Link: The 12 Rules of Value Investing – CANSLIM

Jun 11, 2007: 7:58 PM CST

GoldenTicker, a new site steeped in William O’Niel’s CANSLIM approach for finding value stocks for the long run, posts 12 quick rules for value investing that will be helpful to long term investors and position traders.

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Confusion in the Market: How to Understand

Jun 10, 2007: 10:27 AM CST

Have you been a bit befuddled by the recent stock market action? I admit that I have, but I expect such events and have experienced various strange scenarios in my trading career.

If you are new at trading, the current market environment must be difficult to comprehend and I wanted to state a few of my thoughts on this topic.

First of all, we expect the market to be an “anticipatory vehicle” wherein stock prices reflect all that can be known about a company and the general economic/business environment. This is in line with the famous “Efficient Market Hypothesis” academics teach us.

It is also stated that the market tends to anticipate (lead) economic conditions by about six months, such that economic reports of today are parsed with implications regarding trends in the future. An example would be “If the Fed raises rates today, then businesses will have a more difficult time financing projects and their profits will decrease, leading to decreased valuations in earnings projections.” The opposite is true, of course.

While this partially explains why the market can act contrary to the current news, it’s not complete.

Case in point, the surface explanation of the recent action was confusing. The Federal Reserve announced the economy would be stronger in the near future, and the general situation is better than first expected. As a result, the market fell around 3% in the days following the announcement. Why would the market not surge on this news?

Until this point, there were so many catalysts that would suggest that the market and economy was headed for recession (high gas prices, slowing earnings, low GDP growth, international tensions, rapidly decreasing housing market, etc). Why did the market keep rallying on this news? It was confusing on the surface level.

While this is the case on the macro-level, the situation plays out in individual stocks, further causing distress and confusion to entry traders and new investors.

While news will generally “explain away” the confusion by explaining that good economic conditions increase the chance that the Fed will raise rates, bond yields rise, and that is generally bad news for a market in late expansion. This is the reason attributed to the market’s quick fall, despite good news. There are a variety of reasons, many of which you can find from other websites and news sources.

What the market pricing mechanism comes down to is the mechanics of supply and demand. Major firms and major traders (funds) often need to unload a major supply of shares onto the market and they cannot do so when conditions are poor and every trader is united in thinking and selling positions. The price would move so far so fast against them that they could be put out of business.

Instead, large firms need good news to unload their positions to the ‘masses’ of traders and need bad news to purchase large amounts of ‘inventory’ at lower prices. Such large firms (in aggregate) may comprise 10% or less of the number of aggregate traders in a market, but their actions consume the vast majority of stocks/shares and thus the volume. They must be in ‘contrary’ mode by default to unload or acquire large positions.

Professional ‘smaller’ traders try to mimic the movement of these funds and this adds to the ‘contrary’ movement in price. Such ‘smoke and mirrors’ is absolutely necessary for profit, as trading (not investing) tends to be a ‘zero-sum’ game where there are winners and losers as part of the transaction. This is absolutely true for futures and options traders, but mostly true for stock traders.

It would be great if the market moved up slowly and nicely following good news, and down calmly and slowly on bad news. Everyone would rush in to buy good news and the price would rise and we all would benefit. The market would be easy and we all would be rich, having quit day-jobs and we’d probably be trading in the Bahamas or by the beach all getting rich together. There really wouldn’t be a need for blogs or websites, as we would trade for a few hours, then go enjoy our lives.

We all know – who have traded any length of time – that it doesn’t work this way. We enter a position, it frequently goes against us, sometimes we buy the absolute high-tick of the day or week, and then when we exit the trade in frustration, the market reverses and we sometimes sell the day’s or week’s low tick. We buy at the touch of a moving average only to have ‘support’ break, but price reverse as out stop is hit.

Professionals and probability keep confusing us and we keep participating (until we give up in frustration). Either way, success comes from learning to think in probabilities, realizing that (often) half our trades will end in a (small) loss, and thinking counter to what the media and popular opinion is on a stock.

Sadly, engaging in the market and ‘making mistakes’ is absolutely necessary for success. Instead of getting frustrated when you get confused, take the experience in stride and vow to learn from the situation and realize you are one step closer to reaching your goals as a trader!

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Links: Market Top or Correction?

Jun 9, 2007: 8:16 PM CST

Chris Perruna posted a brief article with a few major points and well-annotated charts in his article “A Natural Correction or a Top?“.

Perruna notes, “Corrections are due when markets move up by 30% over their levels from the prior year.”

He also annotates charts on Crude Oil, the Nasdaq, and the Dow Jones.

I wanted to point to this brief analysis and have readers address the points he makes.

Also, if you wanted a major linkfest a Sunday afternoon reading, The Big Picture provides a plethora of links from blogs in categories such as the overall economy, market, and housing.

The Active Trader makes a bold statement with the post “What the Market Will Do Next” and notes that there could be similarities between the February 07 ‘crash’ and the June 07 ‘thing’.  The chart deserves a look.

Bill Cara’s Saturday report is another absolutely wonderful reference, containing various tables of ETFs and stocks sorted by one week relative price performance, as well as great market analysis.

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Morning Charts on Momentum Divergence Unwind

Jun 8, 2007: 6:36 AM CST

Attached are swing charts with the 3/10 MACD momentum oscillator. The most recent daily bar on each index turned red following the decline, meaning we have extended 2.5 Average True Range readings from the market peak (near Dow 13,700 and S&P 1,540).

I know I write a lot that “Momentum Proceeds Price” in the form of divergences, but it tends to be true more often than not. Momentum readings definately can form a strong tool for your trading strategy, though they are not the ‘end all’ for a trading strategy alone.

Longer Swing Chart of the Dow:

dow-june-7.jpg

Four month chart of the Dow:

dow-close-june-7.jpg

In both charts, please note the rising price swings and declining peaks in the bottom pane oscillator. This is no coincidence. Buying pressure (strength) began to weaken as the rally continued. It was literally as if the buyers were running out of steam to push prices higher and any sort of news or reason would cause avalanche selling to trigger stops and anxious short trades in an environment with few buyers.

The same is true for the broader S&P 500 index:

spx-june-7.jpg

The price swings and momentum divergence is a bit clearer in the S&P than the Dow because the Dow failed to make clear price swings, but rather it formed a pattern of almost a pure rise with extremely shallow (one day) counter-swings.

As a bonus, here is a Chart of the 10 Year Bond Price (@TY futures). Remember falling bond prices occur because of rising yields, and the bond market tends to lead the stock market in price and anticipation of economic conditions. This is true in terms of intermarket relations, but Kevin at Kevin’s Market Blog recently posted a possible day-trading indicator using indtraday pricing of the 20 year T-bond fund leading the S&P by an hour.  The bond market has been in free-fall since mid-May, signaling plenty of warning of (possible) impending doom.

10y-yield.jpg

The 10 Year Treasury Bond (price) is making new price lows and new momentum lows. It is only 30 points away from a 52-week low set almost exactly this time last year (7/07/06). That price low was 104.00 and we now stand at 104.30. Price is making lower lows and lower highs and the bonds are in a technically confirmed downtrend.

Caution is important and so is your own analysis on the markets and economic conditions.

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Today’s Market Decline and Implications

Jun 7, 2007: 6:06 PM CST

Normally, I like to post charts of the general indexes and do minimal annotations and speak from the perspective of my own swing charts and momentum readings, but I wanted to showcase a few excellent brief commentaries on today’s action.

TraderMike writes a very concise yet informative post with an excerpt from the Worden Report in his “Stock Market Recap”. TraderMike posts some of the best snap charts of the daily action of the major indexes and is always worth a study.

The Trading Goddess, another popular blog, offers a quick S&P chart in the article “The Overall Market Tone has Changed… For Now“.

I wanted also to highlight a newer blog – Active Trader Blog – who recently posted a quick chart and post about the action and I had to reference his concluding question: “The ball has fallen off the building…will it crash or bounce?”. The author uses similar techniques as I and similar chart set-ups and I wanted to highlight the remainder of his posts and blogs. The blog is also frequently updated.

I actually almost referenced his site last night when I read his post Markets Doing as Expected where I wanted to reference his index chart and note the clear momentum divergence in the MACD bottom pane indicator.

The market was experiencing a prolonged momentum divergence and extremely overbought (overextended) conditions and a snap-back like this (400 Dow points suddenly in 3 days) is absolutely an expected result of such conditions. It was not a question of ‘if’ but ‘when’ and as Active Trader says, we must wait and see if it is over.

From StockCharts, we see a rare picture – it’s a day where almost everything has turned red on the market summary page.

First, ALL major US Indexes were down over 1% each. Notice the 3% daily damage to the Utilities (sensitive to rate increases).

sc-indexes.jpg

All S&P Sector SPDRs were down as well. All 9 market sectors suffered.

sc-spdrs.jpg

As if that wasn’t enough bad news, every major market industry suffered today.
Only disk drives, hardware, and hospitals escaped a full 1% or more decline.

sc-industries.jpg

As if the whole of the US market declining wasn’t enough, every single MSCI iShares (via StockCharts) international fund was down.

sc-international.jpg

And now it’s time to see green. What was green today? Hint: Most were green by greater than 2%

sc-bonds.jpg

That’s right – the Treasury Bonds Yields. Bond prices fell, stock prices fell as a result of bond yields increasing extremely rapidly.

What’s likely to be worse is that traders could set off a panic selling wave for any reason whatsoever, especially those who ‘fear’ losing large gains they have recently made in this rising market that defied seasonal patterns (‘sell in May’) and overbought conditions, as well as a wave of relatively negative economic news for so long.

Please be careful and don’t panic out of positions because of a day’s action. Also, don’t jump in short just because every thing’s red for the same reason. Have a plan for what you do and how you trade and do so within contained risk parameters. The traders with whom I spoke with today said they survived because of risk controls. Others made a large profit short. Do what you understand and know why you do it – and know how to objectively quantify your actions and results so that you can make corrections as necessary when you were wrong or the market moved unexpectedly against you.

Remember, if you feel frozen, take any action at all. Put a stop-order in or a bracket order (a bracket order is a simultaneous entry of an upside stop-market exit and a downside stop market exit so that you’re guaranteed to exit the stop either at a price better than the current price or a bit worse than the current price. Either way, you will be taken out of your position). See my post on “Deer in Headlights” if you linked directly to this page.

It goes without saying: Be safe and learn from what’s happening.

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