Steady Gains Through Rough Seas

• August 4, 2000
• Mark Boucher

face=”arial, helvetica” size=2>Last week showed some distribution days and some
breakdowns by high-flying tech stocks. We were again whipsawed
in Shuffle Master
(
SHFL |
Quote |
Chart |
News |
PowerRating) and also took nice profits on trailing
stops on our remaining Elantic Semiconductor
(
ELNT |
Quote |
Chart |
News |
PowerRating). Nonetheless, thanks to big gains in ACLN Limited
(
ACLNF |
Quote |
Chart |
News |
PowerRating) and small gains in our other
longs, our longs actually gained an average of 0.86% on the week.style=”mso-spacerun: yes”> We’re now only 24% long with three
remaining positions, all of which have trailing stops that lock in profits.style=”mso-spacerun: yes”> On the short side, we got two new signals
and our shorts fell an average of 5.5% last week.style=”mso-spacerun: yes”> Thus through troubled waters, our
long/short approach gained a little better than 2.5% on the week and stands at
new equity highs.

face=”arial, helvetica” size=2>Let’s look at the numbers.style=”mso-spacerun: yes”> Our Top RS/EPS New
Highs list showed 19
new highs last Thursday, 22 on Friday, 18 on Monday, 22 on Tuesday, and 19
today. Once again that’s only two
days of the week with more than 20 issues. 
Clearly it is not an ideal environment to be adding lots of new
longs. However, once again new highs
didn’t plummet in number during the week as we would expect in a powerful bear
move. Our Top RS/EPS New
Lows list
showed 7 new lows last Thursday, 9 last Friday, 14 on Monday, 25 on Tuesday, and
16 today–again with only one day above 20 issues.style=”mso-spacerun: yes”> The environment is not great for
aggressively adding shorts right now either, according to these
breadth numbers.  While our short
allocation is rising, and we now have more allocated to shorts than longs,
neither the short nor the long environment appears to be great for this strategy
now.  Let’s continue our defensive
rule of only adding two trades in either direction in a given week.

face=”arial, helvetica” size=2>An analysis of breakouts and breakdowns shows a
similar mixed picture. We actually
had more long breakouts than short breakdowns on the week. Amazon

(
AMZN |
Quote |
Chart |
News |
PowerRating) and S1 Corp
(
SONE |
Quote |
Chart |
News |
PowerRating) both broke down and met
our down-fuel criteria–we thus added these to our shorts.style=”mso-spacerun: yes”> However, few other stocks on our Bottom
RS/EPS New Low list broke down in any sort of valid fashion.style=”mso-spacerun: yes”> From our Top RS/EPS New Highs list we had
breakouts in: Armor Holdings
(
AH |
Quote |
Chart |
News |
PowerRating) (PE-to-Earnings
growth ratio was poor), Eaton Vance
(
EV |
Quote |
Chart |
News |
PowerRating) (met criteria but didn’t break out on high enough
volume), Catellus Development
(
CDX |
Quote |
Chart |
News |
PowerRating) (met criteria except that it didn’t have earnings momentum), and
possibly Manhattan Associates
(
MANH |
Quote |
Chart |
News |
PowerRating) again (PE-to-revenue growth was poor and pattern was questionable
again).

However, there were no valid
long breakouts. Despite our
increase in short allocation from around 26% to 42%, real short-side
opportunities
to get aggressively short will only develop when we get consistently greater
than 20 new lows on our list every day, and we get dozens of valid breakdowns on
valid patterns in a given week for many weeks in a row.style=”mso-spacerun: yes”> Similarly, real long-side opportunities
will now require a couple follow-through days or very strong breadth to the
upside along with consistently greater than 20 new highs on our list every day
and dozens of valid breakouts on valid patterns in a given week for many weeks
in a row. This was the environment
from November of last year through February (when we were 100% long and 100%
short), but this is clearly not the environment now.style=”mso-spacerun: yes”>  We can continue to make money in this
environment (as our performance in this whipsaw market is showing), but we must
proceed cautiously, defensively, and with our foremost concentration on keeping
risk low. 

face=”arial, helvetica” size=2>

face=”arial, helvetica” size=2>Our overall allocation remains low.style=”mso-spacerun: yes”> We are now around 24% long (including
open profits) and 42% short for aggressive accounts using leverage (12% long and
21% short for unleveraged, more conservative accounts).style=”mso-spacerun: yes”> Last week, our longs gainedstyle=”mso-spacerun: yes”> an average of 0.86% (and with 38%
allocation this added 0.32% to our overall portfolio), while our shorts fell an
average of 5.5% (and with 42% allocation this added 2.31% to our overall
portfolio), giving our overall portfolio a gain of about 2.63% on the week, and
leaving us with around a 78% gain on the year (new equity highs again) on a 12%
maximum drawdown so far. Conservative investors not using leverage show about half these gains and
drawdowns.

face=”arial, helvetica” size=2>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, of 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.”style=”mso-spacerun: yes”> 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 4-week or longer flags, or of valid cup-and-handles of more than 4
weeks. Buy trades are taken only on
valid breakouts of stocks that also meet our up-fuel criteria.style=”mso-spacerun: yes”>  Shorts are similarly taken only in
stocks meeting our down-fuel criteria that have valid breakdowns of 4+ 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.

face=”arial, helvetica” size=2>Upside breakouts meeting fuel criteria (and still
open positions) so far this year are: Alliance
Capital
(
AC |
Quote |
Chart |
News |
PowerRating) (@44) w/ 46 ops;style=”mso-spacerun: yes”> 
(
ELNT |
Quote |
Chart |
News |
PowerRating) @50.25–out on 63
ops; GBC Bancorp
(
GBCB |
Quote |
Chart |
News |
PowerRating) @30.38
w/31 ops;style=”mso-spacerun: yes”> 
(
ACLNF |
Quote |
Chart |
News |
PowerRating) @30.5 w/32 ops; and
(
SHFL |
Quote |
Chart |
News |
PowerRating) @16.25 -out on 14.25 ops; and this last week we had no valid pattern
breakouts up in stocks meeting our up-fuel criteria (see 10 week trading
course): The average gain in these stocks from
breakout points of entry to Wednesday’s close is 67%, substantially
outperforming the NASDAQ, DOW, and S&P for the year to date.style=”mso-spacerun: yes”> Continue to watch our NH list and
buy flags or cup-and-handle breakouts in NH’s meeting our up-fuel criteria.

face=”arial, helvetica” size=2>

face=”arial, helvetica” size=2>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 down-fuel criteria (and still open position) in: Ciber
(
CBR |
Quote |
Chart |
News |
PowerRating)style=”mso-spacerun: yes”>  @13.44–now use 12 ops; Airborne Freight
(
ABF |
Quote |
Chart |
News |
PowerRating) @17–now use 16.5 ops;  Six Flags
(
PKS |
Quote |
Chart |
News |
PowerRating)
@18.13–now use 16.75 ops; and Ventro
(
VNTR |
Quote |
Chart |
News |
PowerRating) @13.94–now use 13 ops; and last
week we had valid breakdowns in down-fuel stocks
(
AMZN |
Quote |
Chart |
News |
PowerRating) @31.38 w/40 ops;
and
(
SONE |
Quote |
Chart |
News |
PowerRating) @18.13 w/26 ops. These shorts are down over 55% from breakdown levels on average so
far this year (before current prices or exits).style=”mso-spacerun: yes”> Continue to watch our NL list
daily and to short any stock meeting our down fuel criteria (see 10-week trading
course) breaking down out of a downward flag or down cup-and-handle.style=”mso-spacerun: yes”> 

face=”arial, helvetica” size=2> 

face=”arial, helvetica” size=2>The trend of the market is really not wildly
dominant in any direction now. Longs have had the upper hand, but shorts gained strongly over the latest
few weeks. Neither the long nor the
short side look like great opportunities in which to aggressively position right
now to me. Nonetheless, we’re at
all-time equity highs. Remember
that when you have a strategy that can benefit from up markets, down markets,
and sideways markets that your profits aren’t dictated by what direction the
market is trading at, but rather by how in sync with the market your positions
are, and by the action of the select group of stocks that you’re trading.style=”mso-spacerun: yes”> While this is a tough environment for
many traders and it is certainly not even remotely close to ideal for our
strategy, we are continuing to eke out higher and higher profits from our
long/short strategy. Let’s stick
with it!  Remain defensive on
both the long and short side this week and don’t add more than two stocks in a
week on either side. Also only add positions in stocks that meet all of our
rigorous up fuel and down fuel criteria and have valid breakouts.style=”mso-spacerun: yes”> In this way, we’ll continue to let the
market action determine our allocation and posture.

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