Downward Bias Trading Range Getting Oversold

September 29, 2000
Mark Boucher

The
market has fallen further in the latest week across the board, yet
still lies within the confines of a trading range established in May. Some of
our oscillators are now signaling oversold, while the bulk of negative earnings
surprises (which are typically announced early on in the earnings announcement
season) should be passed within the next week. Money supply figures show that
the Fed has his foot on the gas in the pre-election period. And each of the
indexes is getting within a couple of hundred points or less of a pretty
significant support level. Thus, we should get a rally from somewhere close to
these levels. If we do not, and we break through the May lows, then this market
is in pretty big trouble. I suspect a rally will ensue, however, and investors
should watch the expected rally for internal strength to gauge whether this is
just a rally within the trading range, or will it have enough force to test and
better the highs made early this year? So far there is no internal strength
evidence that either the bull or bear side is taking over major dominance.

Let’s
look at some numbers from the week. New
Highs vs. New Lows on our RS/EPS lists were
20/29, 29/34, 45/24, 27/36
and 23/31, respectively, for the latest week, last Thursday through
Wednesday. There were roughly nine breakouts on the upside with seven breakdowns on the downside of four-week-plus consolidations on our RS/EPS lists.
There really was only one breakdown that we would consider valid (in
Priceline.com
(
PCLN |
Quote |
Chart |
News |
PowerRating), but we won’t count this in our model portfolio
performance because I missed real time, and it moved so quickly.) There were,
however, four stop-outs on the long side, and we’re going to be exiting another
long. We got creamed on the long side, but our shorts did exceptionally well
(you actually made money on the week if you caught PCLN and nearly broke, even
if you missed it: PCLN met all our short criteria and investors following our
strategy could have sold on a breakdown on the 21st @ 21.56 — but if you missed
the close, PCLN plummeted so fast that we won’t count it in our model portfolio
track record — it’s now at 10 and change). However, neither long opportunities
nor short opportunities are developing in anything remotely resembling full
gear. We will continue to advocate a cautious stance, with investors to add no
more than two trades per side in the next week.

Our
overall allocation is now very cautious. We
remain around 7% long (including open profits) and 27% short for aggressive
accounts using leverage (4% long and 14% short for unleveraged, more
conservative accounts). Last week
our longs fell an average of 8.6% (and with 42% allocation, this subtracted 3.6% to
our overall portfolio), while our shorts fell 7.2% on average (not including
PCLN, which fell 56% on the week since entry) (and with 27%
allocation, this added 1.94% to our overall portfolio), giving our overall
portfolio a gain of about 1.66% on the week and leaving us with around a 78.3%
gain on the year (1.7% below new-equity high!) on a 12% maximum drawdown so
far. Conservative investors not using leverage show about half these gains and
drawdowns. Our snail-slow gains with
relatively low volatility in our total account continue.

For
those not familiar with our long/short strategies, we suggest you review my
10-week trading course on TradingMarkets.com, as well as in my book The Hedge
Fund Edge and course "The Science of Trading".
Basically, we have rigorous criteria for potential long stocks that we
call "up fuel," as well as rigorous criteria for potential short
stocks that we call "down fuel."
Each day we review the list of new highs on our "Top RS and EPS New
High list" published on TradingMarkets.com for breakouts of four-week-or-longer
flags, or of valid cup-and-handles of more than four weeks.
Buy trades are taken only on valid breakouts of stocks that also meet our
upfuel criteria. Shorts are similarly
taken only in stocks meeting our downfuel criteria that have valid breakdowns of
four-plus-week flags or cup-and-handles on the downside.
We continue to buy new signals and sell short new short signals until our
portfolio is 100% long and 100% short (less aggressive investors could stop at
50% long and 50% short). In early March,
we took half-profits on nearly all positions and lightened up considerably as a
sea change in the new economy/old economy theme appeared to be upon us.
We’ve been effectively defensive ever since, and continue to be.

On
the downside, this year we’ve had breakdowns from flags (one can use a down
cup-and-handle here as well) in stocks meeting our downfuel criteria (and still
open positions) in: Corus
Group
(
CGA |
Quote |
Chart |
News |
PowerRating) @ 11.88 w/9 ops; Blockbuster
(
BBI |
Quote |
Chart |
News |
PowerRating) @8.94 w/10 ops; Kmart
(
KM |
Quote |
Chart |
News |
PowerRating) @6.38 w/7.25 ops;
Sprint
(
PCS |
Quote |
Chart |
News |
PowerRating) @40.81 w/40.25 ops; and
this last week, we had valid pattern breakdowns in stocks meeting our downfuel
criteria (see 10-week trading course) in Priceline.com
(
PCLN |
Quote |
Chart |
News |
PowerRating) @21.56 — now
take profits if you caught it, but PCLN fell so far so fast, that we won’t count
it in our model portfolio track record, even though those watching stocks daily
should have caught it (in truth, I missed it as well, so I couldn’t count it in
conscience). These shorts are down over 62% from breakdown levels on average
so far this year (before current prices or exits). Continue to watch our
NL list daily and to short any stock meeting our downfuel criteria (see 10-week
trading course) breaking down out of a downward flag or down cup-and-handle.
Here, too, remain cautious by only adding two shorts in a week.

We
need a couple of weeks of abundant breakdowns that meet our criteria on the downside in order to release our cautious stance toward
shorts, and we need a couple of weeks of abundant breakouts that meet our upfuel
criteria to release our cautious stance toward longs. I still suspect that if we
can get through October without a breakdown below the May lows, we’ll get a
normal seasonal rally from November to January. We may be near the lows now, as
many oscillators are pointing toward oversold conditions, and the breadth of the
decline is not impressive. If this rally unfolds, let’s watch breadth and groups
and numbers of Top
RS/EPS New Highs closely to see if it has enough teeth to push these markets
to one more new high and to pull out a decent set of long-side opportunities.
Remember to let the market be your guide. Only when our opportunities grow to become abundant will we
be able to get more excited about moving our long allocation or short allocation
up to more aggressive levels.
Until we can see the whites of their eyes, don’t shoot too much allocation at
these markets. We’re doing quite well this year so far, given the market
environment — so let’s stick religiously with our strategy and let it tell us
how aggressively to allocate and to what vehicles on what side of the market.
Enjoy the ride. Remain defensive and cautious during the week ahead.

Downward Bias Trading Range Getting Oversold

BUY THE FEAR, SELL THE GREED

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