New All-Time Lows For Freddie Mac and Fannie Mae

Aug 20, 2008: 11:21 AM CST

Mortgage backers Freddie Mac (FRE) and Fannie Mae (FNM) made new lows today, after erasing all gains made from the July ‘Savior Rally” that was widely expected to be the absolute bottom for these stocks.  Let’s look at where we are price-wise and how far these stocks have fallen recently.

First, their daily charts:

Fannie Mae (FNM):

Freddie Mac (FRE):

I’ll discuss these charts together, as their price patterns are extremely similar (only their prices are not).

Price consolidated (flat trend) throughout April until June, when price began a slow ebb to the downside that turned into a vicious snowball effect move washing out investors to the downside until the eventual July 15th bottom when virtually everyone was most pessimistic about these companies (myself included) but then a massive, triple digit percentage surge occurred and almost 400 million shares changed hands in both companies.

Both stocks gained over 100% from their respective bottoms, rewarding those almost instantly who grabbed the falling knife and reassuring us all that these stocks were ok and that the worst was behind us.

All that has changed dramatically now, as both stocks have breached the intraday gap-down low of July 15th and made new lows for the year.  In fact, both stocks have made all-time lows today (Freddie Mac began trading in 1992 at $10 per share while Fannie Mae common stock began also in 1992 at $15 per share. Preferred shares – FNA -began trading May 2008 at $50 per share.)

What’s interesting to note is that the ‘off the bottom’ surge was halted sharply at the 20 period EMA on both stocks (Fannie Mae actually closed slightly above this average before failing its test here to roll back over to make new lows).  In a downtrend, the 20 period EMA often serves as initial expected resistance.

Notice also how volume is significantly lower than the July period, almost as if this bottom is being made in absolute ‘hush-hush silence,’ hoping that no one will pick up on this event.  Generally, new lows being made on reduced volume from previous lows is a bullish non-confirmation, so be sure to keep that in mind before rushing out to get short these stocks at these levels.

Let’s step back and view Freddie Mac’s Weekly chart for clues that could have saved investors such financial pain:

Freddie Mac (FRE) Weekly Structure:

As mentioned above, in a downtrend, the 20 period EMA (regardless of timeframe) can be expected to provide initial (and often significant) overhead resistance.  It’s also the ideal place to enter a short-sell, or to exit a trade you may have held too long emotionally, as it offers favorable risk/reward.  Red arrows mark these zones.

The July ’savior rally’ is a mere dragonfly doji on this chart, but recall that this rally was indeed a 100% up-move (initially fueled by shorts exiting the market in droves thanks in part to new changes in short selling, namely curbing “naked shorting” of 19 stocks including these.

So, looking at these charts and what’s happened now, it’s abundantly clear that the massive surges of July were caused by a significant short-squeeze or short-covering rally by large funds and traders, rather than a rush to buy these supposedly infallible companies.

Will investors pick up these stocks at these levels?  It’s impossible to tell by the charts alone, but we’ll need to keep our attention to these stocks to see what the level of risk-taking appetite is for funds and investors in these difficult economic times.

For more information, Mish’s Global Economic Trend Analysis released an article today entitled “Fannie, Freddie – $223 Billion Debt Rollover Problem” which includes economic data and commentary.

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A Return to Simplicity: Up, Down, Sideways

Aug 20, 2008: 10:47 AM CST

We tend to overcomplicate trading at times, myself included, but sometimes it’s refreshing to step back and recall the simplest, most basic (almost oversimplified) concept of broader trends and possibilities.

Adam Hewison of Market Club released a new video today entitled “Three for One,” in which he takes trading and investing back to the foundational principle “Markets can do one of three things… go up, go down, or go sideways.”  From this structure, trading strategies of infinitely complex nature can be developed.

Adam walks us through a simple decision matrix and then explains how they constructed their “Trade Triangle Technology” using these principles with additional inputs, and how it’s used to generate profits by identifying basic price structure/behavior across all markets.

In describing the video, Hewison states,

“The most important element in the market is not the news, it is the market action itself. Everything else is secondary. In my new video I explain exactly how we look at the market and how you can benefit from looking at the market the same way.

The simplicity speaks for itself.”

I’m in the middle of doing various backtesting studies and strategy development, and I get caught up in the optimal parameter for an indicator, the optimal stop-loss strategy, the optimal position sizing algorithm and can get carried away in the finer nuances of price action and trading opportunities.

To some extent this is a necessary progression, but it’s important not to forget that price behavior is driven by supply, demand, expectation, etc. but that when all is factored away, price can only go up, down, or sideways, thus it’s important to identify the current environment and then develop strategies to take advantage of low-risk opportunities within the current structure.

As an updated disclosure, I am a commissioned affiliate of the Market Club.

Let’s remember the foundation of technical analysis, according to Martin Pring:

“[To] Identify trend changes at an early state and to maintain an investment posture until the weight of the evidence indicates that the trend has reversed.”

(Pring, Technical Analysis Explained, an essential book for those serious about the art of technical analysis).

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Crude Oil Reversal Back Up Underway?

Aug 19, 2008: 1:30 PM CST

According to a few price calculations and support levels, odds have now shifted to favor a current possible short-term bottom for crude oil prices and a reversal to test higher levels – a technical development that comes at a time that gold has supported at similar levels and the S&P 500 is breaking down out of a daily trend channel.  Let’s focus for now on crude oil.

Crude Oil ($WTIC) Weekly Fibonacci Grid:

Taking the 2007 price low and projecting a Fibonacci retracement of the move to the 2008 highs, the following long-term Fibonacci retracement grid is created, which has the first level of support – the 38.2% retracement at $110.97, or roughly $111.00 per barrel.  The 38% retracement often provides initial support in an uptrend, which price clearly is in (despite a steep correction, on the longer time chart, we cannot deny the uptrend is still in tact).

Quickly – why is price still in an uptrend? Price is now making a higher low with a pullback after making a higher high.  Also, the moving averages remain in the most bullish orientation possible (20 above the 50 above the 200).

In addition to the possible support via Fibonacci, we have the 50 week EMA just below price at $108.89 (roughly $109 per barrel).  It would be quite impressive for price – after making such a large volatility price move down recently – could not find at least moderate support at these levels.

As if these levels were not enough to provide a solid case for a potential bounce, let’s look at additional confluence from the daily chart:

On August 4th, I published a post entitled “Crude Fails Test – Continues its Slide” in which I set a price target of roughly $110 per share, which was the ‘magnet trade’ or next zone of support via the daily chart.  Indeed price has now fallen just short of that $15 target and this current action can be considered a “test” of that level, meaning the 200 day moving average – currently at $110.20 – provides additional confluence for a strong and likely successful test of these price levels before mounting a possible reversal (however long lived) to the upside.

In terms of momentum, there’s also a clear positive momentum divergence forming, which often tends to precede price reversals.

To recap:

38% Weekly Fibonacci Retracement:  $111.00
Weekly 50 period EMA:$109.00
Daily 200 period SMA:  $110.00

All of which provide a confluence of possible support and price reversal at these levels.

Should price fail here, it would be a significant development.

Continue to look at your intermarket relationships, meaning gold also has found possible support (as I posted this weekend in the article “Is there Potential Support for Gold at These Levels?“, and the S&P 500 (and Dow Jones) are possibly breaking beneath a key rising support trend channel (mentioned in today’s post, “Market Gaps Through Support Trendline.

Keep a close eye on all these developments and critical areas, all of which are happening simultaneously – I’ll be sure to keep you all posted on these situations as they develop.

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Market Gaps Through Support Trendline

Aug 19, 2008: 10:44 AM CST

With the inflation numbers (double what was expected) and weak housing data, the market took the opportunity to gap downwards through the prevailing rising support trend channel on the daily chart (evident on the Dow and S&P 500).  We’ll need a close beneath the trendline to validate it, but as of noon, it looks like we’ll finally get that close.

Dow Jones DIA ETF Daily Chart:

I’m showing two interpretations of the daily bottom channel trendline (the top channel is not drawn) which is likely seen by all – on one trendline I use intraday closes and on the other, I use closing prices – the recent difference being yesterday’s action broke the trendline using intraday prices (candle wicks) and today’s action broke them both.  It’s possible that price could support, or could be stealing stop-loss (or triggering short-selling) orders and that we’ll need to re-draw the trendline, but for the moment – with a close beneath $114, we will need to classify these two valid trendlines as officially broken.

I’m sort of jumping the gun prematurely and posting intraday, rather than waiting for a close, but we must do our analysis in real time and be ready to chage if market conditions dictate so.   It will be frustrating if this turns out to be a whipsaw, but again, analysis and trading decisions are made in real time.

I mentioned yesterday that a test of the trendline offered an attractive place to ‘get long’ and play for the upper channel, but luckily before we could put on a position at that level, the market gapped lower, invalidating that play (opening and moving into the area where a tight stop-loss would be placed).  It is a great example of how we should do evening analysis, develop a strategy/game plan, and then wait for the market to confirm or disconfirm our analysis.  In this case, the market disconfirmed it, and a trade was not taken.

Let’s take a peek at the intraday action so far to see how this happened and what might be in store.

Dow Jones DIA ETF 5-min Chart:

Yesterday’s ‘trend style’ day action gave way to a late and pronounced positive momentum divergence and end-of-day rally, which seemed to indicate that price – being at support from the daily trend channel – would trade higher into Tuesday’s action and could travel as high as $117 to $118.  The economic news invalidated this pattern/analysis and the trend is strongly confirmed as “down” on the 5-minute timeframe (notice the most bearish orientation possible of the moving averages).

Also, notice the daily trend channel is – as of this writing – just over $1.50 away.  Odds are quite high that we’ll get that close definitively beneath this line, which would make the bullish case much more difficult.

Visit the Market Club daily blog for more information and analysis, and consider joining the Market Club service for daily scans, news, analysis, charting, education, and more.

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Monday’s Intraday Trading Tactics

Aug 18, 2008: 9:43 PM CST

With a semi-trend day behind us and plenty of trading opportunities at hand, let’s look at some of the price structures and idealized trade entries we could have taken now that Monday’s action is complete.

Dow Jones ETF – DIA 5-minute:

First, the day started with a mini-index gap, which was instantly filled for little chance of profit, however this gap was indeed at least $0.20 above yesterday’s close, so it will count as a successful gap fade in the August statistics (compiled at the end of each month).

Price made a new price and momentum low on the day, setting up a potential “Impusle Sell” trade whenever price retraced to the 20 period EMA – or better – a confluence of intraday moving averages.  This confluence occurred as price pulled back in a 45 degree angle around noon, when a classic bear flag style trade developed (or a “Measured Move” as I’m more fond of calling this pattern).

Entry came as price crested to test the 20 or 50 period EMA, and the break beneath any of the dojis (or during the 5-minute doji formation) would have been an excellent short (with patience) with a stop above the key moving averages here.  The trade’s target would have been an equal or “Measured Move” of the prior impulse, or roughly $1.00 (100 Dow points) which was achieved very rapidly after the break of the price consolidation of the flag.

One could have played a retracement back to the 20 period EMA trade, given the three dojis in a row, but such countertrend reversal trades are often very low probability of a big win and offer little more than a scalper’s profit – it’s much better to step aside as price retraces and then look for an area to “get short” which came as price neared the 20 period EMA again and formed a tight doji (red arrow).

Price now formed a momentum divergence, but still it would have been better to step aside (no position) and then wait for a proper short entry again – this time signaled by three dojis in a row (second red arrow).

Price eased its way lower on less downside momentum, and a growing positive momentum divergence developed, which should not have been ignored, and could have been sensed without the use of any indicator (notice price swings narrowing to the downside).

The final ’short’ trade occurred as price retested the 20 period EMA for the last time before swinging back, forming yet another doji (today seemed like the “Day of the Doji” to me) and then broke to the upside, as hinted by the lengthy and pronounced positive momentum divergence.

All and all, it was a rough day for the market, but we sit cautiously on rising trend channel formed on the daily chart.  Unless there’s a significant down move Tuesday, odds slightly favor upside potential, and a good risk to reward trade long, given a tight stop beneath the trend channel, should it hold – either way, you won’t risk much to find out, and the upside (potentially to $117 to $118) is almost too good to pass up if I do say so myself.

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