Trading Notes for the Week of October 13th

Notes to Note: 

Friday was a direct result of emotions meeting reality. The drop in the NASDAQ blended the emotions of selling in light of what many fear is a global slowing economically and the reality of a chip making saying that is true. MCHP warning about the state of the global markets hit home and that started the semiconductors lower and that seemed to fed on itself as it was added to the other comments from the IMF, the Fed, government officials, etc. If everyone believes it to be true, it must be true. Thus, one companies confirmation of what others think to be true, made it true and the SOX index fell 6.8%. Throw in the towel and the party is over? This is interesting as we have not seen this type of swing to the downside since 2011 and 2009. That raises the question, which downside move will this be? A correction with optimism to follow like 2011 or a correction that feeds on itself like 2009? If may be neither, but you have to step back and watch how investors respond this week.

Unlike CNBC or John Bogle I am not privy to the answers of where we are headed from here as we have stated and as the models have validated you find less to own and stops are hit as the storm builds to the point where you are essentially in cash when the worst of comes. I don’t have the answers to the market, but I do know following a discipline strategy will keep you focused on what you believe and not what others are saying will happen. The one simple fact I do know and believe is the market will do what it wants regardless of what you think. No one person is smarter than the market as a whole.

Some thoughts on news/events impacting investor psyche:

*  Trading environment has now escalated into the fear zone and the sellers are in control. How long? How much? Those are questions for the media… we need to be focused on managing our money relative our strategies and beliefs. This is not a time to follow the herd, but to stop, evaluate, adjust and move forward with extreme caution. Don’t let your emotions get the best of you and remain true to what you do, now is not the time to change or adapt a new strategy simply in response to what the market has done. Emotions are running the micro trend let them play out and then make move accordingly.

* FOMC minutes where the catalyst to the current string of events playing out. The rally relative to a dovish Fed was shown to be worthless if the global economies are faltering. In other words, investors believe the global slowing is of more danger than the Fed’s willingness to delay the hike in interest rates. This story is just starting to unfold as we head towards the FOMC meeting the end of the month.

* It’s October! enough said. The month know for volatility and corrections is at again. That will only add fuel to the fire of the sellers. Watching to see how emotional this gets short term.

*  Clarity is the primary issue with stocks. Without the ability to forecast with some confidence investors react to news and worries which creates a choppy environment. You either hold through the chop with a longer term focus or you sit on the sidelines and await clarity to develop. The latter allows me to maintain my sanity and is my preference relative to short term holdings. Cash remains king for now.

*  Please note above… Cash is King! That is not a mindless comment it is a simple truth. When you hold cash as we do now… your emotions are not running wild. You are not losing money and that keeps you in place of calm. You are able to look at the movement and outcome of this event with the eye of opportunity not crying and weeping about losing money. Stay focused and remain true to what you believe.

Sectors to Watch:

S&P 500 index held the 200 DMA, but did move to my downside target at the 1900-1910 level near term. This does not make me smart, only and observer of charts. We set the levels to watch how traders respond and in turn the markets. The party is still going and the loud music from the media is giving everyone a headache. Stay focused, keep your cash and let this play out. The short trades are still working… manage the risk. Today: More selling or buying? Watch the futures for some clues to start the day and respect the control of the sellers even if we trade higher to start the week.

Consumer Staples (XLP) bounced off the 50 DMA and made a move above $45.75. Looked for follow through on Thursday, but failed. Held up better than the rest on Friday and closed positive. Still looking for the sector to hold up as a defensive stance to the selling. Watch and manage your risk.

Financials (XLF) Testing lower and broke the trendline, but $22.48 support is next level to watch. I still like the outlook for the sector going forward… assuming no global economic collapse that is now being forecast by some. Not a buyer or shorter of the sector, but and observer looking for the next opportunity.

Utilities (XLU) attempting to trade back above the $42.60 mark short term. Like the consumer staples this is a defensive sector and in the initial stages of the correction offers some safety for traders. Patience is the key overall, but expect volatility in the sector if you own it near term.

Bonds (TLT & IEF) The uncertainty towards the Fed should have cleared up some of the issues with the minutes, but if anything is cleared of the Fed’s view of what is going on globally that will impact the US. Fear rallied bonds with TLT hitting $120.05 and is at a new 52 week high as fear continues pushing money towards safety. The FOMC meeting this month will likely put and end to the QE program, but money is moving into bonds, and the yield movement remains on the downside. Today: Riding out the bonds and seeing how this ends going forward.

Bonds historically have been and indicator to watch relative to stocks and growth. They tend to forecast the belief about the economic picture with a high degree of accuracy. The challenge is it takes time for stock investors to agree with bonds. This year you can see rates have fallen from near the 4% mark on the thirty-year bond to 3.03% Friday. After nine plus months of this forecast by bonds, investors are starting to believe? Watch and see it is a story that is still unfolding.

Small Caps (IWM) the sector has broken down cutting the 1090 support and 1008. This has been an indicator for the current selling from the highs in early July. Watch how the oversold sector plays out going forward as it will likely be an indicator of when the selling is done… at least short term.

Two sectors to watch from my notes:

Impact of Crude oil on other sectors is important to watch. While lower prices in crude are a positive for the price of gasoline you have to extrapolate that to the potential economic impact in the US. Trucking costs decline, jet fuel declines, etc. All of the pass through benefits to the consumer are a positive for the economic picture. Some believe the benefits will not pass through to the consumer, but the Airlines, Trucking companies and others will keep the profits to add to their bottom line. If that is true, then we should look at who stands to benefit the most going forward. Since Airlines spend approximately one-third of their revenue on jet fuel and if prices fall 20% doesn’t that translate to a stronger bottom line without much effort? Sounds like a good reason to scan the Airline sector for stocks like Delta and Southwest. You get the point… it is good to look where opportunities will improve going forward despite what is happening in the world. The only wild card to this situation is the Ebola situation as it will put more stress on airlines and travelers. Remember the objective is to outline what we believe could happen and then let the charts validate the truth or reality going forward.

Treasury yields continue decline with the 10-year bond now yielding 2.33% and the 30-year bond at 3.06%. They are both sitting on support and the speculation is for rates to rise in response to the Fed hiking rates next year. If we remember the FOMC minutes from the last meeting, the Fed is worried about the stronger dollar… the impact of higher US rates to the global economies and low unemployment rates in the US. In other words the Fed wants rates to remain low longer to help the world economies. I believe this is the greatest risk facing the financial markets currently… if rates rise too abruptly it could trigger a sell off in bonds raising yields and impacting the outlook for growth as cost rise proportionately to the cost of debt. The downside trade is TBF which is the non-leveraged short for the 20+ year Treasury bond. If Humpty-Dumpty (treasury bonds) fall as yields rise, all the worlds Treasuries and banks will not be able to put Humpty back together again. This is most definitely a sector to watch going forward. Don’t let the short term fear factors driving rates lower be a distraction from the longer term outcome for the sector.

We will track to see how this unfolds going forward and what trades or investments materialize.

Model Position Notes: 

Below are some notes on positions in models and what we are watching looking forward:

  • Basic Materials (XLB) added the short entry on the downside break in materials and they continued test lower. $46 support and target is near short term. Be patient and manage the risk of the trade. See stop below.
  • Natural Gas (UNG) still in trading range and bounced off support to keep position in play for now. Watching the upside move and follow through may add to our position with some positive confirmation. Tested the bottom of the trading range. Held position, but will exit today if we sell lower.
  • Short trades on the NASDAQ and the S&P 500 index were added on Friday and we need to manage them accordingly. As stated above the downside is in play, but the bigger question is how traders and investors will react in the coming weeks.
Watch List Opportunities:
  1. S&P 500 Model – updated watch list
  2. ONLY ETF Model – updated model table.
  3. Pattern Trading Model below.

Pattern Trade Setups:

  1. The downside returned and we have to see how this unfolds today. Bounce? More Selling? My bias remains with the sellers after yesterday’s display.
  2. All scans have shifted to the downside trades. I want to see how we react on Monday to the selling. If we bounce could set up short trade entries with better opportunities. If we continue the downside support is near by and how the buyers respond is of interest going forward for short trades. Patience is the key.

Pattern Trade Tracking:

  1. SDS – Entry $25.90. Next level resistance follow through on upside trend (micro term). Don’t chase on a gap higher and watch to see how it unfolds on the day. Stop $25.30.
  2. QID – Entry $46.30. Next level of resistance to follow through on the upside trend (micro term). Don’t chase on gap and watch to see how it unfolds on the day. Stop $45.90.
  3. XLB – short entry $49.40. breaking down as weakness gains strength in broad markets. Stop $47.
  4. BAC – entry $16.30. breakout. Held the move higher and now looking for the follow through to $17.30 short term. Stop $16.30
NOTE: The pattern trades above are setups that I see for a potential swing trade or short term trade opportunities. Some will fail to follow through on the pattern, some will break and trade according to the pattern. The key is to use discipline in the trades. Entry, Exit and Target on all trades is vital. I am posting these as opportunities that I see when doing scans daily. You can use them as a teaching tool or you can trade them, either way please use discipline. The best way to treat these as a learning tool is to assume a $100,000 portfolio and each positions receives a 5% allocation. If we state to take a 1/2 position as an example you would only allocate 2.5% to that position. I would use a downside risk of $500 per trade as a maximum loss. That will help  you learn position sizing and risk management. All investing comes with risk. Our job as investors is to manage the risk. Keep your focus and discipline in place.
Long Term Opportunities: 
Both positions held on in the storm Monday and Tuesday. Exercising some patience as the issue of the Fed unfolds. These are long term holdings and we don’t want to over react tot he short term news. If the short term volatility made any rationale sense we would trade the events, but they are too news and emotion drive for now. There will be opportunities on the other side of this and we will take advantage of that as it arises.
  • Facebook (FB) – Testing the break higher and has held up well in the recent choppy markets. $73.15 entry point to add 1000 shares back on the long term outlook. (see note page for history. ADDED shares on 8/7 – $73.15 — Stop $73.80. Joined the selling modestly, but watch is the selling accelerates in the broad market indexes. However, still positive opportunity long term for the position. HIT STOP ON Positions
  • Twitter (TWTR) – entry $45.50 1000 shares (last trade). This was recommended on our webinar as the next long term position we have been trading since bottoming in June. Adjust your Stop to $49.25 for now on position and we will make adjustments as we go forward. Broad market selling is challenge short term. Watching after big drop on Friday.
  • Bank of America (BAC) entry $16.30 2500 shares added on 8/25. This has been a long term recommended stock for the last three years and we continue to own the stock as a core holding in portfolios. We will start tracking here for our long term components to follow and trade against the positions. (we also own the Jan 2016 $17 Calls at $1.85) Banks are selling in the current push lower, watch and manage the position. We will hold options is the stop is hit on the stock positions.