Legacy Funds

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Are we nearing the end of this rally?

Last week had all the characteristics of an options expiration week. Weakness begins week before, and early part of the week, and then a run up in prices so that options that were purchased for pennies on the dollar earlier in the week end up profitable. That would set next week up to be a negative week if the pattern continues, and it has high odds.

However, the bigger question remains is this rally ever going to end? Obviously, the answer is yes, but then it becomes a question of when. So let’s go to the charts and see what they have to say beginning with a weekly chart:

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If a picture is worth a thousand words, would a chart be worth a thousand dollars, maybe more. There is a gap slightly above that I can’t see being left unfilled before resuming business to the downside. How can I be sure we have downside business left? Well obviously nothing is for certain in the market, but if the recession did end, and that is a very big IF as I put a very low probability on that being the case. Stocks are currently overvalued and this would be an outlier on the charts just based on PE ratios after recessions. Furthermore, at best we would be looking at below average multi-year returns. Technically, there are a number of resistance areas above. As you can see on the chart above, I plotted a few and in trying to keep the chart clearer didn’t bother with the 50% fib retracement discussed in previous posts at around 1120. We have the 89 week moving average, close to the 80 wma covered in other posts, but I prefer the 89 week since it is a Fibonacci number. In either case, they are close enough: the 80 wma is at 1065 for the SPX whereas the 89 wma is at 1099, near the upper end of the gap, so pretty much all contained near the 1100 area.

Let’s look at some shorter term charts for some clarity of short term direction:

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Now this also doesn’t mean that we have clear sailing in filling the gap to 1100 or so, as in the short term we may be due for a slight pullback even though it may not be the end of the rally, another bear trap possibly. Of course we may not get that short term pullback, increasing the odds that a gap fill would be the top. Clearly in both cases the ultimate risk is to the downside, with the exception and very low odds of a rally piercing through all these resistance levels and holding. In that case I will concede that this is a new bull, but only in that case.

August 24, 2009 Posted by | Legacy Funds, Uncategorized | , , , | Leave a comment

What is India up to?

While all the talk has been about the Shanghai and its big rally for the year — not as much has been written about the Indian stock market. I am going to base the analysis here on the India Bombay Stock Exchange 30 Sensex index or $BSE.

I find the Sensex a bit more interesting here because although the Shanghai and S&P 500 retraced exactly 38% of its last move so far, the Sensex has retraced 61.8%. It has gone from 8k in March to 16k just recently before correcting and sitting over the 50% retrace at around 14.5k.

Over the weekend I posted on a global macro forum that the Sensex looks like it may have topped at the 61.8% retrace around 16k, with a huge gap to fill down to 12k. The 200 dma is down near 11k. I stated that it wasn’t a time to be complacent, but was then told by top market analysts that droughts and swine flu didn’t keep the Sensex from climbing. Well whatever the reasons, there is a huge gap down there that is just begging to be filled when I glance at the chart. I also mentioned a big concern is that just filling the gap or touching the 200 dma would be larger than a 61.8% retrace (corresponds to 38.2% on chart or ~13k) so that sets us up for a retest of the lows if not lower. Let’s analyze a condensed chart.

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The numbers are a bit hard to see, but the 61.8% retrace at the 16k level was hit and has been acting as resistance. If it punches higher than we are very likely to get to the highs at 21k. However, regardless of how hot markets are, they usually come down to touch their 200 dma at some point. Same thing with gaps, they usually get filled at some point. It looks like back in July the Sensex was trying to do just that but everything got aborted and all markets soared. Technically, that is an unfortunate event because now to fill the gap requires falling below the 38% retrace in the upper 12k. That puts a retest of the lows back on the table.

Of course, this is just the most likely scenario based on current data and no one or model can predict with certainty any event — just not a time to be complacent and to trade with technicals and serious risk management.

I trade the Sensex via IFN, and my models gave me a sell signal August 10th.

August 18, 2009 Posted by | Legacy Funds | , , , | 9 Comments

What’s up or down with Shanghai?

The Shanghai index has obviously been on a major tear lately, rallying something like 100% this year alone, wow. The index made its lows in October of last year at 1664.92, made higher lows in March 2009 when the SPX made lower lows, and recently went over 3400 before a 4.4% decline last week. China is running at a .87 6 month correlation to the SPX, that is pretty high. However, and what is most interesting is both the Shanghai and SPX are at exact 38.2% retracements from their low to their high even though the lows were in different months.

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Above was the Shanghai so let’s compare to the SPX below:

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Furthermore, the Shanghai has already turned down from its 38.2% retrace experiencing a down week last week whereas the SPX is likely to follow suit this week — but then again it may not. Only time will tell obviously, but worth observing.

These are difficult markets to play right now, both long and short, but find what indicators you like and can trust, and keep emotion out of the decision making process.

August 10, 2009 Posted by | Legacy Funds | , | Leave a comment

A method for trading leveraged ETFs

Leveraged ETFs keep making headlines, and more so than usual lately.  There is a lot of mystery and conclusions ranging from these are fraudulent vehicles to these are powerful tools that can help the retail investor generate hedge-fund like returns. If you have read any of my comments, I obviously belong in the latter group.  However, I do agree without knowing how to trade and manage the risk, these do end up feeling like another fraudulent gimmick because the losses come fast and furious.   Trading these on fundamental analysis alone will not work due to the time decay.  There definitely is a lot of complex math behind what is going on to result in this time decay:  basically one is long gamma and short volatility so ending up with time decay or theta. However a strong trend can offset and even outgain the losses from decay.  Furthermore, you don’t have to know the math behind it, just like I don’t have to know the intricate details of my car engine in order to drive. I need to know the basics…accelerator, brakes, steering wheel… so I can safely drive the car. So for these leveraged ETFs the main thing you need to know is to use them in the direction of the trend and to get out quickly when that trend is threatened — so you need a short term trend following strategy with position sizing and risk controls. Since you are trading in the direction of the trend, and these come in pairs, there is something that can be traded when the market is trending up or down, how nice is that…

So let’s move on to a very simple trading strategy.  This one will utilize a single moving average, and for our purposes today we will use a 21 dma.  As you get more proficient you can use moving average crossovers, moving averages in different time frames for confirmation of a shorter time frame signal, etc. But just a simple 21 dma will at the very least keep us out of trouble by providing some level of brakes (to go back to the car analogy) to avoid a crash. Let’s try this on QID (the double inverse QQQQ):

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Obviously we don’t have a buy signal since it is below the 21 dma. QID is bought when the price crosses over the 21 dma, and sold when the price crosses below. Let’s check out QLD (the double long QQQQ):

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As you can see, QLD triggered near mid July, and it has been long since. You can see other times where it triggered and was profitable, and some times where it triggered but the trend didn’t continue. There are times when you have to sell only to get back in when it gets back over the line again, sometimes at a higher price then you sold. Just consider these whipsaws the cost of having protection from the big drops — look at late August of last year to see the size of QLD’s decline from that point. It is no surprise that it was the start of a very profitable uptrend in QID.

Look at past charts, and paper trade a large variety of these leveraged ETFs to give you a feel for how they trade. Next time I will cover how to set an initial stop loss, how to use that to size your position, and how to keep adjusting the stop loss as your ETF trends. Feel free to comment if you have any questions.

August 3, 2009 Posted by | Legacy Funds | , , | 6 Comments