A Z-Trader's Thoughts on Recent "Vol" 9/25/11

Excerpt from one of our contributor's articles at SeekingAlpha:

Here are a few quick thoughts for these volatile conditions, during these difficult economic times:

• Don’t try and catch a falling knife. Most good trading systems will minimize risk and “stop losses” from accumulating. You can never tell how far emotions will carry a large market move.
• When “contagion” spreads, it is sometimes best to step aside and reduce positions because psychology and emotions can also spread – causing markets to move past any "reasonable" level.
• Many portfolio managers are reducing positions, so markets become more "correlated" to one another.
• “Diversification helps until it no longer helps.”
• Trade down to the level that lets you "sleep at night."
• From a trader's perspective, once the markets find footing, these "dislocations" may offer opportunities.

Read more here:
http://seekingalpha.com/article/295688-a-trader-s-thoughts-on-recent-market-volatility

Market Update; Trader Thoughts (9/23 - 7am)

The stock market has dropped swiftly and viciously the past few days.  This has impacted most other markets -- including crude oil, precious metals, commodities, currencies and fixed income.  A few quick thoughts from the blog's contributors who are traders and investors:

• Don't try and catch a falling knife.  We had a blog post recently about this...
• Trade down to the level that lets you "sleep at night."
• Stick to your trading plan and/or system.  Systematic approaches maintain discipline and reduce the impact of emotion and psychology.

We are writing an article for Seeking Alpha on some of these topics.  And in case you were wondering:

• Our stock market indicators are currently "overall" bearish.
• Our short-term indicators have dictated our stock market positions because the other indicators (long-term and intermediate-term) were neutral.  
• As our readers know, our intermediate-term and long-term indicators went to neutral on our last post on stock market indicators -- when the S&P was at 1216.  
• Currently, however, our long-term model flipped to bearish (depending on market action, this may change; we will keep you posted).  In addition the intermediate-term indicators are moderately bearish (but a look-ahead shows that the oversold indicator may flip to bullish in the near-term). 
• The S&P closed Thursday at 1130. 

Quick reminder: "falling knife"

Just a quick blog post about the old saying, "Don't try to catch a falling knife."  Most good trading systems will use this kind of approach -- because you can never tell how far emotions will carry a big market move.

Although our intermediate and long-term stock market indicators are long, our short-term model has us on the sideline (although not before taking some losses -- less than the general market's decline.).

We will continue to follow our trading models -- and depending on how the signals are -- will trade accordingly. Long-term investors may look to add to their positions at some point -- and traders should be cautious due to the high volatility.

Stocks in the Long Run

Franklin Templeton and Stocks in the Long Run -- this is a nice look at long-term stock performance including poor ten-year periods like we have seen recently.

https://www.franklintempleton.com/retail/pages/generic_content/sales_tools/2020vision/pub/history_favors.jsf

Comparing Greece to US: OK, but need to tighten belts

"...how different, really, is the United States?

The United States will probably not face the same kind of crisis as Greece, for all sorts of reasons. But the basic problem is the same. Both countries have a bigger government than they’re paying for. And politicians, spendthrift as some may be, are not the main source of the problem.

We, the people, are..."

_______________

Check out this article for more info.

http://www.nytimes.com/2010/05/12/business/economy/12leonhardt.html

______________

Intermediate Indicators Go Long (Fear)

We just Twitted about our intermediate-term/oversold signals going long this morning. There is a lot of fear in the market right now. Stocks may be volatile, but at least historically, this kind of fear creates short-term and intermediate-term opportunity.

We are stepping back into the market (and increasing our stock allocation) cautiously.

Snow Days and Human Nature

My daughter was very sad today because she had to go to school -- even though it was supposed to be the fourth day of a four-day weekend. We couldn't cheer her up even though she had two snow days OFF FROM school last week.

Last week, when we were getting pummeled by almost four feet of snow within four days (!!), we enjoyed some fun and happy family time on those extra two days off from school. BUT -- if you could measure the fun, it would go something like a "normal happiness level of a 7" up to, say, a "9." (So a decent jump in happiness; we all remember snow days, right?).

However, if we consider that today was supposed to be a day OFF from school, we can see why kids will be sort of bummed. Our daughter's happiness went from the "normal 7" all the way down to about a 2. A BIG disappointment. So -- even with two snow days last week, and today's make-up day, the net is a slight disappointment. People HATE losing something they thought they had!

There is a whole field of behavioral finance, but this morning's "off-to-school routine" made me think of some of the factors that help drive markets. In particular, we can try to use patterns of human nature to obtain an edge:

• Most people are risk-averse
• People often "compartmentalize" gains and losses
• Contrarian methods
• Fear versus greed
• Climb wall of fear

We use systematic methods to invest and trade the markets to keep us disciplined -- the human element. We perform tons of research, but then use computerized and automated trading approaches.

So Goes January?

There are a number of "theories" that say things like:

• If the stock market is up during the first five days of the year, it should be a good year for the stock market.
• Others look at the entire month of January as an indicator for the year.

Indeed, some people have studied this -- and the numbers DO show that this is true around 85% of the time. As you might imagine, we don't give these "systems" very much credence -- but we DO believe that the market currently has a healthy balance between both bulls and bears. In fact, with the market rallying early in 2010, we're surprised that we haven't seen more press, analysts, or blogs screaming about this "indicator."

We think the reason that more people aren't screaming about this indicator -- is because inside, they are bearish. The stock market scared a lot of people -- and that fear still exists. The stock market continues to climb the "Wall of Worry" that we talk about regularly. The existence of fear -- and bears -- gives the "contrarian" inside of us reason to believe that this market has more room to rise.

Our long-term stock market indicators remain bullish. Our overbought/oversold indicators are currently mildly bearish -- so we have a neutral to slightly long outlook on stocks.

Climbing the Wall of Worry

Our indicators -- and in particular, our overbought/oversold indicators remain bullish. The past week or so has seen some scary declines, where analysts have been predicting larger declines and mini-crashes. We may see that, yet, but for now, our indicators remain bullish.

This "stance" has led us to some pain over the past few trading days, although our Short-term models helped to reduce the losses to some degree. The Shorter-term systems follow the tape and had to turn bearish as the market declined on some of the recent volatile days.

While some people are surprised that we remain bullish, some contrarian investors like the fact that people are very emotional these days. With so many people predicting a large decline, it means that the markets are "balanced" a bit. It means that we can "climb this wall of worry" perhaps a bit more...

Emotions are very difficult -- and the reason we like to use systematic trading systems for our investments and trading approach. For now, we will continue to follow our bullish indicators -- AND we will alert our readers (at least via Twitter; but often with a Twitter and blog post) when the Overbought/Oversold indicators turn to neutral or bearish.

Today's opening "gap up" has us getting ready to enter more bullish positions after a typical "gap fade" decline.

Runaway Markets: Technical Analysis and Fundamentals

The stock market has been in a sustained rise since its March lows. Using 20-20 hindsight, people have said it was an inevitable bounce from scary lows, followed by a short squeeze that lasted longer than expected (due to the excessive fear and shorts in the market). Whatever the reasons, equities have been in a runaway market for almost six months now -- with the S&P rallying an amazing 50% in just five months!

We agree with many naysayers -- that our global economy isn't the greatest -- and that this might be a bear market rally. However, we are technical traders and our mentality is to "shoot first and ask questions later." Emotions can really move markets and cause them to overshoot -- often past where fundamentals might dictate. For the most part, our trading systems have kept us on the right side of the market (stocks, bonds, currencies, etc.) during this rally. We don't "fight the tape" -- and let the markets direct our actions. We believe that emotions and technical action move the market in the intermediate and short-term, but that fundamentals move the markets in the long-term.

We're wary of the direction that the world's economic fundamentals will eventually move the markets, but hope that our technical approach to the markets will keep us on a good path.