Stocks – Short Bias

Long Term Bias

When trading stock, I have a process that starts with asking “What is the longer term bias?”

This matters as it determines which way will have the most potential gain. When stocks go up, they tend to be more like a sine wave on a 45 degree up angle, that is: Flat, UP, flat, UP, flat, UP. Now that “flat” part can be somewhat down, it’s not a perfect flat, but your major gains come from that UP portion. When stocks are headed down, it’s more like: Flat, DOWN, flat, DOWN, flat, DOWN. However, during a bear market run, those “flat” parts can be very sharp spikes up, but also very short. It is more that the moving average of a few days is fairly flat. Your major gain potential is on the DOWN (and also the major risk if you have bought into one of those “flat to up” spikes.

As a consequence, I’m very reluctant to try to ‘make a gain’ out of a short sharp up spike during a generally down market trend. The tendency is to get in late, then out late, and make a loss rather than a gain. If you look on a daily interval chart, you can see that often the ‘up’ spike is only a day or three, then the market opens down a lot and you have no chance to get out on that good day. So during a down market, the best way to bet is to the downside. And to avoid the temptation to play into one of those ‘up’ spikes.

SPY 5 yr Weekly W%R MACD DMI

SPY 5 yr Weekly W%R MACD DMI

On this chart, we have 5 years of data, in weekly ‘ticks’. The first indicator is a “Williams %R”, the second is the Moving Average Convergence Divergence, and the final one is ADX / DMI.

So lets look at them a bit. First, notice that when the price line is headed generally up, DMI+ is on top (the blue line is on top in that ADX/DMI indicator) and when stocks are in a general down trend, it’s red on top. The stronger the trend, the higher the black line (ADX). So you can see strength and general direction pretty quickly. The problem with it is lag time. The change from dropping to rising tends to happen at an ‘inflection point’ in the red line and the black line, while it is still on top. Similarly, the change from a dropping trend to a rising trend happens at an inflection of ADX down while blue is still on top. So it can set a context, but with a lag time, and you must watch for inflections.

What’s our context in this graph? Red on top. Black ADX line still rising and not inflected down. That’s the early part of a down run, not the end. Context is “Bear Market Rules” for now.

How about MACD? It is “opening pointed down” with red on top. Rather similar to August of 2007. But it is still above the zero line. So we’ve got a negative direction, but not yet the ‘below zero’ confirmed bear market. Potentially it’s just a ‘correction’ in an ongoing bull market. But until that blue line crosses back over to the topside and the opening is pointed up, it’s “bear market rules”.

Finally, lets take a look at Williams % R and what it says. During a run to the topside, a spike down is a ‘buy indicator’. But during a run to the downside, you don’t want to be buying, you want to be placing a short after a spike up. So take a look at October 2007. We’ve got a spike down, and prices do rise for a couple of weeks after that, then we get a terrific plunge. If we are, in fact, inflecting into a modest bear market, that’s what would be coming. So we ‘manage the risk’ by assuring we don’t have that hit us. Yeah, maybe there is a positive run that we don’t ride. But the avoided loss is more important.

Finally, lets look at the Simple Moving Average stack. The shortest term, 20 weeks or 100 market days, has gone flat after a long run to the topside. This is very similar to what it looked like at the last top inflection in about October of 2007. Notice that the blue line ( the 40 week or 200 market days line) has also flattened. In May of 2006, we had a flat 100 day, but the 200 day line was still rising. That both are flattened is a worry. You don’t need to buy worries.

So in times of market turbulence, you want to be “Early Out, Late In” on the long side. Shorter faster trades. Until we establish a definite trend, you do not want to be betting on a rising trend that may have already left the building… Once a clear bear market trend is in place, then you want a bias to be ‘short the market’ with buying when prices touch the SMA stack and covering at those ‘W%R down spikes”.

So am I buying this market pop today? “Not Yet, not yet”…

I’m doing some day trades, but those are based on very fast indicators ( 5 day 15 minute charts). Things with no commitment as to longer term directions.

A 1 Year Daily Chart

SPY 1 year daily RSI MACD DMI

SPY 1 year daily RSI MACD DMI

The RSI is something of an overbought / oversold indicator that tells you about the ‘sentiment’ of the market. Notice that it was nearly 80 just before the Flash Crash. When RSI is ‘near 80’ a downturn is the most likely next event. In particular, notice that RSI pulled down to a slightly lower peak than the 80 peaks just before things crashed. That ‘lower high’ is a signature event. Now it’s “near 20” and that typically means “up run is next”. We’re looking for that ‘higher low” peak as the signature event. In a bull market run you will often get RSI going between ‘about 50 – about 80 – about 50 – about 80’ while in a bear market it’s ‘about 50 – about 20 – about 50 – about 20’. At inflections you go from one extreme to the other. From 80 to 20 or from 20 to 80. So looking a few months back, we had a bull run of 50-80, then a minor ‘correction’ in late January / early February. That “dip” is not as low as our present ‘dip’ in RSI. That’s a worry. The trend is weak now, compared to then, and we’re much more like an 80 to near 20 transition. If our next run up ‘tops out’ with RSI at about 65, then ‘dips’ to 20, we have a confirmed transition to a bear market. Right now it’s saying “inflection underway, at least to flat and rolling” (which would have RSI about 35 -65 and back, but they usually don’t stay in that state for long). But we’ve got roughly ‘equal dips’ (not progressing to the downside) between the Flash Crash and now, so a short term trade to the upside is most likely in the shorter term, but trade it, don’t trust it.

Next is MACD. Notice that it called for an exit about the end of April with a clear ‘opening pointed hard down’ and red on top. We’re now also “below the zero line”. My trade rules will not let me enter a ‘long bias’ as long as it stays like that. I can do a counter trend day trade, but not a trend trade. Swing trades are ‘iffy’ (as my attempt to do a swing trade out of the Flash Crash demonstrated. You have to be OUT FAST when it stops progressing to the upside. You can not trend follow on the exit from such a fast trade.) So we’re waiting for it to cross over to blue on top and head back to above that zero line before letting long positions run for long periods of time.

Yeah, I’ll miss a couple of days to the upside if this is a return to a bull run. But I’ve avoided a much larger risk. (Besides, I’m probably day trading anyway and catching some of that rise).

And finally, the ADX / DMI. The red line (DMI- ) has crossed the black line (ADX) and that’s a very positive sign. But the ADX line has not yet inflected to the downside. I’m not seeing enough to embrace yet. The indicia is for a run to the upside ‘soon’, but the context says it’s likely to be very short and choppy. Higher risk for less reward.

Day Trade?

I’m seeing a bit more love here, but not a whole lot…

SPY 10 Day Hourly with GLD SLV FXY FXE

SPY 10 Day Hourly with GLD SLV FXY FXE

We do have the SMA stack flattening and preparing for a crossover to the upside. RSI is ‘stair steps up’ off an 80 bottom, but that just means it’s far enough along for a day trade to be a bit old for an entry. MACD gave a decent entry about the end of Tuesday and is now crossing over the zero line, so that’s all good. But look at the ADX and DMI+- lines! Nearly nothing and dead flat. We’ve not even got a trend on the day trade.

Now look at our prices on this grand “up day”. Hardly at all above what they were Thursday, Friday, Monday. All we’ve really got is a recovery from the one lousy day of Tuesday. And no momentum mid day. I’m not seeing much here to interest me.

How about those other lines? Much more interesting…

FXY is the Japanese Yen, and it’s taken a dip, while FXE the Euro is bounced up. Someone is turning in Yen for Euros. Is our “whale” borrowing on the Yen carry trade and preparing to do something with Euros? Or are they covering their short (that would involve getting Euros to ‘buy the stock’ with and selling they yen holdings to do it.) My guess is the latter. They’ve been sucking money out of the short positions and putting it in yen, now they are taking those yen and buying in their shorts.

So my take on this is that it’s a whale doing a slow short cover. I’ve seen those before. You get a day up, then nothing, then some more up, then nothing. It all depends on when the whale places the buy. The short fast and hard to scare folks out, but they cover slow and sporadic to avoid moving price up (to the extent possible). Very hard to trade against that.

So my conclusion is to do what the Whale is likely doing. Raise cash and prepare for the next shorting opportunity. Yeah, you could likely make a ‘long bias swing trade’ here as we return to the moving average stack, but that’s a hard fast trade…

Those other lines? Silver and Gold. Some money is continuing to enter those metals, but that is a different day trade…

Notice on Charts

Note that these are live charts, so what I’ve described will not match the chart over time. The daily chart will be ‘out of day’ in a week or two. The daily in a few weeks to months, etc. Also, you ought to be able to click on the chart to get a larger version (or do a “ctrl click” for Mac users).

About E.M.Smith

A technical managerial sort interested in things from Stonehenge to computer science. My present "hot buttons' are the mythology of Climate Change and ancient metrology; but things change...
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5 Responses to Stocks – Short Bias

  1. Wes says:

    Chief,

    This is an interesting discussion of your use of certain stock technical indicators for entering and exiting trades. It certainly points out that there are many ways to be successful in the market.

    As for me, I “wasted” the day playing golf, although I am heavily long the market (QLD) as you know. Tonight I will get an early indication of the reaction to market strength. If the strength is embraced by the majority, it will of course bode less well for a further advance than if the majority continue their recent fearful ways.

    The psychology indicators I follow are usually posted by the charting service by 9 PM, but I’ll probably just wait until tomorrow morning to study them. I’ll try to keep you posted.

    Meanwhile, we are still quite oversold, so I’d be very unlikely to be swayed by the reaction to today’s advance.

    One item you might want to comment on though. My indicators are saying it is much safer to put your money into the market now than it was a month ago.

  2. Wes says:

    Chief,

    As a follow-up to my post above, the majority of psychological indicators continued to register great fear today. So far, market participants are not anticipating a bull market resumption.

    Of course it’s very early with just one day of real bullish action. As always, time will reveal just how fast fear will turn to greed.

  3. pyromancer76 says:

    EM, you have a very strong stomach and a quick mind. It seems to me that you use the charts — which I am slowly and gratefully learning — to understand a kind of psychology. If stocks are about what some people are willing to pay for what some people are willing to sell, both to their own advantages (gaining value) — and the whales to their great advantage — then it seems you are watching about as closely as it is possible to watch without being one of the major movers (or “fraudsters”) of the whole shebang. Also, in your explanation above, it seems you are most interested in “process” rather than “content” (from a psychoanalytic perspective) because process gives you the most basic understanding of the current financial reality — the real gut-experience.

    I guess I am concerned about when the “fraudsters” might be in the majority and when little of real value is being traded (from a psychoanalytic perspective, a “psychotic [non-reality] state of mind”. Can you take a look at Karl Denninger’s last two charts 5/27/10? http://market-ticker.denninger.net/ Do you have any real danger signals you use to warn yourself to stay out of a mess, which might mean where everyone is pretending that there is some value in what they are doing? I am thinking of earnings-per-share or some other metric of fundamental value.

    My mind and education tell me: energy to do the work to produce value first; creative minds to invent the work to use the energy second; “interpreters” (engineers, e.g.,) to move the creative ideas to the market third; committed workers to make it happen fourth; consumers, business or private, to make use of the product fifth. Government useful to smooth the rough spots, indict the fraudsters (keep the process relatively fair), and to protect the homeland so the process can proceed. Government produces nothing of value; it can only enable the (market) process. The current “psychosis” is that government produces. If this anti-reality takes over, producing value grinds to a halt — your “socialism shiny thing”, I imagine. Can there be any stock market in this situation?

  4. E.M.Smith says:

    @Wes: I expect a fairly short sharp rise as we are fairly far below the moving average stack (and it always returns to the moving average, one way or another). Then we will either make a ‘higher high’ and it’s a return to the bull run; or we make a ‘retest’ that fails to make a higher high, and we’re in a bear market condition. I’m expecting the latter (but will change expectations on a dime if the price action dictates.

    With RSI near 20 and a ‘double bottom’ in it, there ought to be a relief rally of some sort. So on a swing trade basis, I expect a rise. But on a trend basis, it looks like the trend is dying. No sense investing in a dead trend… And the fast ‘day trade’ land is just nutty lately. It’s a “buy the dips sell the rips” and don’t think market. I’m just not very good at that, partly because of my time zone ( I often get my first look at things 1/2 way through the ‘day’. Hard to day trade with only half the time period to work…)

    Further, the short sharp ‘bull swing trades’ of an inflecting or falling market are very fast as well. Notice that in the “Flash Crash” the bulk of the ‘opportunity’ was from about 1 pm ET on the crash day to about the same time 3 days later. That’s closer to a day trader time scale than a swing trade. So if you miss a few hours, you miss the trade. The exit had to be called in about 40 minutes in the afternoon of the last up day or you got slaughtered in the following drop.

    So it’s not that I’m saying “There will be no spike up” so much as I’m saying “There will be a spike up, but too violent to easily trade, especially given a mid-day check in schedule” If I was in Florida, it would be a lot easier to be up and awake at the market open…

    Two other complications:

    1) I have a minor head cold… and one of my rules is no trades when ill. I’m only a little ill, so I’ll do minor trades, but I’m not going to be making big bets when I’m looking for hot tea and allerest… no matter how strongly I might hold a belief… And certainly not high energy high focus day trade time scales.

    2) Things get ‘odd’ around holidays. We had a European holiday (that looked to leave a quiet US market as the ‘Whale’ was not active) and we get a US holiday… So I’m more inclined to wait until after Monday to add risk (basically, buy a ‘dip’ after the run to the upside is confirmed.

    Remember that I did post a comment about 2 days back that RSI and MACD were calling an ‘entry’ but I was going to sit out that trade…

    All in all, this is a long winded way of saying what I said before: I’m good at trend and swing trades long, especially in rising markets; I’m not so good at shorting and choppy day trades (that timing / time zone thing) but I’m learning.

    Perhaps with an added “and managing risk means not trading when you feel ‘off’ and not trading with a long bias at a potential inflection point after a long run up.”

    And yes, it’s a lot safer now than a month ago. A month ago was a clear top, now were in a bouncy stage…

    FWIW, I’m expecting that about next Tuesday I’ll trade to the long side of general stocks for a short swing trade. We’ll see.

    For now I’m doing OK in gold, silver, oil, etc. Made some very nice money in oil today ;-)

    I tend to trade 4 or 5 things at once. Always oil, often stocks via ETFs, sometimes individual issues, and metals (with sporadic currency ETFs and farm ETFs.) So even when I’m “out of stocks” I’m often long oil or gold or yen or…

    It makes it easier for me to sit out a minor run up in, oh, SPY when I’m making some on oil and metals…

    So when the SPY chart shows a red MACD and DMI, that says I must take a ‘short bias’ and avoid long side trades: I’m still able to trade other things with charts that have a positive MACD and DMI with blue on top.

    @Pyromancer76;

    Wine helps 8-)

    Yes, the psychology is the key. That’s getting a bit harder are more trades are computer driven, though…

    Denninger’s stuff looks about right to me. “When” is missing, but that’s life… There is a lot of money to be made in a bubble, just be out when it breaks… but how to know when that is?

    By exactly the method in the above posting. When it goes “red on top” stay out…

    If the whole economy melts to nothing, then the economic debt bomb is the lest of our worries. If not, we pay a high price but paranoid trades avoiding risk lets us keep some capital…

    The good news is that debt and population issues tend to grow slowly over many years. We’ve got time to work on it.

    As per a more intense avoidance, well, that will depend on what country will have me ;-)

    Until then, you just keep an eye on charts for things like oil and gold and copper and when they start running up (or the dollar is running down, move money into them.

    Finally, that ‘intrinsic value’ thing… what intrinsic value is their in paper with the portraits of dead presidents on them? So we trade things with no real value and hope that the reality is under or attached to them somewhere… So if folks start manipulating the markets soo much that retail leaves (and at least on commentator a CNBC noted that retail stock buying was off…) then they will be even wilder games and Joe and Jane Sixpack will be holding oil trusts or other assets with real value and ignoring the market. IMHO, we’re getting close to thqt now.

  5. Wes says:

    Chief,

    I sold about 5% of my position at the close today. I guess when you see a number of sudden reversals, it makes you you want to trade for one. Of course, I’ll be pleased if one doesn’t occur.

    The psychology indicators are still a 2 with 1 most bullish, and we’re nowhere near overbought. Fear of more downside dominates the market currently.

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