Too Much Market Stress? Follow a System

From the editor's desk

BY BRYAN DEMCHINSKY, THE MONTREAL GAZETTENOVEMBER 5, 2009

The markets came in like a bull and went out like a bear in October.

Four days of triple-digit losses on the TSX last week conjured up the ghosts from the Crash of '08 and had me wondering, what, short of not being in the game, can a poor investor do in the face of a nasty downturn?

Looking for answers, I called up friend and colleague Alex Roslin, who has a trading blog called Cots Timer.

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Read the full story at the Montreal Gazette website here.

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

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

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.