Double Journey

Is the turn I’ve been waiting for finally happening?

The market has continued its downward trend that it started last week.  The broad market was down almost 3% today.  This looks particularly bad when you compare it to the uptrend we have experienced. Are people finally waking up to the fact that markets should not run up 40% in a few months?  There is a saying in trading, don’t fight the tape.  It was one of the reasons I could not get more short the market as it ran up and up.  The market wanted to rally and I had no desire to stand in front of it.   It is what makes it so hard to short this market.  We had such a sustained run up that shorting now could be suicide.

I’m not sure I would short from here.  If I were to short from here, I would get in and out quickly.  Take a quick 2 or 3% gain and get out.  I would look to buy more things 10 or 15% down from here.  Just depends how violent the moves are down.  I’m very interested in inflation bets.  Buying commodities and selling treasuries.  Commodities will go down as people worry about demand for them if the economy tanks and treasuries will rise as people look for a safe place to put money.  But the long term outlook for this trade looks good which is why I would want to take a position if the market sells it off in the short term.

If I am going to short I’m going to short even more the real estate sector.  I still think commercial real estate is in big trouble. I look around my city and downtown L.A. and there are empty buildings everywhere.  This is going to get worse before it gets better so I don’t see any relief for this sector in the near term.

The market was down significantly today, almost 2%.  Despite this my portfolio was up about 1%.  Now you might think that is because I am short the market but that would not be the whole story.  I made money yesterday when the market was up by almost 2%.  Now I did not make as much money as the market but I also did not give anything back today.  One of the secrets that Warren Buffet always uses is to not lose money.  In a market like this one, it can be hard to do because of how it is whip-sawing back and forth.

I am achieving this through a very specific strategy.  I am pairs-trading.  This strategy is relatively simple.  You go long of one thing and short of another.  For example.  Say you are bullish on Broadcom.  You would like to buy it but it has had a pretty good run the last three months running up more than 50% in that time period.  To do a pairs trade you can buy Broadcom and go short of a broader index like the Nasdaq or the Semi-conductor index (SMH)  Why would you do this?  You are taking the market risk out of your stock purchase.  Stocks move up and down for any number of reasons.  Only half of a stock’s price has anything to do with the actual company itself.  The other half is related to the broader market and the sector.  You are betting that the thing that you buy will outperform its peers but hedging yourself in case the market does crazy things.

I am short of the Dow, the real estate sector, and U.S. Treasuries while being long China, Materials, and a bunch of individual stocks.  This on a whole has performed quite well.  I’ve lost some money on my short positions since the market has continued to rally, but my long positions have more than carried me up.  Could I have made more money if I wasn’t short?  Sure.  But the hedges have kept me sane by limiting my gains and more importantly limiting my losses.

I continue to use this strategy to great effect.  I think we are about to have another leg lower from here, there is weakness in the market right now and that is pretty evident.  I would like to get more short of the  market but won’t get too crazy right now as I can easily be wrong.

I would like to say I called the top of this particular rally.  With the Dow down over 180 points and consecutive days of weakness, it sure does look like we have come to the end of this particular little rally.  However much I would like to say that I called the end of the rally I could not say that with any credibility.   This rally has lasted way longer than I would have ever guessed.  Oddly, over a month ago I said that we would probably reach 900 before the rally reversed.  I’m looking like a fortune teller right about now as that is exacly what the market did.  The S&P traded up to 900, got slightly past it, and is now coming back down.

But however great that call was, I can’t say I knew what I was talking about.  I thought we would get there much quicker than we did.  That call was over a month ago and I honestly thought we would get to 900 in a matter of a week.  Not a bad guess considering how much the markets were moving at the time but no way did I think a rally would last nine weeks.

So where now?  Let us see how accurate I can be.  I think we go lower here, significantly so in fact.  I doubt we will get all the way down to the mid 6oo’s like we saw before but I do think we get close to the low 700’s over the next several months.  I have a pretty sizable short position, so I’m well position to weather this downturn but if the market is slightly down tomorrow and hasn’t run too far, I will probably short some more.  Of course, I have been hedging most of my trades and I will do it here too.  I will go net short for sure, but I will probably take a position that is long on interest rates (short on bonds).  I’ll explain that trade tomorrow if I indeed do it. 

The market moved down over 3% today.  Is it wrong of me that I’m hoping it continues on its way down?

I went short the market by buying a leveraged short ETF (DXD).  The thing is, I’m really not all that bearish in the market from here.  I have been saying for months that we are likely to be trading in a range for the next several years.  We have been up over the last six weeks, up almost 30%, and we are likely to come back down.  I’m just trading here and hedging my long positions in case we get a market correction.

I am not sure we will retest the lows from before, we may have put in a bottom, but at the same time I don’t think we are anywhere near a bull market.  The movement we are seeing in this market is being created by traders, not investors.  Most of your average Americans have no interest in getting into this market.  I know of several people pulling back on their 401K contributions and people thinking this is just a bad time to invest.  Forget the fact that they are thinking wrongly here, there is just not enough interest by your average american to keep this rally going.

and at your own risk.  The market had a monster move just two days ago, and did its normal 2% correction the following day.  It was pretty predictable after such a huge move.  But the question is, what next?

I actually think we probably go up from here in the short term.  If you can get in and out quick, that might be something you look at doing. But if you are like me, and do not sit in front of a trading window all day, then you have to think long and hard about putting any cash into the game.   What is my big concern?  I have not figured out how to play the Fed’s one trillion dollar gamble.

Here are the undeniable realities.  We will have inflation in the next few years.  The value of the dollar will definitely drop in relation to other currencies, particularly the Chinese Yuan.  But the question is when will it happen.  If you have a long term horizon, your move is simple.  You need to short US treasuries and take an inflation play like gold.   The problem is determining where these are going to be in the short term and if you can stay in these plays long enough for them to play out.

I think Gold trades in this $900 range for some time.  I do think it will probably break out above $1000 and stay there over the next year or two.  Same can be said for the treasuries.  But it presents an even bigger problem.  Short term, I think treasury prices could actually go up.  But there is no way that investors are going to continue to stay there when yields are this low.  So do you get in now?  Can you wait two years for this to play itself out?

I need to spend some time thinking what the other side effects of this move will be.  This is a non-trivial shift in money.  There are going to be winners and losers and the trick is to be on the winning side of it.  The bad news for the rest of us?  Taxpayers will MOST DEFINITELY be the first loser if this plan goes south.

Thus far, I’ve been pretty spot on with some of my trades.  Two days ago, I bought more of the financial ETF UYG.  In essentially one day, I’ve made 25% on this.  If the financials rally again tomorrow, I’ll be getting out of part of the position.  In this environment, you just do not ignore a 30% gain in two days.  A few days ago, I also got into material names by buying the ETF XLB.  I’ve done this not because I think we are going to rally strong and we have hit bottom.  I did it because we were way oversold and there needed to be a short term rally.

I think this rally still has some legs, but not much more than this.  I would not be surprised if we break through 850 on the S&P and we get up beyond 8000 on the Dow.  I still went short on the DOW recently to give my portfolio some balance and hedge my bets but I think we still have some room on the upside before we correct again.

Do not chase this rally.  You should be selling now, not rushing in and chasing stocks as they take off.  If you feel you absolutely must get in now, just be ready to get out just as quickly.

Going to take a slight detour from my normal blogging routine to talk about a trade I made today.  It was a pretty good trade for me, but most of it was pretty lucky.

I’ve been, for a while, wanting to get long the market and get less short.  But work has been pretty busy lately (we had a layoff, more on that another day) and so I have had very little time to even think about what I want to do in the market.  I went to bed early last night, mostly because I was so tired from the long week, and was able to get up early.  I had some time to kill before work, so I started to see how I could finally get some trading done.

Now, the market was down about 10% from where I wanted to start to get a more long.  My strategy was to continue to get longer while the market moved down.  I want to trade the range.  That is, I believe the market will trade between a range that is about 20% wide.  When we get close to the bottom of that range, I get rid of my shorts and get more long.  As we get close to the top, I get out of my longs and increase my shorts.  It is extremely hard to do and takes a lot of discipline because it can seem like the market will never stop moving in a given direction.

Well, despite the fact that I think the financials are going to be hurting for awhile, I decided to get long, ultra long in fact.  Not a huge bet, but at least wanted to start another position.  So I bought 800 shares of UYG which cost me a little bit under $2500.  So not a huge positon by any means.  But like I said, I was going to buy a little more if it went down even further.   The ETF proceeded to end the day up 23% from the previous close.  I got about 18% of that gain.

Now I’m tempted to just get out.  In this market, best to just take your gains and run.  Granted, it is only about a $400 gain.  But in this environment, that really is not anything to sneeze at.  I might hang on for a little bit longer but will probably get out soon.  While I do think the market is probably up for the next few sessions, I believe it is best to just take profits when you get them and look elsewhere for opportunities.

Bear markets are very dangerous.  No matter what side of a trade you take, you can lose money.  Even if you yourself are a bear, chances are you will lose your shirt as well.

On Friday, the market decided to make sure I understood this point.   The worst job numbers in recent memory came out on Friday.   The numbers, while they look horrible, are actually worse then they look on the surface.  I have always had a problem with the employment rate and how it is calculated.  It counts as employed people who are underemployed.  That is, people who work part time but want to work full time or people who have a job that pays them much lower then they are qualified to make.  It also does not count people who have just given up.   In this type of economy, there are many people who fall into these categories.  People must also remember, that the financial and credit crisis are just starting to make its way into the economy.  That means, we are only in the first half of this problem with plenty more to come.

Anyway, the market was down after the numbers came out, as it should be.  I decided to get short the market.  But then a funny thing happened.  The market decided to shrug it off and rally, ending the day up by about 3%.  Now, there was no news that should have made the market rally.  In fact, there was more bad news after the job numbers came out.  But bear markets just do not care.  They move, very rapidly, in directions that do not really make any sense.  Since I was double short the market, I instantly lost about 7% of my investment

Now you could argue that the market has bottomed.  And you might be right.  I personally don’t think so as I think people still have not quite digested just how big of a bubble we really had for a year.  How do I know this?  I just look around me for the data.  I have been scanning the house listings seeing how much houses are going for in my area.  Housing that are selling are at about 2004 prices.  Houses that are listed are around 2006 numbers.  Now I live in Southern California, the epicenter for the housing collapse.  Yet people are still insisting on premium values for their houses.  2004 housing prices are still about double what they were in 2000 when the bubble started.  Does anyone actually think housing prices should have doubled in four years?  Further, the average house in the area is still selling for about 8x income.  This is more than double what it should be.

If this market bottoms, I am certain it will not be a violent ride up like this.  It will hover at the bottom for a while because the United States has a long way to go to work through all the issues that we have.   I still have an appetite for risk, and will continue to try and trade this market.  I jut hope that hungry bear does not get me before I get it.

I went short the market last Wednesday.  I did it by my normal method; I bought the Exchange Traded Fund SDS.  I bought this ETF when the market turned negative in the morning.  After three days of Rallying, I figured we would get at least one day of a correction.  My plan was to get in and out of the ETF as quickly as possible.

Unfortunately for me, it was also a travel day for me.  I was returning from my trip in San Diego so I was in the car for the middle part of the trading day.  In the car, I was listening to the news, and the market continued to go higher.  It ended the day several percentage points higher, meaning I was down almost 5% just that day.  Thursday, the markets were closed, so I was forced to hold on to the position.  I resolved to get out on Friday.

I woke up early on Friday to find the market trading relatively flat.  I was still certain that there was no way we would get five up days in a row in a market like this, so I waited until the market dropped a little bit, and I was going to sell.   The drop never came, the market inched higher and higher throughout most of the day.  Since it was a short trading day the market close before I could do anything meaning I had to hold on to my position throughout the weekend.  I was now down 10%, right at my stop price, and I was for certain going to get out on Monday.  I was hoping the market would not open up sharply higher, as this would increase my losses.

Well the market gave me a gift today.  The market tanked, dropping 8% in one day.  Since I was double short in my position, I made up my losses and more in one day.  While I was going to sell in the morning, it was clear the market was weak so I held on to it till the end of the day.  I sold half the position at the close and made a small profit after taking some very big losses.  I will get rid of the rest of the position as soon as it is reasonable.

The point of the post should be pretty clear.  I got REALLY lucky in this trade. I should have gotten out way before I did.  I almost had to take some big losses and the market bailed me out today by falling apart.   If you were me, you would also understand this.  Trying to play this market can really drive you nuts.  There was really no good reason the market was rallying last week.  There was no bottom reached.  Even if the bottom was reached, there was no reason stocks should have been up 15-20% in a week.  That’s insane.  That is not a sign of a healthy market.  But the fact remains, just when you think you have it figured out, the market does crazy things.

I was watching CNBC with someone at lunch today.  He is not that familiar with how markets work, and I was explaining to him how I was playing the abnormal volatility we are seeing these days.  No sooner had I explained this did we see the Dow Jones go swing 100 points up and then 100 points down.  Literally in a matter of about 3 minutes.  After the 100 down, it came roaring back and ended up almost 300 points from that level.  And all it took were 20 minutes.  That’s just nuts.  He remarked that watching it was more exciting than watching the baseball playoffs.  In some regards, he is totally right.

So how am I playing?  Today, I sold off my short position, SDS.  I bought it at 97 and sold it at 106.2.  So I got a quick 10% profit.  I was debating on whether I should hold on to it or not.  But then my coworker gave me some sage advice, “Don’t be too greedy”.  He was right.  I have been saying I was going to sell when the S&P broke 900.  It had, and by a few percentage points, so I got out.  Of course no sooner did I get out did the stock go straight to 108 on its way to 112.  I felt a little twinge of regret, as it was about a $600 difference in a matter of an hour, but I still felt I did the right thing.  No need to be greedy, the stock could have easily gone the other way.  And ironically enough, it did, ending the day at 100.

As the market ran up, I played the other side of it.  So now I’m long the S&P index.  I’m very uncomfortable here, and would be happy to just get a few percentage points.  If I get a 2%-3% pop in the index, giving me a 4%-6% gain, I’ll head for the doors and reverse my position again.  I’m willing to take about a 10% loss on this, and then I’ll be out on the other end.