) that trading with two signals based on this data tends to be far more reliable than trading off just one signal (my initial method when I first started researching this data a few years ago).

It’s not clear how long the current bullish gold signal will last. Each Friday afternoon’s data brings the possibility of a new signal. One warning sign has already shown up for a few weeks out. The large specs total open interest shot up suddenly to a bullish extreme last Friday. However, this signal works with a seven-week trade delay, so it doesn’t affect anything for a little while yet. Just a warning sign that any coming rally might get overbought real fast.

I should also point out that my signals are no guarantee of a winning trade. No trading strategy I’ve ever heard of wins 100 percent of the time; mine certainly hasn’t, even in the hypothetical realm of backtesting. I use stops and appropriate position sizes to help control my risk.

Visit my free blog COTsTimer.Blogspot.com for my weekly updates on this and other markets, to see how on how my system works, to learn more about the importance of risk control and to download a spreadsheet to crunch the data yourself.

***

Disclaimer: This report isn’t meant as financial advice or a recommendation to buy or sell any security. Please do your own homework before trading. My system involves substantial risk, has experienced large drawdowns in some past trades and requires the use of additional risk-control techniques. Past results are no guarantee of future profits. I’m not a certified financial advisor. While I consider my information to be reliable and accurate, I make no guarantees. Visit my blog for more important disclaimer information.

Zen and the Art of Portfolio Management

2008-12-23T11:20:00.006-05:00

As the markets tumble and all about you are losing their heads, you need not lose yours

Alex Roslin

Saturday, December 20, 2008

The Montreal Gazette

Is it finally over? The Market Horror Picture Show is lurching to a close. What fresh horrors will 2009 bring? And how can we be ready?

You know it's been tough when even the brightest minds in the investing world are running for the hills.

"What a sick beast this is," complained trader Stephen Vita in a post on his Alchemy of Trading website a few months ago. "This market is exasperating, and I'm frankly more than a little sick of the whole thing."

Even the world's richest man has gotten stomped. Warren Buffett's Berkshire Hathaway crashed an astonishing 50 percent from its high of last year to their lows of this fall's selloff, before recovering a little in the last few weeks.

But if the planet's best investor is on the run, what hope is there for us average schmoes? How can we possibly survive 2009, a year we're being told could be even worse?

Advice, as usual, is all over the place. "Hold tight, things will eventually turn around," say some. Or: "Sell now! Or you could lose everything."

Still others say, "Buy! Valuations are cheap."

Who is right?

I don't know. Nobody does.

This, I think, is the lesson of our times. Insanity is the new normal. Here's a typical market day: stocks shoot up 5 per cent in morning trading, crash 10 per cent by mid-afternoon, then rally to close even for the day.

We've seen enough of this kind of action to safely say it's impossible to know what tomorrow will bring in the markets.

So what? you ask. You knew that already. The question is, do you actually act as if you have no clue what lunacy tomorrow's market will bring?

Not if you're anything like most amateur investors. Most of those I know act as if they have some secret knowledge about the future - even when their past mistakes prove they don't.

Case in point: I was recently talking about the markets with two people who shall remain nameless - both of them sharp, careful businesspeople.

They had both independently arrived in the same pickle. They bought energy stocks at the height of the commodities boom last spring; the stocks had since crashed 80 to 90 per cent. They had lots of chances to sell as their holdings were decimated.

They never did. Why not? Well, they didn't want to miss the inevitable rally that would let them at least get their money back.

Out of pride or misplaced hope, they were ignoring some basic math. The stocks must climb five to 10 times for them just to break even-an unlikely concept in the foreseeable future. The odds are probably just as high, in fact, that those companies will pull a Nortel and be penny-stocks. Some could even fold.

The fact is both people knew they had failed miserably in predicting the future. But by refusing to sell, they were still acting as if they could predict.

I don't think they are so different from many under-water investors out there. Despite the devastation of the Crash of '08, I think too many of us are still pretty deluded about how we approach the markets.

And this is what I think separates amateur investors from the pros who trade for a living. I think it's a key for surviving the times ahead.

The traders, at least those who are successful, know what they don't know. And they act accordingly.

Meanwhile, the rest of us too often don't. We paid the price for that hubris in 2008. And we could pay again in 2009.

It's not just you and I who have a hard time making money in the markets. It's often said the best traders typically make a profit on only 60 per cent of their trades.

So how do they afford their Porsches, country villas and Brioni suits? It took me a long time to get this, but the secret isn't insider information or expensive computer trading software. They profit by controlling risk.

Risk control isn't just for professional traders, of course. Limiting our vulnerability to bad things is something we do all the time. Think about how you approach the other unknowable things in your life -the risk of STDs, theft, accidents, death.

We try to minimize the chances something will go wrong by wearing protection, locking our doors, buckling up, wearing a bike helmet when rolling down the hill in a shopping cart. And, just in case, we get insurance.

But most people seem to have a completely different approach when it comes to investing. In fact, the market may just be the place people take the wildest chances with their livelihoods, with the very fewest precautions.

Is there an investing equivalent to insuring and locking your house?

Fortunately, yes. We can minimize risk with a few simple investing rules. Such risk-control rules are common knowledge among professional traders, but they're still little-known to average investors, despite the freefalling markets.

The rules all boil down to this: If we truly don't know what grenade tomorrow's market will lob at our heads, always be ready to duck.

***

CUTTING YOUR LOSSES 101

Here are some simple risk-control rules commonly used by professional traders:

Decide when to sell before you buy: Buying is often easier than selling. When do you cash in if your stock goes up? When do you sell if it craters? Most everybody has an ouch point—even a buy-and-hold investor. Is it after losing 60 percent of your assets? Ninety percent?

The pros tend to avoid this conundrum by picking their selling point before they buy. It’s their way of admitting they don’t know what’s going to happen in the market.

A simple way is to look at a chart. Take the S&P/TSX composite index. It bottomed at 7647 in late November and has since gained 1,000 points. Not bad. If I were to buy it today, I might place my sell point (often called a “stop”) below a recent major low (like 7647) or the 20-day moving average.

Traders often set stops a little below such levels because they don’t like to get stopped out by regular market noise; they want to sell only because of a serious breakdown.

I use the same rule to figure out when to sell a winning stock. For example, I might place my stop one or two percent below a stock’s 20-day moving average and adjust upward as the price rises. That’s called a trailing stop.

The exact stop level can be adjusted based on the timeframe of the investor. A long-term purchase could use a stop 10 percent below a major multi-month low or the 50-day moving average; a very short-term trade may use a stop one percent below a recent low or the five-day moving average.

(You can view free charts of Canadian and U.S. securities, including nifty indicators like moving averages, at StockCharts.com and Yahoo! Finance.)

Size matters: Knowing when to sell tells me how much money to risk on an investment. A common rule-of-thumb is not to risk losing more than one or two percent of total assets in any single trade.

In our TSX example, say I buy the index at Tuesday’s closing price of 8742 and my stop is 7532. That equals a 14-percent loss if my trade goes sour and my stop is triggered.

A little math tells me I should invest no more than 14 percent of my portfolio in this trade if I can’t stomach losing more than two percent of my total assets (100 percent divided by half of the 14-percent potential loss).

Diversify: Stops and appropriate positions don’t help me much if I’m 100-percent invested in a single sector that goes belly-up. If my stops are hit at the same time in 10 energy companies, I’ve just lost 20 percent of my Freedom 55 fund. Sayonara, beach house.

That’s why pros often put no more than 20 or 25 percent of their assets in any one market.

Cut your losses: “To make great sums of money,” trader Paul Tudor Jones once wrote, “you first have to learn how to lose much smaller sums of it when you’re wrong.”

I had my own lesson about this last fall. I often invest with a mechanical investing system that I developed. Last summer, the market data started to hit extremes it had never seen before. Signals were often wrong and costing me money. I wasn’t down as much as the broader market, but enough to make me take a closer look at my approach to risk control.

I realized I had no rule for when the market data was acting completely out-of-line with historic precedents.

To account for this I adopted a slightly adapted version of another commonly used trading rule: If my portfolio loses more than six percent in any four-week period, I sell everything and go to cash. Call it a time-out for a misbehaving market.

I adopted this rule just in time to sidestep the worst of the market carnage in October and November.

When the time-out was over, I was set to jump back into the markets just as they rallied powerfully in late November and December.

Has the market finally bottomed? I don’t know. I do know the market can turn on a dime. And if I want to survive, I must, too.

Which brings me to another good trader’s rule: get a little Zen. Lose the pride and don’t be sentimental about an investment. It’s money, after all, not romance. Emotions are the worst enemy of an investor. If I’m wrong, I try to learn something and move on to the next idea. I think of my loss as a tuition fee.

This approach was captured nicely in the movie Kung Fu Panda. “Master!” says the kung fu teacher. “I have… very bad news.” “Ah, Shifu,” the wise old turtle replies. “There is just news. There is no good or bad.”

Hey, that really is a wise old turtle. Perhaps Mr. Buffett could use a kung fu lesson. Perhaps we all could.

Cutting Losses 101

2008-12-23T11:17:00.000-05:00