May

Investing Systems Stock Trading Research Lab Blog Update for Week of May 17th, 2010

We would characterize the current market environment as quite dysfunctional.

While our long-term market timing indicators have not officially signaled a sell, it’s no mystery we have been cautions for quite some time. We continue to suggest, as we have for weeks, that one must be acutely aware of account drawdowns. This holds true for both investment accounts and trading accounts. Basically we see no reason to hold any equities through another 2000 or 2008 type of market.

We warned at the top of the weekly channel that an “investor” should calculate the potential drawdown should the market retrace the bottom of the weekly or monthly channel. Investing is very personal, and one has to evaluate their own propensity to sell first and ask questions later. We have also suggested that an incremental strategy of scaling in and out at specific technical levels is the best way to actively manage your investments.

Daytraders don’t have these problems. Long, short, hedged, cash, or sidelines mode, it doesn’t matter as each days trades are actively managed. Traders know that CASH is the primary position that allows you to do battle tomorrow and next week. I talk to more and more traders that don’t hold anything overnight in this current environment. We hope things stabilize a bit so we can go back to capturing multi-day runs, which produce the largest profits.

Recently on the Wednesday evening show we commented that if one were an active market timer they might take some equity off the table to redeploy later at lower prices. It’s not time yet…

We are Market Timers and our basic timing strategy is quite simple. If, on the LAST DAY of any month, the SPY closes on the opposite side of the 10-month Simple Moving Average, that’s the signal to get in or out. On the first day of the subsequent month you either move your investments to cash or you use your cash to reinvest.

No indicator is perfect and there will be months where the indicator says to sell, then the following month you have to buy back. But the beauty is that you will always be on the correct side of a major trend. Simple as that. If there are any “Widows or Orphans” reading this, please write it down as it’s a great “hands off” way to manage your own investments rather than turning it over to the so-called “professionals”, who may have ulterior motives and nefarious agendas.

As “proactive” traders and investors we can build on this simple strategy using the 30-week moving average and perhaps even the 200-day moving average, but the philosophy is that you MUST “time the market”.

To illustrate this simple principle let’s look at the monthly SPY going back a couple years to see where the 10-month moving average cross signaled an “adjustment”

The sell signal was December 1, 2007 or January 1, 2008, take your pick. It really depended on how close you zoomed in on the price and moving average or which charting platform you were using. The price at the end of Dec was right on the 10-month and subject to interpretation, but there was a clear signal on Jan 1, 2008. The yellow arrow is signaling caution at this very moment as lows so far this month are indeed below the 10-month. We still have to see where it closes on the last trading day this month in relation to the moving average.

Just about everyone is familiar with the old “sell if below the 200-day moving average” rule, but we prefer to use the monthly indicator since we are working within the context of a long-term timing strategy. We find the 30-week and 200-day MA’s to be great ‘confirming” indicators. For this purpose we will focus on the forest rather then the trees.

Notice the buy signal on the chart indicated by the green arrow would not have got you back in at the bottom. That’s just fine with us as the timing indicator is not designed to get you out at the top or in at the bottom, it’s designed to keep you on the correct side of any major trend that develops.

With trading commissions so low and the ability to point and click to easily move investments to cash equivalents and back to investments, it does not matter that there will be zig zag months that straddle the moving average.

It’s interesting to look back even further to see the last cycle. Here is a chart of the SPY from 2001 to 2008.

The red and green squares indicate buy and sell signals, while the yellow ellipses show the ‘fake out” moves where you buy or sell one month, then have to make the opposite move in the next few months.

With a sell signal given at the end of 2000, you would not have bought back in until the beginning of 2002, which was a false signal of sorts as you would have turned right around and sold again the next month. BUt look what happened then!

By the way, the indicator would have had you out of the market on Sep 11, 2001…

There’s not much more I want to add on this post as we will cover this in-depth on the Wednesday show, where we can discuss some of the more detailed aspects of market timing.

The take-away from this post is to help educate friends and family members that might not be in tune with this type of strategy. There are many “common investors” out there that have been conditioned to buy and hold no matter what and have been told for decades that the market can not be timed. They are probably just now recovering from losses incurred in 2008, and might be receptive to the idea of “preserving capital” should the recent “correction” turn into something more dire.

At the other end of the spectrum, we, as traders, are on the edge of our seats with the current volatility. The intra-day moves that individual stocks are making are perfect for long-short, in and out trading. The average true range of most stocks has increased considerably, providing opportunities to trade both ways. For those that don’t short individual stocks, the inverse and leveraged inverse ETF’s are useful for scalping a few percent on big down days.

We suggest it is a good time the to focus on the Daily Market Bias indicator in the Research Lab during the day.

This indicator consists of only 8 potential symbols, the 2x Long and 2x Short the 4 major indexes.

The real secret lies in the fact that it is measured from the OPEN price each day.

If the market gaps down real big, then spends the day going up, you will see the 2x longs.

If the market gaps up then falls, you will see the 2x shorts. Even though the market may be up or down from the previous days close, we are measuring the directional move off today’s open. What’s more is that the magnitude of the move is indicated by the percent change you see displayed in real-time.

For instance if we see less than a 1% move in these leveraged ETF’s, we know the market is relatively flat from the open. We may also see periods when there are both long and shorts showing up,and we know there is not a clear direction yet off the open. When we see these ETF’s move over 1% at any time and all 4 symbols represent the same side of the market, we know there is a significant directional move.

Some days the indexes flip back and forth on both sides of the open, and the daily market bias allows us to monitor the trend visually.

We talk a lot about using the red or green daily candle as a sort of intra-day timing indicator and the Daily Market Bias meter accomplishes essentially the same thing.

In the current choppy and volatile market environment we can use this gauge to our advantage each day and we will be discussing this in depth next week on the Live broadcasts.

We will present some ideas on how we “time the market” on an intra-day basis using both ETF’s and stocks.

Moving on, we would be remiss if we didn’t discuss gold and silver. As we have been saying for quite some time, they are the only true money. Fiat currencies have come and gone over history but gold always preserves purchasing power over time and geography.

The price of gold is now the highest in nominal dollars is US history, however in inflation adjusted dollars it still has a long way to go to even match the highs of 1980.

We use GLD as a proxy for the price of gold, however we only trust the ETF as a trading vehicle as it is settled in cash, not physical gold. Below is a monthly chart of GLD.

We think the likely trading range of GLD lies in the yellow circle for the near future, however we can’t rule out extraneous events that send it much higher. Our eventual price target is infinity when priced in fiat currency.

“Politicians shun gold as it acts as a barometer whose price announces how a government is handling their country’s fiscal and monetary affairs”.

There are certain “powers that be” that constantly fight to keep gold from becoming the “go to” investment in times of turmoil. They orchestrate “take-downs” to scare off ordinary people and cover short positions. Based on the chart, the upward sloping trend line would be a good place to consider taking a position if it were to trade back down there.

The old saying “put 10% of your money in gold and hope it doesn’t work” comes to mind. We have expanded on that to include perhaps another 10% in silver as we honestly think silver will outperform gold in the long run for many reasons.

One is the gold to silver ratio. Right now it takes 63 ounces of silver to buy an ounce of gold. The earth’s crust contains roughly 16 oz of silver for every ounce of gold, so Mother Nature provides the best benchmark. Over long periods of time ratios like this that get out of whack have a tendency to revert to the mean.

Let’s look at a monthly chart of SLV, which we can use as a proxy for silver.

We see a clear breakout on the chart of a triangle pattern going back two years. While we suspect some backing and filling on both gold and silver, this indicates higher prices down the road.

We have been suggesting for years that anytime physical silver can be purchased for under twenty bucks an ounce, it is a bargain and the idea is to slowly accumulate physical silver until you can no longer pick up and carry it. Silver has a long list of reasons as to why it is an excellent investment but I won’t go into all that here. You can easily find articles that explain in detail why silver is a true investment with almost unlimited upside potential.

Some of the best articles on gold and silver can be found at:

http://www.financialsense.com

Last but not least, here is that chart of IFLG we were discussing last week with some marks showing potential entries, scale-out targets and stops. It’s not everyday one of the picks makes a move like this but we do see it frequently. This is just another example of our intra-day entry strategy that we will explore in-depth on the show.