GDX - Rising Wedge

That huge volume looks like distribution to me ahead of the strong resistance around 38. Looks like a good place to take some profits off the table if you've been long gold for a while. Just my two cents.

Testing new setups

This month I'm paper trading a couple of simple setups designed to work better in a choppy market. One is fading an extended move to a major support or resistance point and the other is a speculative double top at an important level. It is not the most comfortable way of trading as it feels like you're stepping in front of a bus sometimes, but it seems to have a high win rate. I'm using tape reading to filter out stocks with very high momentum.

Here is an example of the double top setup:

40 is a significant level and the 200 DMA was at 40 on the daily chart. I look for a bearish candlestick in the morning and expect price to get rejected at the same level as long as I don't see too much momentum on the tape. I like to see the tape slow and a mix of red and green (trades being executed at bid and ask).

Market evolution

I've been thinking a lot lately about how dramatically the market has changed over the last year. The overall behavior of markets is a synthesis or average of the behavior of each individual decision maker participating in the market. Those with more capital have a greater influence of course. I think that market participants can be broken down into four categories: hedge funds, mutual funds, retail investors and retail traders. I'm going to ignore the effect of market makers, as their influence has probably remained relatively stable and doesn't apply to Nasdaq stocks.

From 2003-2007, hedge funds were a growing segment. When hedge funds were at their peak, they could produce strong, trending moves as more and more money was poured into the hot sector of the moment (i.e. oil). Today there are far fewer hedge funds left standing after the crash in 2008 and they have less money to manage. I have read that many hedge funds have resorted to intraday trading. According to Hedge Fund Research, the assets under management have declined from a peak of 1.9 trillion in 2008 to 1.4 trillion due to losses and investor withdrawals. This is a significant change.

I view the influence of mutual funds as more random. At the end of the month, they rebalance their portfolios which shows up as sector rotation. When they want to invest in a particular equity or sector I think they basically use programs or bots to buy in over time and I don't believe they pay much attention to technical analysis. Mutual funds control vast quantities of cash so their effect is important in the long term, but I'm not sure if their presence is predictable in the short term. The effect of mutual funds has probably decreased slightly since 2008 as the quantity of cash under their management is less vast. I'm sure that many seniors close to retirement have moved their money to less risky investments and that money will unlikely reenter the market.

If you define a retail investor as someone who invests in the long term and holds for a period of months or years, then I think you would agree that the number of retail investors has declined since 2008.

That leaves the retail trader. From what I've read, this is a fast growing segment. Brokers are gaining customers at a rapid pace. Many believe that buy and hold is dead and that our markets could be rangebound for several years, or even a decade as seen in Japan. The number of traders seeking to gain from intraday price moves has arguably grown considerably over the last year or two as holding anything overnight has become a very risky strategy.

To summarize, the effect of hedge funds is decreasing as there are fewer around and they have less cash under management. Large, trending price moves will likely be a thing of the past in the near future. I've noticed that the average intraday setup is now more likely to only extend to .382 or .500 (for the Fibonacci lovers). Less money at work means less extension. The influence of mutual funds has decreased. More retail investors are evolving into retail traders. Swing traders are becoming intraday traders. The intraday trader who used to hold for two hours is now holding for one. The scalper going for 5 ticks is going for 2. The retail trader segment is becoming very crowded. In the past I think that this segment could be safely ignored as most retail traders were riding on the coattails of the hedge funds. But I think today they (or we) have reached a level where they are starting to shape price movement as all other influences in the marketplace are contracting.

Hopefully this little essay has sparked some reflection on how the market has changed and how we can adapt our strategies to conform to the current market conditions. I think it was possible to trade using the same basic strategy from 2003-2007 but I doubt that there are many traders using the same strategy today as they were using during that period. As traders we must evolve along with the market.

Further reading on Hedge Funds:
http://marc.brightonhouseassociates.com/wordpress/2009/02/demand-increases-for-short-term-highly-liquid-trading-oriented-hedge-fund-strategies/

January Review

I'm done trading for January. My performance has declined over the last few months. I haven't been seeing many good setups and even the ones that look good don't fully extend. And of course when there aren't good setups there is always that temptation to trade less than stellar setups. I overtraded at the beginning of the month because I had too much of a preconceived idea about January's. One would expect an increase in volume and for certain sectors to start pulling ahead of the crowd. This is usually the month when new money goes to work, but that hasn't been the case. Over the last few months I've been trading less and trying to wait it out until conditions improve but now I have to assume that this is how conditions may be for the next few years. I need to find a way to trade low volume, choppy, directionless markets--the achilles heel of any trending system.

I reviewed my trades during a successful period last year. What I noticed was that not many entries were that great, but most trades at least went my way for a little while and I was quick to bale out of trades that weren't doing much. Lately, I've been "going down with the ship" too often and stubbornly staying in trades that I know aren't working in the back of my head. I'm considering using time stops. For example, I will start a stopwatch at the beginning of a trade and move my stop to the point where I would only lose .25R after 10 minutes. Then I would move to break even after commissions after 30 minutes. I'm going to be paper trading some new ideas in February so I might not be posting much...

Weekly SPX chart - disturbing symmetrical triangle

I don't focus much on the long term but I noticed this symmetrical triangle on the weekly SPX chart. If this resolves to the downside, we could see the S&P at 500. It's not too unrealistic if you consider several of the financials/banks could be nationalized like AIG and approach zero.

Having too much directional bias

Am I the only one who has trouble going long? I'm like Paul Giamatti in Sideways, "I am NOT drinking any Merlot!" but substitute drinking any Merlot with going long. That was a stretch, I know. I've heard that a lot of new traders have trouble shorting, but I have the opposite problem. The majority of my trades are shorts. I like how fast stocks can go down. When a stock goes up it pauses retraces, goes up some more, pauses. With a good short you are often in and out on one bar. I don't have any long overnight holdings (except for Motorola, don't ask) so that I can be market neutral, but I'm thinking about actually going long a token amount just so I can even out my bias. Short covering or not, if the market's making a move I should be in on it no matter which way it's going.

Friday trade - WYE

This was a pretty nice setup that didn't work out. I was sensing more choppiness today so I wanted to trade a gapper that was in play so it wasn't as affected by the overall market. WYE broke out but couldn't get past the open range low. I stayed with it because buyers weren't coming in even while the market was beginning a choppy rally. It got stuck in a tight range so I kept tightening my stop. I wasn't sure which way it would break but odds seemed to favor breaking down. It got stopped out before CNBC announced that the merger with PFE was more certain than initially reported in the WSJ, supposedly something will be done Monday. In retrospect I should have just closed out the trade so I could focus on stocks that were actually moving. I told myself I was being patient but I think I was truthfully being stubborn. This one trader always says treat your capital like it's your employees. You don't want your employees standing around doing nothing. I took a small .4R loss but it distracted me from better trades.

Setup:70