For now, I am going to drop the discussion regarding the EURUSD for now (though I could cover the finer points of what will determine direction, but that will be quite a long post). What I will do for now is quickly cover the finer points of what could be happening with the AUDUSD (the Aussie Dollar, U.S. Dollar pair). For that, let’s start with the daily chart. This is done by request (and I am interested in trading this pair myself.

The break of 1.02322 was significant last week, and led to what has (as of just after the open, a test of 1.051, and what I eventually think will be a retest of 1.05453. The 127.2% extemsion of the February high and the recently broken April 2012 low would project a target of 1.00596. As one can see from the long wicks on those candles, it would not be impossible for that retest, and even a retest of 1.00455.  Should there eventually be pressure because of a “stronger” (tongue in cheek) U.S. Dollar in what would seem to be a logical reaction to the winning parties’ elections in France and Greece (both of whom want to fiscal restraint and higher taxes), one would expect the possibility of a retest and break of parity back to 0.9841. That target would equate to AB=CD price symmetry from the first move down from February 2012 to April 2012.

I think the most likely scenario at this point is the retest of the 1.00596 area. Why? Because there will likely be some negotiation with regard to what looks like a total repudiation of fiscal austerity. Where this breaks down, of course, is that, at least in the Eurozone, there are fewer and fewer options available to the ECB to manage such a mess.

Let’s for now stick with the forecast that we retest 1.00596, and let the rest work its way out. There are also specific tax issues (mining and energy taxes for now) in Australia to deal with, which could hurt commodity production, but the bigger issues are abroad, and for the very short term, the major emphasis will be on the so-called stronger U.S. dollar to pressure world currencies. Hoe long that is going to last is anyone’s guess. We are watching the slow dismantling of order in the currency markets, and no one has the currency “Richter Scale” or earthquake monitor to measure the shock or determine the fault lines. That means currency traders will get out their forked sticks (and forked tongues in some cases) to measure assumed direction and magnitude.

Anything can (and probably WILL) happen. I am still trading large hourly swings, so as to avoid 24/7 sitting at the monitors. More soon on this pair as things develop.

No time for a big discussion. Just look at the daily chart of AAPL. The correction will likely be settled at the gap, because the gap is also filled right at the 61.8% (o.618) retracement of the swing that occured from March 6 to April 10. The gap between 575.40 and 568.18. I will wait until I see a momentum reversal confirmation (which I will show when I see it).

AAPL’s earnings are still growing like a weed, and NO STOCK CAN RALLY FOREVER. The reason the QQQs and $COMPQ are falling is because AAPL is somewhere between 16 and 18% of it. AAPL is either are 787 Jumbo Jet or a boat anchor to the index. That is the reality of the situation.

Assuming it settles and surpasses previous highs, a new target would be set at around 678.61 and perhaps 722.82.

Instead of looking at lagging moving averages and other garbage, look at simple price structure and verify a reversal with volume.

‘Nuff said. Have a great day.

“Markets can remain irrational a lot longer than you and I can remain solvent.” -  John Maynard Keynes

At the end of March, I began to notice the number of QQQ shorts getting blown away as the NASDAQ 100 Stock Index continued to climb. Many shorts were getting crushed as Apple Computer (AAPL) continued its rather meteoric rise after its founder’s (Steve Jobs) death. I think many believed that price resistance alone might be the factor that would drive the NASDAQ lower. Many traders were hurting as their shorts get taken out on stops left and right.

About 10 days ago, it appears that three individuals on StockTwits somehow came up with an epiphany or some moment of zen regarding the NASDAQ. Dan Wlasiuk (@milktrader), David Aferiat of TradeIdeas, and me(@IRON100A) all tweeted basically the same thing. We all thought that the QQQ and the $COMPQ could trade to extremes as long as companies like Apple Computer (AAPL) continued to forge its way higher. At a Market Technicians Association meeting on Tuesday, March 26, 2012  in Charlotte, Dan showed me a chart of the QQQ in 1998 and compared them to today’s chart, and the breakout similarities are rather striking.

To best understand the Fibonacci pattern similarities, its best to look at a monthly chart of the $COMPQ to see the patterns to which I am referring. I think the thing that is most apparent is that we are approaching the 61.8% retracement of the distance from the peak in February 2000 and the low that was hit in October 2002, which happens to be 3595.34. Currently, there is virtual AB=CD price symmetry very close to the current weekly close of 3080.50. While I do think that there could be some very critical price resistance found there, the real question is whether or not we might be in the midst of a stock market bubble in technology shares, like the year 2000. We will explore that in a moment.

I know many of you feel like Spicoli (whose face from the movie “Fast Times At Ridgemont High” adorns the nondescript chart below the blog post title) when I discuss Fibonacci price patterns. Today I am going to reference the patterns and their targets, but also discuss some of the fundamental and valuation reasons that the $COMPQ (NASDAQ Composite Index) could go to price extremes we have not seen in awhile.

I  believe that the 3595 value on the NASDAQ composite is still possible (and perhaps a little more), because there are stocks in that index for which earnings growth is exceeding current valuation. There will be more challenges ahead, but there is still a possibility that the 3595 figure is achievable within the coming year.

Why is that?

1) Relative valuations are relatively tame in 2012 when compared to 2000:

At one time, stockcharts.com had a comparative price/earnings (P/E) ratio chart over time for the NASDAQ 100 Index (QQQ), but somehow, that is no longer with us. What I do have is a current NASDAQ 100 Index Calculated P/E ratio which uses a more reliable measurement of trailing earnings as opposed to forecast earnings. Under that calculation, the P/E ratio currently is 27.04. That number is a bit extreme, but let us put that data point into perspective with this video. NOTE: What I do not agree with in regard to this video is the video creator’s assertion that low interest rates necessitate higher price earnings ratios ( because, as we discussed earlier, forecast earnings are not as easily measurable or comparable as are PAST recorded earnings, which are the basis of inflation-adjusted historical price/earnings ratios).

Another way to compare the relatively tame current valuations (notice I did not say cheap, but relatively tame valuations) are shown in the second part of Eric Janszen’s blog post (see the comparison of the inflation adjusted NASDAQ Composite to the actual values to see what the peak value might have to be in today’s dollars).  From that report, one sees that on an inflation adjusted basis, we would have to have a $COMPQ of over 6000 to be back at those truly nosebleed levels. I am not all that excited about relative valuations now, but it would take quite a move to get into stratospheric levels again. In 2000, the price earnings ratio was north of 150 on the NASDAQ 100. Why did I effectively leave the stock market in 2000? Well, that was certainly one of  the reasons, as was the fact that $SPX inflation adjusted price earnings ratio of greater than 40.  Those were unprecedented (and quite frankly, insane) valuations, and I took my money and ran. I decided from that point forward to trade at the margin and not to be exposed to what I thought (and for the most part, still think) is a secular bear market.

2) Individual components of the NASDAQ, like AAPL (Apple Computer, Inc.) are still growing and have P/Es lower than their earnings growth rates.

AAPL still is growing at somewhere between 25% to 35% per annum in earnings at least through September 2012 it would appear.  Take a look at the AAPL weekly chart just for the moment. The next most current price target is just above $655/share. A fully extended 2.618 extension of the breakout move in January would give it a target of 795.66. If one were to use the Peter Lynch growth ratio target model which is composed of (earnings growth in percent plus dividend rate in percent)/(price earnings ratio) times the current price, one would get an even bigger surprise. That target (at a 35% growth rate maximum) would be 655 * (35/18.04) = $1270/per share. Again, this is at the EXTREME, but it is not impossible. Seems no one believed that Apple’s stock price would be able would have moved up almost 50% from Steve Jobs’ death, but it has.  Assuming everything else remains stable. As of Friday, April 6, 2012, AAPL was equal to about 17.5% of the $COMPQ market capitalization. Assuming everything else were to remain stable in the coming 6 – 24 months, the $COMPQ could be estimated to hit a target of (( 0.175 * 35/18.04) + 0.825 (1) ) * 3080.5 = 3587.31. It is rather interesting that this figure is very close to that 0.618 retracement of the last move down, which is 3595. My friend Andrew Cardwell says that technicals actually can lead fundamentals in terms of establishing price targets. Only time will tell if this adage is true again or not.

The point of this post is that there is still some room for growth in many of the largest tech indexes, as many of these companies are the only engines of growth in the American and world economies. As the Federal Reserve (regardless, it seems, of who runs it) continues to keep interest rates at near zero and primes the liquidity pump, savers and investors must chase returns in riskier assets. As most of the growth is in names like AAPL, one can suppose at least for the next few months that the NASDAQ can outrun the other major U.S. indexes, and screw with the minds and account values of those who attempt to short that index or the bigger and more successful stock names within it.

How long can this last? I am not over-bullish or over-bearish. I do think that the day of reckoning with interest rates will bring the hammer down certainly sometime within the next three to 10 years as debt continues to spiral and tax rates will likely be forced upward. That set of conditions will force many to make decisions on equity investments as the boomers begin to retire in greater numbers each month. It is a little hard to say at this point, but I think the golden ratio target(3595) likely gets tagged first before we see a significant decline in the NASDAQ. After that, from my perspective, all bets are off, given what we have seen in recent employment data and the recent rebuilding of debt at the consumer level. Still, if you have problems with rising stock markets, just go back and read the Keynes quote at the top of this post.

So for now, let’s catch the next wave and have fun. But watch out for rip currents somewhere ahead. More is coming with regard to the trading model series next time. March was an ugly month, but what better time than within that context to discuss the subject of money management.

As always, thanks for supporting this blog!

I am busy working on a few projects and because the month ends this week, I will delay the next installment of my series on trading models until next week. I decided I would do two things this week in lieu of a larger post on another subject.

First, something I found in the Stocktwits stream from Robert Sinn, The Stock Sage. It is again one more extension of Dr. John Hussman’s discussion of where we are in a secular bear market, in which he divines the differences between secular markets as a whole and cyclical periods of bullishness and bearishness. He makes full use of economic data and not just technical equity data to make his points. Pay close attention to the concept of the “iron law of equilibrium” as he discusses it. It is more evidence that one should be adequately hedged should any number of events change the economic climate and force risk assets like stocks to be avoided in haste. The cartoon is a bit of a representation of  what the financial talking heads are promoting while the main act is waiting in the wings.

The central purpose of this post is to honor an individual of great note to both the technical analysis and quantitative analysis community who passed away this week, Steve Ward, of Ward Systems Group, Inc. His picture is shown above.

The official statement read as follows:

“We have some sad news to share with the Ward Systems Group community.  Steve Ward passed away unexpectedly on March 20, 2012.  He died peacefully in his sleep.

Ward Systems Group employees have lost a friend who looked out for us and inspired us to think outside the box and to create quality products.  Under his guidance, the company developed sophisticated versions of neural networks and genetic algorithm optimization software.  He led the company in developing world renowned software such as NeuroShell, NeuroWindows, NeuroShell 2, GeneHunter, and ChaosHunter.  He also led the design team that crafted the neural network and optimization code in NeuroShell Trader.  Steve was extremely dedicated to his customers and worked many hours on new ideas.

Furthermore, he developed a master plan for the company that we have and will continue to follow into the future.  Steve’s son, Denham, is the principal developer of NeuroShell Trader and will continue in this role.  Ward Systems Group will continue to develop new products and provide excellent customer service.  We will honor his memory by dedicating ourselves to carrying on the work he loved so much.”

What is not stated in that message what was a tireless idea guy and natural researcher that Steve Ward was. He was probably the most generous person I have worked with when it came to his knowledge and applying his products to my own trading. While I have known quite a few people who work with neural nets in trading (among them, Murray Ruggiero, whom I think @milktrader on Twitter knows. I believe was the first person to actually incorporate neural nets into a trading platform), none have striven to incorporate his programs and platforms with other data suppliers, trading platform vendors, and the general trading community the way Steve Ward did. I think he and his staff at Ward Systems made it possible through magazines like Technical Analysis of Stocks and Commodities to make the entire concept of neural net based trading both understandable and usable to less experienced and even novice traders. He was a kind human being and as likable a person as I have ever known. He has had more of his work copied and co-opted than just about anyone I know, but he continued to develop new ideas and products and never once looked back.

I really appreciated it when he would talk with me over the phone about application problems I was having, and it was always a pleasure talking with him at the many Ward System conferences I have attended over the years. I never realized that he was 68 (and that is way to young to pass away). He looked and acted far younger and had a zest for life and a lot of energy.

I have been fortunate in my trading career to meet and know many of the technical analysis titans, Robert Prechter, John Bollinger, John Murphy, my friends Andrew Cardwell and Larry Pesavento, and Perry Kaufmann among just a few, but I will truly miss Steve Ward.  He was a wonderful man who has contributed a great deal to the science of applied neural nets and to basic quantitative analysis, not only in trading, but in the boarder field of science and applied mathematics. He built a wonderful organization in Ward Systems Group as well, and his legacy will live on with new and more innovative products for concise analysis of mathematical problems in trading, finance, science and economics.

He will be greatly missed. His work, however, will live on after him.

I will get back into the normal routine next week. Thank you one and all once more for supporting this blog! Readership is once again expanding and I greatly appreciate it.

I am delaying Part 3 of my installment about trading models to have a brief discussion about the $SPX which just broke above a key resistance level this week on the weekly chart. It is important to note that the 1.272 (or 127.2% Fibonacci extension of the 6/28/2010 low and the 05/02/2011 high at 1468.37, which is very near resistance at 1440.24, and even the outside extension of the $SPX at 1592.81 would be just above resistance at 1576.09, which was the 10/08/07 high. There is certainly no doubt that with Fed liquidity maximized and risk capital still flowing away from the Eurozone and into our supposed “safe haven”, we are now beginning to see something old school investors like, a declining bond market (or at least one tending to bend negatively) and a rising stock market. The question is, how high is high, and what would the future cost be if all that rally is accelerated as we go into the 2nd quarter of 2012?

I woke up a bit earlier than I normally do on Sundays, and I was scanning though the Twitterverse and at Stocktwits and began to read some summary blog posts. I will toss one out for you here, a bit of a gloom-and-doom-er perspective, posted on Distress Volatility. It includes the comments by Charles Biderman of Trimtabs calling for an eventual fall in the $INDU to 6000 at some point in the future. Remember, even I came up with one apocalyptic scenario back in March of 2011. Everyone knows, who has read my blog, the concerns even I have with regard to inflation-adjusted P/E ratios which are calculated via the Shiller index as shown here. As of Friday’s close, that value was at 23.41. It is at the high end of values in the 132 years of monitoring the index. We are above the P/E values we saw before the crash in 1987 though we are far below the insane valuations we saw that the dot.com bubble of around 43. I was introduced to this index in 1985 when I began reading Norman Fosback’s Mutual Fund Forecaster, now Fosback Fund Forecaster. He is also the author of the book Stock Market Logic. A new one isn’t cheap, but I do believe it is a wonderful reverence regarding broad technical market indicators and should be part of your library. I still have the one I bought 25 years ago and I do refer to it. Fosback is considered a bit of a renegade technician, as opposed to being a pure quant like Dr. John Hussman.  I do not get paid to make that recommendation about the Fosback Fund Forecaster, but I do share an Amazon Associates link as part of the process of paying for server costs, so if you are interested in buying his book , click that link to support your local blogger). Had I listened to Mr. Fosback’s advice in June of 1987, I would be a much wealthier man than I am today. He was early at seeing what was happening to the interest rate markets and to stock values, and was advising his clients to exit the market or to hedge significantly. Those who did avoided most of the mess between August 1987 and early 1991. He was virtually alone in his forecast until Martin Zwieg made his call on Wall Street Week, but subscribers blossomed afterward. He was (and I think still is) the most successful financial newsletter writer in history (and not just for one prescient call). He used the Schiller index as one of his primary valuation gauges.

From a long-term historical basis, the market, at least as measured by the $SPX, is not cheap. I hear all of the tales that forward P/Es are low, but, as I have stated in the past, those numbers are based on forecasts, and we all know how accurate those can be. The Schiller ratio is based on recorded history, which can be as accurately compared as any other measure.

From a technical perspective, it is certainly possible, (within as high as a 65-70% probability based on previous pattern analysis) that $SPX could achieve the 1468.37 (16.6% higher than the 1258.86 open on 1/03/2012). The $SPX could within a coin flip’s chance hit 1592.81 ( 26.5% higher than that same open on 1/03/2012), assuming symmetry patterns hold. The estimated static Schiller P/E would then be 1468.37/1404.17 * 23.41 or 24.48. At the extreme end that ratio would be 1592.81/1404.17 or 26.55.  Those are both relatively nosebleed levels compared to 13 decades of market history.

Because, Dr. Hussman uses data-backed comparisons without a ton of hyperbole, he came up with a matrix scenario for interest rate and stock market trends and had I identified conditions that he considered bad times to invest in the stock market. The one scenario referred that is analogous to the one we are dealing with today is “overvalued, overbought, overbullish, rising yields”. In his piece this week called “Do I Feel Lucky?” , Dr. Hussman shows how this scenario combined with recently declining economic activity can be used to forecast a little less sanguine scenario for stocks. Though I do not have the most current data on that investor’s sentiment, the AAII indicator is getting close to 47% now. The spreadsheet attached to this blog came from Standard and Poors as was part of a Business Insider post. If earnings decline, that ratio will rise, and once again the question of value will arise, leaving even the institutional investor to question the value of holding stocks rather than sitting in cash, particularly if rates rise. But as we know, the Federal Reserve continues to force investors into higher-risk investments, punishes savers, and forces those near retirement to make some rather dire choices when it comes to a risk profile. We simply do not know what factors may first force the hand of the Fed to raise rates, but they are out there lurking.

Are we heading to 6000 as Charles Biderman thinks? It is hard to say, though no sustainable bull market in U.S. history has ever started unless the Shiller Price-Adjusted P/E level on the $SPX sinks into the high single digits, and we are nowhere near those levels. There are tons of risk factors in the world economy (the unending idiocy of European sovereign debt restructuring, a potential conventional or nuclear war between Iran and Israel, a further energy crisis associated with that (which would cripple the U.S. consumer economy), and the United States inability to deal with its own debt, which could destroy our economy and lead to social unrest the likes of which we are likely prepared for. I will do my best to update this data in the coming weeks, but with 43% of Americans with less than $10,000 in retirement savings in March 2010, tax rates will have to rise or means testing done for anyone to receive Social Security, which is fading. That does not bode well for stocks either, since a vast majority of Americans of boomer age will cash in to pay bills in retirement. The last median number I saw for individual retirement savings (from early last year, was $127,000 approximately, from an article to which I can no longer link, from October of 2011). That is not enough to survive 30 years after retirement, which many could do.

Should one hedge one’s bets if he or she is close to retirement? I think that answer is definitely YES, because of historical precedent. If one is a couple of years away from full retirement, the figures tend to indicate that the upside is limited and that the extent of upside like I see, would, as I have said previously, discount a few years of future earnings growth should we get there sooner or later. Go read my post from March of last year for the downside extremes, but you have to have a plan that will protect you in such high relative valuation environments. Should our debt crisis accelerate, which it likely will given the intransigence and stupidity of the current U.S. political class, rates will ultimately rise and clearer choices for stable return will be made by those unwilling or incapable of taking large incremental risk with savings. If you are young, and you believe that free markets will survive the current mess we have in the United States, then continuing to invest for the long haul is a good thing. If not, one has to make rational choices to protect and extend savings. Perhaps in the coming weeks I can discuss inflation in the context of simply holding investments. Most people do not know how rapidly inflation destroys savings, but it has to be accounted for as part of planning. Although this blog has been primarily devoted to trading, I think a good discussion about return needs to be had again.

I will have more on trading models soon, as well as more discussion about some broader market and economic issues that affect it. Thanks again for supporting this blog!

I have had numerous traders either e-mail me or tweet me regarding my thoughts on the EURUSD (the Euro Dollar Currency Pair), GLD (SPDR Gold Trust ETF), and what I think of the US Dollar Index at this time. I probably could write 2500 words or more on this subject, but I am going to attempt to be concise. Though I still think the correlation between the Euro, U.S. Dollar and even the U.S. stock market indexes are still highly correlated, I think economic events may have to crest before we see them once again rear their ugly heads (and frustrate traders and investors once again). To make this a uncomplicated as possible, I will begin by discussing the Euro, shifting gears to the US Dollar Index, and then moving lastly to GLD. I still do not believe the current 11-year bull market in GLD is over, but it could be getting more complicated than ever before, as the political class begins its brinkmanship in an attempt to save the ultimately un-salvageable debt crisis the Eurozone.  The buttons pushed will distort markets in very strange ways, but likely will not disturb the longer-term trend until governments prioritize and limit SPENDING, which is the source of its problems.

EURUSD : I still believe its best to look at the weekly chart on the EURUSD to get the best understanding of the basic patterns involved and what they might be telling us. Traders last Friday basically told us that they were not sanguine with the Greek debt restructuring, as it still leaves, even after bond holders take a huge haircut (of up to 90% when all adjustments are figured in), roughly 30 billion Euro in unpaid obligations. That could send Greek credit default swaps to kick in, and that might futher pressure the EURO, which lost over 0.01 last week versus the U.S. Dollar. If there is the fear of debt contagion, that would cause the support levels at 1.26264 to be retested once again. That would likely strengthen the dollar, cause U.S. Treasuries to fall a bit, and cause an ever stronger rally in the U.S. Dollar.Momentum on the weekly chart has turned negative as well. If support at it could get up a symmetry target of  about 1.1623 with an intermediate low around 1.2184.

U.S. Dollar Index: Take a look at the weekly chart.  As the U.S. Dollar takes on (deserved or not) its “safe haven” status for frightened Eurozone investors, the U.S. Dollar Index could indeed rally to resistance at 81784, and beyond that to the vicinity of 84826. This could indeed be the simple knee-jerk reaction because of the doubts about the solidness of the Greek bailout. I still believe that whatever bullishness this portends for the dollar will be relatively short-lived, even though the rally might extend to the vicinity of 87020 at the extreme.

GLD: What does that mean for GLD? Take a look at this weekly chart. Should the dollar rally, one could expect pressure in GLD all the way back to the 143.97 area or slightly below. I am going to avoid some Fibonacci price pattern theory here to keep this discussion brief, but there is some AB=CD Fibonacci pattern price symmetry just underneath 151.45 support. With any rally related to fears over Greece (or Portugal, which seems next to be facing restructuring), GLD could easily correct to that area and still basically still be following a longer term bullish trend. A completion of that pattern would be considered bullish if the correction held there. I had tweeted on Stocktwits and discussed in one trader’s chat room that when we touched the 173.77 area that an option straddle might have worked there (which, it appears so far that it has). It is possible that if we hold close to that  143.97, the same kind of strategy might work again, though it is too early to make that decision at the time of this post.

What one has to realize is that the profligate spending on our “side of the pond” isn’t changing, and until there is some real attempt at containing entitlements in Europe, the adjustments will become even more unsteady, regardless of which nation is forced to take a “haircut” in their sovereign debt, is only going to force the credit default swaps to spike, and more money running to any safe haven available. How long the U.S.A. with it’s “bullet-proof” printing presses can keep this up is the real question. At some point, investors and institutions will regain their disdain for fiat currency, and they will revert to GLD and gold as their true safe haven. I will reserve comment on new targets for GLD until we see a little more price action this spring, but I think the targets above 200 for GLD (and $2000/oz for gold) are still within reach.

We are now in a transitional period as the political maneuvering in the Eurozone and in the United States (after all, it is a Presidential election year), and the commodity-related and currency-related markets are going to become volatile and frustrating.  I still think the Euro shoe is going to drop harder than the U.S. shoe in 2012. The shoe may begin slipping in the U.S. in 2012 (with deteriorating corporate earnings in the second half and fiscal woes facing the lucky (?) winner of the 2012 Presidential election in 2013. I think one of the final rally crescendos in GLD and gold will begin late this fall or early in 2013, when fiscal projections begin to deteriorate here, and the battle to confiscate the wealth of Americans begins in earnest. For now, we have to watch key resistance and key support on each of these markets. If they hold, the new floors and new ceilings of those markets are not far away, and will be lucrative for patient traders and investors. For gold, it will likely be a new ceiling, for the Euro, a new (or retested) floor, and for the USDX, probably near and intermediate term chaos with a slightly bullish bias until we get into 2013. I will work on U.S. dollar index targets in coming posts.

What does that mean for the $SPX? Stay tuned for that as well. And as always, thanks for supporting this blog!

P.S. To maintain the free aspects of this blog, I will be running some inside-post ads from time to time. They have proven in other situations to cover server costs, which are increasing all the time. I enjoy this blog, and would likely continue to pay the costs of hosting (as it assures that readers can readily access this blog). I would like to attempt to make it free for me also, until such time (and that time is coming) that I have a paid product that I can offer those who want a little deeper insight into what I do on a daily basis. I hope it is not an annoyance to you, but I am going to test out the advertising concept for awhile.

After a longer hiatus than I had expected to take because of pressing business matters, its time to address the concepts that make a model work, even within the context of a neural net trading model for swing trading. I am not going to get too specific on the individual concepts that make up my specific model (one part of it is proprietary, not because of anything I want to keep a secret but the protect the intellectual property of another trader/analyst and friend), but I will address one of the comments from the last post about not being able to sustain returns (part I will address here, and part in the next post). The thing to remember most is that most people lose money in trading and in investing by not following rules and following their emotions. Read any of Jack Schwager’s books, Market Wizards and The New Market Wizards. I hear traders constantly blow off these books as worthless, but if people would really understand what these traders are talking about, they would understand that rules and self-control are the key elements of any success in trading.

I am going to put up a PDF file of a PowerPoint presentation I made at the Angelika Theater in Houston in 2007 from my BizRadio Network days (which sadly is now closed, and NOT because I presented there). It covers in a little more detail the kind of style this model trades. There have been a few modifications since that time, but I will do all I can in the next couple of sessions to explain the differences between then and now.

I want to address these key points (and again, this may go against the wisdom of the good people at Wards Systems Group, but these are based on literally nearly 20 years of work on the subject both with and without the product):

1) Good models typically track and follow basic price structure of the security being modeled. That is, if it’s a long-only model, it buys low and sells high. As you will see in the PDF, I have basically five input factors, four of which are price-pattern-based.

2) Pre-screening stock for external  risk factors is important. I use a commercially available package mentioned in my PDF to do on a cash flow value and relative momentum basis before deciding to trade the stocks that meet the momentum and pattern. I also follow earnings news and company news prior to trading a stock on a given day.

3) I pay attention not only to sector activity (the more stocks that screen within a given market sector, the greater interest I have in it because of institutional buying in clusters), I also STICK with the statistics. If it does not trade at that minimum 1.60/1 profit to loss ratio and does not produce 60% winners, I do not care what the stock is. Anyone who followed coal stocks on Friday saw ANR and CLF move strongly. The coal mining sector screened strongly, but the model itself disliked those stocks. I do not feel bad about missing the trade. I know another will come along soon enough.

4) Managing the risk in terms of stops and targets is as important as entries and exits. Instead of taking profits only at entry and exit points in the model, I will sequentially take profits in positions as they move forward, or get stopped out. Why do I do that? I want to make sure that, over time, I can slowly increase my position size and take more profit overall as time goes forward. Anyone who does not understand that very important concept should look at page 36 in the PDF. 2.5% of 10000 is much larger than 2.5% of 3000. How do you get there? One does it by taking a portion of the profits when they are available ( as Mark Douglas discusses in Trading In The Zone).

Take a look at the results for the month of February 2011 so far(these are trades I have taken in a different account but applied to a simulation account. If you look at the average percentage at the very bottom, it is right at 2.5% per trade. Not great, but well within expected parameters. Typically in months near market tops, we begin to see a decline in the number of potential candidates and a drop in the average return. We are seeing BOTH currently, and if anyone who used to read my Buffalo Trader Bullish Reversal Reports knows, that tends to confirm we might be a top. How will that affect my trading and how to use these models? Stay tuned, I will discuss that in the next post. I will also cover in more depth position size and money management, which are both critical to success.

And what happened to CAKE (Cheesecake Factory) on that last trade? The model liked the entry with a positive expectancy, and it STILL STOPPED OUT. I guess you can’t always have your cake and eat it too, but that is the nature of trading. If you are afraid to take the next trade in the sequence of trades, then you are afraid of trading success, and you will ultimately fail if that happens.

What you saw in the Google document is a product I am currently working on that may become a daily or twice weekly trade advisory if everything works out. If I am going to continue to consume time in writing when my trading and other businesses can make money, I would like to get paid to invest the time I have with it.  I can barely post trades the way I used to. Much of what you see here is what I used to tweet every day in the early days of Stocktwits. I simply do not have the time to post every trade any more. Let me know if you are interested in this kind of thing. I am working with a partner now who is trying to figure a way to market it through his own affiliate network. I will still post in this blog for free, but I would like to cover the cost of the server upon which I have built this blog. It is at least partly responsible for my maintaining decent traffic since I have ceased making this a daily blog.

Thank you one and all for continuing to support this blog!

I am writing this at the request of a few readers and a few people in Joe Donahue’s chat (which, by the way, you can learn a lot in if you happen to join Joe’s premium service at www.upsidetrader.com (this was a totally spontaneous and unpaid plug for his service on StockTwits.com by the way). Lets talk about models, but not fashion models. I mean trading models. I will likely make this a multi-part series because I am in the middle of two business projects and I want to do some additional back-testing of an hourly forex model. For tonight, we will simply address the numbers.

In later posts I will discuss how I built models using NeuroShell Day Trader Professional Version 6.2. You can find out more about it by going to this link or to this link for more information from Ward Systems Group, Inc.

I for some reason cannot find the original post I did way back in 2004 in which I made comparisons of trading models to models like Jessica Simpson. I think I stated that if trading models were as inconsistent and unreliable as Jessica Simpson that one should basically stop trading. Why is that? Well, it has something to do with statistical expectancy. B.C. Lund wrote brilliantly about such things in his blog post this weekend. Study what he shows in terms of the number of losses one can suffer as reward to risk slips to parity. To quote Mr. Lund at the end of that table, “You can see that if you only take trades that have a 1:3 risk/reward ratio, and you are correct just 50% of the time, you will have a 10R profit on ten trades.” What one must realize is that during that sequence, one will lose on EVERY OTHER TRADE, so that reward/risk ratio will have to be skewed in your favor strongly if you are to end up with profits.

What you see at the top right of the picture (and quit staring at Faith Hill will you?) is a model for Cheesecake Factory (CAKE) I built in August of 2010 (that is right, about 18 months ago). It has three key statistical characteristics that I like in a trading model:

1) Look at the red box a the top right (percent change in price and annual change in price). Those are the numbers for a pure buy and hold from August 25 2010 to February 2, 2012. The box below is is what the return would be from the trades the model produced. The model on its own produced a better return than pure buy and hold (and by a decent margin). That is a primary sign of a good trading model (I will comment on tax implications at a later time, but the point is, the model traded better than if you had simply bought and held the stock.)

2) The win to loss ratio which is $3.69 made for every dollar lost. Typically, I would like to see this ratio at least at 1.60/1 or higher before I would trade it (as is discussed on the Lund post).

3) The percentage of wins to total number of trades is 83.3% (basically 8 out of every ten trades is a winner). My minimum acceptable winning percentage is 60%. Tom Joseph, an expert oil trader who developed Advanced GET a couple of decades ago, used the 1.60/1 and 60% statistical model as his minimum acceptable statistic because he figured you needed at least that kind of edge to cover both for losses and potential trade errors that could be made. I think he was right when he said that.

Models have improved over the years. Jessica Simpson dumped Tony Romo, got married and is now pregnant with her first child. Faith Hill, well, you saw her at the start of Super Bowl XLVI. She hasn’t aged a day and didn’t need to lip sync her  intro the way Madonna lip sync-ed her Halftime show. Neuroshell Day Trader Professional has gotten better as well. In 2001, it might take 45 minutes to build one model. Now, it takes as little as 15 seconds given the processing speed of Intel i7 chips and the ability of the software to use multiple cores from all areas of a computer network.

Do I believe that only neural nets can produce trading models with positive expectancies? No, because I have seen and personally traded models that were thoroughly back-tested and consistently make money. Why do I use them then? I use them because they provide me with statistically viable stable models that  are basically “buy at open” with stops and targets at the ready. I do not have to use finesse or emotional judgements to make a trade. It eliminates the hesitation to pull the trigger when I have to. I already know that not every trade is a winner, but I have the confidence that the statistics are still on my side when I trade.

In the next installment of this series I will discuss the basic components of what make up a good trading model, and not just a good neural net trading model. There are components of the model that make the good basis for a specific trading plan, which most traders don’t have. Typically, that is the reason most traders fail to make money.

I hope you ladies were not offended by this post, but let’s face it. Some models ARE better than others. The numbers prove it.

Thank you, ladies and gentlemen, for supporting this blog!

I am still working out details on the new course of this blog with individual stocks names as well as sector analysis as time progresses, but for now it is time to look at perhaps a critical junction in the price action of the $SPX (S&P 500 Stock Index).

As stated previously in this blog, I had anticipated either a deep correction followed by a rally, or a continuation of the current rally followed by a serious correction. It looks, for now, like option 2, the rally, is occurring so far in 2012. One of the things you must learn in my opinion as a trader is that there should be a primary focus in technical analysis, as John Murphy has written about on several occasions. That primary objective is to set reasonable price objectives when holding a long or short position in the markets.

Under the current price action, we could have three very possible bullish outcomes:

1) Price symmetry at a point of resistance. Look at this monthly chart. What you see an example of here is AB=CD price symmetry. The retracement level from B to C is 0.618 the length of price segment A to B (form the low of A to the high of B). If that holds true, we should see a target high of around 1370.58. That is right at the cycle high set in April of 2011.

2) One of two butterfly patterns could play out. One would end at 1427.94, and the other at 1451.04. The retracement of A to B is roughly 0.786 of the  X to A down move. Both of those patterns should end in a later reversal which means both patterns are bearish in nature.

Which one will it be? Well, the momentum indicator I use still sees the $SPX bullish in daily, weekly, and monthly time frames. The neural nets also are still bullish on a daily basis, though the current daily rally is extended a it.

On an inflation adjusted price/earnings ratio basis, the$SPX cash index is quite extended also at a value of 21.97 at the time of this writing.

Conclusion: I still think that if any short-term euphoria remains, the resistance level at 1350 to 1370 is achievable in the coming couple of months. After that, however, any extension of the market toward new highs will essentially exhaust what ever future return could be achieved over the next couple of years after that (2013-2014). The return from 1258.86 to 1427.94 is about 13.4% and to 1451.04 would be about 15.2% . Nothing says this cannot happen (does anyone remember the ridiculous returns of the late 1990s?), but I think to expect something beyond that level completely ignores the difficulties in the Eurozone and the world-wide problems associated with sovereign debt.

For now, I think the 1356.48 to 1370.58 level will be a point of exhaustion, with an outside possibility of 1451.04 at a bearish butterfly completion. I have no clue whether this will happen, but I do know that the analysis that I have done is consistent with profitable trading practices I have used in the past. These extensions and pattern completions are highly repeatable in various time frames, so that is my story, and I am sticking to it.

More will come soon. The neural nets are back in gear again and as I see particular stocks or sectors that begin to look appealing, I will report on them.

Thanks for supporting this blog!

As most loyal readers of this blog know (and I know from Google Analytics that there are still about 750 really hardcore readers of this blog around), this blog has shifted gears a lot as my schedule and priorities have changed with time. In 2004, this was literally a reflection of my swing trading in stocks, with the neural net models my basis for all analysis. I still have the capability of screening the entire US stock market (imposing a $10 minimum stock price, which drive some people nuts as many will only trade low-priced stocks), and do a very competent job of figuring out which sectors were hottest from the long end and picking the best of the best from a momentum,Fibonacci price pattern, and value perspective. I could also invert the model for shorts (something I never did because I never really had to until we ran into the brick wall in 2008). I can still do that, but I chose not to as I began working on other projects.

I used to show people what I traded every day, for good or ill, and it was read very widely as I approached 2008. From that time forward, things began to change. I had to take a little business over after my brother passed away, and I decided to turn it into some kind of a cash flowing business (and it does in a small way now, and perhaps in a much larger way in the future). I also had begun to work on other projects and help others with their businesses. That has also taken off within the last year. I do not have the time to physically knock out the research I once did. Over the last couple of weeks, I finally repaired a software error that allows me to run the latest version of NeuroShell Day Trader Professional 6.2 and I have restored full capability to that model.

I am now considering turning that output (with an inverted screen for shorts) into a product with a friend of mine, a former prop trader, who now runs a training service of his own. This is a product I had considered creating in 2007 but put on hold as I took on other responsibilities.

What I would like to do in this blog, however, is to do some kind of bi-weekly sector analysis using the same kind of screens you used to see like this. What I hope to do is to find a WordPress widget that replicates the chart posting I used to do for Mr. Swing that will demonstrate the consistency of the patterns (and that readers really liked when I had that capability).

What I want to know is, what do you want me to focus on in this bi-weekly format? Sector analysis with individual stock names added, or would you simply want me to feature single stocks?

I do not have the time to post daily any longer. Between the forex trading and all the other stuff I do, it prevents me from getting real work done.

Many of you will not post in chat, but will send me an e-mail. My e-mail address for this blog is buffalotrader100@gmail.com. I can also post on forex as I see major patterns hit and when there might be a significant swing opportunity.
Thanks for supporting this blog!