Ilene at PSW's  Instablog

(Excerpt from Stock World Weekly)

We wrote in last week's Stock World Weekly, Tightening the Screws, "This bull run might resume, or not, but we may be seeing the initial 'weakness' that leads a correction. We have been skeptical of this rally, and concerned that it is building on air, that when things turn down, they will do so with a vengeance. Let's not be in a place where the 'air' will fall out from under us, dropping us into an air pocket!

"Phil surveyed the market on Friday and wrote, 'While the market has been content to ignore and soar during this gathering storm, now we begin to see the size of the wave that may be coming in, and it's starting to look scary indeed…

"Last Friday, March 30, I summed things up as we finalized our month's plan to 'Sell in March and Go Away' where I concluded the post with: 'Yes, cash is good, CASH IS KING!'"

This past week saw all the classical symptoms of a market getting very tired. It was about time. Phil had been gradually positioning his virtual portfolios into more bearish postures over the last three weeks. We will see if this holds true next week - let's see what Lee Adler and Allan of Allan Trends are thinking in the next two sections.

Lee Adler of the Wall Street Examiner:

The markets get a gift in the coming week. Depending on how strong tax receipts are, the Treasury will pay down as much as $48 billion in expiring short term bills on Thursday. That's cash that will come back to holders of the paper. They'll have to put it somewhere. This is a normal feature of tax week, and some of that cash usually flows toward stocks.

What appeared to support the bond market last week were some phony ginned up misses in the economic data. That was an excuse to dump stocks and scare money into Treasuries just at a time when the Treasury had to both roll over old paper and sell new paper totaling $156 billion. Is it my imagination or does the "bad" news, both real and imagined, almost always seem to come in the weeks when Treasury supply is heaviest? It would make an interesting academic study.

My impression from observing these things closely for the past 10 years is that, call it "conspiracy," or call it "metaphysics," this is how the markets seem to function. The government and Primary Dealers need to keep bond yields down-they find ways to accomplish that. If it means they need to shake the stock market tree to do it, then that's what happens. (Treasury and Primary Dealers Shake The Stock Market Tree When Needed) (Click this link to try WSE's Professional Edition risk free for 30 days!)

This week, Allan of Allan Trends is sharing his weekend update for subscribers with us. Allan is an active trader, and an old friend, who has been playing the stock market for many years.

New Signals

VXX Hourly-->??

VXX Hourly

VXX Hourly (top) closed the regular trading session on Friday 13 cents from triggering Long. In Friday's after-hours trading, VXX closed at 19.40, one cent away from triggering Long. Any weakness on Monday morning will push it into a new Long trend.

Allan's Market Analysis

The DJIA Daily is the most important chart (below) of this week, this month and this year:

Let's break it down:

(1) DJIA Daily chart from October, 2011, market low;

(2) Elliott Wave counts 5 waves up, i.e. a completed impulse wave;

(3) Elliott Oscillator (lower study, chart below) is showing a series of lower highs throughout the six months that DJIA was making higher highs. This is a highly significant divergence with 30+ years of historical accuracy in foresting major reversals;

(4) DJIA Daily Trend Model has already reversed Short;

(5) April-May annual Top pattern (see DJIA Weekly on the next page).

Sometimes the evidence is overwhelming that the market is making a major turn. This is one of those times. That's not a 100% guarantee, but it is a compilation of very reliable indicators that a change is at hand. We only really care about one of these factors, number 4 above, and since that one indicator is in the direction of the weight-of-the-evidence turn, we trade in the direction of least resistance: SHORT.

The pattern described above for the Daily chart is almost identical on the Weekly chart that goes back to 2007. Here again we see 5 waves up with a divergence in the Elliott Oscillator. The only element that is missing is a Short signal in the Weekly Trend Model. That signal will come on a break below 12,370 - about 4% lower from current prices. There is enough confirming factors present in the Daily chart to forgo waiting that extra 4%.

Trading Strategies

Under the assumption that a new downtrend has begun, here is a review of my favorite strategies for garnering maximum returns from the new dominant trend. These strategies are presented roughly in order of risk, starting with the most conservative and ending with the those that have the highest risk, and the highest reward.

(1) SH - This is an ETF that will go up at the same rate that the SPX goes down. Simple one decision investment. For every 1% that the SPX falls, SH will rise 1%;

(2) DXD (DJIA); SDS (SPX); QID (Nasdaq 100) - These all correspond to the major market indices (in parenthesis) on a 2X leveraged basis, i.e. they should go up by twice the percentage that the corresponding index goes down. For every 1% in value that the index/market goes down, these will go up by about 2%;

(3) TZA (Russell 2000) - There are several 3X ETF's but TZA is the one with all the liquidity. This is the one for maximum leverage in an index ETF.

(4) VXX - This is the volatility index that has historically maximum leverage for any market decline. We have seen VXX go up 100% or more on a 20% decline in the market.

(5) UVXY - Structured to go up 2X the rise in VXX and so far it has performed as advertised. The big caveat here is TVIX. This is an ETN and it was also structured to go up 2X the value of VXX, but it ran into big trouble after its sponsor, Credit Suisse, pulled the plug on the issuance or new shares. Nonetheless, UVXY was up 10% on Friday, on a 1.25% drop in the market (and a 5.5% rise in VXX). That is some leverage.

Options

Options are the riskiest way to trade market direction. They are especially suited for the above ETF's, as well as commodity ETF's and individual stocks. (Yesterday the market was down 1.25%, VXX was up 5.5% and VXX May calls were up about 35%.) Trading options adds risk; detailed analysis and special attention are needed to trade effectively.

Options aren't necessary to achieve outstanding returns. For those returns, our trend models only need to get the dominant direction of the market right. After over two years of real time trend following, it is clearly evident that they do.

*For a risk-free trial, click here for Allan's standard service, or click here for the premium service. The premium is for more active traders. For more information, see "Can you trade a chart like this?"

Trading at Phil's Stock World

We are heavily concentrated in Bearish Hedge positions, although we do have Bullish/Long positions also.

We never go completely Bearish OR Bullish. We straddle a range of about 30% to 70% around the center line. Remember, hedges are INSURANCE against things going really wrong. If you are invested in Long Positions and want to hold them, that's fine, over the long term. But select proper hedges to protect yourself in case your bullish premise is wrong.

Right now? We this think is a time to have Bearish Hedges in place, in proper proportion to protect most of your Long Equities. Insurance is something you EXPECT to lose, and it is relatively cheap. The "value" of insurance is not always apparent until AFTER the house burns down.

Friday gapped down heavily in the morning, traded sideways all day, and then went down again in the last half hour. That is very unusual and almost always signals a poor start to the next week. Barring any extraordinary news over the weekend or early Monday, we don't see any fuel to keep things up on Monday and Tuesday.

Note: Phil Davis was interviewed live on the radio Friday morning out of New York City. It was very informative and entertaining. Check it out.

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Tightening the Screws

Excerpts from Stock World Weekly: (Click here for a free trial)

The major indexes closed lower this week. We had been anticipating a rest in the "fake" rally, and wrote in last week's newsletter, Under Pressure, "We're feeling cashy and cautious again. Looking over the last two and a half weeks, the Dow has done nothing, the Russell has done nothing, the S&P has only gone up a little. The Nasdaq is up a lot - but we know that is largely due to one company, Apple Inc.!

Phil's short term trade ideas have been mostly bearish. (We included a section on Phil's put buying adventure in last week's newsletter.) We've been expecting a correction and wonder if this is the beginning of a significant move down.

Discussing his view of the Treasury and stock markets going into next week, Lee Adler wrote to his subscribers,

"The markets face another week on relatively easy street in terms of Treasury supply.

"Even though the Treasury is auctioning a big slug of longer term paper, it is paying down bills. Thursday will see a cash paydown to the market, and the big note and bond settlement a week from Monday will see only $23 billion in new paper, which is about half of the usual mid month supply hit. The government has benefited from a surge in tax receipts toward the end of March and in early April. If that continues through April 15, then overall, April will be a light month supply wise.

"The market only had about 40 minutes to react to the expected weak jobs report in the stock index futures. The reaction wasn't what I expected. I had thought that a bad jobs report would be like ringing the bell for Pavlov's dogs as traders salivate in anticipation of the next treat [more quantitative easing] from their handler, Ben. The guys trading the futures didn't agree with me, and they dumped.

"Holding down yields during note and bond auction week is Job One for the government and its co-cartel members the Primary Dealers [firms which buys government securities directly from a government, with the intention of reselling them to others], who still hold record long positions in their longer term Treasury portfolios (chart above).

"So I think the Primary Dealers will be happy to have more bad news to keep the cash flowing into the government bond market. With no big economic releases coming this week, the best way to do that is to shake the stock market tree.

"The public is still buying bonds like mad and the markets are getting renewed help from the foreign central banks and the commercial banks in the last 2 weeks. That could underpin a return to a bullish tone for stocks once the big Treasury auctions are out of the way on Thursday. All in all, the pattern looks weak for stocks and strong for bonds early in the week, with Thursday afternoon shaping up as an opportune time for reversal." (Explore Wall Street Examiner's Professional Edition - try it risk free for 30 days!)

Ryan Vlastelica shares our worries that the market has been running up too far too fast. He wrote, "Since October, estimates for first-quarter earnings growth have tumbled while the S&P 500 has surged. With the earnings season starting next week, the outlook is not as sunny as in previous quarters.

"Investors will assess whether slower growth is priced into the U.S. stock market, or if the S&P 500's retreat from Monday's four-year high is the start of a larger decline - if results disappoint.

"After the S&P 500's rise of about 30 percent since October, there is concern that buying interest is not strong enough to drive further gains, particularly after soft March U.S. employment figures were released on Friday... (chart by Yahoo)

"Friday's nonfarm payrolls (NFP) report was a disappointment, with just 120,000 jobs added in March, short of expectations for a gain of 203,000 jobs. Stock futures fell 1 percent in a shortened session, with the cash market closed entirely." (Wall Street Week Ahead: Will earnings spark further declines?)

The weakness in NFP may, rather than sending the market down, revive hopes for another QE, thereby raising share prices. This market is singing, "what's good is bad, what's bad is good, you find out when you reach the top, you're on the bottom." (Bob Dylan) We will see.

Tim of The Psy-Fi Blog explained why he believes this is a dangerous market. It has something to do with the scientific method (you have to read the whole article to discover what):

"I think there's danger for anyone executing anything other than the suggested default option of a low cost, globally diversified, occasionally rebalanced portfolio. Active private investors are engaged in an arm's race with the securities industry and most of the big guns are facing the wrong way. The problem is that darned scientific method, which is why there's also never been a more dangerous time to invest...

"The idea that we're in an arms race against a better equipped, better funded and far less moral enemy isn't one that most private investors take on, but they should. Despite our manifest deficiencies we aren't without our own weapons - the behavioral weaknesses of the financial industry itself. We can fight a successful guerrilla war by refusing to engage in a pitched battle on their terms: trade rarely, go where they don't go and never, ever believe you have to react in seconds or even minutes and hours. When High Frequency Trading algorithms can execute faster than you can blink you're wasting your time, your money and throwing away your intellectual advantage: faster is not better." (Why There's Never Been A More Dangerous Time To Invest)

From the PSW Strategies Section

Phil and PSW members post numerous trade ideas during the day in the chat section. Selling (options), doubling down, scaling in, rolling forward... These are a few of the methods that are commonly mentioned.

The following is a detailed example of a trade idea by Phil. This strategy can be applied to buying any stock that you want to own as a long-term holding. (Note: Microsoft is trading lower now, at 31.38 on 4-9.):

"If you REALLY like a stock and REALLY want to own it at the net price - then why not sell a put on that stock? Let's say I like Microsoft (MSFT). I could buy 100 shares for $32.29 and just cover it by selling a Jan 2014 $30 call at $4.90, for net entry of $27.39. I make $2.61 if the shares get called away. Very dull.

"I could also just sell the Jan 2014 $27 put for $2.50. Then I make (keep) the $2.50 if MSFT is over $27 at expiration - better but not thrilling. My net entry is $24.50, if the shares get put to me. That's the difference between the price of the stock if it gets put to me, $27, and the money I collected from selling the put, $2.50, i.e., net $24.50.

"I could also buy the Jan 2013 $25/30 bull call spread (bcs) for $4. If I sell a Jan 2014 put against this bcs, I would collect $2.50, bringing my cost go down to a net $1.50 in cash ($4 for the bcs minus the $2.50 collected from selling the put).

My upside is $3.50 if MSFT holds $30 to Jan 2013 AND holds $27 to Jan 2014...

"Bull call spreads are NOT good for cashing out early in general as you get locked into the trade if you don't have good margin (and good timing to use it with). You are far LESS likely to make quick money on a straight bull call spread, but it depends on what underlying you select. Mostly, a bull call spread is about burning premium - you sell more than you buy and it helps to have the stock move in your favor, of course.

"In the MSFT example above, the net delta on the bull call spread is just $0.22 so a $5 move up in MSFT (15%) is barely going to make you $1. On the bright side, a $5 move against you will only cost you $1, and that means you have plenty of time to react before the net drops 50% and makes it too difficult to roll, which is why we like these - they need less hedging..."

Discussing the markets, Phil wrote, "If you UNDERSTAND why something is happening, rather than panicking with the herd - you can calmly jump in and take advantage of opportunities when they present themselves...

"Who wants a market that goes up and up and up - where's the sport? Even the Nasdaq finally blew its 15-week winning streak and that helped us decide to stay bearish going into yesterday's [Thursday's] close. I simply don't see anything in particular to be bullish about at the moment."

For more on our strategies for buying stocks at a discount, go to Strategies for Buying Stocks.

(Click here for a free trial to Stock World Weekly)

Allan is an old friend who has been developing and trading a "Trend Following" System (read "Can You Trade a Chart Like This".) (Click here for a risk free trial.)

I've assembled some of his recent ideas, including his speculative trade for 2012, which he mentioned in his weekend update.

Here are several examples of his current signals and thoughts. ~ Ilene

Weekend Update (March 10, 2010)

New Signals

VXX Daily---> SHORT - note: Allan's daily signal is for a short on the VXX. But his trade for the year is going long VXX calls.

IWM Weekly--> LONG

XLF Weekly---> LONG

Speculative Trade for 2012

In early July of 2011 the markets appeared as they are now, in stubborn up-trends despite the mounting bullish sentiment and relentless, yet limp-wristed rallies that were all but untradable. As George Costanza did in a famous episode of Seinfeld, I started doing the opposite. I began the accumulation of VXX December calls, a bet that just two months later was up over 500%. Based on historical patterns, the market declines even in a bull trend 2-3 times a year and usually in a sharp, steep, fast sell-off that is accompanied by a spike in volatility and a spike up in VXX. I didn't know when, but I was pretty sure such conditions were coming and coming soon.

Fast forward to March, 2012. I have begun the same trade with the same expectation of market behavior. As you should know by now, this is the opposite of the philosophy of trend following. I am deviating and sharing the trade this weekend because the gains were massive last year and I expect they will be just as massive this year….not a guarantee, just an expectation and there is a possibility it will not happen at all, or not happen in the next six months. But I think it will.

I have started accumulating VXX September calls. That gives the market about six months to suffer a steep, volatility spiking decline. It does this usually 2-3 times a year, even in the midst of a three-year bull market. Imagine what would happen if a bear market took over the next few months. During last year's 13.8% mid-year decline, VXX went from the low 20′s to 60.

VXX closed on Friday at 23.17. I've been buying the September 25 calls between $4.50 and $5.00. If VXX spikes again this year, even to 50, these calls will have the intrinsic value of $25.00. Again, this is not a guarantee, it is only my off the cuff analysis and just because it worked last year doesn't mean it will work again this year. But I think it will.

Below is a screen shot of the September call options on VXX. They are for the most part, thinly traded which makes for relatively large bid-ask spreads, but they pale in comparison to the gains if this gamble pays off:

[Click on charts to enlarge; clicking on the screenshot below will take you to a more recent page, the screenshot is not very clear]

September VXX Calls

As you can see, there are plenty of strike prices above and below 25 that will work with the assumptions underlying this trade. The Sep 15 calls, which could be bought for about 9.00, would have less then a single point of time premium in them for the next six months. The 18′s, 20′s and all of the strikes up to 30 all look good to me this weekend as increasingly aggressive ways to bet on a spike in volatility in the coming months.

VXX Hourly Trend Model

VXX Hourly signals are triggered by price moving above or below a price threshold generated by a trend following algorithm. Trading these signals at that price instead of at the close of the bar (as we have been doing) results in significantly better entries/exits and is making such a big difference in profitability. It is worth an effort to implement this change for those of us who are trading the hourly model. Without the end of bar "confirmations" these trades need to be managed a little differently, with a tight stop if the trade is not confirmed. I should have the mechanics worked out by Monday. If it results in a substantial increase in profitability, we need to be trading it that way. More in the week ahead.

TRENDS TABLE for March 10, 2012

CME - March 12

CME Daily Trend Model is very close to reversing SHORT. This has been one of our better trading models over the year. A close below 270.19 will trigger the Sell. CME is currently at $276.55.

TLT/TBT - March 14

We follow TLT (Barclay's 20-year Bond index) in the Commodities portfolio and is in the midst of a very profitable SHORT trade. It's inverse is TBT, that seeks to achieve the inverse return of Lehman's 20-year bond index. In other words, TBT is a play on higher interest rates. (See also Bruce Krasting's Is the Ten-Year going to 3%?)

With today's Open, TBT, in addition to being on a LONG, has broken out of its trend regression channels. You can see the breakout just above the top channel line:

TBT Breakout

TBT is a good way to play the SHORT on TLT, which as you can see, has broken down out of its channel.

Learn more about Allan's "Trend Following" system here.

Click this link for a risk-free trial.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.