ONE-TWENTY TWO - A collection of personal articles on financial markets including analysis you can use
Aug
27

Solar City’s 2014 Low Has Behaved Like A Critical Pivot Point

written by Dr. Duru
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The solar industry has taken an extra hard beating in the wake of the market’s general sell-off. Solar City (SCTY) has caught my interest because the stock has exhibited a clear pattern during this sell-off: a pivot around the 2014 low.


The recent market sell-off sent Solar City (SCTY) through the lower support of a long-standing trading range

The recent market sell-off sent Solar City (SCTY) through the lower support of a long-standing trading range


Solar City’s primary trading range extended back to late 2014. If I could extend the chart backward in a neat way, I could also show how SCTY experienced what now looks like two brief spurts above this same trading range. Under this looser definition, SCTY’s trading range goes all the way back to late 2013. The duration and durability of this trading range heightens the importance of the current breakdown.

The chart below shows a close-up of this breakdown.


This close-up of Solar City shows how well the 2014 low has served as a pivot.

This close-up of Solar City shows how well the 2014 low has served as a pivot.


Source for charts: FreeStockCharts.com

Note well how the 2014 low has served well as a pivot. On August 12, SCTY made a very neat bounce directly off the 2014 low. At the time, the move looked like a promising bottom in the making. The warning began the very next day as SCTY failed to print any buying follow-through. The stock drifted lower for 6 trading days as the downward channel defined by the two lower-Bollinger Bands (BB) guided SCTY. As a result, last Friday’s major market sell-off found SCTY extremely vulnerable. SCTY made a clean break below the trading range for the first time since November, 2013. Selling volume had not been that high since November, 2014. This was a serious technical breakdown.

The good news for SCTY is that the stock has not CLOSED any lower since that day. The bad news for SCTY is that two attempts to close above the 2014 low were effectively faded by sellers.

This trading action turns the 2014 low into a very important pivot line. IF SCTY makes a new closing low in this cycle, traders should assume a lot more downside lies ahead. IF SCTY can manage to close above the pivot line AND next show at least one more higher close, preferably on strong buying volume, then traders should assume SCTY has primed itself to rally. The first upside target rests at overhead resistance from the downward sloping 50 and 200-day moving averages (DMA). The very bullish target rests at the top of the former trading range.

Adding to the intrigue was a well-reasoned buy rating from Morgan Stanley analyst Stephen Boyd. Boyd set a $93 rice target which is WELL above SCTY’s trading range. He even defended SCTY against short-seller Jim Chanos who recommended shorting SCTY on August 21st on CNBC. Chanos has a LOT of company: 44% of SCTY’s float is sold short! Talk about a potential powder keg…



Be careful out there!

Full disclosure: no positions

Aug
27

T2108 Update (August 27, 2015) – The Volatility Index Hits A New Milestone On Follow-Through Stock Buying

written by Dr. Duru
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(T2108 measures the percentage of stocks trading above their respective 40-day moving averages [DMAs]. It helps to identify extremes in market sentiment that are likely to reverse. To learn more about it, see my T2108 Resource Page. You can follow real-time T2108 commentary on twitter using the #T2108 hashtag. T2108-related trades and other trades are occasionally posted on twitter using the #120trade hashtag. T2107 measures the percentage of stocks trading above their respective 200DMAs)

T2108 Status: 15.9%
T2107 Status: 23.0%
VIX Status: 26.1
General (Short-term) Trading Call: Bullish
Active T2108 periods: Day #5 below 20% (oversold), Day #6 under 30%, Day #29 under 40%, Day #69 under 50%, Day #86 under 60%, Day #284 under 70%

Reference Charts (click for view of last 6 months from Stockcharts.com):
S&P 500 or SPY
SDS (ProShares UltraShort S&P500)
U.S. Dollar Index (volatility index)
EEM (iShares MSCI Emerging Markets)
VIX (volatility index)
VXX (iPath S&P 500 VIX Short-Term Futures ETN)
EWG (iShares MSCI Germany Index Fund)
CAT (Caterpillar).

Commentary
Buyers managed to stage follow-through buying to yesterday’s notable end to a long losing streak. Incredibly, the S&P 500 (SPY) is now ABOVE where it closed on Friday and so is UP for the week. Such is the power of a bounce from oversold conditions.


The S&P 500 (SPY) has gained a whopping 6.2% as its bounce from oversold conditions gets underway

The S&P 500 (SPY) has gained a whopping 6.2% as its bounce from oversold conditions gets underway


This chart is Exhibit A of why sellers and bears should NEVER chase a market down when it is oversold: such trading is a recipe for whiplash or major losses. Anyone who sold into that panic selling at the close on Tuesday is experiencing seller’s regret right now. So the pressure turns to the sellers to decide whether to cover and/or jump back into the market before “it gets away.” Note well, I am NOT saying the market has found its ultimate bottom. Instead, I am speaking from the standpoint of properly managing risks relative to potential gains.

T2108 is still oversold at a close of 15.9%. T2108 lags the S&P 500 given it has not yet recovered to Friday’s close. At the current pace, T2108 could easily exit oversold conditions by Friday’s close. Friday should represent an interesting battle between short-term traders who want to lock in profits before the uncertainty of the weekend versus bears and sellers who might rush to cover/buy fearing that “world peace” over the weekend could send the market gapping up on Monday. At 5 days and running in the oversold period, T2108 is right at the average duration for an oversold period. So, time SHOULD indeed be running out for the oversold period.

Even more importantly, the volatility index, the VIX, hit its next milestone on the downside. The VIX closed below the low of the last major surge; it now sits below the intraday high from 2012.


The volatility index, the VIX, has now lost half its value from the intraday high just three days ago.

The volatility index, the VIX, has now lost half its value from the intraday high just three days ago.


This milestone gives the green light to less aggressive traders/investors to do some buying. However, the current setup is a great reminder of why I prefer the more aggressive strategy. Being aggressive can deliver better risk/reward setups. By buying on volatility spikes to new highs, I very quickly nailed an extremely high profit opportunity on this upswing. Traders and investors buying here face the very real risk of a natural pullback. The S&P 500 is up 6.2% in just two days – even a 3% pullback over a few days would be quite normal.

This pullback risk increases for traders/investors who follow the “conservative” strategy of waiting until the oversold period ends to do some buying. Granted, my early analysis of drawdowns for different strategies showed that the less aggressive strategies effectively limited big drawdowns. This cap on losses comes at the “cost” of more limited upside as well.

I am going to call Friday a “toss-up” day, so no individual stock charts (I will reload chart this weekend! There are many good ones). Here is a quick summary of the trades I did: added to Caterpillar (CAT) put options as a SMALL hedge, locked in more profits on ProShares Ultra S&P500 (SSO) call options, sold AAPL call options for a nice profit, sold NFLX call options for an even better profit, and restarted a “strangle” on iShares MSCI Emerging Markets (EEM) which features out of the money put and call options. I have discussed the strategy on EEM in several earlier posts. I have yet to capture gains on both sides of the trade, but I have consistently been able to log large enough gains on one side (mainly the put side!) to more than pay for the losing side. I fully expect more major moves ahead for EEM.

The iShares Nasdaq Biotechnology ETF (IBB) made its own important milestone: it closed above its 200DMA. This technically makes it a screaming buy. IBB is one of my biggest misses during the panic earlier this week. I did buy a call option last Friday, but it will likely expire tomorrow (August 28th) worthless. (When I finalaly get my short-term timing right on IBB, it will be huge!).


The healing for iShares Nasdaq Biotechnology (IBB) has arrived in the form of a solid close above the 200DMA upward trendline.

The healing for iShares Nasdaq Biotechnology (IBB) has arrived in the form of a solid close above the 200DMA upward trendline.


Finally, I want to demonstrate why it is important to follow currency markets during times of stress like this one.

euro recovering and $AUDJPY looks topped out. Likely signals $SPY rally has or is topping out for the day. #forex

— Duru A (@DrDuru) Aug. 27 at 11:03 AM


As I have noted earlier, I am keeping a close watch on the Australian dollar (FXA) versus the Japanese yen (FXY) as a market tell. It worked like a charm today although I did not act on a trade. The move on ProShares Short VIX Short-Term Futures (SVXY) was simply too fast for my non-computer brain. At least I knew that buying near that top was a very poor risk/reward proposition.

Third day in a row around $51 has held on $SVXY. Today's support was touched just for a hot minute!

— Duru A (@DrDuru) Aug. 27 at 12:29 PM


Anyway, check out the very tight correlation between AUD/JPY and the S&P 500. I included an overlay (blue) of EUR/USD for comparison. While the euro is behaving inversely to the S&P 500, it is not as tightly related as AUD/JPY. The euro’s inverse relationship will only last as long as traders are closing out carry trades; I have to believe they are almost finished at this point.


The Australian dollar versus the Japanese yen (AUD/JPY) topped out ahead of the S&P 500 - it was only a matter of time before the index topped as well. The subsequent plunge was supported by the sudden drop in AUD/JPY.

The Australian dollar versus the Japanese yen (AUD/JPY) topped out ahead of the S&P 500 – it was only a matter of time before the index topped as well. The subsequent plunge was supported by the sudden drop in AUD/JPY.



Daily T2108 vs the S&P 500

Black line: T2108 (measured on the right); Green line: S&P 500 (for comparative purposes)
Red line: T2108 Overbought (70%); Blue line: T2108 Oversold (20%)


Weekly T2108
Weekly T2108
*All charts created using
freestockcharts.com unless otherwise stated

The charts above are the my LATEST updates independent of the date of this given T2108 post. For my latest T2108 post click here.

Related links:
The T2108 Resource Page
Expanded daily chart of T2108 versus the S&P 500
Expanded weekly chart of T2108

Be careful out there!

Full disclosure: long SVXY shares, long SSO shares and call options, long WDAY call options, long UVXY put options, short USO puts, short USO call spread, long CAT put options, long IBB call option

Aug
26

T2108 Update (August 26, 2015) – The VIX Remains Rangebound As Stock Buyers Finally Close Strongly

written by Dr. Duru
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(T2108 measures the percentage of stocks trading above their respective 40-day moving averages [DMAs]. It helps to identify extremes in market sentiment that are likely to reverse. To learn more about it, see my T2108 Resource Page. You can follow real-time T2108 commentary on twitter using the #T2108 hashtag. T2108-related trades and other trades are occasionally posted on twitter using the #120trade hashtag. T2107 measures the percentage of stocks trading above their respective 200DMAs)

T2108 Status: 9.7% (a 59% increase and first after six straight days of declines)
T2107 Status: 19.4%
VIX Status: 30.3
General (Short-term) Trading Call: Bullish
Active T2108 periods: Day #4 below 20% (oversold), Day #5 under 30%, Day #28 under 40%, Day #68 under 50%, Day #85 under 60%, Day #284 under 70%

Reference Charts (click for view of last 6 months from Stockcharts.com):
S&P 500 or SPY
SDS (ProShares UltraShort S&P500)
U.S. Dollar Index (volatility index)
EEM (iShares MSCI Emerging Markets)
VIX (volatility index)
VXX (iPath S&P 500 VIX Short-Term Futures ETN)
EWG (iShares MSCI Germany Index Fund)
CAT (Caterpillar).

Commentary
The buyers finally showed up and stood victorious at the close. T2108 rushed upward to 9.7% from 6.1%. (I forgot to note yesterday that T2108 just missed the intra-day low of 5.9% from the historic March, 2009 low!). The S&P 500 (SPY) ended a 6-day losing streak and FINALLY closed above its lower-Bollinger Band (BB) for the first time in 5 days. This produced a 3.9% gain on the index.


Buyers finally take the baton from the persistent sellers on the S&P 500 (SPY)

Buyers finally take the baton from the persistent sellers on the S&P 500 (SPY)


Surprisingly, the volatility index, the VIX, failed to close below the low of the last major upward surge. This bear/bull line just happens to coincide with the intraday high from 2012’s market sell-off.


The volatility index remains above the old 2012 intraday high and thus stays in the "dangerzone"

The volatility index remains above the old 2012 intraday high and thus stays in the “dangerzone”


Why do I think the VIX is still in the dangerzone? Check out these stats from VIX expert Bill Luby:


So, I had to ask…is the term structure of the VIX in contango (futures at a higher level than current (spot) levels) or in backwardation (futures at a lower level than current (spot) levels)?


Typically, people have more fear about the future than the present because the future is unknown. The current backwardation means there is a LOT more fear about the current day than the future. I culled Bill Luby’s blog The VIX and More for a good post on backwardation. A post from October 21, 2012 titled “The 2012 VIX Futures Term Structure as an Outlier” includes a graph that I reprint below showing the “typical” contango pattern for the VIX. The year 2008 is the only year in the sample at that time to produce significant backwardation.


Normalized VIX Futures Term Structure from 2004 to 2012

Normalized VIX Futures Term Structure from 2004 to 2012


Source: VIX and More

You should read the article for more background. The bottom-line is that while fear about the present is running so much higher than the future, we should expect wild swings in the market as over-sensitized traders and investors react and over-react and respond to every signal. Special reports like the ones CNBC runs every night like an emergency response center likely add an extra element of anxiety. The GOOD news for those with strong stomachs and good risk management: betting AGAINST the current high levels of the VIX will most likely pay off (and pay off well in these particularly extreme days) if you plan out a strategy that you can sustain over the course of weeks (or months if the current panic REALLY gets extreme).

I forgot to note on Monday that the CBOE Crude Oil Volatility Index (OVX) broke out. The rangebound trade I made a month ago on United States Oil (USO) is of course not working out well with volatility soaring like this. However, I am getting ready to make a fresh bet if volatility reaches the earlier highs. My first trade was like dipping my toe in the water. The next one will be the serious bet. Stay tuned.


Volatility on USO, aka OVX, breaks out. Will it reach earlier highs?

Volatility on USO, aka OVX, breaks out. Will it reach earlier highs?


The Australian dollar (FXA) and Japanese yen (FXY) combination, aka AUD/JPY, threw the market a bone by holding the previous day’s low and making a comeback. This was a small positive, but only a renewed rise gets the market out the dangerzone. A break of the major low from Monday would mark a disastrous breakdown and fresh wave of bearishness. I hope to write another piece soon explaining again why I think of AUD/JPY as such an important tell.


The Australian dollar versus the Japanese yen holds the line for now.

The Australian dollar versus the Japanese yen holds the line for now.


I was watching AUD/JPY when I was asked a question about buying ProShares Short VIX Short-Term Futures (SVXY) on StockTwits.


An important question on SVXY

An important question on SVXY


I was hesitant because I sold yesterday’s fortuitous grab of SVXY shares right at the open. SVXY faded from there and even traded under $50 for a spell. It SEEMED like a great moment to get back in. However, my trading rules were ringing in my head, so I left it alone and instead placed a low-ball limit order close to Monday’s low.

As time wore on (I am talking minutes!), I noticed that the Japanese yen was continuing to weaken. I decided to speculate that the strengthening indicated buying returning to the market (in-line with my trading rule on AUD/JPY), so I bought a single put option on ProShares Ultra VIX Short-Term Futures (UVXY). These options are VERY expensive right now, so I do not want to load up on them as I normally would do. As a reminder, I prefer to speculate with options because they automatically limit my downside to a small amount.

Sure enough, the yen continued to weaken, AUD/JPY rose strongly into the close, and I sold the put for a tidy gain. The buying on the market was strong enough for me to lock in a double on my ProShares Ultra S&P500 (SSO) call options that triggered near yesterday’s close.

Going back to the standard T2108 rules, the rangebound VIX did not trigger any fresh trades. I have chosen the aggressive path, so I load up again on T2108 trades if the VIX breaks the high for the current cycle. If this happens, I will try to wait for an additional 5 to 10% rise above recent highs. Less aggressive traders/investors should keep waiting for the low of the last major surge to break. Again, the intraday 2012 high conveniently marks this dividing line.

For good measure, I got back into a (small) hedge using Caterpillar (CAT) put options. This move is VERY early. However, with this oversold period now in its fourth day and T2108 still in single digits, I do not want to stay as “naked” as I have been since closing out most of my remaining short positions on Tuesday (August 25th). The relative weakness in copper miner Freeport-McMoRan Inc. (FCX) triggered my interest in CAT puts. FCX closed right at its historic low from late 2008 – a level that was last since in late 2002. Yikes.


Someone forgot to tell Freeport-McMoRan Inc. (FCX) about the day's rally!

Someone forgot to tell Freeport-McMoRan Inc. (FCX) about the day’s rally!


Buckle up and brace for more drama!

(In after hours news, Workday (WDAY) managed to disappoint and closed down about 7%. That ruins one of the call options I bought during Friday’s sell-off into oversold conditions.)


Daily T2108 vs the S&P 500

Black line: T2108 (measured on the right); Green line: S&P 500 (for comparative purposes)
Red line: T2108 Overbought (70%); Blue line: T2108 Oversold (20%)


Weekly T2108
Weekly T2108
*All charts created using
freestockcharts.com unless otherwise stated

The charts above are the my LATEST updates independent of the date of this given T2108 post. For my latest T2108 post click here.

Related links:
The T2108 Resource Page
Expanded daily chart of T2108 versus the S&P 500
Expanded weekly chart of T2108

Be careful out there!

Full disclosure: long SVXY shares, long SSO shares and call options, long WDAY call options, long UVXY put options, short USO puts, short USO call spread, long CAT put options, long FCX

Aug
25

T2108 Update (August 25, 2015) – Sellers Maintain Control of the Stock Market

written by Dr. Duru
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(T2108 measures the percentage of stocks trading above their respective 40-day moving averages [DMAs]. It helps to identify extremes in market sentiment that are likely to reverse. To learn more about it, see my T2108 Resource Page. You can follow real-time T2108 commentary on twitter using the #T2108 hashtag. T2108-related trades and other trades are occasionally posted on twitter using the #120trade hashtag. T2107 measures the percentage of stocks trading above their respective 200DMAs)

T2108 Status: 6.1%
T2107 Status: 15.5%
VIX Status: 36.0%
General (Short-term) Trading Call: Bullish
Active T2108 periods: Day #3 below 20% (oversold), Day #4 under 30%, Day #27 under 40%, Day #67 under 50%, Day #84 under 60%, Day #283 under 70%

Reference Charts (click for view of last 6 months from Stockcharts.com):
S&P 500 or SPY
SDS (ProShares UltraShort S&P500)
U.S. Dollar Index (volatility index)
EEM (iShares MSCI Emerging Markets)
VIX (volatility index)
VXX (iPath S&P 500 VIX Short-Term Futures ETN)
EWG (iShares MSCI Germany Index Fund)
CAT (Caterpillar).

Commentary

The day's been weak since the open. On notice to continue expecting large intraday moves. Buckle up! $SPY #VIX

— Duru A (@DrDuru) Aug. 25 at 12:42 PM


The sellers kept up the pressure today. Futures were notably weak before the open. Yet, buyers showed up in time to gap the market up in a move that COULD have confirmed an oversold bottom. Instead, the sellers immediately moved to retake control, and the ball rolled all downhill from there. T2108 closed at a fresh low of 6.1%!


How low will T2108 go?

How low will T2108 go?



The S&P 500 closes for a loss for the 6th straight day...aand below the lower-Bollinger Band for an amazing fourth straight day

The S&P 500 closes for a loss for the 6th straight day…aand below the lower-Bollinger Band for an amazing fourth straight day


The sellers remain strong as they have been able to press the S&P 500 for a fourth straight day below its lower-Bollinger Band (BB). The index has lost 11.2% over six straight days of selling. Whenever the buyers return to bring some balance, the resultant rally is likely to be very impressive.

Here is a chart of the NASDAQ (QQQ) for additional context. The tech-heavy index closed with a fractional loss only because Monday’s low (and open) were so incredibly (and unbelievably) deep. The NASDAQ has lost 11.5% in six days of selling.


Little consolation a the NASDAQ's selling did not create a new low.

Little consolation a the NASDAQ’s selling did not create a new low.


According to the rules I laid out yesterday, there were no trades to make no matter your risk preference. The VIX managed to trade perfectly between the previous day’s high and low. As a reminder, a break to a new high gets aggressive traders buying. Less aggressive buyers wait until the VIX CLOSES below a previous low.


The volatility index swings through a wide range but stays "in bounds"

The volatility index swings through a wide range but stays “in bounds”


This action translated into large moves in the volatility products. ProShares Short VIX Short-Term Futures (SVXY) plunged into the close while ProShares Ultra VIX Short-Term Futures (UVXY) is putting on a rare display of resilience.


ProShares Short VIX Short-Term Futures (SVXY)  gets crushed again as an initial rally quickly fades

ProShares Short VIX Short-Term Futures (SVXY) gets crushed again as an initial rally quickly fades

ProShares Ultra VIX Short-Term Futures (UVXY) reaches again for its 200DMA downtrend

ProShares Ultra VIX Short-Term Futures (UVXY) reaches again for its 200DMA downtrend


Although the trading rules did not trigger, I did execute three key trades.

With T2108 oversold, I set at least one limit order for call options on ProShares Ultra S&P500 (SSO) at a low ball price to catch a plunge while I am not monitoring the stock market. Surprisingly, my low ball offer of the day triggered near the close. I guess it makes sense given the rush of selling. Again, I strongly prefer at this stage of the oversold period to buy additional positions when the VIX is surging to new heights.

The second trade was on shares of ProShares Short VIX Short-Term Futures (SVXY). The plunge into the close looked so much like panic that I could not resist buying back into SVXY for the next short-term swing. This is even more speculative than usual given the VIX did not print a new high.

Finally, the third trade was a two-for-one on solar stocks Canadian Solar (CSIQ) and First Solar (FSLR). I included CSIQ in my shopping list of stocks on the first oversold day because I concluded the stock was “ridiculously” oversold. I took a risk and bought as CSIQ faded to close the opening gap up (I wish I had CSIQ on the list for Monday’s plunge!). I set a tight limit order to sell at $18 since I am already holding call options. Fortunately, the stock proceeded to rally straight up and took out my price target in short order. After CSIQ, I took a look at FSLR and decided to jump back into my favorite solar stock with call options.

Unfortunately, both CSIQ and FSLR hit walls later in the day along with the market and ended up closing at their lows. FSLR was turned back from resistance at its 50DMA. CSIQ has a chart commonly seen in the market right now: a gap down and a rally on Monday; a gap up and a fade on Tuesday – almost a “sloppy” abandoned baby bottom except the upside showed too little conviction. The battle between bears and bulls, sellers and buyers is just getting warm.


Canadian Solar (CSIQ) is struggling like so many stocks to pick itself up and out of deeply oversold conditions in what ALMOST looks like an abandoned baby bottom.

Canadian Solar (CSIQ) is struggling like so many stocks to pick itself up and out of deeply oversold conditions in what ALMOST looks like an abandoned baby bottom.


Here is what a proper abandoned baby bottom looks like (from Steve Nison’s Candlecharts.com):



Source: Candlecharts.com

Nison: “A very rare Japanese candlestick top or bottom reversal signal. It is comprised of a doji star that gaps away (including shadows) from the prior and following sessions’ candlesticks. This is the same as a Western island top or bottom in which the island session is also a doji.”

Me: An abandoned baby bottom "traps" bears and sellers on the second day. These sellers assumed the big gap down confirmed the bearishness of the selling on the first day.

Finally, finally…a nod to China’s increasing woes with this short news video from a Canadian network followed by chart showing the on-going collapse of the Shanghai Composite Index (SSEC).




The Chinese government loses control of the Shanghai Composite Index as it continues to collapse from its 200DMA breakdown. This reverses a gain that was as high as 59% for 2015.

The Chinese government loses control of the Shanghai Composite Index as it continues to collapse from its 200DMA breakdown. This reverses a gain that was as high as 59% for 2015.



Daily T2108 vs the S&P 500

Black line: T2108 (measured on the right); Green line: S&P 500 (for comparative purposes)
Red line: T2108 Overbought (70%); Blue line: T2108 Oversold (20%)


Weekly T2108
Weekly T2108
*All charts created using
freestockcharts.com unless otherwise stated

The charts above are the my LATEST updates independent of the date of this given T2108 post. For my latest T2108 post click here.

Related links:
The T2108 Resource Page
Expanded daily chart of T2108 versus the S&P 500
Expanded weekly chart of T2108

Be careful out there!

Full disclosure: long SVXY shares, long SSO shares and call options, long FSLR and CSIQ call options

Aug
25

A Time To Sell Some Housing Stocks

written by Dr. Duru
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(This is an excerpt from an article I originally published on Seeking Alpha on August 19, 2015. Click here to read the entire piece.)

I have spent a lot of time over the past four years touting the attractiveness of stocks in homebuilders. The ride has offered a lot of bumps along the way but my single mantra coming out of the housing trough to “buy the dips” has served me well. {snip}


The iShares US Home Construction (ITB) has swung its way widely to fresh 8+ year highs

The iShares US Home Construction (ITB) has swung its way widely to fresh 8+ year highs


Source: FreeStockCharts.com

This ride’s poignant lesson is that neither euphoria nor despair have long shelf lives among most homebuilder stocks. The market is at a particularly interesting euphoric phase with ITB trading at 8+ year highs and once again out-performing the S&P 500 (SPY). {snip} ITB has a relatively poor record of sustaining such moves (no surprise for almost any equity), so I decided it was time to unload my shorter-term holdings into the current euphoria. I sold my call options on ITB and Toll Brothers (TOL).

TOL has become a trading favorite because the stock is supported by a healthy buyback. {snip}


Can earnings next week (August 25th) help Toll Brothers (TOL) sustain this strong extension to a 10-year high?

Can earnings next week (August 25th) help Toll Brothers (TOL) sustain this strong extension to a 10-year high?


Source: FreeStockCharts.com

For braver traders who still see more short-term upside I offer up KB Home (KBH). {snip} With the company apparently hitting full stride on several important California communities, especially in Northern California, my interest is rising again. I will be closely watching earnings on September 24th to confirm a return of positive momentum.


An encouraging bounce from KB Home (KBH) as it rebuilds post-earnings gains

An encouraging bounce from KB Home (KBH) as it rebuilds post-earnings gains


Source: FreeStockCharts.com

This encouraging vote of confidence for homebuilders comes just ahead of what is supposed to be the first rate hike from the Federal Reserve on its way to policy normalization. The potential for a rate hike is coming just as housing looks like it is finally achieving sustainable upward momentum. {snip}


Single family housing starts have returned to an uptrend from the post-recession trough but have still not quite reached the LOW of the pre-recession cycle.

Single family housing starts have returned to an uptrend from the post-recession trough but have still not quite reached the LOW of the pre-recession cycle.


Source: US. Bureau of the Census, Privately Owned Housing Starts: 1-Unit Structures [HOUST1F], retrieved from FRED, Federal Reserve Bank of St. Louis, August 18, 2015.

The debate on the timing for a Fed rate hike is quite distracting, but it is important for assessing the potential for the market’s movement in coming months. {snip}


The market contradicts a lot of pundits by insisting on December as the month where odds of the first rate hike go above 50%

The market contradicts a lot of pundits by insisting on December as the month where odds of the first rate hike go above 50%


Source: CME Group FedWatch

There are even valid reasons for doubting the Fed will hike at all in the near-term. {snip}

{snip}

All the accompanying uncertainty makes it all the more prudent to take some profits on some homebuilder positions and have the cash ready for any subsequent buying opportunities. {snip}


Housing affordability has dropped to a post-recession low but remains better than at anytime before the recession.

Housing affordability has dropped to a post-recession low but remains better than at anytime before the recession.


Source: National Association of Realtors, Housing Affordability Index (Composite)© [COMPHAI], retrieved from FRED, Federal Reserve Bank of St. Louis, August 14, 2015.

{snip}

Source: Zillow

This contrast may seem like a perfect driver for ramping up sales of housing. However, the exorbitant levels of rent are slowing down the ability of many households to save for downpayments in an environment where credit remains relatively tight. {snip}

The bottom-line is that housing is at a very critical juncture given all the points described above. While I stick by the overall bullish thesis on housing as described in earlier pieces and supported by one earnings report after another, selling some housing stocks here provides some cushion to help ride out whatever is coming. If recent history holds, the current rush into housing stocks will soon be followed by a nearly equal retreat before the rapid cycle repeats.

Be careful out there!

Full disclosure: no positions – see earlier pieces for the cases for core positions

(This is an excerpt from an article I originally published on Seeking Alpha on August 19, 2015. Click here to read the entire piece.)

Aug
25

T2108 Update (August 24, 2015) – How To Profit From An EPIC Oversold Period

written by Dr. Duru
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(T2108 measures the percentage of stocks trading above their respective 40-day moving averages [DMAs]. It helps to identify extremes in market sentiment that are likely to reverse. To learn more about it, see my T2108 Resource Page. You can follow real-time T2108 commentary on twitter using the #T2108 hashtag. T2108-related trades and other trades are occasionally posted on twitter using the #120trade hashtag. T2107 measures the percentage of stocks trading above their respective 200DMAs)

T2108 Status: 7.1% (a drop 61.0% from 18.1% ranks as third highest on record (since 1986). The two bigger plunges came from the crash of 1987. Now in fourth place is the plunge during the financial crisis on September 29, 2008.)
T2107 Status: 16.4% (a drop of 35.6% from 25.5%)
VIX Status: 40.7 (a jump of 45.3% that ranks as the fifth highest single-day gain since 1990. The VIX went up as much as 90% at the highs. That is NOT a typo – NINETY percent! )
General (Short-term) Trading Call: Bullish
Active T2108 periods: Day #2 below 20% (oversold), Day #3 under 30%, Day #26 under 40%, Day #66 under 50%, Day #83 under 60%, Day #282 under 70%

Reference Charts (click for view of last 6 months from Stockcharts.com):
S&P 500 or SPY
SDS (ProShares UltraShort S&P500)
U.S. Dollar Index (volatility index)
EEM (iShares MSCI Emerging Markets)
VIX (volatility index)
VXX (iPath S&P 500 VIX Short-Term Futures ETN)
EWG (iShares MSCI Germany Index Fund)
CAT (Caterpillar).

Commentary
Today was an epic sell-off for the ages. I heard comparisons to the crash of 1987, to the financial crisis of 2008 to 2009, and to the massive debt ceiling driven sell-off in 2011. From a technical standpoint, these are all adequate comparisons even if the fundamental backdrops are different.

I have organized this post to first talk about my standard trio: T2108, the S&P 500, and the VIX. Next up are individual stocks that demonstrate the wild nature of the trading. Third, some market commentary from the experts. All these points are context and backdrop for the punch/bottomline: how in the world to profit from the madness. I use examples from my trading on the day to show my approach and rules.

T2108 fell a whopping 61.0% from 18.1% to today’s close of 7.1%. This was the third largest percentage drop on record (I have data going back to 1986). The top two both come from the crash of 1987: October 19, 1987 delivered a 85.4% drop to 0.86 (yes, that is LESS than ONE, not a typo!) and October 16, 1987 delivered a 65% drop to 5.88. Now in fourth place is September 29, 2008 with a 60.2% drop to 8.8, similar to today.


An EPIC drop for T2108. The entire stock market is oversold and broken down.

An EPIC drop for T2108. The entire stock market is oversold and broken down.


The S&P 500 (SPY) swung through an incredible range. The index fell a whopping 3.9% or a loss that was even larger than Friday’s sell-off. This makes a VERY rare string of two straight days where the ENTIRE length of the sell-off occurred below the lower-Bolligner Band (BB). The market simply cannot (OK, SHOULD not) get more oversold than this! A year of hard-fought gains (measured from August, 2014) have been wiped away in less than a week.


The S&P 500 (SPY) is already challenging the lows from the last oversold period in October, 2014!

The S&P 500 (SPY) is already challenging the lows from the last oversold period in October, 2014!


The daily chart hardly does justice to the swing of selling, buying, and more selling on the day. In fact, the gap down on the open is not clearly identified, probably partly as a result of a chaotic and slow open of the U.S. market. Here is the SPY ETF to show the real open followed by the 5-minute trading action.


The "real" market of stocks gapped down at the open and gyrated wildly from recovery to fade.

The “real” market of stocks gapped down at the open and gyrated wildly from recovery to fade.

The 5-minute chart shows a steady march to the highs at lunchtime, a fade once traders returned with full bellies, and a resumption of selling with the 2:30pm margin calls. Sellers even managed to beat back a late rally attempt.

The 5-minute chart shows a steady march to the highs at lunchtime, a fade once traders returned with full bellies, and a resumption of selling with the 2:30pm margin calls. Sellers even managed to beat back a late rally attempt.


Note how the index actually managed to get tantalizingly close to a complete loss reversal.

Since the market movement was epic, volatility had to be epic as well! The VIX, the volatility index, closed at 40.7. This level was last seen during the 2011 sell-off. HOWEVER, the one-day increase of 45.3% ranks as the FIFTH largest since at least 1990 (I have data that far back). Incredibly, the VIX was up as much as 90% at it highs! That level of 53.9 was last seen….right around the historic March, 2009 lows. Talk about epic.


The VIX soars to epic levels in an epic way

The VIX soars to epic levels in an epic way


The impact on the volatility products, the ETFs, was equally dramatic. The ProShares Short VIX Short-Term Futures (SVXY) closed with a 18.8% loss and was down over 33% at one point.


ProShares Short VIX Short-Term Futures (SVXY) ranged from 45.7 to 67.2

ProShares Short VIX Short-Term Futures (SVXY) ranged from 45.7 to 67.2


Before talking strategy, I am skipping to three individual stocks to demonstrate the unreal open that many stocks experienced. Verizon (VZ) was down as much as 17% after the open.


Was that a REAL drop on Verizon (VZ)?!?!

Was that a REAL drop on Verizon (VZ)?!?!


Apple (AAPL) put on one of the more spectacular shows on a day of spectacular shows. AAPL opened down a startling 10.0%. AAPL was down 13% at its low. Suddenly, AAPL became a steamroller in the opposite direction.


Suddenly, AAPL was up 2.9% at its high of the day before settling in for a 2.5% loss.

Baidu (BIDU) dropped to $100 and then gained FOURTY-ONE percent into the close!?!?!


Baidu (BIDU) put on an unbelievable show. Yowza!

Baidu (BIDU) put on an unbelievable show. Yowza!


In case you were wondering, yes, the currency markets went absolutely bonkers starting from Sunday and all the way into the U.S. trading close. My favorite indicator of market sentiment, the Australian dollar (FXA) versus the Japanese yen (JPY), made things plain to me that panic was in full effect. It is very rare to see currencies move well past the Bollinger Bands. The sharp bounce back surprises me much less than the ability for AUD/JPY to drop as low as it did in the first place. This move could be an early warning shot on what I see as an increasing chance for a huge collapse in the Australian dollar.


The Australian dollar finally takes a steep plunge as the Japanese yen emerges as the strongman in the current panic

The Australian dollar finally takes a steep plunge as the Japanese yen emerges as the strongman in the current panic


The U.S. dollar (UUP) continues to suffer as the market increasingly realizes the narrative of policy divergence is fading to black. I guess the stock market’s problem all along was NOT an overly strong dollar. Now the problem appears in the form of a weakening dollar.


The U.S. dollar temporarily breaks its previous low since the downtrend from the March 12-year high.

The U.S. dollar temporarily breaks its previous low since the downtrend from the March 12-year high.


All this trading chaos must have drivers, right. For those of you yearning for an explanation, I offer a bulleted summary of Jim Cramer’s sober analysis in “Cramer Remix: Waiting to buy? My message for you“:

  • First of all, do not mistake the U.S. stock market action with the action in the U.S. economy.
  • The Federal Reserve’s indecisiveness on interest rates is causing market nervousness and extra uncertainty.
  • China has inflicted damage on the global economy – the Shanghai Composite should reverse its entire gain from 2200 to 5178 since “…it was built on tremendous account growth and loose requirements about borrowing on margin.”
  • There is no systemic risk that could take the market down 25%, maybe there is another 6 or 7% down from here.

So that is a relatively bullish take.

I prefer master technician Tom McClellan’s outlook given what I see as continued deterioration in the underlying technicals of the market. Mclellan completely nailed this sell-off. I noted his well-timed warning last week. McClellan appeared on CNBC today dropping straight knowledge in the most deadpan, non-celebratory tone one could imagine. He even admonished CNBC on the definition of a correction like a stern schoolteacher (a correction is a market move contrary to the prevailing trend; a bull/bear market is defined by an up/downtrend). McClelland considers what’s coming a correction in an on-going bull market. Here are the famous technician’s most salient points:

  • The VIX went way above its futures contracts. Whenever that happens, the market always bounces.
  • The stock market correction has just begun and should run through April, 2016.
  • The main tell is the eurodollar futures contract which is an interest rate contract. It predicts stock market action a year out (not perfectly!). The correction that happened is something McClelland has been looking for all year.
  • The leading decline in the Dow Transports is similar to what happened in 1999.
  • The biggest wildcard is the Federal Reserve. If the Fed comes in and provides fresh liquidity for the market, it will ruin his forecast. (This point was NOT included in the clip).



OK. So how to profit from all this? First and foremost, establish your trading rules and stick to them. Re-evaluate as needed but do NOT get swayed by the latest shift in the market, the loudest stampede, the biggest fears, or the loudest celebrations of a potential bottom. I of course recommend picking from the T2108 trading rules for trading the oversold period…

  • With selling pressure so intense as represented by sky high volatility, by the ability of sellers to continue pressing well beyond lower Bollinger Bands, and by T2108 plunging to rock bottom lows at a record-setting pace, oversold buys must be made VERY strategically.
  • Aggressive traders can buy when the VIX cracks a new high for this cycle. The longer you can wait, the better. There should be a bias for taking profits.
  • Less aggressive traders can wait until AFTER the VIX closes below the previous day’s low. This approach could produce misses on key buying opportunities. Traders in this category should target holds until at least T2108 exits the oversold period. This occurs once T2108 closes at or above 20%.
  • Conservative investors should wait until T2108 exits the oversold period to make a buy. This approach could cause more whiplash than the more aggressive strategies. I am also least inclined to follow this strategy as I believe the overall market is weakening at least through the seasonally weak months of August, September, and October. Exits from oversold periods may occur right below key resistance levels that could shift my preference to fades.

T2108 does not typically spend much time oversold. This is the huge opportunity for making aggressive buys during the oversold period, especially when the volatility index is soaring.


Mean and Median Duration Below Given T2108 Threshold

Mean and Median Duration Below Given T2108 Threshold


The longer T2108 stays in the oversold period, the more likely the S&P 500 (SPY) will exit lower than when it entered. So, once the oversold period reaches the mean of five days, traders need to start bracing themselves. I think the current dramatic plunge in T2108 means that we should brace for an extended stay in the oversold period.


S&P 500 Performance By T2108 Duration Below the 20% Threshold (Oversold)

S&P 500 Performance By T2108 Duration Below the 20% Threshold (Oversold)


Finally, here is a shortened summary of my trades as an example of the more aggressive approach to trading the oversold period.

The headlines in the early morning were full of global stock market carnage, and the U.S. futures were down significantly. I dusted off the rule book and got ready. Recall the 5-minute chart above on the S&P 500 and note that the action was moving fast. It was definitely a time I wish I had the trading bots on my side. At least I got the kind of trading day I love during oversold trading: initial selling to take stocks to over-extended lows followed by a rush of buying into the vacuum. At the open, my price alerts were firing like crazy, and I had to simply ignore them. They did not contain any new information that I needed. EVERYTHING was gapping down hard and deep. It was just a matter of selecting a few, focused targets and make the most of them. I also largely ignored the options I purchased on Friday. I knew they were dropping to zero, but my purchases already incorporated that scenario. The great advantage of buying options is never worrying about gaps against the position that instantly cause a loss larger than I was willing to take.

I met with a lot of frustration early on because market makers were not providing liquidity in the options market. This was understandable given the huge amount of selling at the open. It helped to solidify my resolve that this selling had to be bought. That is, market makers were likely anticipating a bounce and were slow to get proper pricing done. I created what limit orders I could on call options. Most of these orders in the likes of Disney (DIS) (see “Disney’s Bearish Breakdown: A Case Study of Risk Management for Long-Term Investors“), Apple (AAPL), Netflix (NFLX), and Canadian Solar (CSIQ) never filled. Google (GOOG) DID fill, and I was able to notch a quick double on that position. I quickly moved on to cover more short positions. I am now VERY naked and fought the urge all day to dabble in fresh put options and shorts. As a reminder, in the oversold period short positions get pared back significantly or closed out completely.

As I struggled to get options orders placed, it dawned on me that I should go after shares and plan to hold tight. Indeed, share purchases turned out to be my big winners on the day. I first doubled down on Friday’s “longer-term” purchases of ProShares Ultra S&P500 (SSO) and ProShares Short VIX Short-Term Futures (SVXY). At one point during the day’s rebound, I was sitting on a surprisingly good gain. I did not sell. In retrospect, I should have sold the SVXY position which had reached a 10% gain. It is not yet a standard play in the T2108 arsenal although I need to make it one. In this case, I could have preserved the SVXY-generated cash to fund future SSO positions. In shorter-term trading, I managed to flip SVXY TWICE in the midst of the volatility. The day turned out pretty well even as the close disappointed.

As I will continue to remind readers, I fully expect the oversold period to feel painful. Whatever I can do to buffer the pain, I will do. The quick flips and short-term trades help to provide the profits to do just that. This is also NOT a time for bears to chase stocks downward. That is asking for trouble. I think of stocks in the oversold period like rubber bands. They could snap upward at any time for any reason and quite abruptly. That kind of behavior is a recipe for quick losses on bearish positions. On the flip side, I am applying the T2108 trading rules to avoid random attempts at catching falling knives.

Finally, if you are not a currency trader, I highly recommend you at least make a habit of checking on the currency market. The wilder and more extreme things are in foreign exchange, the same you should expect for stocks….and the more you should expect an imminent reversal.


Daily T2108 vs the S&P 500

Black line: T2108 (measured on the right); Green line: S&P 500 (for comparative purposes)
Red line: T2108 Overbought (70%); Blue line: T2108 Oversold (20%)


Weekly T2108
Weekly T2108
*All charts created using
freestockcharts.com unless otherwise stated

The charts above are the my LATEST updates independent of the date of this given T2108 post. For my latest T2108 post click here.

Related links:
The T2108 Resource Page
Expanded daily chart of T2108 versus the S&P 500
Expanded weekly chart of T2108

Be careful out there!

Full disclosure: long AAPL calls and put spread, long SSO call options and shares, long UVXY put options, long SVXY shares, short AUD/JPY, net long the U.S. dollar

Aug
24

The iShares US Home Construction Reaches A New Level Of Outperformance

written by Dr. Duru
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My case for managing risk by peeling back some of my holdings in homebuilders turned out to be quite timely. In what has become a near regular pattern for the iShares US Home Construction (ITB), sharp selling has quickly followed a strong run-up and rush of excitement in homebuilders. The sellers and bears are almost as stubborn as the buyers who helped send ITB to a new 8-year high earlier in the week.


iShares US Home Construction (ITB) begins another pullback after a strong run-up

iShares US Home Construction (ITB) begins another pullback after a strong run-up


Source: FreeStockCharts.com

While it may appear that news of existing home sales helped drive ITB lower, it was more likely general market malaise. Existing home sales reached a new post-recession high in July.


At a post-recession high, existing home sales are now back to where the last housing cycle BEGAN

At a post-recession high, existing home sales are now back to where the last housing cycle BEGAN


Source: National Association of Realtors, Existing Home Sales© [EXHOSLUSM495S], retrieved from FRED, Federal Reserve Bank of St. Louis, August 22, 2015.

Supply and demand are still out of balance in the aggregate. Unsold inventory dropped 4.7% year-over-year and sits at 4.8 months of supply. While prices rise partly as a result of this imbalance, supply has still not responded in terms of number of units. Filling this gap is one of the opportunities that still lies ahead for homebuilders.


The total number of unsold homes in inventory remains around post-recession lows as prices steadily rise.

The total number of unsold homes in inventory remains around post-recession lows as prices steadily rise.


Source: National Association of Realtors, Existing Home Sales: Housing Inventory© [HOSINVUSM495N], retrieved from FRED, Federal Reserve Bank of St. Louis, August 22, 2015.
S&P Dow Jones Indices LLC, S&P/Case-Shiller 20-City Composite Home Price Index© [SPCS20RNSA], retrieved from FRED, Federal Reserve Bank of St. Louis, August 22, 2015.
National Association of Realtors, Median Sales Price of Existing Homes© [HOSMEDUSM052N], retrieved from FRED, Federal Reserve Bank of St. Louis, August 22, 2015.

While ITB fell 2.0% on Friday and sits 4.0% below the newly minted 8-year high from last week, the S&P 500 (SPY) fared a lot worse. The index’s 3.2% loss on Friday capped a whopping 6.3% loss over for 4 straight days of selling. This divergence produced a new level of outperformance for ITB over SPY. The ITB/SPY ratio rose back to levels last seen during the early optimism over the 2014 spring selling season.


The iShares US Home Construction (ITB) last performed this well against the S&P 500 (SPY) in early 2014

The iShares US Home Construction (ITB) last performed this well against the S&P 500 (SPY) in early 2014


Source: StockCharts.com

If the current market and global economic malaise dissuades the Federal Reserve from hiking rates this year or at least persuades the Fed to soften expectations for further rate hikes, homebuilders will become a natural go-to trade/investment. The market must wait another 3 1/2 agonizing weeks to get its next dose of Fed-speak. In the meantime, one more jobs report will arrive to cause yet more debates about the odds for a September rate hike. Along the way, volatility in the market should remain high and provide plenty of time for picking spots for the next buy-the-dip opportunity on homebuilders.

While my eye is trained on $28 for ITB (around the 50-day moving average), two individual stocks have already made sharp reversals to potential buying points: KB Home (KBH) and Meritage Homes (MTH). Not surprisingly, these are also stocks that have recently underperformed relative to other homebuilders in ITB.

I am still waiting on September earnings for KBH. However, fans of KBH are getting yet another chance to buy the builder at its pre-earnings price.


KB Home (KBH) has quickly retreated back to its post-earnings low on the recent sell-off

KB Home (KBH) has quickly retreated back to its post-earnings low on the recent sell-off


A break below the recent lows would likely motivate more selling, particularly given short-sellers have tended to chase KBH downward. Short interest in KBH is a very large 23% of float. Interestingly, the shares short are actually back to levels last seen when KBH made a post-recession peak in early 2013. This peak occurred after a tremendous run-up in the shares. (I did not collect shares short data during the period of the gap shown in the chart below).


Bears on KBH have retreated to lows last seen in early 2013

Bears on KBH have retreated to lows last seen in early 2013


Source: NASDAQ.com

Meritage Homes (MTH) is another stock revisiting important levels. MTH’s last rally stopped cold at the 50-day moving average (DMA). In April, June, and July, MTH failed to break the post-recession high set back in 2013. The stock is now back to 200DMA support.


Meritage Homes (MTH) has lost its momentum from the announcement of a strong start to 2015.

Meritage Homes (MTH) has lost its momentum from the announcement of a strong start to 2015.


Source for stock charts: FreeStockCharts.com

MTH is one of a small number of homebuilders that sold off after its last earnings announcement and has yet to recover. I suspect a tough crowd penalized MTH for announcing that “abnormally heavy and persistent rain in Texas and Colorado” forced the company to push out 200 home closings into 2016. Other builders with heavy presences in these states did not make such declarations. This disparity in performance reminded of the heavy penalty KBH paid a few earnings cycles ago when it was the only major builder blaming logistical issues with city governments for poor sales flow. Still, I think the selling in MTH was overdone given otherwise stellar earnings and revenue performance. The stock tops my list, after ITB, for the next round of buying.

Like KBH, MTH has an outsized volume of bets riding against its fortunes with short interest at 17% of float. Unlike KBH, shorts have recently ramped UP on MTH to new highs. This activity suggests a positive catalyst could send MTH skyrocketing higher again. (I did not collect shares short data during the period of the gap shown in the chart below).


Bears are crowding around Meritage Homes (MTH)

Bears are crowding around Meritage Homes (MTH)


Source: NASDAQ.com

The general sell-off in the market could continue to drag down homebuilders. I am staying patient with buying the dip as I still have a sizable core holding of builders. There is a strong chance the market will bounce in the coming week. However, for buying more homebuilder stocks, I am looking beyond that bounce and anticipating a resumption of weakness going into the September Federal Reserve meeting.

Be careful out there!

Full disclosure: no positions

Aug
23

Disney’s Bearish Breakdown: A Case Study of Risk Management for Long-Term Investors

written by Dr. Duru
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The stock of Disney (DIS) has suffered a massive and very bearish breakdown this month. At the time of writing, the stock has lost 19% since closing at its last all-time high.


The last time Disney (DIS) suffered a big breakdown buyers showed up quickly - not this time.

The last time Disney (DIS) suffered a big breakdown buyers showed up quickly – not this time.


Source: FreeStockCharts.com

Disney’s first breakdown came earlier this month. The stock lost 9.2% and closed below its 50-day moving average (DMA) on extremely high trading volume. The headlines were abuzz about poor ratings on ESPN and cord-cutting millennials who apparently will never watch another Disney show (and never have kids who will demand Disney products or go to Disneyland?). For Disney bulls, the drop looked like an excellent buying opportunity. I even jumped at the chance to get back into a long-term option (expiring January, 2017) and successfully managed to flip short-term call options to help pay for the long-term position.

The very next day delivered a warning that this time may be different. DIS lost as much as another 5.6% before bouncing away from its 200DMA line of support. Trading volume was almost as high as the previous day. Interpretation: there were still PLENTY of investors who wanted to get out of DIS. From that second day, DIS dribbled slowly downward toward its 200DMA. That line broke in spectacular fashion on August 20th. Trading volume ramped up again as DIS followed (or led) the general market into a large sell-off.

On Friday, Disney sellers finally took a RELATIVE break as DIS “only” lost 1.2% with the S&P 500 (SPY) losing a whopping 3.2%. (I know DIS is a member of the Dow Jones Industrial Average, but I ignore that index given its price-weighting – a completely outdated and outmoded way of measuring performance in the stock market). Buyers even showed up to pick DIS off its lows. This relative strength is encouraging and short-term traders can play this attempted bounce with a stop-loss at the lows. But what about longer-term investors?

Long-term investors could completely ignore this temporary bout of selling. They could rest in a comfortable assumption that the market will come back around to the bullish case with little to no additional downside risk to the portfolio. I am assuming you are NOT one of those content folks if you are bothering to read this post. This kind of blissful blindfold is a dangerous approach. DIS has broken down in a bearish fashion, so I am assuming the odds of a continued sell-off are high enough to make most bulls uncomfortable. If the selling continues, even long-term investors who have not taken steps to reduce risk will be VERY tempted to capitulate just when the fear and panic is high enough to create a sustainable bottom in the stock. Very bad.

I propose two investing scenarios for consideration that investors can apply to any stock. The first scenario offers fully invested investors an option for trading off risk for the opportunity to buy cheaper shares. The second scenario offers investors already itching to accumulate more shares a structured and disciplined approach to buying with lower risk. Note that these scenarios share the same buying strategy but differ in how to apply cash.

Scenario #1: Fully invested in Disney
Investors in this position have the MOST to lose. Presumably, you have no spare cash to buy more shares, so you will be most eager to protect profits (or limit losses) if DIS continues to fall. You will be most vulnerable to disposing of your shares just as DIS makes a final bottom amid a peak in panic and fear. Building up fortitude NOW should pay off in the long-run.

If looking ahead you could withstand, say, a 50% loss in DIS without breaking a sweat, then you can stop reading now. If not, then the bearish breakdown below 200DMA represents a critical event. A prudent investor could sell at least half his/her shares and put the cash aside as a buffer. If DIS makes a quick comeback, then use half of the buffer to buy back into DIS after it closes above its 200MDA two days in a row. The 2-day rule reduces the odds of getting whipsawed by a false breakout. The other half of the buffer sits waiting for the next buying opportunity. If DIS continues to sell-off then apply the entire buffer according to scenario #2…

Scenario #2: Looking for buying opportunities in Disney
Investors in this position can stay more relaxed with a lot less to lose and cash at the ready to reduce the cost basis of current holdings and enhance future long-term returns. Take the investible cash and divide it into three equal parts. The first buying scenario is the same 200DMA conditional described in scenario #1 above. If DIS continues along its bearish ways before crossing above the 200DMA, then identify three buying points. The last buying point does not apply if you were unfortunate enough to get whipsawed by a fake breakout above the 200DMA.

The first buy point is a fill of the February post-earnings gap up which would be a price around $94. This point has multiple layers of importance. Not only was it the last time positive news catapulted DIS to such a large gain, but also it marks a significant breakout that established the subsequent run-up for DIS. A complete reversal means investors are getting another shot at buying DIS at a price I am guessing you thought you would never see again.

The second buy point comes from the lows from 2014 where DIS last broke down below its 200DMA. That price is around $80, a gut-wrenching additional 19% loss from current levels. The significance of this point is more technical. October was a significant bottom where the entire market became oversold as panic and fear climaxed. If Disney’s long-term story remains intact this level should certainly hold firm.

The worst case scenario comes from sellers succeeding in pushing Disney through this critical $80 level. At THAT point, even Disney bulls will need to re-evaluate the bullish thesis. Either way, it will be time to press the reset button, and I hope to be ready to rewrite the investing strategy for DIS.

The rules around these scenarios apply some structure and discipline to managing risk and making purchases. I like targeted buy points rather than more or less random successive purchases which are typically done in the hope that the selling has reached some kind of extreme. This latter approach also carries the “affectionate” name “trying to catch a falling knife.”

For managing risks even more tightly, I prefer using options. I like using options even MORE in a case such as Disney where a significant breakdown has occurred. The structured buying rules are nice, but they are no substitute for a crystal ball. Disney could fall further for longer than any of us could imagine sitting here now. Options offer a way to significantly reduce downside risk while maintaining significant upside opportunity.

For investors in either scenario #1 or #2, the first two buys go into call options. One call option offers the right, but not the obligation, to buy 100 shares of the underlying stock at a price called the “strike price.” The third buy should be in shares of Disney. At THAT point, you are truly digging in your heels and committing to Disney for the very long time it will take for shares to recover. Since you only lost the purchase price of options on the first two buys, you will have plenty of cash on hand left for the shares.

Determine the MAXIMUM amount to spend on options by the amount you are willing to lose in Disney if you were to buy shares. Since you are a long-term Disney bull who probably wants to participate in the coming hype over Star Wars, etc…, you want to go for the January, 2017 call options. Let’s see how this works.

Start with a long-term price target. Since you are long-term bullish, you can certainly believe that DIS can re-obtain its all-time high by January, 2017. So, let’s set a long-term price target of $123 or a 24% gain in 17 months. Without context, such a target sounds aggressive. Of course, it is not so aggressive considering Disney was trading at this level almost three weeks ago. DIS is up a whopping 546% from the historic 2009 lows. DIS has doubled since the end of 2013. These are heady gains that have probably spoiled a lot of investors!

Let’s assume you are willing to lose a maximum of $750 on this incremental investment. The January 2017 call option with a strike price of $110 costs $750. This option expired on January 21, 2017. If DIS hits the $123 price target at the time of expiration of the call option, it will be worth $1300. Subtract the $750 to get a total profit of $550, excluding commissions. This is a 73% return in 17 months while the underlying stock gained just 12%. You risked only $750 to get this gain. To earn $550 on Disney shares on the same 12% gain in the stock, you would have to buy, that is RISK, $4583 worth of Disney shares (at the current price this amounts to 46 shares).

The benefit of this call option extends beyond trying to nail a specific price by January, 2017. Let’s say we turned out far too pessimistic about Disney’s recovery – for example, the stock hits $123 by next April, 2016. The call option will deliver even more profit because it will retain significant time premium. The time premium compensates the seller of the option for the risk of selling you the option. The longer the time to expiration, the wider the range of possibilities for the stock and thus the greater the time premium. If DIS hits $123 by April, not only will it have an intrinsic value of $1300, but also it will include some of the time premium embedded in the $750 you paid for the option. Note that since DIS currently trades below $110, the entire $750 represents time premium right now.

Additional nuances exist with volatility pricing, but for simplicity, I am not accounting for changes in volatility (isn’t this post long enough?). Suffice to say that the market is finally taking risks seriously again. The higher the volatility, the more pricey the option because of the implicit increase in the range of price scenarios by expiration.


The volatility index, the VIX, maakes the most severe and extreme move as it challenges the peak from the last oversold period.

The volatility index, the VIX, maakes the most severe and extreme move as it challenges the peak from the last oversold period.


My bottom-line for long-term investors: avoid assuming that your valuation model is the correct one. The market actually does not know or care what you think. It is going to go where it is going to go on its own schedule no matter what or how you buy or sell (unless you are Carl Icahn reading this or something!). So, when the market is going through a serious disruption, take risk management seriously and check and re-check your rationale for your bullishness. Invest according to your convictions, but do not allow those convictions to cripple your ability to navigate your way forward. If Disney’s bullish case does indeed remain intact, then January, 2017 should provide PLENTY of time for the market to come back around to believing as you do.

Please consult a financial advisor if needed before trying any of these trading strategies, especially if you are unfamiliar with options. I am of course not guaranteeing any specific return or result. I am just describing some possibilities and some options for managing risk in a highly volatile and uncertain time. These principles apply generally to almost any stock with buy points well-defined by historic milestones.

Suggestions and feedback welcome!

Be careful out there!

Full disclosure: long DIS call options

Aug
23

The Commodity Crash Takes A Pause: An Attractive Trade on Coffee

written by Dr. Duru
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(This is an excerpt from an article I originally published on Seeking Alpha on August 17, 2015. Click here to read the entire piece.)

The crash in commodities continues nearly unabated against a wide swath of commodities. The selling has become so extreme that I have started moving from following the trends downward to watching for trend breaks. An early candidate for trend-breaking is the iPath Bloomberg Coffee SubTR ETN (JO).


The iPath Bloomberg Coffee SubTR ETN (JO) is showing the early signs of finally breaking from a vicious downtrend

The iPath Bloomberg Coffee SubTR ETN (JO) is showing the early signs of finally breaking from a vicious downtrend

The iPath Bloomberg Coffee SubTR ETN (JO)  shows a strong tendency to trend - when it gets moving to the upside, it can move quickly

The iPath Bloomberg Coffee SubTR ETN (JO) shows a strong tendency to trend – when it gets moving to the upside, it can move quickly


Source: FreeStockCharts.com

{snip}

The past breakouts were not just technical accidents. In both cases, coffee slammed into severe production issues that caused severe supply shortages relative to demand. (I wrote about the late 2010 and early 2011 price spike in “Coping with Destabilizing Coffee Prices“). Per the latest entry in the blog for the International Coffee Organization (IOC) dated August 10, 2015 titled “Coffee Prices Fall to 18-Month Low as Supply Concerns Fade – Coffee Market Report July 2015“:

{snip}

In other words, the margin for error in the coffee market is getting dangerously thin. {snip}

{snip}

My prime interest in coffee comes from the Commodities Crash Playbook. {snip} Coffee demand is very robust. World consumption has grown essentially linearly since at least 1990.


The world's consumption of coffee increases reliably year-after-year

The world’s consumption of coffee increases reliably year-after-year


Source: The International Coffee Organization in “Factors to achieve a balanced market“, September 8, 2014

Notably, prices have not followed demand ever higher. Instead, there is a definitive cyclical behavior in price that investors must respect. This requirement was one of the important changes I added to the Commodities Crash Playbook. In “Factors to achieve a balanced market“, the ICO explains coffee’s market dynamics this way:

{snip}

Be careful out there!

Full disclosure: long JO

(This is an excerpt from an article I originally published on Seeking Alpha on August 17, 2015. Click here to read the entire piece.)

Aug
22

Another Blow-Off Top for the U.S. Dollar Versus the Turkish Lira

written by Dr. Duru
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Did the misery for the Turkish lira (USD/TRY) just reach a climactic end?


The U.S. dollar quickly soars against the Turkish Lira and just as quickly reverses its gains. The 2.88 level is key.

The U.S. dollar quickly soars against the Turkish Lira and just as quickly reverses its gains. The 2.88 level is key.


The Turkish lira quickly lost favor in the wake of more political turmoil in Turkey. Most of the losses actually occurred right before midnight (Eastern U.S. time) and within minutes. This delayed but sharp reaction made the move look highly suspect. The rapid reversal of that loss seems to confirm the appearance of a blow-off top where the last panicked sellers of the lira have finally exhausted themselves.


This 15-minute chart shows a sudden and brief bout of weakness in the Turkish lira. It looks like an accidental blip that could translate into a climactic top for USD/TRY.

This 15-minute chart shows a sudden and brief bout of weakness in the Turkish lira. It looks like an accidental blip that could translate into a climactic top for USD/TRY.


Source for the charts: FreeStockCharts.com

On Wednesday, August 19, 2015, Turkish President Tayyip Erdogan announced his ruling party had failed to form a government. This ends many weeks of political negotiations attempting to find a junior partner for the ruling AK Party. The failure increases political uncertainty in Turkey and puts the country on track for another election. The lira weakened in the weeks going into the last election, but the move ended with USD/TRY making just a marginal new all-time high. The election also created a blow-off top. At that time, I did not think the lira’s new strength would last. I am of the same mind now. Even as I am fading the blow-off top, I am prepared for signs that the lira’s weakening momentum will continue. However, one has to wonder just how many more blow-off tops explode on USD/TRY…buyers have had a very long and successful run…

Full disclosure: short USD/TRY

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