Rebel Traders – Analysis Without The Hype

In 1959 a television show began airing in the United States called the Twilight Zone, this very popular and highly acclaimed series was a combination of science fiction, fantasy, and horror all wrapped up in one 30 minute story, which most always concluded with an unexpected twist. Today whenever we think of something very strange we think of the Twilight Zone…

There is a fifth dimension beyond that which is known to man.
It is a dimension as vast as space and timeless as infinity.
It is the middle ground between light and shadow,
between science and superstition,
and it lies between the pit of man’s fears and the summit of his knowledge.
This is the dimension of imagination.
It is an area which we call . . . the Twilight Zone

I brought up the Twilight Zone analogy because with each passing day the markets and the economy just seem to be getting more and more surreal. Economic data received today continues to point to a worsening outlook and today the market took that as a sign that more rate cuts will be coming. The economic conditions are deteriorating so quickly and with inflation rising again the US Dollar today set another new low today. Many Wall Street professionals who were paraded on CNBC a month or two ago stated that they felt the bottom was in on the US Dollar. We never made any claims like that because we don’t call bottoms on speculation or conjecture. We work only with facts and the facts showed us that the dollar could still go lower. And lower it has gone. And with today’s gloomy economic data the markets are now pricing in yet another rate cut. With inflation growing substantially over the past few months, the US Dollar continuing to fall, and commodity prices still rising another rate cut will only exasperate this alreay volatile combination.

But today’s advances in the market stopped right at a significant resistance point. As we said previously, our short position on the Dow Jones Industrials would be covered at break even if the market advanced upwards towards the next resistance level. And that we would short at the next resistance level, and that is what we did. We are maintaining our short position on the market. In technical analysis you have to set emotions aside and use the charts as your guide, never mix emotions and investing/trading together… for that is a bad mix.

The chart below is that of the Dow as of today, observe that we are now at a significant resistance level and from the technical perspective this offers us another opportunity to take an entry on the market in a short position. We are at a point where the markets are likely going to become more volatile very soon, and typically when volatility goes up the markets go down.

(Dow Jones Industrials – Daily chart)

And speaking of volatility, applying technical analysis to the $VIX works just as well as with any stock. In this chart of the volatility (VIX) index I have identified the ascending triangle pattern and superimposed the S&P 500 on top. The volatility index is the blue line (observe the ascending triangle pattern highlighted with the blue trend lines). The S&P 500 is shown as the red line. Each time the volatility rises the markets decline, and currently we are very near a point in the volatility where we can expect to see a rise as it bounces off the trend line. Ascending triangles usually resolve to the upside, so this would tell us that we are likely to see much higher volatility in the future.

(Volatility VIX Index with S&P 500 – Daily chart)

On the economic front we received the Producer Price Index (PPI) data today. This measure of inflation had a top line gain of 1% over last month and a 1% jump is significant. The core PPI rose by 0.4%. Those who say the core is more important than the top line numbers live in an artificial world. Core data is what is left when you strip out food and energy. In the real world people live by food and energy, so those who slam their fist on the table and say "the core is more important" are somewhere in the Twilight Zone.

Inflation is continuing to grow, yet the markets are screaming for more rate cuts. More rate cuts will only add more fertilizer and water to the growing inflation seeds. Cutting the interest rates may help in the short term to un freeze the credit markets, but at what cost to the American people? The old saying is true "They are dammed if they do and dammed if they don’t" (with respect the the Federal Reserve). There is no easy fix to any of these problems, cutting rates only creates an illusion of a functioning market but underneath the fires are being stoked and will result in a pressure cooker explosion.

(PPI data – 10 year chart. Data source: Moody’s Economy.com)

Home prices continued to decline as measured by the very accurate S&P/Case-Shiller Index. We are now at a point where the year over year declines are the largest ever since the index began in 1988. The summary report issued stated that there are no signs of stabilization in the data. The renewed hopes of more rate cuts by the Federal Reserve coupled with the irrational buying on the announcement by IBM that they are going to buy  back $15 Billion dollars of their stock is what is responsible for most of our advance today. Recall that Lisa wrote about the significance of companies buying back shares of their stock. Companies that buy back their shares are essentially "hunkering down". It is used to artificially inflate their EPS by reducing float. The amount of stock buy back announcements has been very high during the past 6 months. And in the course of history we usually see large stock buy backs in times of economic turmoil and bear markets. We will begin our own index of tracking stock buy backs by companies on the S&P 500 and use this index in the future as one more measure of corporate sentiment of the economy.

How about this news item… The Federal Deposit Insurance Corporation (FDIC) is hiring people to get ready for bank failures. As reported by the Wall Street Journal:

(US) WSJ reports that the FDIC may be preparing for a rise in bank failures

- The FDIC is looking to rehire 25 retirees from its division of resolutions and receiverships.
- Many of these agency veterans worked for the FDIC during the late 1980s and early 1990s, when more than 1,000 financial institutions failed due to the savings and loan crisis.

For now, as we wait for the next bit of economic data, or the next announcement of losses by a bank, or as the FDIC is now hiring back employees to get ready for the onslaught of bank failures we can only wait and see, and use the charts for our guide. But one has to admit that the events over the past year could have been something right out of a Twilight Zone episode.

You unlock this door with the key of imagination.
Beyond it is another dimension- a dimension of sound, a dimension of sight, a dimension of mind.
You’re moving into a land of both shadow and substance, of things and ideas.
You’ve just crossed over into . . . the Twilight Zone

Good morning, Rebel Traders.  The futures were up big earlier this morning, but have since dropped to just barely on the plus side.  Hewlitt-Packard reported positive results and has everyone jumping for joy!  Pundits are saying since PC sales are up that means consumer and business spending is alive and well.  I’m glad they are doing well and they are gaining market share.  This is good.  But, I’m not jumping on that bandwagon.

Goldman Sach’s Global Alpha is looking at a $6B loss for 2007 from trades and investor redemptions.  Freddie Mac (FRE) posted horrible numbers and say they need capital.  They are “seriously considering” cutting their dividend.  Nordstrom (JWN) had a good earnings report and guidance, but Target (TGT) is sinking.  TGT announced a proposed share buyback of up to $10B (about 20% of outstanding shares), sounds a bit desperate to me.  Dillard’s (DDS) has announced a buyback of $200M.

Research In Motion (RIMM) has been given another upgrade, and pre-market the share price is jumping.  I expect to see plenty of selling into that jump.

Housing starts came in at 1229K vs 1170K consensus.  Building permits came in a bit lower at 1178K vs 1200K consensus.  A little mixed, but overall it’s nothing to write home about.

The FOMC minutes are due out at 2PM ET.  Many traders/investors are so entirely focused on getting another rate cut I’m surprised they remember to breathe!  Be careful out there if you’re trading, volatility is still king.

The Dow was up over 300 points, the Nasdaq Comp. up almost 90.    Goldman Sachs says they are “short” the housing problem and they don’t seem to have any exposure to the CDO’s or SIV’s.  The other broker/bankers also reported that the whole SIV/CDO problem is contained.  Wal-Mart had decent earnings and forecast in-line revenues.  The Nasdaq 100 QQQQ’s jumped up, too.  Is this the “all clear signal”?  It all sounds good, right?  Two questions I would have is, why is GS “short” anything  and why did Citigroup, Lehman’s, et al., want an SIV bailout fund if all the problems are contained?  New lows outpaced new highs today and there is still a lot of selling into any strength.  Yes, some stocks recovered some of last week’s losses.  We said to expect a technical oversold bounce and that is what we got.  Nervous shorts were definitely covering.  The anxiety and fear in this market runs on the buy or the sell side, whether selling, buying, selling short, and covering shorts.  That’s why we are getting such big point swings on a day-to-day basis.  The bias is still to the downside at this point.

It is very difficult to keep emotions out of a day like today.  Seems like everything is going up and it will never stop.  There isn’t any real evidence of an “all is well”, we just had a technical rally and the Q’s experienced a short squeeze.  Option’s expiration is this Friday and I expect a wild week.

More later!

The existing home sales numbers showed more houses waiting to be sold and prices going lower.  Merrill Lynch is having some major problems with the “sub-prime” issue.  They are writing down billions, and during the conference call they were not willing to discuss how much worse it could get.  This caused the stock to drop even further.  There is no clear picture on how bad these losses will be for any financial institution.  This problem is far from being “contained”.  Not a great start to the day.

The Dow had another up/down time today that can give one whiplash!  13400-13500 is the area to watch on the Dow, not wanting to see it below.  The S&P closed over 1500, but under the weekly trendline. 1490 is a critical support short term.  The yen is holding it’s strength, adding to worries of carry trade unwinding.  The Nasdaq composite is trading in a rising wedge on the daily (Chuck will put charts up tomorrow, he may disagree, but I see the wedge).  The semiconductor sector (what I deem “tech”) is sickly.  The SMH and $SOX lost a good bit of ground today.  The QQQQ seems to have a mind of it’s own, but weakness in the Nasdaq 100 may finally have an effect on it’s upward trajectory. The financials, homebuilders and retail sectors are still down.  And the flight to safety in bonds continues.

 The volume today was higher than normal, decliners outpacing advancers, more new lows than highs.  The pattern continues with higher volume on the down days.  The rally at the end of the day was interesting.  Apparently, there was talk of the Fed’s instituting an emergency rate cut of 50 basis points.  Why an emergency cut would be necessary before the meeting next week is beyond me.  Confirmation did not come and the market pulled back a bit from it’s upward frenzy.  What this shows, however, is the extreme emotions at work here.  It could be a preview of what will happen when the Fed’s do cut rates next week.  Of course, I have no idea if they will cut or by how much.  But, if I were a betting woman, I’d say they are cutting rates.  This volatility will be at work in the market for some time.  Don’t forget that the popular momentum stocks can go down even more quickly than they go up, so understand you are playing against big funds when it comes to these stocks.

 The primary trend of the market is still upward.  That doesn’t mean that the short-term trend is up, or even the intermediate term trend!  That’s why we are watching more than just the major indices to tell us the health of any move in the market.  Then we make our trading plan.  That keeps us from jumping into or out of stocks based on an emotion-driven, rumor-laden move. 

These wild swings in the market can drive a trader crazy.  It will bring out emotions you don’t want others to see in public, especially if your stock is dropping.  Even if your stock is rapidly going up, your heart races, your palms get sweaty, you get knots in your stomach.  It’s a bit like meeting a blind date.  Your friend said he has a great personality and he sounds intelligent on the phone. You’re nervous about seeing him for the first time. Then, you meet and he’s incredibly handsome to boot, and now you’re really nervous! (Anyone who’s ever been in this situation knows what I’m talking about).  But, the thing that keeps you from stuttering, sputtering, and acting silly, is if you have a plan for the date.  Dinner, movie, drinks, and dancing.  It’s the same with trading.  To keep us from acting silly we have a plan with entry/exit, support/resistance, broad market outlook. We have to keep things in perspective.

See you in the morning!

The only real notable event today was the ISM (Institute for Supply Management) released their June manufacturing index. The index was 56% which was a bit higher than the market was expecting. This eased the minds of some in that it suggests a lighter inflation picture. Remember that the markets are all about greed and fear. The bulls and bears will jump all over any news that feeds them. While there was food for the bulls today it only takes something else to turn the table and get the bears hungry.

The market advance today brought AKS up to my buy point. AKS was entered long @ $38.58.

Current open position BIG also advanced well today and got close to the second buy point for adding the next 1/3 of the swing trade funds.

Watch list item WDC also advanced fairly well today and if the upward move continues then we will reach the buy point.

Some subscribers to RebelTraders knows I am long on FRPT as a long term play. The close on Friday was a great price for any new investors. Today that proved to be correct. FRPT rallied almost 10% today. And after the close of the market today there was news that Congress may be adding additional funds to purchase 4 times more vehicles, the type that FRPT builds. This will most likely add to the momentum in FRPT.

On the DOW index we are still stuck inside this trading range that we have been in for a month now. We really need to see a move out of this range in order to see the market regain some composure and get the volatility back down and stable.

Fp80

That darn $VIX !! Today, just like yesterday the VIX spiked again and today it ended the day at the highest level of the week. The chart below is the volatility chart for the past two days (5 minute chart).

The markets have become extremely hostile for us traders. Even long term buy and hold investors are seeing some of their gains from the early part of this year slip away. Again, just like yesterday some money was placed on the table to only have the pit boss (bears in this case) take it away. More later…

Fp80

Trading is oscillating back and forth within a range. there is no conviction at all to the market direction. Again, this is why I’m not taking any new trades just yet. And you should not be trying to enter new swing trades here either. With the trading moving back and forth within a range the chances are good you can get stopped out of your trade.

Remember that as swing traders we want as many forces working in our favor for us to succeed. This volatility is not one of those forces we want.

Today the market has gone up fairly well at one point to again have it all erased. There is no need to fight this action.

Yesterday I was not liking how the market was looking early on in the day. Too many trades were going through that gave me the feeling that some big money was quietly looking for the exit.

I sold my open positions yesterday and locked in the gains up to that point. I did not want to see them evaporate in what was shaping up to look like a trap for the bulls. Even though the market ended the day yesterday up it still looked like a trap. And today that feeling of a trap was evidently true. The bears came out of hiding right as the market opened and ran off with the bulls lunch (money)!

This morning I said as the market opened that today was a day to stay out of the markets. That the volatility would spike today. And it did. So what is this volatility (which we measure by charting the symbol VIX)?

Volatility is the measure of the tendency of a market or security to rise or fall sharply within a short period of time. It is typically measured by the standard deviation of the return of an investment. Standard deviation is a statistical concept that denotes the amount of variation or deviation that might be expected. So what is this VIX thing?

The VIX is a measure of the volatility of options prices on the Chicago Board Options Exchange (CBOE). The VIX, even though is a measure of options pricing has become a popular gauge for the overall markets’ volatility. And we can use it to give us a visual presentation of just how volatile a market is. In general when the VIX goes up then the markets are more likely to have wild price swings.. or even a downright sell-off. When the VIX is low the market is considered ’safe’ and investors are more prone to enter a trade when they feel it is safe.

Think of VIX as an earthquake Richter scale. When it goes up then everything starts shaking, and crashing down! When the VIX is low everything is safe and stable.

As an example. If you were to apply the formula that makes up the VIX to your certificate of deposit at your local bank which offers a fixed rate of return you know what the volatility measurement would be? Zero of course. If you have a rate which is locked and can not change then there is no deviation and subsequently a zero volatility.

There are three variations of the volatility indicators

• VIX tracks the volatility of options within the S&P 500
• VXN is for the Nasdaq 100
• VXD is for the Dow Jones Industrial Average

But the VIX has become the most popular for traders to gauge the overall market volatility. The chart below shows the relationship between the VIX and the S&P 500 SPX

Notice on the chart that the S&P 500 index (red) takes a dive when the volatility (blue) spikes. Day traders love a little volatility in their coffee each day. But for us swing traders and position traders too much volatility can play havoc with our setups. So the smart thing for us to do is to wait out the storm. When the market settles down then we make our moves. And when an earthquake hits we duck and cover and hold our chips close!

Fp80