Falling Off the Blade

This post will focus on the recent technical contention point of the broader US market and the influences that have guided what will become the new trend. Several trends were involved, some of which will emerge as the new trends for the time being. If you interpret charts enough, you can usually always find a downtrend and an uptrend. When the two connect, it's a technical paradox, with signals going both ways. It's an unstable equalibrium. Sometimes it's like a tennis ball on a hill. Sometimes it's like a needle balanced on a knife, with the slightest input causing the system to diverge decisively towards one solution. This was one of those needle on a knife moments, and this post will discuss what to do with it.

In the abscence of new economic data, it's a battle between two self-sustaining patterns, exactly like two storms colliding. The more organized flow, usually the more established trend, will usually win. In this case, we have new economic data, lots of new economic data. In fact, there's so much economic data that the dominating mechanic is unmistakably fundamentals.

The needle on the knife was a well established downtrend going back a little less than a decade. The beginning was so long ago that I remember a professor of mine using the word "megatrend." The big picture consists of the rise of oil consuming India and China (US consumption is figuratively a tautology), the Iraq war, the tech crunch, and the general doom and gloom of terrorist hysteria. All of these factors put dampers on the US economy via various mechanisms. Let's take a moment to reflect. Every great once in a while I pull out bigcharts.com when I need...big charts.


Here you have it, the history of the universe for the last thirty years. Roaring 90's, y2k bubble pop, 2001, and finally the housing bubble-bust. Notice how the first two decades of this chart show a readily identifiable curve? Then in the 90's, suddenly things went ape. In 2001 we reconnected with a "curvy" interpretation of the previous trend. Right now we're connecting with a linear interpretation of the previous trend. This is all art of course, but remember that the mechanisms of simple trends are mostly psychological, meaning that as humans who share similar psychology, we're already perfect indicators of how we visually process charts. If you've ever taken a class in trig or calculus, you have every tool necessary to be a curve fitting artist.

The last feature to pay attention to in that chart is the almost unbroken downtrend starting in 2001. What broke it? The housing and derivatives trading bubble. Bubbles pop, and in short, since reality brought the trend back in line, there was a good chance that it was still a dominant economic mechanic.

Now let's break out the microscope and look at this recent contention point:





The big question for this recovery rally from the bottom was whether to consolidate again at the bottom, letting the down trend make another run, or to have a summer rally now that the sky isn't falling. We hit that 200day moving average and almost started to head back South, but then the economic data hit and most of it indicated that the sky is in fact still well overhead. This was the wind that blew the needle off the blade, and now it's falling towards the North.

What to Do With It?

The DJIA will undoubtedly make a run back to the 50day after earnings are over. Profit taking after the flow of news slows down. At that point, the trend will take over. I would look to build positions as the earnings sink in. Any downward movement here is a buying opportunity for the summer. Pick long stocks and play their technical trends using the 20-day exponential moving average or whatever trend indicator is being consistent for that stock (more on this later.)

Short plays are a bad idea in an up market. If you're not sure the company's bankruptcy is going to happen in the next three months, look at this upward movement as the potential building of a bubble. It's frustrating to try to play a stock short that's being propped up by market movements. The simple truth is that long plays will get help from the market, so any short play is trading upstream.

What does this mean for me? I'm letting go of AMD for the time being. Yes the earnings were terrible and foreshadow the chronic failure to execute that has plagued the company, but they have enough cash to go for at the very worst several quarters, so the clouds of chaos aren't yet there.

What am I doing instead? NVDA. There's a trading gap at $14 that represents a large technical leap. NVDA is a great company with a great future. I'm sure I'll write more on this before the end of the week to give you some perspective on how I make these calls, but in the end what I'm doing is taking advantage of a stock that has a wound up technical spring and market that's poised to set that spring loose.

Ponder This

What a coincidence that the technical contention occured right around the same time as earnings. What a conincidence that most stocks' charts that I'm watching showed this same type of contention at about the same time. What another coincidence that the down megatrend occured around a huge spike in trading volume.

Computer trading started in the 80's and was driven simply by the emergence of the technology. What could have lead to the need for so much more trading activity? Let's say you're a major fund manager and you realize that the megatrend has meat in it and that investing long isn't going to pay well. What do you do? Play volume, derivatives, arbitrage, and market smoke and mirrors to take advantage of every move that occurs in the relative market stagnation.

Notice that the volume was about a billion shares per day and was fairly consistent over the last decade. Notice how it started directly coincident with the tech crunch. No, this isn't a conspiracy theory. Don't read into this line of thought too much, but I will go ahead and suggest that there was a recognized need for large trading establishments and hedge funds to generate profit from trading in the relative shortage of investable stocks.

What makes this line of thinking consistent is that the trading activity didn't continue to grow, suggesting that market fees and other limitations put a hard cap on how much profit could be squeezed out of this type of trading. Or perhaps there is an overlay of two conflicting trends. Either way, the volume spike and subsequent stagnation starting in 2000 is a little curious and I'll get back to this before the end of summer.

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Leeroy Alert

Today we have a good example of how a minor Leeroy event can threaten to completely change the stable pattern that was forming. Earnings season is very prone to Leeroy popping up, and this is why I prefer the quieter months of the year. Earnings is when excessive divergences from reality get reined in and loose ends in the minds of investors get tied up somewhat. As a whole we will correct our worst mistakes and decide where to go in the future. Well, that sounds very egalitarian, but let's focus on putting trading dollars to work.

The event I'm going to highlight is the Intel earnings report. I'm pretty sure that they beat. I'm not particularly concerned with the details. Yes, I know. Just leaving nice, solid information out on the clothes line to get bleached in the sun. But the truth is that I have my eye on a bigger ball. Within this cycle of earnings, the Dow and several individual stocks I'm watching will all be decided. What I mean is that we're on the cusp of the technical patterns diverging either north or south. A 5% move this week will probably turn into a 30% move in the next month. Check out what this little pop has done to the Dow's chart:


The Dow is unquestionably running into a well established downtrend and the only question is whether it's going to head south to consolidate the bottom or break out for a summer rally. There's always the possibility of stagnation, but doldrums neither lose or make money, so I'm typically focused on identifying the divergent behavior even if stagnation takes hold. In the previous article, it was looking pretty set in stone that traders would respond to that echo resonating in the 200-day moving average and take the market south. This one day of upbeat earnings has pushed north of the 200-day, and now we're left with a much more exciting picture. It could break either way. I say that not because the stock has simply crossed the line, but has done so on the back of plausible evidence that the economy is doing alright.



Back to AMD, we're seeing that the 20-day exponential moving average has been broken. I'm going to fast forward given what I know about AMD. The investors who follow AMD are the most rabid, underdog loving, cinderella buying lot on Earth. INTC just put out a positive earnings report. This usually bodes well for AMD stock. I'm going out on a limb to predict that without some contradicting earnings report from somewhere else in the sector, the AMD dead cat will bounce one last time. Although they're bleeding less on the income statement, note that this is only because the fab operation has been spun off. Just like the flash operation, AMD's partial stake of 44% in the fab will continue to dog them one way or another.

I'm keeping an eye on AMD and NVDA. Short AMD. Long NVDA. Depending on how they break, I'll be looking for one of them to develop into a nice profitable trade. I'm going to do a little bit of research into AMD's chips before the 20th, when AMD's earnings come out. It doesn't take a rocket scientist at this point to determine whether AMD can survive or not. Chips tend to be make or break products, with most of the money concentrated in the ability to earn the performance premium across you product line. Flagship chip prices are very telling as to how well a company is doing this. If AMD can't gain this premium, they will never return to enough profitability to have even a slight chance of paying down their massive debt and getting back in the black on the balance sheet.

The important thing to take home from this Leeroy upset is that stocks are very sensitive at the breaking point. Minor disturbances can take something that was stable and make it start diverging one way or the other. Focus on the medium-term outcomes that will result from the short term chaos. Once the pattern starts to stabalize, if it is founded in at the very least trader hope and confidence, it will usually go on to develop a solid upshot or breakdown depending on the circumstances.

The Leeroy watch has begun.

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Find Yourself a Hammock

I've been more stagnant than I want to be with regard to writing the blog, and I swore I didn't want to start making recommendations, but for one this is one of those situations I can't help but get excited about and second it's a good opportunity to start delving into -drumroll- applied theory.

Basically what you're looking at is the bottom of the recent crash and the recovery stalling at the first major resistance test. I'm going to go on my experience and say we're looking at the first indications of some major summer doldrums during which the bottom will be solidified as the market continues to weigh the impact of recent events on back-half seasonal profitability as well as long-term profitability. If Dow 7000 roles around again, I'll be about as surprised as I am about seeing a hurricane on the Weather Channel.


The second exhibit is one of my favorite trading stocks in one of my most favorite situations: the pointless breakout in an unfavorable market. In short, since I'm short on the market, the fact that I'm short on AMD has insurance. It will take more than just a minor Leeroy event to derail this breakdown. AMD, during most of its ascent and breakout, demonstrated what you call "weak buying," where the stock is bleeding a lot of red even as it trades higher, indicating that there is a lot of selling into the springback off the bottom. Basically it's a dead cat bounce that created an opportunity to dump shares, and now the bouncing dead cat is headed back to the ground.

I'll continue to revisit these two examples as I move forward into the conclusions of my model. I'm feeling pretty certain at this point I want to go back and re-approach some of the material. I've had a decent time getting my head around the material in the context of writing the book, so a little reorganization seems more than appropriate.

Good luck trading.

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