Think longer-term
Well as I said last time, things will come back to life all of a sudden. It now seems like they already have, which is wonderful news.
Aside from bringing the shorter-term S&P business back to providing much better and more frequent opportunities than we have seen for many months, there is another factor we need to be aware of right now.
I also mentioned a few weeks ago that I felt we were close to significant inflection points across a whole range of markets. I still stand by that view and believe we have now seen longer-term tops and bottoms put in across a wide range of markets; commodities, currencies, equities, energies, metals. A quick look at the daily charts will give you good feel for which markets are showing new directions and which are still just slopping around. The only market group that I am less convinced about are bonds, where I don’t really have any good insight at present.
I think many markets are in the process of starting new longer-term trends. In fact I have no less than 17 markets on my watch list for next week, for possible early entries into new trends. That is a lot of markets. Of course they won’t all set up suitable low risk, high probability entries which we look for. But with or without us on board I am looking for new trends to develop. Some markets such as the Dollar and the Euro are already well ahead of the rest having established new trends some weeks ago.
If I am correct (!) this provides one of those relatively rare opportunities to think longer-term. I don’t mean holding onto individual positions for longer necessarily, but changing perspective slightly to take advantage of a relatively unique situation. These opportunities only show up every couple of years or so, but here is how I believe we should capitalise on them when we are able to.
- Trade absolutely as normal – use the same entry setups, trade management and exits as you always do.
- However where you are able to, keep a small piece on, rather than exiting the whole trade each time. Tuck these small positions away with a breakeven, or close to breakeven stop.
- Forget about them! Don’t fiddle around or micro-manage. Think in terms of weeks, not hours or days. If you get some runners you will need to handle contract rollovers and in the future you can tighten up and start trailing stops.
- As the new trends progress and new trades setup – repeat the process, leave another tiny piece on. Keep repeating for as long as new opportunities present themselves.
- When adding to an existing position use a breakeven stop based upon the average entry price of both (or all) small positions. This gives the market plenty of room to work, but without risking any of your own capital.
- Aside from any necessary rollovers, give these speculative trades a few months (yes months!) to work and see what happens. Some will work and some will not. If you catch major moves on just 2 or 3 markets that could be a heck of a big bonus this summer. If you don’t get lucky the cost should be minimal, if anything at all.
I’ll leave you to play with the concept and see if your own trading style and approach can adopt a little add-on of this nature to take advantage of this particular situation.
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Copyright © Simon Townshend Ltd 2010, all rights reserved
Keeping out of trouble
I know many readers of my articles are S&P traders. If this is your primary, or only market, then this article is aimed squarely at you. If you trade other markets then the same concept applies to all markets, but each market reaches this point in its own cycle at different times.
In my opinion the S&P is currently presenting the most difficult environment that we have to face. Volatility has collapsed and volume is extremely light. This is a continuation of the declining environment that we saw over the last few months of 2009. This is the most dangerous place for a trader to be trying to eke out a living. The true opportunities are very few and far between and when they do present themselves the risk / reward ratio is well below the realistic levels we should all be striving to achieve most of the time.
The loss per trade should be much smaller than normal with reduced volatility, so you shouldn’t be doing too much damage to your capital with a few losers. However the percentage of winning trades will be well down against most traders normal strike rate too, so the losses may be smaller but potentially there will be a lot more of them.
The reason I regard this as is the most dangerous of environments is that there is a real risk of serious overtrading. Frustrated, eager traders find it very difficult to sit on their hands for long periods of time and that is precisely what a professional trader must do at this time. In the essentially random noise that we have been seeing over recent times it is all too easy to think you have spotted a worthwhile trade only to discover that it is actually just noise and your trade is a loser, albeit a smallish loser.
Really good days present relatively few trading opportunities if you think about it, yet it is all too easy to “keep spotting setups” in the current rubbish environment. So you can easily find lots and lots of those small losers. Guess what, at the end of the day a lot of small losers add up. This potential death by a thousand cuts is why I regard this as such a dangerous place to be.
So should you stop trading? My advice is to try to continue as normal provided you have or can develop the personal discipline necessary to take very few trades. When this market suddenly all comes good again you want to be there in the saddle and in touch with the market, not reading about it in a newspaper lying on the beach somewhere. As easy as it may sound, such discipline in extremely rare and only comes with experience. That experience must also include living though times like this I am afraid!
If you find you do not yet have that level of discipline to rein in your trade frequency, then my second piece of advice is to put in place mechanical rules to prevent overtrading. As an example I have a simple rule in my own trading plan that I may only take a maximum of 3 losing trades in a day and if reached we shut up shop for the day. That is 3 losers in total by the way, not just 3 in a row etc. Even if we had 5 winners mixed in with the losers, once 3 is hit then that’s the day over.
In this environment I tighten that up even further. 2 losers and I’m done for the day. Your risk per trade is probably only half what it would normally be. So you can take a couple of small losers per day for a long time before doing any real damage to your capital and that is really what we are trying to achieve here – keeping your hand in, whilst protecting your capital.
When this all changes as it will eventually (and probably all of a sudden), you want to be at worst only a few percent below your equity high. If you burn off 30% of your account unnecessarily in this junk today, then you will waste a lot of the profit from the new good environment just climbing back up to where you were before. Believe me I have done this in the past and working hard just to get back to where you were before is even more frustrating than losing the money in the first place! That’s why I am never going there again.
If you have little or no ground to recover when things get good again, then those first 30% of profits go straight to the bottom line where you want them. That is worth developing the discipline for and being patient in these challenging times.
If you find that you just don’t have the discipline to stop at the maximum number of losers per day that you have set yourself then further action is called for. (I have been here before too and it is another place I have chosen never to revisit again!). Speak with your broker and ask for a maximum daily loss limit to be set on your account. This is an amount more than which you cannot lose. Once the limit is reached your platform will shut off trading access for the rest of day. This way you are forced to stick to your rules, whether you have the discipline to do it yourself or not.
Finally don’t despair! This will change and probably very soon. This reminds me very much of the last throws of the bull market in back in 2007. Volume slowly fizzled out as all of the buyers reached the end of their cash reserves. As the volume dried up the volatility diminished to the point where you often wondered if the market was even open at times (sound familiar?). Just when you thought everything had changed for good and you would never see money flowing through the market again – Bam! The market turned down under its own weight and before long the sellers were only to keen to jack up the volume once again.
I am no forecaster, but my gut feel is that 2010 is going to be a great year. If I am right (and I hope I am of course) the key to maximising success this year is starting off from a good place and not at the bottom of an ugly drawdown. So have faith, keep your powder dry and preserve your capital.
I wish you a very successful 2010.
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Copyright © Simon Townshend Ltd 2010, all rights reserved
Ending the year – artificially
Believe it or not we are coming into the close of yet another year, at least as far as short term S&P trading is concerned. November is all but over. With Thanksgiving this coming week – Wednesday, Thursday and Friday are days to avoid trading.
In December the first couple of weeks is where the best opportunity will lie, but volume will wane from mid month so that’s a good time to shut up shop for the year. Perhaps I should say volume will wane further, as let’s be honest stock market volume has really stunk for the last few months!
I have actually found Decembers to be quite good months historically and here is a little trick I want to share with you. This is how and why I play Decembers. I will trade the first 2 weeks absolutely as normal. Provided we show a profit at that time I will stop and take the rest of the month off. I am prepared to venture tentatively into the third week but will only do so if I really need to. The week of Christmas and the pre-New Year week I simply don’t want to touch.
My goal in December is to make a profit (obviously!). But over and above this my goal is to close the month not just with a profit but right at equity highs. I find it psychologically powerful to finish the year right on a high, rather than after a few days of “give back”, even if the cost of so doing means we actually bank a lower profit on the month than we might otherwise if I pressed on right to the bitter end.
3 good reasons
I find this December play important for several reasons, three in fact. Firstly we all need to take breaks from whatever business we are in. In this business I try to coincide my breaks with the lower probability times in the market whenever I can and the second half of December is about as low probability as they come.
Secondly I plot my equity curve every single day throughout the year. This is a necessary part of the controls when managing a fund. But it is also a very good habit to have when trading any sized account and I had been doing this for years prior to opening a fund. This chart stares back at you from the screen every single day throughout the month until it gets zeroed again at the end of the month. By choosing an artificial end to a month, you can engineer the graph to end right at a peak. Then throughout your 2-3 week break that is exactly the picture that remains in your mind. Every time it passes through your mind you feel a sense of satisfaction which reinforces your confidence.
Then when you start back after the break your confidence is high which is exactly what you need after time away from the market. Contrast that with ending on a low or even just ending having given back part of the month’s takings. In this case the feelings experienced are those of frustration and bitterness. The longer your holiday the more you regret it and the lower your confidence ebbs.
Which mindset do you think sets you up best for a good January and a good year?
I know many traders find it difficult coming back from any break and I really believe that this sort of psychological programming plays a big part in your return from an extended period away from the market. If you end on a low the chances are that is exactly how you will start back. If you end on a high, confidence in your system and your ability will carry through to a great start to the New Year.
If you are an S&P trader, you may not have had a great year this year, most people I speak to haven’t. It has been the most rubbish low volume environment over the last few months that I can remember in a long time. However, whether this year is a good one, a bad one or just a treading water sort of year for you, what has past has past so forget it and move onwards. Work on ending December in positive fashion and on a high. End it artificially like me to force this outcome. If you do this it will set you up very well for next year as well as forcing you to have a nice long break which is also very important and regularly overlooked by most traders.
New Year plan
The third and final reason for doing this is that by drawing a line under the year with several days or even several weeks in hand it gives you time away from the trading screens to plan for next year. With a clear head, uninterrupted by watching the market, you have time to review and evaluate the year just gone and plan what you need to hone to improve your game next year.
An end of year review and New Year plan is essential. But if you try to do it whilst still trading your thinking won’t be sufficiently objective. That last losing trade will feature far too much in your improvement plans, when in reality it probably shouldn’t feature at all. So take a break, clear your mind and start planning for next year without any such influences clouding your thinking.
I am already gathering information and ideas ready for my own annual appraisal and planning exercise for next year. But I won’t actually undertake the work until I have finished trading for the year. However as a consequence of starting the data collection for this exercise I have already gathered together a number of items that I think might be helpful to you too. So over the next few weeks I am going to write a series of articles on each of these.
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Copyright © Simon Townshend Ltd 2009, all rights reserved
S&P is a Short!
I know it sounds insane and yes it is a darned aggressive stance to take. But last week closed with a sell setup on the weekly timeframe, the first sell signal since January. That is what the system says, so who am I to argue. The system is right around 8 times out of 10 and if I traded based on emotion I certainly wouldn’t be. That’s why we use a model in the first place after all, to prevent our human shortcomings getting in the way of success.
There have been a few sells on the daily chart in recent months which have led to retracements only. This weekly setup might be just the same, there is just no way of telling if we will get a retracement only or a more significant turn back down. It might not even work at all.
Here’s the catch: We have a sell setup, but at the moment no entry trigger. In my book a trade can only be taken if there is a valid setup and then an independent trigger to execute the entry. Using a trigger prevents a trader from jumping the gun and that leads to significant improvements in performance. What we really need is one more week for this to properly “ripen”. A down close next week would probably be sufficient to have the system pulling the trigger.
So if its important not to jump the gun, why am I? Well actually I am not as I don’t actually trade on such a big timeframe. But I am putting both of us on notice that there is a sell setup in place now, so this is a time to be very cautious with long trades and to be open to taking short setups on smaller timeframes if they occur. My fear is that this could kick in early and waiting for next weeks close means we could be entering way lower. Instinct tells me that there are going to be a whole heap of sell stops in the 1060-1070 region. If a few big ones get elected they could easily trigger more and result in rapid escalation as everyone heads for the exit ramp all at the same time.
I could be totally and utterly wrong of course and the sell signal itself might not get formally triggered at all. My gut says we are reaching a significant inflection point in many of these markets. But I have to ignore that and go with the system and that says wait for next Friday and see if we trigger. Darn it so what should I do?
I have concluded that last weeks and high and low should be used as key reference points. If we trade above the high, the sell signal would be invalidated anyway and the market should then continue with more of the same low volatility crawl that recent weeks have seen. If we slice through last weeks lows with good momentum on an intra-day timeframe and accompanied by high volume, then we could well be off to the races and short-term bounces will become short entries. I would then look to build a longer term position by following my usual short-term scalping signals and rather than exiting each trade completely, leaving just a tiny piece on each time in case this thing finally cracks hard.
At least that’s how I will be playing it, whilst my system will be waiting to make its mind up on Friday night. Of course if I’m right I’ll be telling myself “well this is a thinking persons game” and if I’m wrong I’ll be saying “follow the damn system!” Choices, choices! There are so many ways to skin a cat (as the rather ugly saying goes). Anyway I hope this internal debate I have been having with myself today might give you a few ideas to think about yourself.
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Copyright © Simon Townshend Ltd 2009, all rights reserved
Life doesn’t stand still for long
Time to toss a coin !
We have a really interesting and quite rare structure in the stock market right now. This doesn’t occur often at all, which is why it is worth taking a quick looking at. On this daily chart of the S&P, I have highlighted in purple the closing price each day.
I hope you can see how many times the market has closed at almost the same price over the last few days. So what does this mean? It means that buyers and sellers are perfectly balanced, supply and demand are equal at this point in time. Each time the market moves up, sellers bring it back down. Each time it moves down, buyers bring it back up. Then finally the market closes back at the level that both sides agree upon, seen visually by this little row of purple dots.
OK, so everyone agrees that the market is at “the right price”, so what? Well life doesn’t stand still for very long, especially these days and in the markets these balance points alert us to watch out for a sudden shift in the supply and demand equation. At some point, fairly soon I suspect, we will see an impulse – a violent move away from this balance price. Such an impulse usually is the start of a clean and prolonged move as one side takes control. Those on the opposite side of course start to feel the pain of being on the wrong side of the move and as their pain grows they start exiting their positions which fuels the move further.
Interestingly the longer the market rotates around the balance price, the more violent the impulse tends to be when it finally arrives. This is due to complacency on the part of the losing side. The longer the market remains still the more people accept it is “at the right price” and they lower their guard. The more people that get caught off guard the harder the market moves, trapping those people.
That is a lengthy way of saying watch out for a move over the coming days and the longer we wait the better the move we can expect.
Of course you want to know if the move will be up or down, don’t you? Well so do I. But I am afraid that is impossible to know. Plenty of people will guess. Some will be right and some will be wrong. For me, a 50/50 bet has no attraction whatsoever so I will just wait until the market tells us which side is taking control and then work in that direction.
If the market starts making new highs above last week’s highs we will work the long side. If the market takes out the lows of the last few days, i.e. the conservative short entry level we discussed last week, then we will work the short side. Until then we will patiently remain as spectators at this interesting juncture.
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Copyright © Simon Townshend Ltd 2009, all rights reserved
Sell in May ?
OK its a few days late to be May, but this general time period is well known for the stock market to exhaust itself and for upswings to end. It is psychologically tough to look for shorts when the run up has been so strong, but we had a sell signal in the Dax last Wednesday and the S&P closed on Friday with a sell. So it is starting to feel like we are at, or close to, a turning point of some kind.
Our S-I-R system is short the S&P now from 940 but with a tight stop just above last week’s high. That is a purely mechanical trade of course and we should have shorted at that time, but I am never wild about entering positions on the close on a Friday. With the markets closed all weekend the potential for a large gap either way is so much greater. As long as there is no such gap, we will be looking for a suitable short entry on Monday.
Decision time in the S&P - Up or Down?
If you look at this daily chart of the S&P there is the potential for a bull trap to be forming here. The market has pushed up out of its prior range and failed, so far, to accelerate like it would if the bulls were still dominant. The high of the range has held as support so far, which incidentally makes shorts at this level pretty aggressive hence the tight stop. However if the market turns down and takes out last Wednesday’s low, it has the potential to accelerate down pretty hard. So a more conservative short entry would be to use Wednesday’s low as a trigger after the current support has been seen to have failed.
So is this the end of this dramatic upswing? Maybe, maybe not. Not being able to see the future all we can do is take the trades, keep our risk very small and let the probabilities do their thing. We know we wont be right on every trade, far from it in fact. But waiting patiently for good entry signals, keeping risk small and managing trades well more than make up for not having a crystal ball. That is what all professional traders do, so I can’t see any reason for doing anything else!
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Copyright © Simon Townshend 2009, all rights reserved
Watch for the impulse
Coming into today the stock indices are in perfect equilibrium. This suggests a decent move is about to start and we will watch for the initial impulse to tell us which direction we are heading in next. I would expect to see this impulse within the next 1-3 days. Today would be nice to finish off a crappy little choppy week with a bit of action and profit.
I never try to guess which way we will go in these situations and am happy to admit that I have a poor record at making such guesses, which is why we only trade once the market has told us which way it is going! You have to be on your toes though because once these moves start they rarely give you much of a chance to hop aboard. The move to electronic trading has eliminated the leisurely entries that we used to get when all the volume flowed through the pit. Now you just have to pull the trigger, place your stop and walk away without trying to finesse the perfect entry!
Academically I note that gold has been rallying for the last week and rallying gold suggests the next move in stocks could be downwards. But it would take much more that this for me to bet that we break south. Maybe gold’s action improves the odds of a move down in stocks from a 50/50 bet to a 60/40 one.
Personally I’ll wait patiently until the market whispers in my ear that it is now going up or down and then we’ll join in for the ride. So fasten your seatbelts folks and lets see what unfolds.
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Copyright © Simon Townshend 2009, all rights reserved
Follow Up: The S&P breaks out to the upside gaining 9% in as many days. This move is even more impressive given that the market is in a downtrend and had already rallied 28% off its low. As we have said many times before bear market rallies can be very dramatic and are usually more impressive than rallies in bull markets, however counterintuitive that might sound.
How long do bear markets last?
Or equally importantly – how long do they take to recover from?
Recently a financial commentator was heard exuberantly announcing that times are tough but don’t worry in a couple of years the market will recover its recent losses. Oh really? That doesn’t sound too plausible, although if last year taught us anything it is that just about anything is possible, however improbable!
Intuitively we know that there is way too much damage done for this market to regain its losses quickly. This is the largest market decline since the 1929 slide and whilst that market did eventually recover to its 1929 highs that took some while as we will see in a moment.
We should also remember that on average markets fall at approximately three times the speed that they climb. There are many credible explanations for this phenomenon and whilst it is a very crude tool to put too much faith in, it does provide a rough benchmark of what is reasonable to expect (once the market finds the bottom of course). If a bear market from peak to trough lasts 2 or even 3 years, then we should be thinking roughly in terms of 6 to 9 years for a complete recovery to the previous highs. This factor of three is a widely known average across all markets and is not specific to the stock market per se.
We looked back at all the major declines in the Dow Jones over the last century to put the current market into some context and here are the results.
The 1929 decline was obviously far worse than the current market with a staggering 89% peak to trough loss. However it is the time that we were particularly interested in for this exercise. A decline taking approximately 3 years took a whopping 26 years to be recovered. The market fell roughly 8 times as fast as it recovered.
The second worse decline was in 1973, although at 47% loss this was less bad than we have seen so far this time! This bear market lasted approximately 2 years and took 10 years to be fully recovered from. So it took 5 times as long going back up as coming down.
The two more recent and less severe declines had recovery periods shorter in duration: 1987 was only a 3 month “hit”, but still took 2 years to recover. So about 8 times as long. Whilst the 2000 decline put in a performance much better than the average, taking only 4 years to recover from a 33 month decline. It is also worth remembering that this was also the least severe fall in percentage terms and logically the size of the loss would also have an effect on the recovery time. Hence the contrast with 1929 at the other end of the spectrum.
Obviously our current bear market hasn’t quite reached 2 years in duration yet, but neither is there any evidence yet of any bottom being found. But even if we were to march straight back up from here, the prospect of regaining those 2007 highs in just a couple of years is about as likely as a win on the lottery! At some point in time we will get there, it just won’t be anything like as quick as most people believe or hope.
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Copyright © Simon Townshend 2009, all rights reserved.
Expect fireworks in March
After several very quiet weeks in the stock market this is a quick heads-up to expect a significant pick up in volatility over the coming days. If it gets violent, as it has several times in the recent past, rest assured it doesn’t affect Hedgehog in the same way that investments with a directional bias can get hurt.
Once again the market is at a critical juncture and hanging on by its fingernails. We have been watching the 1997 lows over the last couple of weeks as this is the last significant area of support. Below this there is plenty of room for the bear market to accelerate. Yesterday the S&P 500 closed at 735, its lowest close in 12 years and right on top of this key support level. Meanwhile the Dow Jones, shown below, has just a few more points left before it reaches its equivalent low. So we are at or extremely close to this critical support level. You can see in this chart how February has now closed below the previous support level that the market had held six times previously, bring this 1997 low into play.
The prognosis is exactly the same as when the S&P approached that 1200 level a few months ago. Either we will see a violent rally from this level as shorts cover and bargain hunters go on a buying rampage, or we knife straight through and accelerate down as the next leg of the bear market gets underway. There is no way of knowing which way it will go until it unfolds, but either way the action can be expected to be swift. Simply hanging around casually in this area for a long period of time is extremely unlikely.
You may recall when the S&P was at the 1200 level we actually witnessed both outcomes as first the buying frenzy drove the market up an amazing 14% in a couple of days and then when the buyers were all spent out the market collapsed and accelerated down at the start of the move that brought us down to where we are today. Could we see the same again perhaps, or will it just be a clean single move? We’ll find out very soon.
Those who like statistics may be interested to know that the Dow Jones ended February down for the sixth consecutive month – the first time this has been witnessed since 1942! It is also worth remembering that by implication January was also a down close. Many members will be familiar with the statistical significance of January closing down. For newcomers we will recap the January effect and the amazing statistics behind it in a future newsletter.
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Copyright © Hedgehog LLC 2009, all rights reserved.
Expect shares to rally next week
Despite the pain and grief everywhere you look these days at Hedgehog we are just continuing to plod on in our low key way, grinding out a profit most days. We did nothing today as it was just too volatile. But we have a decent month underway. We are making new equity highs on the year so there is nothing to worry about here. (Hopefully that wont jinx the month!)
If you missed the news this evening, no doubt you’ll catch the newspapers over the weekend. “Biggest fall in the FTSE for 21 years”, blah blah blah. The S&P did go as low as 839 today – almost exactly a 50% fall from its high last summer.
So here we are going out on a limb expecting shares to rally next week! Well thats just what our model says so whatever we feel emotionally, we have to give it the benefit of the doubt. Yes the market was down hard today, but we were getting buy signals on the shorter term timeframes towards the end of the day.
These signals (which obviously are not 100% accurate but are about as good as it gets) have to be placed into context. In this case the buy signals would be no more than signals to exit any short positions, but certainly not to initiate new long positions. The reason is simple: the larger timeframes (daily, weekly, monthly) are all making new momentum lows. Therefore the odds overwhelmingly favour new lows to come. Those new lows may be many days, weeks or even months in the future but they will almost certainly be seen.
So short term we expect to see a bounce, probably over the next few days, but ultimately the downtrend will reassert itself – hence the logical interpretation of exiting shorts but not initiating longs. Rightly or wrongly on this occasion that is what the model says and in the long term we take money out of the market by playing the high probabilities.
One important thing to remember is that bear market rallies can be very dramatic, but that does not negate the downtrend nor the downside momentum. In other words this volatility is not going to disappear anytime soon!
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Copyright © Simon Townshend 2009, all rights reserved.
Follow Up: After this email was sent out to members the next 2 days delivered an astonishing 16.1% rally in the S&P 500. A month later however new lows were being made again, exactly as the model suggested.
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