Daily Archives: July 24, 2010

Frequency and Drawdowns

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A well-meaning Sloper from India wrote to me this morning, suggesting that I simply accept the fact that Goldman Sachs has unlimited access to free money from the government and will simply keep bidding this market higher. Thus, I should focus most of my trading on longs with occasional shorts here and there as a hedge.

I recognize this email was well-intended, but I must trade with integrity. If I wind up losing money, and I am faced with a client who wants to know why, I could envision a couple of possible answers:

1. "I was basing my trading on a historical analog which had been working well for nearly two years, but the analog ceased to work, and I was wrongly positioned."

or

2. "Goldman has a lot of money, and they cheat, so I decided to just buy stocks with the hope the market would just keep going Goldman's way."

Reason (2) might actually be a more profitable trading strategy, but I could never utter it in the face of a trading loss, because it would mean I was basing my trades on whimsical innuendo as opposed to a method I respect.

My core problem with this market, as I've mentioned, is frequency. I'm a swing trader. Dealing with a market that does a 180 degree turn every few dozen trading hours is maddening. Because being up 5%, down 5%, up 5%, down 5%, up 5%, down 5% is taxing to a man's soul.

In a market with any kind of trend, I'd instead be up 15%, down 5%, up 15%, down 5%, and so forth, which I can happily handle.

Since I've only said it three hundred times, I'll say it again: my postulate is that the market will reach around 925-930 within the next couple of months, and I want to be positioned for that. I am basing my positions on individually-selected securities that, on their own, seem like good short setups.

I have tempered with positions with three longs – DBA, FXE, and – – much smaller – – CPX (which is a position I suggested a few days ago and has been performing well).

I will say this, however…..at least an actively managed portfolio – even a bearish one – has held up OK in the chaos of the past ten months better than a straight-up bearish position. For instance, let's say you decided the market was generally going to be in trouble, so you bought TWM, which is the ultra-short ETF based on the Russell 2000. You'd be down about 30% at this point, even though the Russell has barely budged. So even though I've been running in place for ten months, at least I'm not facing that kind of uphill battle.

I did go through all my charts again, which I used to do every one or two weeks, but now I am doing nightly (and there are a thousand charts, so it's a lot of work). I did smoke out 20 positions which I put in my Bullish camp, but half of them are nothing more than Badly Beaten So Maybe They'll Bounce Back, which isn't my favorite reason to buy a stock. The other half – – if that – – are honest-to-goodness good-looking bullish patterns, which I'll probably share some of later this weekend.

The bottom line for me is that I'lm going to continue to base my trading on the 925 target until the evidence points me elsewhere. And, should that target be met, I plan to cover all my shorts and trade almost exclusively on the long side for many months to come.

What We’ve Got Here Is A Failure To Communicate (by Goatmug)

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We did recover right?

ECRI DATA – http://www.businesscycle.com/resources/

The ECRI released its weekly data from 7/16/2010 yesterday and it is now showing a drop or growth decline of -10.5%.

Declines of this magnitude are absolutely indicative of a recession.  Now as I've mentioned, officially the NBER has not called the recession over, (I guess they have mental images of President Bush on the aircraft carrier), however by any stretch of the imagination economists should have declared the recession over with the managed recovery we've had.  Of course little things like employment and housing that have not recovered shouldn't stop a few economists and administration officials from stating the obvious right?

IF they did declare the recession over, this data would tell us that we were going to double dip with all doubt removed.  However, now that our friends have held off from declaring victory we may have the fabled L shaped non-recovery.

ST WLI 

 

Weekly_indexes

RAILS – http://railfax.transmatch.com/

Other indicators of slowing are showing up.  I will not post the data here, but rail tonnage is slowing and with carriers are even seeing declines versus last year.  Can you say WHAT?  I thought last year things were terrible and everything this year was all better?  I thought the US consumer was back and commodities were on a tear?  Me too.  Last week almost all categories of shipments were down when compared to 2009's easy levels and this week a few of the categories remain slow again (coal, autos, and food), that is slower than 2009 levels and much lower than 2008 levels.  KSU's shipping declined significantly and so did KSU in Mexico. 

EUROPEAN STRESS TESTS – STRESSED NO MORE?

European Stress Tests were released today and the US markets caught another surge higher.  The uncertainty is gone for now, but the weekend will give traders and portfolio managers time to examine the sparse details and released information provided in the sham tests.  Are we going to feel better about the solvency of the banks when they really didn't stress them and didn't analyze the cost of default of sovereign debt on their balance sheet?  The potential of country debt defaults is exactly what exposes these banks to their very death!  If Greece, Portugal, Spain, or Italy don't have debt problems then these banks don't have problems (don't even mention mortgage assets – that is so 2009, even though it hasn't been addressed, but don't let reality stop a rant!)  Isn't it ridiculous to think that the regulators ran this test and show the results like they've accomplished something?  Isn't it funny to think that 7 banks in Europe failed anyway?  Isn't it funnier to think our markets rallied on this news?

No matter what, the real test for the veracity of this exercise will be the cost of funding between banks on Monday.  If we see declines in funding rates, then we must believe that the farce had at least some meaning between other bankers.  If we see Libor move out more, this will be the tip off that this wasn't the magic elixir that the regulators had hoped it would be.  I'll be watching this chart and I'll have a post on Monday at www.goatmug.blogspot.com.  We've seen a decline of 6 bps over the last several weeks as stress levels have declined.  We'll want to see this come down even more to verify that banks trust each other.  (Libor)

1WKLIBOR-7-23

I'll leave you with the optimistic quote of the day from someone on CNBC right after the release.

"It's not that the banks are failing, it is that the banks have failed a level of stress, and they are taking steps to improve it".

Yes, I guess that is one way to look at it.  To test how this view works with other applications, let's run it through the British Petroleum version of the stress test.

Say this with me ——"It is not that BP is failing to be a good company and manage the environment effectively, it just failed a level of stress, and they are taking steps to improve it".   Feel better about the Gulf of Mexico don't you?  I thought you might!  Perhaps I'll begin to look at all failures with this view!   It's not that they have failed, it is simply that there is a failure to communicate! 

Have a great weekend! — GOATMUG