Trading Lessons You Will Not Find in Books

I have read around six books and countless articles on trading. I have been trading equities for about a year and a half now and options for about four months. There is one thing I realize now: there is no better teacher than experience. Even after reading all that literature, I make mistakes that are stupid and easily avoidable.

In this article, I will list as many of those mistakes as I can remember and what consequences I faced (or someone else faced) by making those mistakes.

1. Diversify
   I cannot stress the importance of this lesson. The main point is if you do not diversify, eventually you will make a bad call and get wiped out. Such a disaster can essentially end your trading endeavors.
   One of my friends made this mistake and brought his trading career to a halt. Close to a year ago when Wachovia hit $10/share, his analysis and thought process said that Wachovia would not fall much further. He proceeded to invest close to 80% of his money in Wachovia. Next day, Wachovia crashed to mere pennies, pretty much wiping my friend out (Although thanks to Wells, it came back close to $7. I personally bought at around 53 cents and sold at around $6 - best trade of my life :)).
   Even if your analysis is perfect, there is always a chance that you could be wrong. Individual traders especially have very limited information and thus can very rarely assume that they are 100% correct. Because of this reason, always know what your max loss on any one trade will be in the worst case scenario and make sure that such a loss will not completely wipe you out.
   


2. Watch the commission rates
   This applies close to home for me because I have very limited capital and any commission I pay significantly cuts into my profits. Things get especially worse when I have adjust and readjust my trades to show profit. There have been many times where although I am showing a 10%-15% profit, really I am breaking even because of all the commission.
   Even now, more than 5% of my account has gone to commissions and in fact at this moment, my commission fees outweigh my profits!
   However, I have truly cut down on my commission fees by making better decisions and cutting down on the number of trades. I think in the past two months I might have spent only 20% of my total commissions and I have been trading options for only 4 months.
   If you use TOS software, make sure you turn on "INCLUDE COMMISSIONS" on the analyze tab as this will really help make better decisions. If you do not use TOS, try to take advantage of any discounts/perks your broker might offer. Keep in mind that some brokers will make special deals with you if trade more than a certain number of trades/month. Apart from that, I have no real way of avoiding commission fees.


3. Have an action plan before you enter the trade
   A lot of the equity/futures trading books emphasize this point quite a bit. However the option educational material seems wanting in this area. Ironically, this probably applies a lot more to the options market than to any other market.
   I think the problem is that there are infinite possibilities of how to handle an options trade. You can simply exit the position, you can switch your position for another one, you can change strategies, you can make a horizontal shift, and you can pretty much do anything you want if you are creative.
   If you do not have an action plan, however, you will simply end up spending a bunch on money on commissions while you keep readjusting your trade and at the end still make a loss.
   I suffered greatly from this when last month I traded a bunch of calendars expecting the stock to remain in the calendar's trading range. However, I was hit with unexplained volatility which took me for some of my largest losses yet. Because I did not have a plan, I chose to simply exit the positions, sealing in those losses. Looking back, there are a variety of things I could have done to avoid those losses and even turn some of those trades into profits.
   I strongly urge you to analyze all the possible scenarios and have plans for each of them: what will you do if the underlying goes up/down 0%, 2%, 5%, 10%, 15%; What will you do if the implied volatility falls/rises 5%, 10%, 20%. If you have these bases covered, most of the times you should be in good shape.


4. Keep a close eye on Bid/Ask before trading
   This, again, holds especially true for options. Let me illustrate with the following example:
   
   Today, PRU is trading at 49.12. I am looking at the option chain and see that the "Mark" (or the quoted price) for Jan 2010 49 Call Option is 3.30. But the Bid/Ask tells a different story.
   Bid Price: 3.20; Ask Price: 3.40.
   So I say, "OK, let me buy a call option". I spend $340 and buy one contract. Five minutes later I realize that I need the cash for a margin call and am forced to liquidate the position (Of course you would never get into this situation if you follow advice # 3).
   I turn around and sell the option while the Mark is still 3.30. No big deal, right? No profit/loss, right? Wrong!
   When I sell, I must sell at the bid price, which is 3.20. So I get $320 back, taking me for a $20 loss. In five minutes I lost almost 6% of my capital even though the option price has not changed!
   I have made this mistake many times because I look at my positions and they show a profit of $XYZ so I get rid of them. But because of the Bid/Ask spread, many times I have quickly turned healthy profits into heavy losses.
   My advice is to use the Bid/Ask prices in your analysis rather than the quoted "Mark" price as most options software will use. If you use TOS, the analyze tab does an excellent job of graphing your profits/losses based on the bid/ask prices.


5. Beware the ITM short options
   When you are short an option and it goes ITM, I become very wary and try to get rid of the ITM options as soon as I can. The reason is that if you get assigned those options, your position changes drastically and unpredictably. Below is an example.
   I had traded a HPQ calendar and the trade, one day before expiration showed a nice profit of approx 20%. On the expiration date, the short options went ITM and at the end of the day I was assigned those shares. Next thing I know, I am short 500 shares of HPQ and the stock jumped around 5% the next day, wiping out all my profits.
   My advice is to buy back ITM and close to ITM options as expiration approaches. You might give up some time value but are protected against drastic market changes that could take you for a much larger loss.

I hope the lengthy advice can help you in your trading career and you can learn from my mistakes. I am also certain I will make many more mistakes and I will try to update this list as I make those mistakes. I only hope that overtime my right decisions outweigh my wrong ones.

-Wown
StockJockz.blogspot.com

GDX, PG, UDN Trades

GDX

Here is the original trade. Today GDX climbed up to 4% at one point, taking me for a pretty significant loss. I took the opportunity to sell more OTM puts.

Sold 2 more Dec 47 Puts and one 52 put. This makes short puts' premium at 30.6% of my long position. I am also not nearly delta neutral and if I simply maintain my neutrality, I can expect to make nearly 30% - ~7% (the time decay in the long position) by end of Dec.



PG Diagonal
Fairly basic diagonal for now. It represents a lot of properties of a calendar and that is because the premium I got for selling the 62.5 Call was higher than any of the other strikes.


UDN
The government seems unlikely to take any action against the falling dollar and I believe the weakness in the dollar will continue for some time.

Long 100 shares of UDN, Dollar Bear Fund.

The Anatomy of the Pump & Dump

I found this very informative video that actually elaborates on some of my previous picks and some of the terminology I have thrown around, ie: "taking profits" and "pump and dumps" -- Shout out to StockJock-e of the HotStockMarket forums for this video.

A Look At My Holdings

When I first started writing here, I had meant this to be a place where I could track my performance and write down my analysis of my various holdings. Lately, I have been slacking off on that because I have been busy with other things/lazy. This is my attempt to get back on track of my original goal.

Below are my current holdings and those that I have not already explained in this blog have a short explanation with them:

GDX Put Diagonal

SPY Put Diagonal
This is a 103/109 Dec/March put diagonal. Clearly I am bearish on SPY and expect the index to drop to around 100-103 area. This diagonal sets me up perfectly for such a scenario and allows me max profit if SPY drops to $103. The short puts expiring in Dec allow me to keep paying myself dividends and each month reduce my total risk in this trade.

So far this trade has returned about 5% as SPY has dropped approx 2%.

MO Call Diagonal
Altria is a fairly stable company with a low beta and a relatively small trading range. Because of this, I expect the price to remain fairly stable and I am going to capitalize on the dividend-like properties of the diagonal.

Addtionally, this is trade mitigates my risks in SPY. If SPY rises, I can expect MO to rise and the way I have the trade set up, my profits in MO should outweigh my losses in SPY. If SPY falls, I expect MO to fall as well but my losses in MO are lower than my profits in SPY.

The trade itself is a Dec/Mar 19/17 Call with a 4/5 ratio. So far, this trade (which has carried over from previous month) has returned -2%.

WMT Call Diagonal
My thoughts on Wal-Mart are very similar to my thoughts on Altria. Same basic strategy and philosophies apply: dividend play and risk mitigation on the SPY.

The trade is a Dec/Jun 55/47.5 Call Diagonal with a 10/5 ratio. This trade has returned approx 1.3%.

UNG Butterfly
This trade went awry and completely did not do as I expected. However, because I had mitigated my risks well, I am still making profit on this trade.

So far, this trade has returned approx 53%.

PRU Double Calendar
A complicated trade that I entered expecting PRU to trade in a range. Instead PRU took a wild swing up and then down. This lead to me having to readjust this trade repeatedly. Unfortunately this is also one of those trades I entered into without a clear action plan and so I am suffering.

At the moment, the trade has become a Dec/Mar 47.5 Call Calendar spread with a 1/1 ratio and a Dec/Mar Put 50 Calendar spread with a 4/5 ratio. Currently this trade has returned approx -3% including all the transaction costs. I am just trying to work this trade off my books and expect that I am in a good position now and should be able to do so by Dec expiry.

Other trades
There are a couple of trades I had similar to the PRU trade which I have managed to work off by today (Nov expiry). The losses from those trades are offsetting my profits on all the trades I currently hold. If I had done my due diligence as I have with all these trades, I probably would be up around 15% for the month. As of now, it looks like I am breaking even - which is a real shame.

GDX put diagonal

Based on my thoughts on the overall on the commodity/dollar and GDX (Dollar, Interest Rates, and Commidities), I traded the below diagonal:



I expect GDX to continue falling to as low as $45 if not more. I also plan to keep rolling the trade by selling puts every month (Dec and Jan). With these short sales, I expect to capture 30% of the long put's price. If GDX rises or stays constant, I will just sell more OTM puts to become delta neutral and get more premium.

For my overall strategy on diagonals in general, please refer to this article. Otherwise this is a fairly bearish simple trade on gold.

Dollar, Interest Rates, and Commodities

Dollar

The USD continues its depreciation against nearly all other currencies. However, seems like this is not one of the concerns of the US government as it keeps overnight interest rates to all time lows (see interest rates). At the same time, this decline cannot continue infinitely before problems come knocking.

Look at this from a purely economic standpoint: if the dollar continues to decline, US buying power will fall significantly. This would mean an increase in the price of all commodities that are valued based on the dollar (silver, gold, oil, natural gas... pretty anything of importance). Eventually, inflation will take over and the moderate GDP growth that we have seen will pretty much be negated.

This problem is further heightened by the fact that China holds trillions of USD in its reserves that it might decide to trade away for a stronger currency like the Euro.

Historically, China's RMB has been pegged at RMB7-8/$. Chinese government has taken a lot of pains to keep this exchange rate constant so that their exporters have an advantage when trading with the US. As China becomes more economically independent, this incentive to keep the interest rates constant is falling. If the Chinese decide to let market forces dictate exchange rates, they would trade away their dollar reserves. This will lead to further weakness in the dollar, leading to all the bad things I have just said.

On the flip side, the weaker dollar allows for more US exports which is a boon to the government as it tries to work off its enormous deficit. However, the negative effects of a very weak dollar far outweigh the positive effects of the increased exports.

Thus, for the economy to continue functioning, I strongly believe that the dollar needs to make a recovery. I am unsure as to when this could happen - Let us look at the charts.



The /DX managed to break both the 8 day and the 21 day MA today. However it wasn't able to sustain the breakout above the 21 day MA, so a turnaround based on MA's is still not confirmed. The Stochastic Oscillator is showing mixed signals as it goes back and forth in between overbought and oversold zone. We have also seen 5 waves down on this chart meaning that this downtrend is over and right now we are consolidating while we decide which way the next trend is going to go.

Unfortunately, at this time, I cannot with much conviction say where the dollar is going to go. I believe it will depend on a major event like interest rate change or other government activity.

Interest Rates

As I mentioned, interest rates are at an all time low - in fact yesterday for a short period the short-term interest rates were NEGATIVE!!! This is pretty amazing and it could mean two things:

1. Investors have such little confidence in the equity/riskier bonds market that they are actually willing to take a little LOSS in interest rates to be able to buy risk-free securities. That says a lot about the investor confidence in the equities market.
2. It also means that investing in US-backed securities is worthless to foreign investor. As an investor in China, I would much rather invest in a relatively risk-free Chinese bond and make a small return than invest in the US and have a negative to zero return. This ties in with the weakening dollar - as fewer investors come to the US, the dollar further weakens.

Once again, I strongly believe the US government is going to raise its target Fed rates to improve this situation. However, I do not know how soon this could happen - probably not until the next Fed meeting.

Commodities

Why have the commodities across the board (except Natural Gas, which I traded thinking it would go up) gone up? Is it because of the booming economy and the increased global demand? No - the simple reason of the commodity bubble (yes, I said bubble) is the falling dollar.

Gold:


A megaphone top has formed on GDX and this is coupled with a bearish reversal on the stochastic. Additionally, the 8 day MA was broken in the last two days further showing bearish signs. Coupled with the possible reversal in the dollar, this could be the turning point in GDX. However, if the dollar continues to decline, I believe at best we will see a modest correction before the gold goes right back up.

Oil:

Oil has been moving sideways for nearly a month now and no significant technical patterns or indicators have developed on the daily chart. An important point, however is that the bollinger bands are now at one of their narrowest point. Generally, if the bollinger bands narrow out that much, one can expect them to widen very soon and widen quickly. Widening would obviously be preceded by a large move in oil. As to when could this happen - watch the dollar.


When the dollar moves, so does everything else.

Multiple Time Frame Analysis on SPY

Weekly


The general up-trend is still very much in tact on the weekly chart. According to EW theory, we have only completed waves 1,2,3 and maybe wave 4. It is also possible that we are in the middle of wave 4 which is really an ABC correction.

If the former is true, we should see wave 5 to continue upwards. However, since wave 5's are generally the shortest, the up-trend is drawing to an end rapidly and we can expect a consolidation or a significant correction fairly soon.

I believe the former scenario is less likely because that would make wave 4 and 5 too short. Wave 2 was four weeks long and both waves 1 and 3 spanned over two to three months. We can expect to see similar numbers for waves 4 and 5. This would put the end of wave 5 in early next year. I believe this makes a lot of sense because this could coincide with a poor holiday retail sales results, which could serve as a catalyst for the end of this up trend.

Thus, the latter scenario, which assumes that we are in the middle of wave 4, which is an ABC correction, is more likely. I believe the waves A and B are over and wave C has begun which could take us down to perhaps the $102-103 level before continuing the move up.

Daily


The wave pattern is harder to discern on this chart, but the key points below show why I believe that we should see a wave C down or the end of wave 5 from the weekly chart.

There is significant divergence between the various indicators and the price. Firstly, the volume has continued to decline while the price has continued to climb. The Stochastic oscillator made a bearish reversal yesterday which followed through today. Finally, the NYSE breadth trend has also reversed in the past couple of days. All this points to a bearish outlook.

Intraday


The most important factor on this chart is the huge resistance at the dark red line. We have bounced off there four times in the past few days and the last time we tested that resistance and failed to break it, we fell about 7 points on the SPY. In the last two days, we again tested this resistance, created a double top, and then today sold off more than 1%.

Also on this chart, the various MA on the chart made a reversal at the end of the day today. Although by itself this is not a good indicator, when mixed in with a double top, this is indeed very significant.

Summary
Keeping the long term view in mind, we must acknowledge the fact that we are probably still in an uptrend. However, rarely have the bearish stars aligned so well that all three charts, the weekly, the daily, and the intraday, are showing bearish signs.

If we do sell off in the next few days, it is most likely this sell off will only be a correction to the overall up trend and people will buy the dip again. However, as I have already said, there is a possibility that wave 5 ends here, in which case the sell off could be very significant indeed.

Short on Laboratory Holdings

On daily chart, you can see a 1-2-3 wave completed. In anticipation of a wave 4, I am shorting LH and expect the stock to fall to close to 71.50 level before starting wave 5.

There are multiple reasons to believe wave 4 is starting. On the daily chart, a divergence in the momentum and price action has begun and a bearish reversal in the overbought zone has occurred on the Stoch. This reversal coincides with the price just reaching important fibonacci levels.

The hourly chart is showing some support at 72.80 level - right at the 21-hour MA. If the price breaks this support, there will be strong conviction behind the wave 4.

Finally, I also believe the overall market is once again losing momentum which could propel the down move in LH.

I shorted at 73.06 with a stop loss at 73.40.

-Wown
Stockjockz.blogspot.com

X and PRU Calendars

Entered two fairly simple trades in a post-earning environment:

US Steel Corp. - X



The price is hovering right in the middle of the Bollinger Bands, the 8, 21, and 200 day MA are converging, and finally the momentum, what little there was, seems to be weakening. The fact that the earnings were just released a short while ago strongly leads me to believe that the price should channel within a short range for a while.

The trade above shows a profit if X remains between $36-$40. This means that a mere 5% move in either direction could put me at a loss. However, if I manage the trade well, I can probably extend this range to around $32-$44. Given my original hypothesis, I strongly believe X will not move out of the 32-44 range in the next two weeks.

Prudential Financial - PRU



The setup is very similar to the US Steel trade. Once again, my profit range as of now is $44.50-$50 but can be extended to $42.70-$52.

Both these trades have a very high probability of success and the risk/reward ratio is within my risk appetite. I will post any adjustments I make as the trade plays out.

Here we go again...

Appears we just completed another buy the dip cycle with today's rather unexpected huge move to the upside. I have found it frustrating (although I have caught on recently) trying to call these dips because each one begins to appear to be a breakout (or breakdown) but then is sold (or bought) immediately and we fall right back into the trading zone. Each time the market breaks out everyone gets a little too bullish or bearish (in my case) and feels as if this it IT. Well so far for the past 2 months it hasn't been IT.

Now with the Industrials at new highs one has to try to determine the next upside target and play this game again. I feel as if its way too late to go long because the risk/reward ratio just isn't there, but I'm certainly not ready to go short yet either. There are a number of things to mention such as the dollar retesting lows, gold perhaps topping, and divergences in the indexes, but I think the most important things to watch is the 50% retracement in the DOW which is within 110 points, and the 61.8% retracement in the Nasdaq 100 which is quickly approaching once again. These should serve as heavy resistance up ahead.

One thing that is pretty evident in this past few rallies is that the rally typically exhausts after a big 1-day breakout move to the upside.Notice in 2 of the past 3 breakouts of the blue line, we had one large full bodied candle to the upside right before we started to top out and then head lower. This is something to keep in mind and is one reason why I would not be going long right here. Chances are you might get 50-100 Dow points if you time it right, but it won't be very easy gain to capture.

The only thing different this time is we had the highest upside breadth in the market since July. That day we had 28:1 Up/Down volume ratio. Today we saw 18:1. Could it really be possible for this entire 2 months to be considered consolidation before we move another 1000 points in the S&P? Too many things lined up (for example my cycle chart) for October 21 not to be the high and it would be rather disappointing if the market continued higher, but I guess thats just how the cookie crumbles.

SNVP: Savory Energy Corp.

SNVP looks to be the next big pump penny stock, but there is reason to be weary. Grassroots and many different penny stock pumping agencies have begun soliciting SNVP as their pick for the month of November, and while the big picture might look bright and prosperous it can also turn dark and gloomy in the snap of a finger.

First let's take a quick look at the company SNVP. I have actually had the luxury of following this stock for the past few months now and although I missed out on today's big pump and this weekends emails from solicitors, I saw this one coming. This company has gone through a number of name changes and mergers bouncing between the male hygene industry to it's current line of work in "the selling of oil that has been extracted from wells". And while their current claim that they are working on 4 different properties located in Gonzales County, Texas may cause excitement in the industry, i'm not sure it is enough to give this stock a $2.92 price projection that grassroots research is providing.

Bottom line, I don't trust that price as far as throw it (I believe they call it making it rain these days). Nonetheless keep an eye out for this one, there is definitely a huge potential for money to be made here if you are willing to take the risk and can get out in time. As of now, this stock closed at .152 today, after a 90% gain on no news (other than the pump emails). I have no problem valuing this stock in the .10-.30 range (as it has been over recent months), and with this pump there is potential for .85 or so. BUT BE CAREFUL! If you are interested in the risk and the huge investment potential, I would recommend considering buying and holding for a nice 1 bagger or so. If this thing does make it to .85 or so it will eventually all fall down before you know it, DON'T GET CAUGHT HOLDING THE BAG! Don't get caught up in the greed, play it safe and take your profits! Best of luck to all!

Go With The (Short Term) Flow

After a two weeks' retreat, I come back to find the market prices nearly unchanged. Although we fell to around 1040 for the S&P, we are now back to the 1093 level I last looked at.

Because I was not keeping on top of my trades, I failed to capitalize on the dip when the prices fell. Although the set up for a lot of my trades played out nearly perfectly, because I did not exit in a timely fashion, I gave up some excellent profit opportunities. Instead, I was forced to exit a few of my positions at a loss as the S&P gained 20+ points today. What is the motto of the story? If you are actively managing your investments, do not neglect them and hope for the best. I read somewhere "Hopium is a drug that will destroy any trader".

Moving forward, I believe we can see the S&P reach 1100-1110 level based on the chart below. As MarketMike already mentioned in the previous post, this upwards move looks very much like an ABC correction to an overall downtrend. However, after the ABC correction, the overall trend could reverse and the upwards move could continue, in which case my target would be 1160-1170 before the next correction. In either case, there is still room to capitalize on this wave C which I believe is not over yet.

HEIKIN ASHI:


CANDLESTICK:


As you can see, the Stochastic is showing a very bold bullish momentum coupled with improving breadth ratios. The Heikin Ashi chart - which, in my opinion, shows the trends in a much more clear fashion (compare to the candlestick chart) - shows that the bullish trend is strengthening (longer bullish bars with shorter to same length tails). Finally, the price broke above the 21-day MA which generally serves as a pretty strong resistance.

So, I am going long SPY with partial exit at around 1100. It is a tight trade with a potential for a mere 3-4%. The time frame is also very small and my time studies indicate we should reach the target in as little as a week.

My reasoning is that we are once again approaching cross roads where the market could go either way. I would rather take small profits and wait while the market makes up its mind than take big bets and have those bets fail. The time for big bets will come, but it is not now.

-Wown
stockjockz.blogspot.com

Taking 5 Steps Foward, 3 Steps Back

Spent some time over the weekend educating myself a bit more in Elliott Wave. A five wave move down from the October 21 high seems clearly evident. So far it has been fundamental in its manner. To remind you all a bit about Elliott Wave - and to double check above...

1. Wave 3 is never the shortest wave, typically the longest
2. Wave 4 will not enter the price zone of Wave 1
3. Wave 2 cannot exceed the start of Wave 1.

Some other relationships to describe the chart above:

• (5)'s price was 261.8% of (2). 
• (3)'s price was 261.8% of b of (2).
• (5) is 61.8% of (1) through (3).
• (2) was a flat correction while (4) was a sharp correction - the theory of alternation.

Since everything has lined up perfectly so far, it would only make sense that the correction reaches the 61.8% mark. And if A = C then our target range is 1074 - 1076.

Lets see how it plays out.

1930 era vs 2000 era

Another comparison, with price and time comparisons between the NDX of 2000s vs the INDU of 1930s.

Judgment Day

Well we got our rally and that is enough to switch the short term trend positive. Now it is time to see the follow through, however I don't believe it will be so easy. You have the 61.8% retracement and plenty of other resistance including the major broken trendline in most of the indexes. Any stop near the 61.8% retracement will generate a head and shoulders top. I don't want to get too excited about this pattern because it has already failed once in this rally since March, however this could actually give it the excuse to sell off. Too many people will be saying the head and shoulders didn't work then, it wont work this time either. Breadth is increasing but not nearly as strong as it fell and is appearing it will continue to diverge. Overall volume continues to be lower on this rally/retest.

SPX Earnings Estimates

Recently I hear all this discussion about the SPX being fairly valued because estimated EPS around $80 is not unreasonable. However if you look at the data above, the current EPS of the SPX is 49 while the current estimates are 62. The estimates for next year as calculated by Bloomberg is 78. Now, if our current EPS is 49, and the estimate is 62, doesn't that lead you to believe that an estimated EPS of 78 is a bit too high. That would require a 59% increase in EPS. I don't see how this is feasible unless I'm missing something here. It seems as if I am, at least I hope so.

I've applied those estimates to the chart above. I've calculated the average P/E ratio to be 16 and therefore have applied a 16x multiple to the earnings to generate a fair value for the S&P. By plotting this against the current price we can also try to compare which one the market appears to be looking at. If we go with actual earnings, our fair value is around 780, while using the estimated earnings would put us to around 1005. I'm not sure how credible this study is but it is certainly something to look at. It would appear no matter how you look at it we are overvalued based on EPS but due to extreme bullishness in the market, momentum has carried us well above fair value just as it carried us well below back in 2008.

Analyst Research
Another thing that I've recently thought about is the fact that analysts typically always have some sort of premium on their targets and more often then none their rating structure looks a bit like this:

• Buy: 60%
• Hold: 35%
• Sell: 5%

Obviously they are trying to make money and by issuing sell reports on every single stock they will generate no revenue for their firm. Everyone knows this but another thing I was recently thinking about is in relation to using price multiples to generate targets. These are great if the company is market is fairly valued, however what's not to say the market has been overvalued for 20 years. Most stocks only go back to the beginning of the bull markets and I don't think there are any that have data dating back to the 1930's. So if you try to find the average historical P/E ratio of a stock and apply an estimated EPS to find a target price, more than likely you're going to be giving an overstated stock price. I could come back in 10 years and laugh at how silly this is but I'm just jotting down some recent thoughts I've had.

Hochberg

Hochberg spoke on CNBC this morning very briefly. He is the guy who does the Short Term Updates from Elliott Wave International. They didn't allow him to say all that much and it almost appeared as if he was being ridiculed, but what I really thought was interesting was the user comment section on the news story CNBC posted on their webpage. You can find it here.

Here are some that I found interesting, and I hope I have their permission to post them on this blog:

"Anyone calling this a "bear market rally" just shouldn't be allowed to touch this market. I feel bad for the people that trust their money with the ones who believe this is a bear market rally. A bear market rally does not have higher highs and higher lows. A bear market rally does not last this long. Come on people. Wake up and smell the recovery."


"Anyone who believes that this was a bear market rally must also believe that we are going to go lower than the March lows. The March lows priced in dooms day. I just don't understand how any reasonable person can look at the charts and the fundamentals and say that this is a bear market rally. This person is mostly likely majorly short."


"I'd also like to know where you get 91% bulls? Every news item you see is about how this is a bear market rally and that the world is coming to an end. If you listen to people who know what they are doing and who have a proven track record such as Warren Buffett and Jim Cramer you wouldn't be fooled by the negativity of the fund managers who have an agenda."

These comments are a good example of the optimism that has been built into the markets. Not a single post agreed with him even though a year ago he had come on CNBC and had done a pretty good job of forecasting the move lower in the markets. The first comment just does not make any sense. I at least agree with the second comment on 2 things. A bear market rally does in fact mean we will see lows below March and EWI is in fact majorly short, in fact 100%. However I do not rule out the fact that this is not a bear market rally because the charts and fundamentals both tell me it certainly can be.The third comment is at least a bit reasonable, but the 91% shouldn't matter its the same survey that told us that there was extreme bearishness at the March lows. If it worked then, it should work the other way around. Also who is to say that Warren Buffet and Jim Cramer have proven track records? I think last year kind of proved these guys can be wrong too. Perhaps a few more years of the bear market will make people have their doubts.

Lastly I'd suggest you guys go and check out elliottwave.com as they are having a free week this week where you can read a lot of their material for free. Just sign up for a free club EWI account. Its certainly worth it in my opinion.

Dead Cat Bounce?

Not much to talk about as the market has been almost uneventful, especially based on closing prices. Despite closing in the green for 3 days, the SPX Cash Index is only up 10 points. The setup was pretty bullish 2 days ago but the longer it takes to develop a bounce higher the less time I give the bulls to try to recover old bullish optimism before fear begins to take over. We attempted to rally today however we gave up just about all of the gains in the indexes by the end of the day. The /NQ made it up to its 38.2% retracement which is typically a minimum target for a bounce, before it sold off. As we speak the SPX futures are down 4 points, despite Cisco's earning suprise, already giving back almost half of the bounce we've seen since Monday.

Short Term Trend: Down
Intermediate Trend: Up
Long Term Trend: Down


I still believe the short term trend is down, but will be broken if we see a pretty decent sized rally tomorrow. The intermediate term trend as indicated by the blue line in the chart above is still up until that line breaks. I believe thats the only thing holding up the market right now in hopes for the continued bounce pattern that had been occurring. However unlike our previous bounces we have sold off on our rally attempt. I believe this has occurred because the long term trend is now down as indicated by the red trendline. I should have a more exciting update tomorrow.

Possible Rally Ahead

Have to respect the falling wedge pattern that has developed on the 30min charts over the course of the past couple of days. Although I believe the longer term trend has indeed changed, we have to respect an oversold bounce to take in effect. Today's action was very weak for the intermediate term in my opinion. It appears as if the sellers are in control.

The Trendline Retest

To explain a little bit of what I mean. Take a look at the chart posted above. Notice the past couple days before today we had some pretty large candles. What I saw happened was initially a break of the trendline support which sparked intense selling pressure. We closed at the low of the day as people sold out as the trendline became more obvious it was going to break. This trendline represented what was holding up the markets rally since March, and everyone was watching it (as they were with the Head and Shoulders back in the Summer).

The only way to save a break of the trendline is by doing what we did last Thursday. Typically you want to see an open on the cash index right at the previous close and you want to see a strong rally right at the open (avoiding any type of tail on the bottom). Usually if you can close near the height of the previous candle, and save previous support, you have completed what I like to term a fakeout reversal candlestick pattern. This is what happened on Thursday and I was actually a bit bullish going into Friday. However for the first time I've ever seen - or at least can recall - we registered back to back fakeout reversal patterns as we rebroke support on Friday and dropped nearly 300 points in the Industrials. It makes it appears as if Thursday's rally was just a retest of the old trendline. I believe this is a monumental development going forward that indicates that in fact we have begun a new downtrend. We shall wait to see if this downturn turns into just a bull market correction or the continuation of the old bear market.

Transports

Here is the transports chart which continues to underperform. Don't be too caught up in the Industrials and ignore whats going on 'behind the scenes'  in some of the other sectors of the market. Transports are getting slammed are are actually looking to be due for a bounce. But that would be in a normal market, the fact is we were so extended to the upside this actually appears to be just getting started. Again time will tell.

Banking Index

Possible head and shoulders top in the banking index, or triple top. What do you think? Either way it appears some type of support was broken as indicated by the blue line. We are in the process of retesting. This is painting a pretty bearish picture, so it will be interesting to see what they can do to recapture that support. If there wasn't that falling wedge in the SPX and I only saw this chart I would be pretty bearish right now in the short term.

USD

I do my best to try to include some original charts that you won't find elsewhere. Here is a long term chart of the DXY Index (US Dollar). The chart is split in two and the peaks are matched up. I would say the dollar appears to go through a cycle of highs and lows and that we are about to start the next bull market in the dollar according to this cycle. However its only worked twice, who's to say its going to work a third time...