A quiet day was expected and a quiet day is what we got. Most of the big money holders are waiting for the economic events to unfold this week before they decide on how they are going to position their funds. With the odds in favor (as far as those on the street are concerned) of at least a 25 basis point cut in the Fed Funds Rate this Wednesday, there is some hedging in the financial sectors for an upward advance in some financial stocks. Today we saw light buying in some of the financial’s in the anticipation of a "FOMC bounce" afterwards. Will there be a bounce if they cut rates? Will it hold? Good questions. When the FOMC cut rates on September 18th by 50 basis points and also cut the discount window rate by another 50 basis points the financial’s did bounce. And if you blinked you missed it. Since that rate cut the financial’s continued their downward march. So don’t always think a rate cut will stop the financial sectors from going any lower. They said back in September that a rate cut would stem the bleeding, it did not. Will another cut stem it this time? Can’t say, there is too much weakness in the financial arenas to gauge at this point if another rate cut is going to do it or not. If you were a high risk trader you could put some money on the XLF going into the FOMC announcement, but it is a high risk trade. I will be in cash heading into the announcement, better safe then to get surprised and have the market go against me. Remember that some of the possible rate cut is already getting priced into the market. So there is the potential for a short pop, then a sell off. No telling what would happen if there is a 50 basis point cut, some have speculated that that would signal even bigger problems exist within the economy and that could send the markets down. And on the other side of the coin there are those who say it could rally. We remain in the middle and will see which way it goes, then decide how to play it.
Some earnings came in after the market closed tonight, it was essentially a mixed bag. If I had to put a number on it of who beat and who missed I would say it was about a 50/50 split of beats and misses. One notable stock is SWHC (Smith & Wesson), they issued a dismal earnings report and lowered guidance for the year. In after hours that stock went down almost 26% (ouch!).
A small lesson tonight on the importance of trend lines and how they communicate danger signals to us. Every stock trades in one of three directions, up trend, down trend, or trading sideways. And each trend can be put into one of three categories, major, intermediate, and minor. A major trend is one which is in force for a minimum of 2 years, an intermediate trend is one which is typically a few months to 2 years, and the minor trend is days to a few months. When trading any stock, long term investment or a short term swing trade, always pay attention to the trend.
As you view a stock chart you want to identify the trend by drawing a line under all of the lows as the stock price has been going up. A valid trend is one that can be marked with a straight line and which intersects at least three points along the way, and you project that line into the future so that you can use it as a gauge to see if the trend of the stock remains in force, or if it breaks it. Technical analysis is at it’s core, the study of human behavior. There are many nuances in technical analysis, all of which tie back to the two basic fundamentals of what makes the markets operate in the first place, greed and fear.
For every action on the chart there is an underlying force driving that action, it is either greed (buying up) or fear (selling out). Every bit of news, rumors, earnings expectations, feelings of the company executives, their cash flow, the products they make or sell, and the list goes on and on. Everything perceived or believed about a company is reflected in the stock price. And all that combined knowledge (fact or fiction) comes back down to greed and fear. So when you watch a stock chart trading on a trend line and you see a divergence, or a break away from that trend that means that one of the two basic building blocks of the market has shifted dramatically. In the case of a down ward break from a trend that signals that fear has taken over for reasons which may not be completely understood or known. Sometimes all it takes is a little bit of inside information to be exchanged between a few mutual funds and they decide to sell out, or it could be a rumor on the street of a bad earnings report is coming, any number of things. Think of it this way, a large group of birds is flying over head and you notice that they suddenly change direction. What was it that sent them running (flying) the other way? All it takes is for one of them to get a sight of something dangerous and that fear is quickly spread to the flock. Same on Wall street, but the birds are the traders. In the stock market, when something happens that drives fear to the forefront, we as traders need to be watching for the signs of the flock moving the other way, for they are taking their money with them and the bird that stays behind could be eaten up by the dangerous bird (which spooked them in the first place), or all alone and holding the bag (reduced stock price).
Always remember, that whenever a trend is broken it means something has changed the trading psychologically of those in that stock, it does not matter what caused that shift, what is important is to recognize that it happened and realize that it may be serious. So you should exit the trade to protect your gains before they turn into a loss. Not all trend line failures will offer you enough time to gracefully exit the trade, but many will. Always use trading rules and technical analysis to your favor, it can save you a lot of money.
The chart shown here is a perfect example of what happens when a trend line is broken, it signaled something was wrong, and the next day the company issued bad news. There was a day before the news hit in which you could have gotten out of the trade and held onto your gains before the bottom fell out. Print out this chart and paste it on your wall, refer to it often, for this is why trend lines are so important and how they communicate to us that something is changing in the stock, and it may not be pretty!
Oh, and Smith and Wesson, there was a danger sign on that too! That trend line broke back in September and offered lots of time to exit the trade. Trend lines are your friends, know them, learn them , and use them
