What to trade now - homework

It appears some of us are interested in the business of trading, hopefully for both fun and profit.
Here's a place to talk about that. I suggest two main categories. How to trade (timeless), and what are you trading now, and why, and how it turned out. Those tend to be missing from the pro boards, so pundits can have selective memory....but that's not all that is important. Being wrong is part of the game, and how to handle it and make money anyway is crucial, for just one example.
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The usual. Be nice, be informative, tell it like it is.

Re: What to trade now - homework

Postby Doug Coulter » Thu Aug 04, 2011 8:20 am

A reader asked me how I knew it was time to short PALL the other day. I thought I'd write it up a little more clearly for anyone wanting to see how I see these things (at least partly).
I find it very useful in technical analysis to use more than one timeframe. Though I might use some pretty short (few days to a month) charts for actual trading, to decide what to trade, I use longer term charts to see the larger picture. I add other things to my tech analysis of course -- I feel like tech analysis yields a little truth, but the larger truth is that when everyone is doing it the same way, and they are basing their decisions on it - it becomes self fulfilling (even the guys who trade by astrology get some of this effect, TA is just the current most popular sect of the trading religion). To this I add some fundamentals, buzz, industry tie-in information, and depending on the issue - balance sheet and other stuff. PALL, being just a metal, is a little easier to do, it doesn't have some of that going on. Here's PALL short term.
Short term pall
I called the trade 8/02, and closed it the next morning, which in the ever present hindsight, was wrong - looks like I missed quite a lot of profit. On the other hand, I was watching that first green bar go up fast, and heck, already had good green numbers for a "quickie". Looks like we might get down to the bottom of the range -- we'll see as the day progresses (this chart shows after-hours trading). Now, lets look at the longer time period.
1 year, dailies

Note PALL went up for the first part of this plot, then kind of stalled out as supply and demand started matching up better. I call this a "trading range" market - and we're likely to see this sort of market for a good while in a lot of things if what Adam Hewison is saying is on point (and that's likely, he's smart and right a lot). I drew lines on this to define the trading range. Note they are both trending up, and about the same. This would be considered a bullish sign for a buy and hold type, though I don't think those types are going to do well for at least the next decade. It's just an "earn your money" market these days.

At the last of the chart, note how once PALL hit the top of the trading range, it faltered and started to turn down again. A tech analyst would call this "bouncing off resistance" which is shown by my upper trend line. Had it "broken out" solidly above this, it would have been time to go long -- buy high, to sell higher. In an uptrending market, this is in general your lowest risk, highest payoff play, and this is one that William O'Neill recommends with his "cups and handles" and CANSLIM approach. But we don't have an uptrending market -- we have a kind of trading range overall.

If I can pound home just one point here, and it's one that's obvious in hindsight (the great humbler, after the markets) -- is that we have at least three types of markets (on just about any timescale this junk is fractal). Trending, either way, and trading range (maybe with a slight trend on top, as we see in PALL of late). If you go by William O'Neill's rules which were developed for trending markets, in a trading range market, you get killed, or at least don't do well. If you try to trade a trending market like it was a range-bound market, you lose too compared to using AN APPROACH THAT MATCHES THE REALITY. Virtually 100% of writers/analysts miss this utterly important point. As the Marines say -- improvise, adapt, overcome. You MUST change your system to match what's really going on -- the ticker is the truth no matter what "it should be".

I'll edit and show another trade I called (but sadly, didn't do) in a bit, market's about to open and I might be making some moves in a minute. This one is short steel. In case you're thinking shorting is my game - it's actually the exception, btw - shorts have a more difficult timing and worse risk/reward. I'm heavy into GLD, SLV, CEF long right now and that's where most of my green numbers are at the moment.

Here's the short term on MT, a large steel company. Other large steel looks similar.
MT (steel) short term

As you can see, that was not a bad call for a potential short. Now lets pull back a bit.
Longer term

At about the same time PALL did the switch into "trading range" -- this stuff just started going generally down. I *hate* calling shorts on well-run companies - they have a tendency to pull rabbits out of their hats and defy gravity. But this is an entire industry. For the non tech analysis -- hey, steel is autos, bridges, buildings, infrastructure - and look what is happening to their customers. Ouch. I didn't pull the trigger on this one myself (oops) because, hey, shorting this is really a bet against a recovery ( I try to be optimistic), and these companies aren't that badly run. But it would have made money. I didn't draw the trends on this one - you should learn to do that by eye most of the time, or you'll spend too much time dinking with the tools to discover what a glance will show you eventually.

More later. But this shows a little of the process I go through to get to a trade call. We'll back up to 30,000 feet view next time I edit this.
I'm Baaaaaack. Ok, now onto what most call macro view. How are things in general, and how does this affect markets of various types, and when? Markets (eg people who trade/invest) are forward looking. The time scale used to be quoted as 6 months and that used to be about right. Expectations (for some future time) set prices now. Obviously the whole world is in pretty deep poop right now, and forward looking prospects aren't that great. Further, until quite recently a very large number of people were in denial, and further hampered by systems and rules that basically say they have to be "all in" all the time (many mutual funds). That number is finally going down - we call that capitulation, the realization that denial ain't only that famous river.
Once we shake out the perma-bulls, we have a shot at going up again, but that process evidently isn't over yet and probably won't be unless we break out of this trading range and really correct hard. A lot of those guys who recently recognized the true state of things are trying to hedge as best they can long-only (because of their rules), and this is creating what we call "flight to safety" which of course is really only a flight to perceived (not actual) safety. Hence, we have gold etc up, and even T bills -- despite that threat of default! That's a much more complex situation. T bills are considered the safest thing (even in the face of default!) out there, and built into various rules about what constitutes collateral and core (Tier 1) capital reserves. Had they caught a downgrade, the rules would have to change -- there's nothing out there that can take their place as collateral and Tier 1 bank reserves. At any rate, this "flight to safety" was predictable as hell, so I temporarily became a "gold bug" for the last little while, since T bills are a PITA to trade, the interest rates are worth holding them, and how much lower interest can they go (eg lower interest is higher bond price)?
I would add that something most others miss is that "lookahead" period gets shorter as things get more nervous - another reason to pay attention and shift your system rules depending on the fear factor out there.

Oops, gotta go watch things some more....I'll be back after the popcorn...
One quick note, a couple of my favorite things to be long are finally back at realistic buy points -- FCX and BTE. However, I've not yet done the analysis about *when* or *if* it's time to buy them yet -- they could go lower, or stagnate for awhile, no point having money at risk on "dead issues". And that other pithy saying "don't catch falling knives". I am watching copper and oil a lot (on ino.com) as forward looking indicators, and copper, while a bit down from all time highs, is still strong - whether that's Chinese manipulation or not I've not discovered. Oil is low now, which tends to be good for other things, but says those other things are currently bad...
Posting as just me, not as the forum owner. Everything I say is "in my opinion" and YMMV -- which should go for everyone without saying.
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Doug Coulter
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