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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.

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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

What a rally since my last post mentioned a run to 1k on S&P

Little did I know at the time that the S&P will be getting that close to the 1k mark before my next post.  In my last blog (Market Signs) I said:

“Technically, the odds are that the S&P will correct to 810 to 820 area over the next month or so.  At that point careful analysis will be crucial along with risk management to cover shorts and position long for a potential rally to the 1000 or so area.  At that point bullishness will be at high levels and raising the odds for a drop to retest and most likely new lows on the S&P and commodities along with a rally in the dollar, later this year or early next year.”

Did I have a crystal ball.  No.  The market didn’t get down to the 820 area, but the short positions were quickly stopped out.  Does this mean the bear market is over.  Again, not so fast.  We are going by the 20 month or 80 week moving averages for that one — slightly different numbers, e.g., the 20 month for the S&P is currently at  1104 whereas the 80 week is at 1082, but close enough that you are free to follow a monthly or a weekly trigger.  Obviously the shorter the time frame, the better the precision over a larger sample of trades.

Again we are faced with a scenario where the S&P can pullback in the short term before hitting the 1k target or it can make a run for it first and then correct.  We won’t know which one will occur first, but can keep zooming in with a shorter time frame to get a better trigger and manage trades accordingly.  Since we have yet to hit 1k, the weekly charts haven’t changed, so left the weekly chart out this time.  The daily chart shows Fibonacci support levels for any corrections in the near term, along with a 100 dma or if you are a shorter term trader the 21 dma:

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However, even if we reach 1k or 1100, the odds are very high that the market will retest the March lows at a minimum.  Make sure you have your seatbelts fastened.  By that I mean utilize some sort of timing indicator to keep you in and to get you out before a decline, even if the decline doesn’t materialize and you end up having to get back in again at a higher price — that is the cost of protection.

July 26, 2009 Posted by | Legacy Funds | , , , | Leave a comment

Market Signs

The market is always giving hints to those that are astute students of history.  What has the market been trying to tell us lately?  The biggest sign has been the correlation of traditionally uncorrelated assets.  There has been an unusually high correlation between global equity market indices and commodities.  Surprisingly this has also included gold.  During the rally from March and the correction over the past few weeks, most asset classes — US equities, international equities, commodities including oil and gold, real estate, and many others — have moved in tandem both on the upside and downside in all time frames.  The moves have been inverse the US dollar.   The charts are currently placing high odds on a correction in these asset classes and a rally in the dollar.  Technically, the odds are that the S&P will correct to 810 to 820 area over the next month or so.  At that point careful analysis will be crucial along with risk management to cover shorts and position long for a potential rally to the 1000 or so area.  At that point bullishness will be at high levels and raising the odds for a drop to retest and most likely new lows on the S&P and commodities along with a rally in the dollar, later this year or early next year.  Sounds like I just let you peek into a crystal ball?  Not so fast.  Although this analysis is based on numerous charts, models, cycles, pattern recognition, number crunching, macroeconomic factors, and the list goes on, a change in certain variables will change sometimes drastically the future roadmap.  That is where risk management comes in place — one plays the mathematical odds but is prepared to quickly cut losses when the variables change.  For example, fibonacci calculations (Fibonacci was a brilliant Italian mathematician) are used to determine the retracement for the S&P in the following weekly chart which shows although we have had a great rally off the low, the S&P hasn’t even retraced 38% of the decline:

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That is where we place odds that even though the S&P is correcting now possibly down to 810, we are likely to rally to 1015 or so afterwards.  We can zoom into a daily chart using the last high and March low to see likelihoods of targets for this pullback, and this is how we get around 810:

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Then we see that if 810 fails, our last line of support is about 780 after which a retest of the lows at a minimum would almost be a given.  Let’s not worry about that for now but manage our trades and risk in accordance to the highest probability set-ups.  Remember this is for informational purposes only and not a recommendation to buy or sell any securities.

July 9, 2009 Posted by | Legacy Funds | , , | 11 Comments

Investing by time frame

I like to think of the market, as do numerous other market technicians, in terms of long term, intermediate term, and short term time frames.  What I consider to be long term is a monthly chart, intermediate term a weekly chart, short term a daily chart, and then I go down to real time using an intraday chart (and even intraday charts can be hourly or 60 min, 30 min, 15 min, 10 min, 5 min, all the way down to 1 min for those that don’t believe in bathroom breaks — for me I use 15 min charts).

Furthermore, I believe that ideally one should track all time frames to give a power rating for a buy or sell signal, but that gets more complicated.  I will delve into more detail in future blogs, once we cover simple strategies for each time frame.  For now the best thing to do is to pick a time frame and make a commitment to always monitor it to that frequency.  I prefer to start from the longest time frame and continue to zoom in to get a total picture.  The long term time frame also works best if you only want to be bothered to check on your portfolio holdings once a month.  Remember it only takes a few minutes to check, and you may or may not have to make any changes.  Let me show you a real live example using SPY.  At the end of the month, you pull up a chart like this and see if SPY is above or below the 20 month moving average or MA as we covered in previous blogs.  You should be out if it is below, and you should be in if it is above.  It really is that simple.  Let’s see what we have currently:

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Pretty straightforward.  After exiting in Jan 2008, you would still be out of the market, and saved yourself from a large decline.  Not bad for taking just a few minutes a month to check on your portfolio.  We can also get more fancy when we have holdings in the market by keeping a stop that is slightly below the 20 month MA to provide protection “intra-month” in case the price violates the MA.  You would readjust the stop each month to reflect the changing value of the MA.  That’s it.  The strategy is not perfect, there will be times that you get out and then get a signal the following month to get in at a higher price.  This is like all the years you pay for fire insurance but your house doesn’t burn down.  It only takes 1 fire.  Same thing here — over the years the protection from large declines will more than cover the slight losses or lag in performance.  No trading strategy is perfect.  However, trading or even investing without a strategy carries the highest risk.  If you want to be more active, next time I will cover a strategy that checks at the end of each week.

June 27, 2009 Posted by | Legacy Funds | , , | Leave a comment

It’s all in the timing

We have all been preached the mantra that it is time in the market and not timing the market that makes money.  Well of course that depends on how well one times the market.  What many fail to realize is that timing is always taking place whether one is a buy and hold investor or a market timer.  The buy and hold investor has to make the initial buy into the market at some point in time and has to sell at some point in time.  Not very different from a market timer, except that a market timer with a strategy has an entry and if disciplined a pre-determined exit to cut losses to a minimum if entry is “mistimed” and a profitable exit to take profits when timing signals dictate.  Time is a non-renewable resource, and the goal is to have better timing in the market to save time.  If you can get out of the market and avoid a 30% decline, think of all the time in the market you just saved yourself.   So there are three basic beliefs when it comes to timing the market:

1.  Those that believe it can’t be done, markets are efficient, whatever…  These folks will not be able to time the market  if they don’t even believe it is possible.

2.  Those that believe it can be achieved easily.  These folks will be taught a very memorable and costly lesson or lessons (for those that don’t get it the 1st time) by the market that it is anything but easily achieved.  If this seems to contradict my earlier posts regarding being able to time the market, charts, technical analysis,  etc., read below to see how even with showing you the tools and giving you ideas of how to do it, market timing isn’t easy.

3.  Those that believe it can be achieved but is a difficult endeavor.  These folks have a shot at being up for the challenge provided they are willing to strive hard and remain disciplined.

Now when it comes to charts and technical analysis, even when there is a clear buy or sell signal given it is not easy to follow.  You can have a sell signal on financials but the talking heads on tv are all preaching buy, valuations are low, … You have to ignore that and sell or even short.  Bullish sentiment will be high at the right time to short.  You can also get stopped out a few times for small losses if you are short and the market goes higher until you catch a good downtrend.  The voices inside you will want you to follow what everyone else is doing vs. staying disciplined and sticking to your strategy even through a couple of losing trades.  Automating this can take away the emotion, but just like a plane doesn’t fly on autopilot alone, neither should a trading system.  There will be times when a human decision is crucial and can’t be replaced by any amount of code.

So in essence what is my definition of market timing?  It is easier to first define what market timing is not.  Market timing is not a call on market direction.  It may look like that from the outside looking in, especially when the timing is correct.  But really market timing is a strategy that helps me manage risk when managing money — risk of course being defined as a loss of capital (not variance as is the case in the MPT or modern portfolio theory world, sorry couldn’t resist taking a stab at it) .

June 19, 2009 Posted by | Legacy Funds | , | 1 Comment

New bull or just a bear market rally?

The rally off the March lows can at times feel like the start of a powerful new bull market.  That is what bear market rallies do, fool the masses.  Last March marked an extreme in bearishness, people started to believe the end was near, the market can only go in one direction and that is down.  Odd that in general investors look at the market as only capable of a single direction and not really think in terms of cycles.  We don’t seem to have that problem in other areas.  When it is night, we don’t have this foolish belief that it is going to be dark forever, we know that daylight will follow.  Same with the change of seasons, the cold days of winter don’t last forever anymore than do the hot, humid days of summer.  But in the market, when the market is down, we have difficulty accepting that this isn’t going to be the way things are from now on.  Same thing on the upside, we start to think downtrends are a relic of the past.  In fact, when everyone believes that the market is only going to go up is very close to the worst time to be invested.  Same on the downside as many that were caught short in March and remained short (yes there are plenty of fundamental reasons, but still it won’t always matter in the short run) ended up adding fuel to the upside when they had to cover their shorts at higher prices.

Anyway, I realize I have not answered the question as to what kind of rally this is.  If you recall from a previous blog explaining how to differentiate between bull and bear markets, we based it off a 20 month MA.

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Clearly we are still in bear market territory.  We are enjoying a nice rally, but until it gets back above the 20 month MA, we must treat it as just a bear market rally.

June 13, 2009 Posted by | Legacy Funds | , | Leave a comment

Should financial advisors follow conventional wisdom?

Being human, we have the tendency to follow crowds and stick to what everyone else is doing.  This helped us survive over the years, and gave us numerous advantages.  However, in the market, whether it is the stock market, real estate market, Dutch tulip market, or any other market throughout history, following the crowd especially when the euphoria gets to an extreme level has numerous disadvantages.  In bubbles, the conventional wisdom and crowd behavior will be wrong with the common belief being “this time is different”.  For the hundreds of years of recorded history,  it has never been different.  The only thing different is the name of the bubble.

But herein lies the challenge for the financial advisor.  If a financial advisor lost money for the client, but the advisor followed conventional wisdom, then it is somewhat excuseable.  Reasons given such as who could have known…nobody could have seen it coming…you must have a long term horizon…or any other excuse of the decade will usually be acceptable.  If on the other hand the advisor lost money by going against conventional wisdom, then he likely has some explaining to do.  So it looks like financial advisors will put their practice at risk by going against conventional wisdom.  So then maybe turning to portfolio managers offers a solution.  Nope.  Most portfolio managers operate under the premise that they are paid to buy stocks, and how much an investor allocates to stocks via the portfolio manager’s fund is the investor’s responsibility — which basically puts risk management back in the investor’s lap.  Worse, many times the investor is not even aware he is responsible for the risk management so nobody ends up covering it.  Furthermore, most portfolio managers are only ranked by how well they follow their benchmark.  I read somewhere that Morningstar’s Manager of the Year was down 20% last year.

So what does one do?  Bubbles will always exist.  Most financial advisors will follow conventional wisdom to conform with the regulatory “prudent person” mandate.  It doesn’t make it any easier that going against conventional wisdom and trying to go against the crowd will feel awkward at the time as well.  The best time to get out of the market will be when euphoria is at an all time high, and the best time to go long will be when bearishness is extreme.  However, clients will soon start demanding some downside protection and start questioning why are they paying a fee for an advisor and not getting any protection in return.  Financial advisors that are capable of going against conventional wisdom to save their clients from losses will find they attract more clients and their practice will flourish.  Whereas those that are stuck following following conventional wisdom will not be so lucky as clients will refuse to hire them.  These clients will decide that they are better off investing in a low cost index fund, preferable an ETF.  Maybe one day an actively managed ETF will exist that does everything a financial advisor wishes to do but can’t for one reason or another…but that may be a topic for a future post.

June 1, 2009 Posted by | Legacy Funds | , , | Leave a comment

Is technical analysis similar to reading tea leaves?

Many proponents of buy and hold investing will try to degrade the usefulness of technical analysis.  They will find all sorts of reasons it can’t possibly work or even wrongly state that technical analysis tries to predict the future.  To be effective, all technical analysis does is build on technical indicators that for the most part will be based on price and volume.  These are the market’s footsteps.  On a chart it will provide a visual of where that security has traded.  Will that tell you what is going to happen in the future, yes and no.  What kind of answer is that, ok, let me explain.  Many times if a trend has been in place on a certain time frame, it will continue until it doesn’t.  OK, still not being very clear, but bear with me.  If the trend continues, you would be positioned to hold on and continue riding the trend.  If however that trend changes, you have a line in the sand, actually preferably on a chart where you will take your profit or cut your loss and possibly even play the other direction.  The more indicators that provide confirmation of direction, the stronger the signal.  Take for example the financial situation of a person that is late on a payment for a small bill.  This alone wouldn’t indicate financial hardship nor predict the future but it is a concern.  Well, what if a few weeks later that person is late on paying their utility bills.  This would start to raise some flags.  If this person ends up being late on their mortgage, then it is a pretty good bet this person is eduring financial hardship.  The market gives the same signals as the financial hardship example.  The more technical indicators provide a signal in the same direction, the stronger the confirmation for that direction.

May 25, 2009 Posted by | Legacy Funds | | Leave a comment