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posted on 19 October 2017

Technical Thoughts: The Wall Of Worry

Written by , A Dash of Insight

-- This post authored by Mark Hines

Our previous Technical Thoughts asked whether your trades fit your style, and reviewed how this can help improve your success. If you missed it, a glance at your news will show that the key points remain relevant.

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This Week: Climbing the Wall of Worry

It’s been a powerful recovery since the depths of the financial crisis over 8 years ago, and the S&P 500 hit another new all-time high this week.

However, the recovery has not been as perfectly smooth as many seem to think. It has been the fear and bumps along the way that continue to create attractive opportunities. And even though market wide volatility (as measured by the VIX) is near all-time lows, there are plenty of stock-specific trading opportunities.

This week’s Stock Exchange expands on how our models trade on market fear, both generating profits and protecting against losses. We highlight several specific picks from our models, and we also dig in to the methodology. All three of this week’s picks highlight how we are able to buy in the face of fear, such as implementing mean reversion trades, buying smaller dips within larger rising channels, and simply using momentum strategies to climb the wall of worry. And of course, we impose strict risk management techniques along the way.

Expert Picks from the Models

This week’s Stock Exchange is being edited by our frequent guest: Blue Harbinger (also known as Mark D. Hines). Blue Harbinger is a source for independent investment ideas focused on value and income opportunities.

Holmes: This week I bought Discovery Communications (DISCA). This stock’s dip over the last month is the sort of set up I like to see. From the chart below you can see it is below its 50-day and 200-day moving averages. However, it has attractive upside over the next six weeks.

Blue Harbinger: Interesting pick, Holmes. As you know, Discovery is global media company providing content across multiple distribution platforms, including television, websites, digital distribution arrangements and content licensing agreements. Can you give us little more color on why you like it?

Holmes: As you know, my style is based on dip buying and mean reversion. However, you may not be aware that I’m really into protecting assets too. My process drastically reduces vulnerability to drawdowns while attempting to stay invested for the longest possible period of time. I use a mix of advanced trading techniques (including profit taking, stops, and trailing stops) and technical analysis.

BH: Interesting. The last broad market downturn I recall was in early 2016, when markets started off the year terribly due to depressed energy prices. How’d you do during that time period, Holmes?

Holmes: I did well, thank you. I did not completely exist the market, but positions were significantly reduced, and I avoided a significant amount of the market wide declines.

BH: That’s impressive. By the way, I am assuming you are aware that Discovery is buying Scripps Networks, and that announcement is a big part of the reason the price of DISCA is down so much since the end of July?

Holmes: I am aware.

BH: Well, from a fundamental standpoint, Discovery has some attractive qualities such as its large library of content. Plus the company has fairly wide global distribution of its programming. Specifically, every once in a while, I enjoy watching the Discovery Channel, TLC, and Animal Planet. However, the company is dependent on cable to a large extent, and the continuing “cord cutting" trend could create problems, especially considering it has a fair amount of debt and so does Scripps.

Holmes: I’m only looking to hold this position for about six weeks. And during that time period I suspect Discovery will rise despite your concerns about the Scripps acquisition and the so called “cord cutting."

BH: Thanks. I’ll watch this one closely. And honestly, I think this is a decent pick, however I prefer to hold my positions for longer than six weeks. How about you RoadRunner - what have you got this week?

RoadRunner: I like Abiomed (ABMD). It’s a $7 billion market cap medical device company. It provides mechanical circulatory support devices to aid heart recovery for heart failure patients.

BH: And you like Abiomed because?

RR: I like to buy stocks that are at the bottom of a rising channel, and if you look at the chart below you can see why I like Abiomed this week.

BH: I can see the rising channel, and I can see why you’d think it has more upside within that channel, but what about the company specifics. Are you aware that the CFO resigned last month? Or that they just received FDA approval this week for their Impella heart pump after five years of research?

RR: I am aware, but I mainly like this stock over the next 4 weeks based on its location within its rising channel. Plus, we have certain risk management procedures in place if anything goes wrong. For example, we limit our position sizes, and we only trade highly liquid stocks.

BH: What about short-term gains taxes? If you’re only holding this position for 4-weeks then any gains you generate will be taxed at the higher short-term gains tax rate. Ignoring Uncle Sam is one of my 7 Deadly Sins of Long-Term Investing.

RR: I am aware, however I expect to generate more than enough profit to offset any additional short-term gains taxes, and I’ve been doing exactly that for many months now. I am not a long-term buy and hold investor. As I mentioned, I typically hold things for about 4 weeks, and my strategy continues to generate outsized profits, even after taxes. How about you, Athena, what have you got this week?

Athena: I don’t have any trades this week, and I’m not going to force anything.

Felix: Same here. No trades stood out for me this week, and I’m not going to force anything either. However, for your reference, here is a look at my rankings this week.

BH: Thanks Athena and Felix. How about you, Oscar, what have you got?

Oscar: I still like the China Consumer ETF (CHIQ). Emerging markets have been performing very well this year, China in particular. Plus, the consumer segment of China is increasingly strong.

BH: I recall that was your pick back on September 1st, and you’ve been doing well on that trade so far.

Oscar: That is correct, despite the strong gains so far this year, and the increasing volume of fearful investors, I’ve been happy to hold shares as this ETF climbs the wall of worry.

And as a general reminder, I typically hold these ETFs for about six weeks. Also, as I’ve mentioned before, my exit strategy is to rotate into a new sector, and I control my risk with stops. And if you’re curious, here are my ETF rankings for the week.

Conclusion

Whether it’s the 8+ year rally since the financial crisis, or one of the many shorter-term individual stock rallies despite fearful market sentiment, there continues to be opportunities to profit as the market (and individual stocks) continue to climb the wall of worry. And depending on your style (whether it’s mean reversion like Holmes, buying smaller dips within larger rising channels like RoadRunner, or simply using momentum strategies to climb the wall of worry like Oscar) there continues to be plenty of attractive opportunities in this market.

Stock Exchange Character Guide

Background on the Stock Exchange

Each week, Felix and Oscar host a poker game for some of their friends. Since they are all traders, they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange." (Check it out http://dashofinsight.com/background-stock-exchange/ for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com". We keep a running list of all securities our readers recommend. The “favorite fifteen" are top ranking positions according to each respective model. Within that list, green is a “buy," yellow a “hold," and red a “sell." Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

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