Economaton

I’m getting sick of reading “the markets are volatile and will remain so” articles and posts, but that’s about all that can be said with any certainty about the current situation. Anyone who says otherwise is either selling something or crazy.

I’ve got slaughtered the past few days. I have a large position in financial stocks, based on my earlier calls for a bottom. Financials, as you know, are getting crushed. However, I also have large positions in gold and in Euros, which are also depressed. This is new. Previously, down days in equities were always offset by gains in gold and Euros. The past few days, however, it looks like the money is moving into Treasury bonds and oil. I have a small bond position, and I won’t touch oil since it’s insanely volatile and speculative relative to anything else. Some transportation stocks are weathering the storm nicely. Is it too late to get in?

I should note that when I say “large”, I mean “large relative to my account size”. My account size is tiny by Wall Street standards. Infintesimal. Risk management is key, as you undoubtedly already know. For those readers who may not, I’m not learning to trade with rent money; this is pure risk capital that I can afford to lose, and even at that, I’m taking on tiny tiny positions to test the waters. Like, “buying 5 shares at a time” positions. I can hear all the professional money managers chuckling and reaching for their mice to click to some other page. The thing is, I am acutely aware of my own ignorance and inexperience when it comes to the markets — which puts me way ahead of the punters who plunk their life savings down on a single “sure bet” futures contract, win randomly, and then think they’re a market god. They’ll be gone in six months. I’ve been at this for over two years, and I still haven’t busted my account. Not that I’ve made any outsized gains, but I’ve learned volumes, and I continue to do so. I’m patient.

The choice I’m faced with now is the perpetual market forecaster’s dilemma: either I was wrong about the bottom, and I should accept the loss, sell out, and staunch the bleeding; or I was right and it simply hasn’t been enough time yet. It’s still too early to say; I’m guessing and betting no matter what I do.

The amazing thing about financial markets is that, no matter what your view, you can find reams of erudite commentary from prestigious MBAs and PhDs supporting your view. I have read many articles written in the last week calling for doom, and many others (though fewer, since the market has been going down) pointing current firesale prices out as a great buying opportunity. I think the truth of the matter is that nobody has any clue what’s going on or what’s going to happen. Everyone’s laying their bets now, hence the volatility.

Looking at this Dow daily chart over the past year, I am hoping (yes, hoping, I know) for a double bottom at 11,500 or so. Volume on this recent decline has been average, indicating less certainty on this selloff. Further, financials rallied at the last minute on Friday, just before close, after a brutal day. My theory is that the recent media blitz has upset the public, who are now panicking and selling en masse while the pros snap up their shares. Edwards and Magee’s classic definition calls for a level to be reached with high volume, retreat on diminishing volume, and then increase to the previous extreme on increasing volume that is not as high as the first time. By this definition, we qualify. BUT…

Edwards and Magee state that the double bottom formation is “exceedingly rare,” very obvious in hindsight, and “referred to by name perhaps more often than any other chart pattern by traders who possess a smattering of technical ‘lingo’ but little organized knowledge of technical facts” (134), but if any set of circumstances warrants the label “exceedingly rare”, it is the state of the markets today. They put the frequency of double tops at “two or three” monthly charts and double bottoms at “one or two” out of “several hundred” charts. The problem, they say, is that the early stages of certain consolidation formations, triangles and rectangles, are virtually identical to double tops/bottoms.

They offer some general heuristics for distinguishing true doubles, while cautioning that there are no hard and fast rules. The extreme points in a consolidation pattern will be closer together than in a reversal pattern. The intervening area of a true double will be “long, dull, deep, and more or less rounding;” they admit that these are vague criteria and offer that at least a month between extremes makes it unlikely that they’re part of the same consolidation formation. That qualifies us so far. They also posit a 20% change between the extreme and the retreat. On my chart, the January Dow low was about 11,500; the highest point of the intermission was about 12,900, giving us a difference of only 12%. This doesn’t invalidate the “double bottom” theory, since they stress that these are general guidelines “not without exception”, but it decreases our odds.

The S&P appears more grim, and we don’t have volume to help us out. Look at that big, fat down candle today. At least we’re closer to the previous low; this can give us a heads-up for the market.

The Russell 2000 is even worse. It’s already breached the previous low. This is a big flashing red neon sign reading “DANGER”.

The strangest thing I’m seeing in this market is the Dow Jones Transportation Average. Charles Dow’s original Dow Theory placed great emphasis on the relationship between the Industrial Average and the Transportation Average. I don’t know what to make of this. It’s not even close to the January lows, while everything else is down.

This could be a sign. This is an anomaly. The Transportation Average is up while almost everything else is down.

I can think of a few explanations: US-based airlines make up a large portion of the average. A weak US dollar naturally encourages foreign tourism to the US; anecdotally, I’ve read several articles yesterday stating that foreign tourism is up. Given the usual chronic problems of the airline industry weighing them down and the market context, airlines are doing remarkably well. The remainder of the average is shipping and railroads. Some shipping companies are getting pummelled (EXPD), but others — Ryder, in particular — are riding high. Ryder has lots of international operations.

Now, let’s get a read on financials. I’m going to use XLF as a proxy. That’s nasty. Oooh, that’s nasty. Lower volume on this low, but it looks even less like it’s trying to work its way back up. We can see a pretty clearly defined channel, and it’s pointing down.

I am starting to sense that I’ve been beaten, that I’ve bet on the wrong horse here. The focus is on financials in the financial media; transport has been quietly weathering the storm. Over the next week or so, I’m going to start scaling down out of financials, booking losses, and getting into transport stocks with strong international components. There is still a chance that financials will pan out, so I’m not going to scale completely out, just reduce my bets and shift that capital elsewhere.

The previous local lows have already been breached in many of my key watch-charts, making my double bottom theory less and less likely with each passing day. I expect the issue will be much clearer by this time next week. In the meantime, I’m going to start realigning my bets.