Charting Freddie FRE and Fannie FNM Perhaps for the Last Time

Sep 8, 2008: 10:20 AM CST

With virtually all news focused on Fannie Mae (FNM) and Freddie Mac (FRE) and their government take-over, let’s look at their charts while they still exist to learn any trading lessons from these companies.

Freddie Mac (FRE) Daily:

The take-away from this chart is that it’s generally unwise to bet against a prevailing or primary trend.  Although there were massive retracement (and two 100% rallies), ultimately price gave back all those gains and more, and in one day price has fallen almost 80%.

Notice that simple technical (chart) sell signals came each time FRE retraced back to its falling 20 day EMA (green line), and notice the ‘dojis of indecision’ that formed at this critical barrier to overcome in a down-trend.  At a minimum, you should exit any long (counter-trend) trade at these zones, but they also can serve as excellent short-sell entries with low-risk stops.

Though you cannot predict government announcements or reports, you can trade high probability, low risk opportunities when they set-up in the basic price structure.

Fannie Mae (FNM) shows a virtually identical price structure, but I added the price from the start of 2008.

Fannie Mae (FNM) Daily:

Identifying a downtrend can be as easy as viewing moving average orientation (that the 20 is consistently beneath the 50 (blue) period EMA) or by comparing price swings (looking for lower lows and lower highs) or as complex as linear regression, autoregression, or other statistical measures.  I find some combination of the “swing high and low” method and the moving average method as being fine for quick trend assessment.

Again, whether or not you can spot ideal trade location set-ups on this chart, what’s important is to grasp the big picture.  A lot of people got excited and purchased shares in these companies (and others that are trending down) and decide to be aggressive buyers when price swings lower.

While this may work for the long-term (studies often show it does, provided the company does not go bankrupt!), short-term, it can be a trying strategy psychologically, and you always run the risk of a company being taken over or bankrupting or ceasing to be listed, particularly when we get beneath $5 per share.

People really do compare it to ‘catching a falling knife’ and if you’re successful at catching it, you can make immense profits… however I find it’s superior mentally and financially (as a trader) to identify the predominant trend and then find low-risk retracement entries in the direction of that prevailing trend, particularly as price retraces to a moving average or Fibonacci number.

Finally, let’s look briefly at Fannie Mae’s (FNM) weekly chart to see how fast and far this stock has fallen.

Fannie Mae (FNM) Weekly:

I’ll let the chart speak mainly for itself.  Notice that even on this timeframe, the 20 week EMA (exponential moving average) provides formidable resistance and sets up entry opportunities.

Study these charts (and print off your own and annotate your understanding of price behavior on them) for further insights, and use these companies as a lesson not to trade aggressively against the predominant price structure (trend) and to understand risk and reward characteristics.

For further fundamental (news) information on these companies, there are many resources to check out today, the easiest way to view many of them would be to use the NewsFlasher Business News and Business Blogs section.

I also wanted to highlight Barry Ritholtz’s “The Big Picture” site which has recently written over 6 articles on Freddie and Fannie (including multiple links as well) that you might find interesting.

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Gap Fade Stats for August

Sep 6, 2008: 4:27 PM CST

Wow – August was another month with a high percentage of overnight gaps, but let’s see how many of these overnight gaps in the DIA (Dow Jones) were filled intraday.

I define a gap as being an open that is at least $0.20 different than yesterday’s close and use Excel for the statistics.

There were 21 trading days in August, and 17 of these (81%) showed an overnight gap of at least $0.20 in the DIA.

Of these 17 gaps, 8 gaps filled, giving us the first under 50% month this year, with 47.06% of overnight gaps filling intraday.

There were 7 up-gaps, and 4 of these filled (57.14%).

There were 10 down-gaps, and only 4 of these filled (40.00%).

Despite the daily chop, there was not one gap greater than $1.00 (there was a gap of $0.98 on August 5th which did not fill).

The following print-out shows the DIA gap fill statistics for August:

I’m including the “year to date” numbers from January 1st until August 31st 2008 in the DIA (of gaps greater than $0.20):

As you see from the table below, 77% of days have opened with a gap at least $0.20, and 62.50% of these gaps have filled.  The table shows the whole picture so far:

Up gaps have been more likely to fill than down gaps this year, and almost 3 out of 4 up gaps have filled, while 1 out of 2 down gaps have filled.

2008 has been a generous year so far for the gap-fade strategy.  Will it continue?

Check out these prior gap fade statistics months:

January Gap Fade Statistics
February Gap Fade Statistics
March Gap Fade Statistics
April Gap Fade Statistics
May Gap Fade Statistics
June Gap Fade Statistics
July Gap Fade Statistics

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Intraday Action from Friday

Sep 6, 2008: 10:27 AM CST

Wow, what a day Friday gave us in the markets.  Let’s look inside the price action to see what potentially profitable trade set-ups occurred in the intraday structure of the major stock market indexes.

DIA Dow Jones 5-minute chart:

Price began the day with an opening gap down, given the bearish ‘trend day’ from Thursday, such a move was quite expected.  The intraday price reversal was not as easily anticipated, though given the ‘chop’ of the current environment (up one day, down the next, vice versa) it should not have been an unexpected development – it’s so easy to get overly bearish or bullish and miss emerging information.

Also, although this will go down as a “Gap Fill Day,” odds are quite high that if you attempted a gap-fill today and used any sort of stop-loss strategy, you were stopped out prior to the gap fill, although there was a quick move to fill the gap within the first 30 minutes of trading – unless the gap is greater than 100 Dow points, the highest probability move is to play to fill the gap.  I do recommend using a stop that’s at least half the distance to your target (meaning, if you target a 50 cent gap fill, place your stop 25 cents away from entry).

Moving on, the price trended lower into the 11:00 hour before forming quite a significant ‘triple swing’ positive momentum divergence, which at a minimum indicates the sellers are losing pressure and risks of holding short are increased – divergences often signal an exit to any (in this case) short positions you have intraday.

In fact, that worked as price surged off the new lows on the day to cross above its falling 20 period EMA (a ‘last resort’ short exit) and then found resistance above the 50 period EMA, forming a new price high and new momentum high on the day.  Price fell gently (sloping in a 45 degree angle) to its rising 20 period EMA, setting up the “Impulse Buy” trade or in this case a “Bull Flag” trade (I drew the pattern in the SPY chart below, not in the DIA chart).

Price then found resistance at the “measured move” target of the flag and also at yesterday’s closing price before consolidating, finding support again at the confluence of the 20 and 50 period EMA, and rising into the close of the day with the classic “Three Push” pattern which developed on a loss of upward momentum.  The “Three Push” pattern is a sign of weakness as price makes the final push into the close – using up buying power to form the three tight peaks.  It’s also analogous to a mini complete Elliott Wave pattern (with the three pushes being the impulse waves of a 5-wave pattern).

Though the S&P 500 (SPY) chart below has similar structure as the DIA, I wanted to provide it to show the similarities in intraday action on these indexes.

SPY S&P 500 5-minute chart:

With a hammer forming on the daily chart (by the way, if you want to look inside a hammer candlestick, Friday’s action showed the inner-workings of the pattern), it will be interesting to see the price action on Monday, which is likely to be bullish given the intervention plan of Freddie and Fannie (FRE) and (FNM) which could cause a big price move if investors are reassured.

Do some good homework over this weekend.

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Inside the Recent Bearish Rising Wedge

Sep 5, 2008: 10:39 AM CST

Technicians should not be surprised with the recent downward price ejection out of the August consolidation pattern, known as a ‘rising wedge.’  Not only did the pattern follow classic definitions and expectations, we were treated with a prior example of the pattern just a few short months ago.  Let’s look at the Dow Jones index and step inside this pattern for a better educational foundation.

Dow Jones Daily Chart:

History repeats itself?  It sure seems likely, and many were aware of the possibility of the rising wedge seen from March to May repeating itself (almost exactly) into today’s environment.  The only major difference was that the current wedge endured two failure tests (failure tests take place after a breakout when price returns to test the lower trendline) instead of the one (red arrow) that occurred last time.

It’s very difficult to enter at the absolute breakout of the pattern, however the highest probability short-sell (or long liquidation) entry occurs at the failure test of the pattern (this is true on most patterns).  In fact, one could also call this a “throwback” rally before final expected capitulation.  Nevertheless, entry takes place as close to the trendline as possible, with a stop being placed on the opposite side of the upper trendline.  The target is often a “measured move” of the height of the pattern.

The initial target is always a test of the swing low, which in the Dow is near 10,800 from the July 15th low.  Odds look greater than ever that price will – at a minimum – test this price for a major battle at that level (the level is 1,200 on the S&P 500).

Notice the negative momentum divergences which set-up as price reached the ejection point (breakout zone) of the pattern – this adds to confirmation and confluence.

Let’s do something a little fun and go inside the bear wedge, sort of like entering the eye of a hurricane or core of a tornado… but safer.

Inside the Bearish Rising Wedge:

I’ve drawn this hourly chart on the Dow Jones index and drawn the trendline according to the “maximum touch” method, meaning you attempt to draw the line so as to maximize its significance in terms of times the trendline has been touched or tested.  You get better insight this way because it makes sense and captures the psychology (thinking process) of those who drew trendlines and experienced what they thought was a true break (such as what happened around August 12th).

This was a breakout as far as the pattern was concerned, but I felt that not enough time (cycle) had elapsed to be a true breakout – patterns need time to form, especially consolidation patterns.  One should also keep in mind that this entire move you’re seeing is an official “Bear Market Rally” or “Counter-Trend Retracement” so you have to keep that as the dominant structure – there was no reason to get excited and to believe a whole new bull market had emerged… or that the bottom was firmly set in place.

That being said, the false breakout took price back to the lower trend channel, back to the upper channel, and then to the breakout price around August 18th.  That level would be an “aggressive” short with a large stop placed above the upper trendline IF you believe that was a true breakout (you really don’t know until it’s been confirmed, but by the time it’s been confirmed, you often sacrifice initial trade location).

I prefer to enter on ‘failure tests’ or ‘throwback rallies’ such as what occurred on August 25th.  However, the flaw in this strategy is that there isn’t always a throwback to enter safely.  Interestingly enough, price came back to test the lower trendline two more times (giving heat to short-sellers and possibly causing them to take a stop-out if their stop was placed too close… ie. inside the channel).

Tuesday, September 2nd’s overnight strong gap likely got buyers excited, but they entered into a retest of a converging trendline and apex of the bearish wedge pattern, which proved to be the absolute top (or ‘perfect’ entry in hindsight).  From here, sellers dominated, the bearish wedge pattern was confirmed, and price has, and continues to plunge to meet its price objective (now around 200 points away).

Whenever you see a clear or distinct pattern, annotoate your charts, print them, and learn as many lessons you can so you can profit the next time the pattern possibly sets up.

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A Quick Look at the Current S&P Weekly Structure

Sep 5, 2008: 12:39 AM CST

Today’s 3% index rout reaffirmed the predominant and primary downtrend on the major US Equity Indexes, and also confirmed the breakdown of consolidation from a bearish rising wedge as the dominant technical pattern.  Let’s look at the S&P 500 weekly chart to see the structure.

S&P 500 Weekly:

Price peaked in October, 2007 and a primary downtrend was confirmed into 2008 (via a variety of methods, including a moving average bearish cross, lower high & lower low, break beneath all moving averages, etc).  Thus, any rallies in price must be labeled as counter-trend rallies.

The July 15th bottom should have been classified as such, and although you can certainly profit on counter-trend rallies, you must know that the risk is higher (it can be like playing musical chairs) and the odds of success are lower.  At any point in time, the prevailing trend can reassert itself, and the dominant technical structure (trend) will take over.  Such is what happened Thursday.

Price found resistance just above 1,300 at the 32.8% retracement of the May high to July 15 move, which also corresponded with a confluence of the weekly 20 and 200 week moving averages – remember that confluences of support can be very difficult to overcome, and often set-up excellent, low-risk trading opportunities.

Now, the bearish wedge on the indexes (I’ll try to detail that later) has been broken, confirmed, and we have bearish price projections, the first of which is a retest of the July 15th low (around 1,200).  Failure there will take price lower, perhaps even to a ‘measured move’ of the prior bear swing – I’ll discuss that more should the break of the July 15th low occur.

For now, don’t panic – manage your risk – and stay on top of any open positions.  The path of least resistance for the US Equity market appears to be to the downside, keeping in mind that September has a historical significance as a generally ‘bearish’ month.

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