Less Is More

We don't have to be trading all the time. This is something I try to remind myself of when markets become less favorable. Sometimes the trends are not in our favor. We have to do our best to recognize those times and attempt to avoid taking too many losses.

When markets are volatile and in transition some strategies are simply going to struggle. If you force too many trades during these times you may end up dwindling away your capital. Some strategies thrive, but trend trading often does not. When markets are moving in one direction or the other, a trend strategy will clean up by letting winning trades run. In volatile range environments, like we are currently in, trend trades will see many more failures than normal.

Identifying when the market is favorable or not is a big part of being a successful investor. For the intermediate-term trend approach that we utilize with our Large Cap Portfolio, the current market is not offering many opportunities. When this is the case, the mantra "less is more" often comes to mind. I have found that limiting exposure and tightening new trade requirements helps tremendously during the difficult period.

Markets ebb and flow. They move from trending to non-trending phases and from uptrends to downtrends. Knowing the difference AND acting on it will go along way to improve your longer-term equity curve. My favorite indicator for intermediate trend is the 20 Week Moving Average. When the 20 WMA is rising the market tends to trade strongly for the bulls. However when the 20 WMA is declining weaker returns tend to accompany it.

The chart of the SP500 above shows the prior occurrences when the 20 WMA was trending lower. Since 2007 there have only been 5 times when the moving average turned from up-sloping to down-sloping.

2007 avoided the significant market collapse.
2010 digested the recovery rally by trading in a tight range for 19 weeks.
2011 the signal avoided the "Euro Crisis" which lasted from June through December.
2012 led to a 12-week consolidation.
2015 The 20 WMA has now been declining for 5 weeks.

Based on the prior periods (regardless of severity) we currently sit at the beginning of a new market environment. At best we are in a constructive consolidation that will then resume to new highs. At worst we are teetering on the ledge of a potential new downtrend and "bear market".

Here is a look at the same chart but shows the returns in the SP500 when this simple trend approach is used:

  I ran a very simple trend system. Signals were taken using two consecutive 20 WMA readings (weekly closes). If two consecutive readings were negative it marked a new downtrend, and if two were positive it marked an uptrend. What this quick and basic strategy did was astonishing. If you only held the SP500 during "uptrend cycles" the return since mid 2006 was 1,023 S&P points. This compares to the returns during "downtrend cycles" which was -522 points. 

By sticking to this remarkably simple strategy you would have outperformed the market by 60% while nearly eliminating any serious downside risk. People don't like to think investing can be this simple, but it can be. It can be if you let it. If you can remain calm and follow a system without being emotional, a simple trend strategy can be highly effective.

We can agree that while the market might not fall significantly from here (it could), the odds of significant upside are greatly diminished while this signal is in a downtrend.

Downtrends increase risk. When risk levels are elevated I prefer to take capital off the table. This is often a natural process where your stop levels are systematically hit by market weakness. Its imperative to protect the majority of your capital so that when conditions turn favorable again you will be confident and ready to deploy your funds into new potential market leaders.
  
Ways to limit exposure/risk in unfavorable markets:

-Trade less: Set limits for trades taken. Lower total portfolio heat, for example if you normally can take on 10% portfolio heat at any one time, reduce it to 5%

-Trade smaller size: instead of your normal 1% risk per trade, trade .5% or less

-Tighten Entry criteria: If you do continue to trade be extra particular in the setup you take. It should be extremely favorable in terms of risk/reward.

-Step away from the market for periods of time
We don't always have to be trading. In declining markets its often best to keep positions small, keep risk light, and take periodic breaks from the action. There will be very favorable trends in the future. We just need to do our best to make sure we survive the weak periods so we can take advantage of the next strong ones.

Our Large Cap Portfolio remains 90% cash, 10% Short AXP

AXP weakened a bit this week along with the broader market. Its trapped under large overhead supply, has a declining 20 WMA, and momentum (MACD) is in a clear bearish range.

This remains one of my favorite short ideas in the market.

Thanks for reading. For updates during the week please follow on Stocktwits and Twitter @ZenTrends.

Shakeouts and Bag-Holders

With the highly anticipated "Will They or Won't They?" Fed meeting now behind us, nothing has changed our bearish posture towards the market. The Fed announced this week that they will keep interest rates near all-time lows due to "uncertainty in global markets". This continues to piggy-back on the idea that Central Banks are trying anything to keep asset prices propped up. Whether they admit to it or not these policy makers are terrified about a downtrend in stocks. At the slightest inkling of weaker markets they fly to the rescue. While this has worked well for some time, we are starting to see the easing effects having less and less impact on price stability. This creates a tremendously unstable environment as speculation grows to whether the Fed remains in control of the market or not.

These things don't mean much to a trend trader. We simply acknowledge price and do our best to adjust our allocations to meet the current environment. From my perspective we still remain in a trap happy market that appears to be transitioning from a Bull phase to a Bear phase. This viewpoint was only proven more likely with this week's price action.

SP500 Daily chart

A lot has been made of the short-term price recovery and the importance of the 1990 resistance level. Both Bulls and Bears alike were watching this level like hawks to determine their positioning going forward. But in the market's usual fashion it provided a jolt to both sides leaving many scratching their heads. Prior to Thursday's Fed announcement the SP500 managed to close just above this resistance level. This acted as a signal to Short Sellers that caution was needed into the announcement. Remember the maxim "don't fight the Fed"? Its been ingrained in us over the past several years and it seemed to be playing out again.

Following Thursday's announcement of no policy change, markets rejoiced and rallied some 25 points. The remaining Shorts scrambled to not be schooled once again by the Fed, and left-out Bulls threw in the towel saying "I can't miss this move any longer". Well as the market likes to do it took both sides of the trade over its knee and gave them a good spanking.

What has now been created by this lovely trap situation are Bears who are now sidelined due to the upside breakout and Bulls who are now holding positions once again from higher prices. Friday's Options Expiration follow-through move didn't help this cause. Prices moved substantially back below the 1990 level and the market remains under increased overhead supply.


SP500 Weekly chart

Looking to the Weekly chart I still see NO reason to be getting excited about a strong rally in stocks. While there are select names that remain in uptrends, they continue to dwindle daily. The 20 WMA is now declining significantly and is about to cross below the 50 WMA. These are long-term averages folks, these aren't fast moving averages. They give a big picture look at the market trend and that trend is simply not looking bullish.

The firm rejection of the first resistance level this week is not a positive sign either. The fact that the market couldn't even test 2040 on a dovish Fed is notable and shouldn't be discounted. While we always keep an open mind to market movements, the weight of evidence continues to favor a changing environment where capital preservation is our #1 goal. 

While a dovish Fed and lower rates have been good to stocks in general over the past few years, one group that has not been able to take advantage have been Financials. Know that while every other major S&P Sector hit new all-time highs earlier in the year, Financials haven't even retraced 2/3 of their 2008-09 decline. This week I want to take a look at the Financial space in light of this recent Fed statement.


We had been quite bullish Financial stocks for the last year as the near term price action had been looking strong. However that posture changed as the market began its dive in mid August. In the wreckage of the August decline many were hopeful that even a modest rate increase from the Fed would have a positive impact on this group. As we saw however there was no rate increase and the Fins took it especially hard Thursday and Friday.

Financials (XLF)

After being stymied at overhead resistance, the XLF gapped lower Friday and closed at the lows. Both Thursday and Friday's declines came on heavier than average volume as sellers stepped in at resistance.

This is not a bullish development as Financials weigh heavily within the S&P index. The individual Financial stocks did not fare any better. Let's take a quick look at a few of the majors: 

WFC

GS

AIG

Our Lg-Cap Portfolio owned these three names until recently. We received exit signals on the breakdown Friday 8/21. All of these stocks are well below our exit points and appear to be resuming lower.

Notice though that while the trend is turning lower in these stocks, they all remain above their October lows. Unlike American Express below, which is below the October 2014 low and in fact rejected that price level at ~78 this week. 

AXP

Our only current holding in the Lg-Cap Portfolio (Short AXP) traded higher this week into our stop level. The price action following the Fed on Thursday rejected this resistance area and along with the other Financials, AXP broke lower Friday.


AXP Weekly

 The Weekly chart shows this rejected level even better. The stock also tested its declining 20 WMA and sold off directly. As long as it is below $78 on a weekly closing basis, I want to be positioned for downside here.

Relative Strength investing works exactly the same with shorting stock. Except instead of calling it Relative Strength, it should be called Relative Weakness. If we choose to short stock we want to do so in the weaker issues in general. That doesn't necessarily mean on a fundamental basis, they can still be fine companies. But rather the price action and trend need to be shifted lower.

We want to seek the weaker stocks in the weaker sectors. In this case Financials are looking like a very vulnerable sector and AXP seems to be one of the weakest trends in the group. We wouldn't for example be looking for shorts in the Consumer Discretionary sector as it remains the strongest group in the market.

Our Long watchlist is heavy Consumer stocks:

AMZN

FB

SBUX

GOOG

UNH

HD

LMT

There are still some potential Long setups forming out there. But nothing is compelling enough to take entry in our Lg-Cap Portfolio. I like the relative smoothness of the consolidations in UNH, HD, and LMT.

Thanks for reading.

-ZT

Entering Short American Express (AXP)

Not much changed this week ahead of next Wednesday's Fed decision. Markets traded higher and are tightening into the apex of a wedge pattern. The current price action continues to form a "Bear Flag" pattern.

SP500 Daily bars

There is still an undecided bias to the broader averages. Until we see a move away from the swing high at 1,993 or below 1,903 not much is to be done. I expect increased volatility around the Fed announcement next week, but it will be this range I will be focusing on.

Should the market breakout to the upside from here there is still the large resistance level at 2,040 to contend with. Its important to keep an open mind and take what the market gives us.

This week we are taking a short position in American Express (AXP)

AXP Weekly bars

We haven't discussed many short opportunities for this portfolio as we've been in a relentless bull market for 3 years. However the price action on all timeframes suggests the trend is turning lower and now is a time to consider taking the other side of this market.

AXP has all the makings of a great risk/reward for our intermediate timeframe. The stock has traded in a 2-year Rounded Top formation and has recently broken below its major support lows. 

What is quite notable to me is how the range has tightened considerably since 2015, at the same time as Volume has increased well above the 3-year average. There has been an increased amount of trading activity in only a $5 price range. And price currently sits below all that volume and prior support. This is called overhead supply. 

All of the trades from 2015 are now underwater and will create selling pressure on rallies back into that key level near $78. As long as price stays below the prior range and resistance at $78 I want to be short this stock. 

Shorting stock is a different animal than trading Long. Moves come much faster to the downside and you have to be prepared to take profits quickly should the trade begin to change direction. It is because of this increased difficulty that short trades for this account will be few and far between. But when I find a setup as clear as this, with a Relatively weak stock, in a now downtrending market, we will take advantage of the opportunity. 

Again shorting stock is something many people are uncomfortable with. If you do not feel confident trading this way, please do not participate. Simply wait with a cash position until the market regains some health and new uptrending opportunities present themselves.

That's really all I have to share this week. I'm trying to enjoy the last few weeks of summer and will be spending most of the weekend outdoors. When the market is undecided I feel its best to give it room and let things play out.

Thanks for reading
-ZT

More Trapped Bulls

Markets continued lower this week with the SP500 declining -3.4%. The continued calls for the correction being over are rampant and persuasive. Yet despite their opinion this remains a market environment like we haven't seen in years. There was much hope for a V-shaped recovery similar to last October, but there are glaring differences this time around.

First the Hammer reversal that tried to form after last week saw no follow through. This is the opposite of what happened in October 2014.

Another key difference is that trend momentum (as shown by MACD) has broken below the zero line, whereas in 2014 the signal reversed well above zero. Holding above zero is very important for identifying trend health.

We also didn't have the overhead supply in 2014 that is currently in place. Overhead supply is best described as "trapped buyers". These are the bulls who where buying dips within the year-long trading range. But because the decline away from the range was so quick and violent, most have not adjusted yet to the new corrective environment. It appears to me that most are very complacent here and have been expecting a rapid snap-back rally. This is also apparent in the failed reversal from last week. The buyers that were scrambling to put money to work late last week are now also looking at losses. This is so important because buyers that hold losses will typically wait for an opportunity to sell those positions where they originally bought or close to it; they want to "see if it comes back".

The psychology is very important to understand here. There are two possible outcomes here for the trapped bulls:

1. The market rallies and they use the opportunity to sell and "get out even"

OR

2. The market declines further making them more and more nervous and desperate.

The first scenario is where the term "overhead supply" comes from. As the market moves back into the prior buy zones (prior support), buyers holding from those levels sell into the rally creating excess supply of shares. This is the "throwback" scenario. Throwbacks are very common on new breakouts and this is a possibility that we have to be prepared for.

The second option is that the market continues to decline further, squeezing the holders with more losses. This action creates bigger losses and causes these investors to do irrational things. In more extreme cases this is the type of action that causes panics and crashes. We aren't there yet but you need to be aware of that possibility as well.

Possibility of a Snap back

Something I can't help but notice is how extended the Lg-Cap stocks and Indices are from their key moving averages. If you have been following this blog you will know I put a heavy emphasis on the 20 WMA. For one reason or another stocks, especially Lg-Cap stocks, revolve around the 20 WMA and it tends to act as a magnet. When prices get too far from the 20 WMA (and all moving averages for that matter) they have a tendency to come back to that average.

I want to show a few examples of what I mean:

SP500

The SP500 is now trading 160 points below its declining 20 WMA. It will take a 7% rally just to retest the underside of that down-trending average and also the prior support zone at 2060-2040.

PG

Proctor and Gamble will require a $10 rally to retest its declining 20 WMA. $10 from here is 15% from current prices. For those who feel these big blue chip companies are "safe" and basically risk free have gotten a wake up call as PG is down -30% from its high back in December. Its a reminder that a 3.5% dividend yield doesn't offer much protection in a declining market.

CVX

Another widely held name, Chevron, is now down more than -40% from its highs last July. The rapid decline over the last four months has left the chart extended to the downside. CVX is currently trading $20 below its 20 WMA. That could result in a 30% rally and still be in a down-trending market. 

If you are nimble enough to play for a counter-trend rally then I think there will be an opportunity relatively soon. But the important reality to remember is that it will still be a bounce within a larger downtrend. To be attempting to build large positions will likely result in opportunity cost of holding assets while they are still declining or correcting sideways.

Moves like this, crashes I should say, take time to recover. There is little lost in avoiding the bottom calling game. CVX will present an absolutely phenomenal buying opportunity. But until it builds a proper multiple-month support base there is nothing to do here from an investing standpoint.

TWX

Time Warner's decline has been relentless early on. It now finds itself -20% below its declining 20 WMA. A rally back to retest will inspire profit taking and this corrective period likely has much more time to go before it resembles a strong buy again.

AAPL

Everyone's favorite stock is in pretty rough shape despite last week's recovery off the lows. AAPL would still require 15% upside to retest broken support and its key moving average. Again, time will be required to rebuild any support base to trade off of.


What concerns me about this current setup is that many of these stocks could rally 15-20% and simply retest the underside of a now declining moving average. In the Lg-Cap universe of stocks a 20% rally is fairly significant and many would be pleased with taking profits at that time. This is how lower highs are set and downtrends gain momentum. Just something to be aware of as we go forward here. Most new traders and investors have simply never seen a stock market decline or downtrend. You can either be prepared for it or you will fall prey to declining price action.

There are a tremendous number of investors who's mistakes have been covered up by the rising bull market. Many have developed bad trading habits and have been rewarded by a rising tide. But as Warren Buffett has famously said, "only when the tide goes out do you discover who's been swimming naked". Anybody can make money in a bull market, where the true test of a trader and investor lies is in how they survive during corrective markets.

Bottom line: Don't be too quick to buy back into this market. As long as lower lows and lower highs are being set caution is advised. When stability comes back into the market it will be manifested on the weekly charts through a support base and higher lows and higher highs.

Our watchlist stocks came under pressure this week along with the broad market, so there is nothing new to report there. Until we see some better price action under the surface we will continue to sit on the sidelines and await new support levels forming.

In this current market its best to keep positions light. I have taken a few setups recently for shorter-

term swing trades and most have been unsuccessful. In a down-trending environment, if you choose to dip in and out I prefer to keep risk per position to half size compared to strong uptrending markets.

Stay light and keep your focus on swing lows and swing highs. As long as they are maintaining a downward bias this is a market best avoided.

I will leave you with a fantastic quote from Chris Ciovacco on Twitter this week: 

"Capital that is protected can always be redeployed. Capital that is lost cannot."
-@CiovaccoCapital

Thanks for reading
-ZT