Sunday, November 22, 2015

LG-Cap Portfolio Reveiw: Entering Lowe's (LOW)

We saw a strong snap-back rally this week and the SP500 is once again just below all-time highs. The resiliency of this market has been incredible. Its had every reason to crumble, yet it digs in and reverses back higher.

A notable development also occurred: the slope of the 20 WMA for the SP500 turned back positive for the first time since the week of August 14th. My trading data suggests new trades have a much higher probability of success when this trend has a positive slope. As the saying goes, "the trend is your friend". Meaning the pull of the general market will cause most stocks to advance with it. We want to be aggressive when the odds are tilted in our favor and it appears we are in a more favorable environment. As long as the broad market is above this line and its slope is positive, good things tend to happen.  

While this is an improvement do note that should weakness follow in the near future this slope will turn back negative and we will have to adjust again. The way I prefer to adjust is by either increasing or decreasing the size of new positions. When markets are trending higher I want to step up my risk and buy more. When markets are trending lower I want to scale back risk and size smaller.

SP500 Weekly
We continue to see large weekly swings, I believe this will be the case for some time, especially if we remain below the highs at 2,135. The 20 WMA just turned positive so there is a suggestion that we could keep pushing higher. A potential scenario I'm watching involves some digestion of the recent October surge, setting up a bullish formation that could then propel the markets to new highs.

This is what Bulls would like to see:
 The strongest scenario I can see would be more sideways consolidation for the next few weeks. Ideally we would see price move sideways in a tighter range just below the highs (within the pink box). For a sustainable rally to occur it would be helpful for a new "higher base" to form just below resistance. Also it would be helpful if any weakness finds support near the 2000 area.

Some back and forth between 2135-2000 would create a "right shoulder" to a potential Inverse Head/Shoulder pattern and would provide bulls the ammo needed to breakout, and hold new highs. 

While we await the next move in the indices, setups continue to form and trigger. This week we have a new entry in Lowe's (LOW). 

+Entering LOW
Lowe's reported earnings this past week and after an initial decline, the stock ripped back to new weekly closing highs. Volume expanded on this week's move which engulfed the trading range from last week. 

The weekly chart shows a strong base formation that also has the look of a Cup/Handle pattern. We have seen similar setups in the past for Lowe's and each led to substantial rallies. 

For risk management purposes we want to be long above the recent swing low at $70. That sets up a solid risk/reward as previous rallies off comparable bases have led to nearly 100% moves. We are risking less than 10% to make potentially 100%, that's a fine trade in my opinion. 

Our other holdings continue to be quite strong as well: 

Costco blasted off to new highs this week and seems to be resuming its uptrend after a couple weeks of consolidation. It's now quite extended above its moving averages so a pullback wouldn't be unexpected soon. 

With the new high we can trail stops to $146.

Lockheed had another strong week and also pushed to new highs. We can trail stops to the breakout level and swing low at $207.50. 

FB remains in a strong position.

Google had a great week rallying to new highs. Similar to COST, it is quite far from its longer-term support. We can trail stops up a bit to the bottom of the breakout consolidation at $639. But we still need to give this room to pullback without being shaken out. 

GE is maintaining its vertical move, I expect a pause coming soon. A pullback to the $28-27 area would be normal and healthy. 

Short AXP
American Express made lower lows once again before rallying into the end of the week. This remains a dog and rallies continue to be faded. Soon we will be able to trail stops to around $75, but it's a bit early yet. 

Long US Dollar
Not much to say here with regards to the Dollar. I believe it's in a new secular bull market, so this doesn't need to be an immediate move. It remains poised for further upside in the future. 

We are now 40% invested and 60% cash. Should we see continuation in the markets and new highs, our allocations will increase fairly quickly as many stocks are setting up for potential breakouts. Here are a few to watch:







A breakout to new highs for the SP500 will likely trigger many, if not all of these setups. Until that happens however we need to be patient and wait for the market's signal. This is the most constructive posture for stocks since early in the year, some leading names have already emerged to new highs, but many are likely to follow if the recent strength can hold.

Thanks for reading

Sunday, November 15, 2015

Trend Trading Near Earnings Events

Last week I was asked how I trade around earnings. There are many ways traders choose to manage risk near earnings announcements. There are traders who exit entirely before the announcement, some reduce positions to account for the higher volatility event, and others who do absolutely nothing.

How you approach event risk is largely based on your timeframe. Because mine is of the multi-month/year variety it doesn't make a lot of sense to liquidate my holdings every three months. My back-testing did not take into account earnings related risk, it simply followed the rules dictated by the intermediate-term trend.

It's very important to understand your trading timeframe and how it relates to earnings risk. For a short-term trader, who holds for only days/weeks, it makes little sense to hold through an event like earnings. But for someone with a longer timeframe it makes just as little sense to sell each position every quarter.

The Key To Managing Risk is by Managing Your Position Size

Trading around earnings is not too much different than any other time, it still comes down to how do I manage risk in a volatile environment. The way I manage risk is to only carry a .50R position size per holding. Most stops are placed 5-10% from my entry price, so even if the stock declines 20% on its earnings, the loss incurred would still be just 1% of my total equity. That is an acceptable risk for my long-term survival in the market, which should be the goal of all market participants.

I believe where traders get into trouble is they begin to think too much about the possible rewards or potential losses that can come from an event like earnings. They let the event make them emotional and can then be prone to mistakes like selling too soon, holding too much of a particular stock, etc. 

Earnings create volatile moves, volatile stock prices make people emotional. Emotional investors do irrational things with their money. The best thing we can do is try to protect our portfolios from ourselves. If we have strong rules that have proven successful in the past, we can reduce our emotional reactions during volatile moments. We will be much more successful if we let the market dictate our allocations rather than positioning based on fear and greed. 

Rules I use for trading near earnings:

-Always maintain a reasonable position size. This is the most important concept. If you manage risk well, you will have little issue holding a winning stock through earnings.

-Re-balance position size if needed. Should the stock be trading sharply higher away from your stop level, sell some of the position to keep open risk at .50% of total portfolio equity. This assures that regardless of the event outcome your risk will be consistent. 

-Often I will place a "within 1-week" limit for entering a new position. If the company will report earnings the following week I will often pass on the entry until after the announcement. This has hurt and helped me in the past, but is a good way to limit earnings related risk.

-Look to add more shares of a stock that has reacted positively following its announcement. I always like to trade my winners more aggressively after a strong reaction to earnings.  

-I am weary of any stock that declines sharply after earnings. Post Earnings Drift tells us that a stock's movement after its announcement tends to continue for the near-term. Therefore a strong selloff tends to lead to lower prices rather than being a buying opportunity.

Saturday, November 7, 2015

Lg-Cap Portfolio Review

The market extended its winning streak to 6 straight weeks. When this rally will tire is anyone's guess. Since October its ascent has been relentless. The SP500 is now trading 12% off its low from 9/29 and is just under all-time highs at 2099.

SP500 Weekly
I have to imagine we will see a pullback from these levels soon. But I've been expecting that to happen for almost a month now, so who knows where this all goes.

Something notable is that this is the first week in the last four that I have not received any new Lg-Cap entry signals. What I am seeing are leading stocks (FB, GOOGL, AMZN, NKE, MCD, etc) quite extended above substantial base support. This means the risk/reward in these names is becoming lopsided and consolidation is needed. Opposite the extended leaders are the laggards that continue to rally strongly in a counter-trend way and still have declining weekly moving averages. These stocks are now back to significant resistance levels (SLB, PG, EOG, CVX, CAT, DD, AAPL, etc).

What I will be watching for is how all these stocks handle themselves when the market does turn back to the downside. Markets do go both ways folks; not just up or down, but rather up AND down. Can the leading stocks hold near their highs and simply work sideways while they digest their gains? Also can the lagging stocks form higher lows on the next pullback or do they just rollover and make new lows? These are my questions going forward, until we have these answers its best to be patient and let the market come to us. Now is not the time to chase stocks that have rallied for 6 straight weeks. We will need to see prices supported on a pullback to prove this isn't part of some elaborate maximum pain scenario where the market continues blowing both bulls and bears out of the water.

With the Fed announcing that they will likely raise interest rates at their December meeting, markets should have a nervous and volatile month or two ahead in anticipation. Its not that a rate increase of .25 basis points will impact the economy, but the psychology on market participants will be shifting from one of an easy monetary policy to that of a tightening policy. This I expect will cause increased gyrations in asset prices for the foreseeable future.

One group that stands to benefit from higher interest rates are the Financials and they showed strength following the stronger than expected October Payroll report on Friday. Here are a few names I will be watching:





If economic data continues to come in strong, these will be names to have on your radar. A stronger economy suggests a more hawkish Fed and therefore Financial stocks should benefit.

Our Lg-Cap Portfolio remains 30% invested and 70% cash. This allocation suits the current environment for my timeframe. Granted we've underperformed over the last month, but this market is still suspect and not behaving in a healthy way. We continue to see tremendous swings in both directions leaving many stocks extended and messy for now. Some tightening price action would do wonders for the majority of charts out there and allow for more favorable risk/reward entries.

Costco keeps motoring higher along with the market. A multi-week consolidation would setup the next leg nicely.

Lockheed saw a pullback following its reversal bar last week. A pullback near $200 would be harmless to the trend.

Facebook shot higher after its strong earnings report. There was a lot of noise in the media this week regarding FB's elevated price, it now has a market cap greater than General Electric and Amazon. The commentary was the opinion that the valuation of Facebook is absurd, in a way. Without saying it, they were saying it. This kind of distraction is exactly the thing you should be ignoring when it comes to your market positioning. All we care about here is trend and the market's reaction to positive/negative catalysts. Is the stock making us money? Yes. Then we continue.

Could the stock pull back? Or course it could. In fact its quite extended from its major moving averages and some consolidation would do it good. But this is why we use stops. To manage risk and to let the market tell us how we should be positioned. You don't need to be listening to punditry and social media for whether you should continue holding your stock positions or not. Let the market do the talking and follow its lead. FB is strong here and is making new all-time highs, what more could you want from an equity holding? 

When it comes to being extended, GOOGL has little competition. This has been absolutely vertical for 6-weeks. The long-term patterns are in place for significant upside in the future, but in the near term expect some back and fill.

GE continues to press multi-year highs. Strong follow-through after a breakout is a very positive sign. But again for a company this large to rally over 20% in a month is a bit much in a short period of time. The recent breakout has long-term implications for higher prices, we will just need to work in that direction a little slower than our current pace.

Short AXP
AXP was able to post a green week along with the Financial sector. However a quick glance at the rest of the Financial group and you can see an obvious difference compared to AXP. This stock is routinely making lower lows and remains trapped under a ton of price action from the last couple years. As long as it is below the $78 resistance level, I like this as a short in my portfolio.

Huge breakout for the US Dollar
 The weekly breakout for the Dollar is fantastic. I love everything about this chart. Its an easy long with stops below 24.40. I will be deploying a portion of my free cash to take a momentum position in the $UUP.

It appears the Dollar is beginning a new uptrend after consolidating the huge gains from 2014. I could even say that this is potentially the start of wave3 after the completion of the wave2 correction.

Another surge higher here will act as a headwind to multinational corporations that comprise the majority of the SP500. This will be an important indicator to watch, especially following the plethora of bottom calls in commodities such as Oil and Gold.

Thanks for reading