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Jim Farrish
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Jim Farrish is the Founder of Money Strategies Inc, a registered investment advisory firm. He has professionally managed money for nearly 30 years. His extensive research on the markets is published daily on his proprietary site Jimsnotes.com. His primary goal is to educate people about... More
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  • Correction Or Bounce?

    The question on most traders minds heading into next weeks trading… "is this the start of a correction or do we get an oversold bounce on the major indexes?" The answer is… YES! Based on what is present in the charts, the sentiment and the media it looks like more downside is on the way, but then that would invite the buyers to catch the falling knife and present a bounce. Let me be one of the few who will admit, I don't have a crystal ball! When emotions and logic meet generally emotions win short term. If I had to chose a side the emotions of the times are in control, but eventually logic will prevail, thus my answer, YES. There is a high probability of a correction followed by a bounce off the lows as we all sort through the data and determine which side we believe more. I am not one for prophecy, but as the charts start to develop rolling tops or volatility near the current highs you have to ask the questions relative to what is driving stocks up or down and which is more sustainable or believable looking forward? The answer will then be validated by the charts as investors cast their votes by buying or selling stocks. Friday's vote solidified the downside for the micro-term view, but it also broke the long term trendlines leaving investors in a precarious position if they still own long positions in their portfolios. This week will either validate the downside in play or we will see some buying to help negate the breaks lower. Either way it promises to be a bumpy week for stocks.

    First things first, if the markets are to resume the uptrend they must first and foremost have leadership. Taking a cursory look across the major indexes and the major sectors you are hard pressed to find any. Biotech and parts of healthcare were one of the few growth sectors we found from the previous leaders still in position to bounce and help lead the a push back toward the upside. On the defensive side of the ledger we have consumer staples, utilities and large cap healthcare offering some support to the broader markets as money rotates to where is believes it will be treated the best looking forward. Fixed income is being led by Treasury bonds as yields decline on money rotating to safety. That would bring me to conclusion that there is a lot of work to do if any bounce is going to give the support or lift needed to rescue it from the current selling.

    Second, the volatility index is a picture worth a thousand words. The chart below shows the last time the index peaked above the 25 level was 2011. If we wanted to draw any comparisons in cycles that is where I would look. Not because of the volatility index, but because of the what was happening in the global markets and the uncertainty of the US markets relative to forward guidance and growth. If the parallels are valid, and if the US markets do continue to struggle relative to the weakness in the global markets, and if the Fed withdraws quantitative easing and delays rate hikes until the summer of 2015, there is still the potential of a spike in volatility due to the lack of confidence in the underlying growth of the economy. That could translate it a correction that is more significant in nature. Target on the S&P 500 index 1730 would be in line. Please note - I am not stating that is the case just looking at what could be the worse case scenario short term.

    Chart

    Third, leadership looking forward is a clouded issues among the seven asset classes. US bonds are leading along with the US dollar. Not exactly the making of a great story. The chart below is the a scatter chart of the seven asset classes since the September 18th high. Emerging market bonds have moved sideways and the REIT index has essentially done the same following a move lower prior to this point. The downside leader is the EAFE with emerging markets, US stocks and commodities not far behind. The chart makes the simple point there is no equity leadership as money rotates to safety short term. The longer term outlook is now being challenged by the follow through selling on Friday. Thus, short term leadership is defensive, longer term the leadership is rotating to defensive. If there is not a bounce of curtailing in the selling going forward the longer term views will shift to negative and validate point number two above.

    Chart

    Fourth, earnings are starting in earnest this week. The revisions on the downside have been hurting the outlook as the S&P 5oo index has been revised down more than 5% since the end of August. Some have speculated the dollar will impact the large cap multinationals as the strength has been greater than many expected or hedged. Yes, a strong dollar will help longer term, but short term it does wage a toll on the US markets relative to exports, albeit helps on imports. The dollar has also played havoc on the commodities market as we have seen a drop in price in the energy space as well as the base metals. Precious metals have been speculated lower on the weaker dollar, but demand has played an equal role in that decline. Earnings could be an additional weakness for the current markets looking forward.

    Fifth, global markets are weak economically and there is not indication of improvement on the horizon. The bantering and rock throwing from the IMF of late is not helping the matter either. If there is no improvement in the Eurozone, Russia, China and Japan short term what will be the catalyst for the global markets to improve longer term? This is the most uncertain of all the issues facing the US markets currently. Looking at any chart of the global market from the highs in June you see a confirmed downtrend in play short term. I expect this will continue without some catalyst along the way and currently there are no real catalyst from our perspective.

    Finally, the Federal Reserve poses the most near term help or threat to markets domestically and internationally. The next FOMC meeting starts in just over two weeks and there are two primary questions that will need to be answered and addressed by the Fed. First, a definitive end to quantitative easing. Second, a idea of when or if the rate hikes will begin. The minutes from the last meeting were seen as dovish, but we will see how that unfolds in the comments following the next meeting. The challenge being that is all several weeks off. In the meantime is will be earnings that take the drivers seat.

    The greatest challenge for investors is over-thinking and over-trading the emotions of periods such as this. Take a disciplined approach and remember cash is a sector and it allows you to be patient and let the story unfold and the clarity of the outcome to be seen. One day at a time is all we can do for now as it unfolds any hypothesis is validated or not by the charts.

    Tags: VIXX, VTI
    Oct 12 3:45 PM | Link | Comment!
  • Trading In A Bear Market

    It has been awhile since the sentiment and trend have combined for a downside move that is sustainable. The drop on Wednesday caught some a little by surprise, but some were expecting the move lower, just not all at once. That has helped fill my email box with questions about what to do if the downside continues relative to specific positions as well as the infamous question, "is it too late to buy the inverse or short ETFs?" You know what I am going to say, but I will say it anyway… You make entry and exit decisions on positions before the proverbial #*^*&% hits the fan. Emotions play havoc with the decision making process and more times than not, you will make bad decisions relative to what is the best course of action if you attempt to do it in the heat of the battle. The later part of the question on buying short ETFs is what I will cover in more detail below. That said, I do want to emphasize the point that position management is a vital component of portfolio management as well as sound mental health. It takes ten minutes each night to evaluate where you are relative to the current market environment and how to manage your exit points and/or stops. It is worth the sound peace of mind to know what will happen if the market goes against your position(s). Invest the additional time.

    The other issue is better addressed under the subject of trading a 'bear' market. Please note that I said trading and not investing. The point being that you trade the downside of a market as the cycles or trends are generally not long enough to establish investments or longer term positions. The peak to bottom move of the correction in 2007 was 17 months. Consider the uptrend starting in March 2009 went on for 67 months. Studies show that the average uptrend last nearly three times longer than the downtrend. Armed with those stats, trading is the best approach to down market cycles. With that in mind let's discuss a simple approach to trading in the downside or sellers market.

    SP500

    The first ground rule I apply to this strategy is let the selling trend lower for at least ten trading days or so before taking any trades or action. You want to see a rise in volume on the selling and lower volume on the buying which is an indicator that the sellers are gaining control of the direction short term. Second, and from my view most importantly AVOID GREED! This is a challenge for traders on the downside moves. Why would there be more greed on short trades than long trades? The speed by which the downside accelerates when the ceremonial towel is thrown in by those wanting out of the market at whatever cost. In September 2008 the S&P 500 index dropped 35% in five weeks (see above chart) as investors stampeded for the exits. It is also important to note that for nearly twelve months prior to that move the index had been in a steady downtrend that had dropped just 17%. Speed kills, but it also creates the visions of getting rich quickly. Greed is not a word you want to describe your strategy for trading a downside move in the markets.

    Armed with the knowledge that the downside moves faster than upside we should take the approach of establishing our short positions in the rallies or bounces off support versus trading the sharp downside trading days. This gives you a calmer approach to entering your trades and your probability of getting the price you want are better. Having said that, it is important to understand human psychology. The price of the market is moving higher and you want to sell… that goes against what we normally due relative to establishing positions in our portfolio. Thus, we are swimming up stream on that approach. It doesn't 'feel' right. There in lies the challenge with short trades to start with, we are going against the psychology of nearly all market strategies. My recommendation is to practice your strategy with smaller size positions and get used to the exercise before attempting to commit larger sums of money on short trades. Short the rallies is the phrase I use to keep my mind focused on what I am attempting to do. Another reason to short the rallies for your entries is to attain better entries. The difference will help you mentally and financially when the market does attempt or is successful at reversing or bouncing off support. Those initial moves higher are equally as sharp as the selling and that will squeeze your profits on the trades. Thus, practice selling into the rally to give you better entry points and less risk on the trades.

    There are two key points that I have to remember as I approach establishing short positions. First, don't short into support zones and second, stop management is a must. Below is a chart of the S&P 500 index currently. As you can see the set up for the downside has been building since early September following a 'V' bottom reversal in August. On the break of support at 1978 on the 23rd of September we got a short signal. Note that it was followed by a rally or rebound day… short into the rally remember… thus a buy of SH on that day would have given you and entry at $22.80. The selling continued as time progressed forward and you would still be in the short position with your stop now at break-even or $22.80. As you can see when you have a defined strategy for how to approach trading a 'bear' market you can define how to get into the trade, how to manage the risk of the trade, and have less anxiety in establishing a short position prior to the bigger drop on October 1st. Trying to short the positions into the selling on the 1st of October would have cause too much anxiety or stress for the trade. With some planning we can eliminate some of the stress and anxiety.

    SP500

    Putting this all together… we allow the downside move to establish itself with roughly 21 days of drifting lower on higher volume selling days. We avoid greed by establishing a support level we wanted to break or violate to establish the short entry. We focus on establishing our entry on a rally or bounce and then focus on managing our risk/stops. This approach takes patience to let the trades develop first and foremost and then it takes discipline to manage both your entry point and exit point. Last, but not least this is a simple approach and not one that involves complex strategies and variables that will create paralysis of analysis.

    If your have not signed up to receive my Notes (Jim's Notes) on markets and trading strategies be sure to do so now, after all it's free. I know you hate to give out your email and get spammed to death. We promise to only provide you with content that is both educational and executable. If you don't like you can always unsubscribe and we promise to not bother you any further. Simple money management is goal!

    Oct 02 6:32 PM | Link | Comment!
  • Gold Rally Waiting In The Wings

    Looking at my list of ETFs that I track regularly, energy, industrials, financials, bonds, utilities, transports and gold miners were showing green on a day when the major indexes were down slightly. For the most part they made sense, the defensive sectors, flight to safety sectors and then there is gold miners? Why? Gold was actually flat on the day and is in the process of testing a key support level, but yet the miners posted a solid gain… did I miss something in the reports and scans relative to gold prices? Not sure, but below we look at the charts and add it to our watch list of things to follow moving forward.

    Looking at the chart of SPDR Gold Trust (NYSEARCA:GLD) below you can see the price continues to flirt with support at the $123.50 level. That corresponds to the price support at $1277 on the metal, of which was touch again in intraday trading. We have been discussing the outlook for gold and what is driving or in this case, not driving the price? Demand is flat, inflation is "under control" according to the Fed, and the dollar is gaining slightly in strength. Overall there is no momentum relative to the metal and that leaves the traders to push price up and down. A break of support a this level would invite the short sellers into the mix, a bounce back above the $124.50 level may invite the upside traders back into the mix, but until there is a defined catalyst it is not likely to accomplish much.

    gld

    Keeping in mind what we see on the chart above, the chart below shows some divergence in the price of the gold mining stocks today as seen in the Market Vectors Gold Miners ETF (NYSEARCA:GDX). They were up 2% as gold was flat. This is worth our attention looking forward as you would anticipate gold to rise or the miners to fall. Either way it is a trading opportunity short term.

    GDX

    Taking this one step further we can scan or filter through the holdings of the ETF to determine what is leading and it may give us further clues relative to the movement of GDX today. Seabridge Gold (NYSE:SA) announced an asset sale today and pushed the stock up 6.7% to lead the sector, that is a one time event and not likely to add much more on the upside near term. Harmony Gold (NYSE:HMY) was up 4.1%, but no real news. I found it interesting reading the news and comments of the top performing stocks. There were plenty of comments on a top being establish in several stocks, overbought indicators in others, and nothing about the potential upside looking forward. There was nothing overly positive to define the move in the stocks of late. My summary of the comments would be the sector is going to move lower, not higher. Of course taking a contrarian view is always an option, but then you would have to believe the metal prices are going to rise near term. At this point I am going be Switzerland and be neutral. It will become clear which side of the trade to be on soon enough, and I have it on my watch list of opportunities to take the side that shows the greatest potential.

    Tags: GLD, GDX, HMY, SA, Gold
    Apr 24 10:30 AM | Link | Comment!
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