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posted on 08 February 2018

Technical Thoughts: Bearish Sentiment

Written by , A Dash of Insight

-- this post authored by Mark D. Hnes

Editor's note: This article was written 3 weeks ago, before the recent sharp downturn.

Our last article asked the question “how soon will tax cuts be forgotten?" Specifically, does our recent market rally already fully reflect Washington tax reform, or are there more adjustments to come? If you missed it, a glance at your news feed will show that the key points remain relevant.

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This Week: Will Market Sentiment Turn Bearish Soon?

Aside from the ongoing stock market rally, and declining market fear/volatility (as shown in the following chart), there are plenty of indications of strong bullishness in the market.

For example, James Mackintosh had two great bullish indicator charts in The Wall Street Journal week of January 12. First, he shows bulls outnumbering bears by the most since 2010.

And next, he shares another survey indicating bulls outnumbering bears by the most since 1987.

It seems the stock market rally, tax reform, low unemployment, and the Fed’s willingness to move interest rates back up toward normal are all indicators and drivers of bullish market sentiment. However, it’s important to not get too comfortable with current market conditions, and to instead stay disciplined in your trading approach. For your consideration, here are a few recent, yet timeless, trading tips from experts. Let us know in the comments which ones you are following and/or challenged by.

1. “Only trade the charts and ignore all other extraneous information."

This is according to Dave Landry’s trading resolutions for 2018, and it can be a tough one to follow, but also critically important. We live in the information age, and there are all kinds of extraneous information everywhere that can distract and disrupt your trades if you’re not disciplined.

2. “Trading is easier when we don’t have opinions."

This is according to a Trade Risk article called How I Took My Trading to The Next Level, and it makes a lot of sense. The article goes on to say:

“When you trade on your personal opinions, and not what the market is actually showing you, it can lead to some difficult situations."

3. “Practice Does Not Make Perfect, Perfect Practice Makes Perfect."

This is according to Vince Lombardi, but it was referenced by Brett Steenbarger in TraderFeed this past weekend, and it’s a good point to consider. Don’t just go through the motions, stay disciplined in your strategy, and it will make you a better trader.

4. “I will place a protective stop after a trade triggers."

This is one more resolution from Dave Landry (above), and it’s important, as we wrote about in our Stock Exchange 2-weeks ago: Do You Know When to Fold Your Trades?

It’s easy to get lackadaisical in your trading approach, especially in consistently strong conditions (like our current market), but don’t. Market conditions may turn bearish, even for a short while, and if you’re not disciplined in your approach then the impact could be severe.

Model Performance:

Per reader feedback, we’re continuing to share the performance of our trading models, as shown in the following table.

Importantly, we find that blending a trend-following / momentum model (Athena) with a mean reversion / dip-buying model (Holmes) provides two strategies, effective in their own right, that are not correlated with each other or with the overall market. By combining the two, we can get more diversity, lower risk, and a smoother string of returns.

And for these reasons, I am changing the “Trade with Jeff" offer at Seeking Alpha to include a 50-50 split between Holmes and Athena. Current participants have already agreed to this. Since our costs on Athena are lower, we have also lowered the fees for the combination.

If you have been thinking about giving it a try, click through at the bottom of this post for more information. Also, readers are invited to write to main at newarc dot com for our free, brief description of how we created the Stock Exchange models.

Expert Picks From The Models:

This week’s Stock Exchange is being edited by Blue Harbinger (Blue Harbinger is a source for independent investment ideas).

Road Runner: This week I like United Rentals (URI). Are you familiar with this stock, Blue Harbinger?

Blue Harbinger: Yes, I am familiar. URI is a North American rental company. They rent all sorts of things like air compressors, scissor lifts, and light towers. Why do you like this stock Road Runner?

RR: As you know, I like to buy stocks that are at the bottom of a rising channel. And based on the following chart, you can see why I like United Rentals.

BH: Interesting pick. This company’s stock price did extremely well in the second half of 2017, as the US economy continued to grow. Also, they completed a big acquisition in April, and they dealt with challenges and opportunities created by hurricanes. There was really a lot going on here, Road Runner. Here is a look at the Fast Graph:

RR: I am a trading model, not a person, so I am not “distracted" by all of the data points you mentioned. Also, as you mentioned earlier “trading is easier when we don’t have opinions" (I am totally objective). Besides, my typical holding period is about 4-weeks. I’ll be in and out of this stock before the company’s long-term fundamental story plays out.

BH: Fair enough. I’ll check back with you on this one in about 4-weeks. Anyway, how about you, Athena - what have you got this week?

Athena: This week I like Teva Pharmaceuticals (TEVA). What do you know about this stock, Blue Harbinger?

BH: I know Teva produces generic and specialty pharmaceuticals. It trades as an ADR. And the shares are up about 12% since Tuesday. When did you buy?

Athena: Early this week, like every week I do trades.

BH: And why did you buy, Athena?

Athena: I am a momentum trader. And you can see why I like this stock based on the following chart.

BH: That’s an interesting chart Athena. What is your typical holding period?

Athena: I typically hold my positions for about 17-weeks. For risk control, I use price targets and stop orders.

BH: Teva presented at a big JP Morgan conference earlier this week, and apparently the big institutional audience members liked what they heard and bought up the shares. The company is facing some big challenges and they’re being forced to take steps with urgency. For example, the company has significant debt obligations coming due in the next four years, and they’ve been facing more competition than expected in generics. Teva is trying to reduce their cost base and divest of non-core assets just to meet liabilities. Here is a look at the Fast Graph.

Athena: Thanks for that information, but I’m not thinking about the next four years. As I mentioned, I typically hold positions for about 17-weeks, and Teva is looking good.

BH: Fine - thanks, Athena. How about you Felix - what have you got this week?

Felix: I have no stock picks this week, but I did run the 30 Dow Stocks through my model, and I’ve ranked the top 20 in the following list.

BH: What? GE didn’t make your top 20? That company is on fire this year (+9%), and now that Immelt is gone, the new CEO is going to lead GE much higher.

Felix: I am a momentum trader. And I typically hold my positions for about 66 weeks - which is much longer than the other models. I exit when my price target is hit, and I use stops and macro considerations to control risks.

BH: So as a momentum trader, I suppose that means you didn’t like GE’s 45% price decline last year? I also suppose your top 3 (Boeing, Caterpillar, and Walmart) also make sense considering they outpaced the market significantly last year. And I guess as long as the market keeps booming there is reason to believe they too will keep gaining, although I’m personally more of a contrarian myself.

Felix: Did you happen to notice my strong performance in the performance table earlier in this report?

BH: Nice job, Felix. How about you, Oscar - what have you got this week?

Oscar: This week I’m sharing my top ranked high-volume ETFs. The following list includes my top 20.

BH: Wow - you’ve ranked (JNUG), the 3x Bull Gold Miners Index first. I guess you liked the strong December? You also have Oil (USO) and Oil and Gas (XOP) ranked highly. I am tempted to call you a contrarian invetor considering all of those ETFs are down a lot in recent years. But I know you like momentum, correct?

Oscar: That’s correct. I am a momentum trader, and my typical holding period is about six weeks, not years! I use stops to protect against downside, and I exit by rotating into another sector.

Conclusion:

It’s important to not get too comfortable with the markets. Strong economic conditions have been leading the market higher for a while now, but that doesn’t mean sentiment can’t turn bearish quickly, thereby causing significant challenges for traders. It’s important to remain disciplined in your approach so when market sentiment does change, you can remain profitable in your trades. We prefer a blended approach including both momentum and dip-buying strategies. And we believe we can continue to generate trading profits whether or not sentiment turns bearish.

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 out Background on the 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.

Stock Exchange Character Guide:

CharacterUniverseStyleAverage Holding PeriodExit MethodRisk Control
FelixNewArc StocksMomentum66 weeksPrice targetMacro and stops
Oscar“Empirical" SectorsMomentumSix weeksRotationStops
AthenaNewArc StocksMomentum17 weeksPrice targetStops
HolmesNewArc StocksDip-buying Mean reversionSix weeksPrice targetMacro and stops
RoadRunnerNewArc StocksStocks at bottom of rising rangeFour weeksTimeTime
JeffEverythingValueLong termRisk signalsRecession risk, financial stress, Macro

Getting Updates:

Readers are welcome to suggest individual stocks and/or ETFs to be added to our model lists. We keep a running list of all securities our readers recommend, and we share the results within this weekly “Stock Exchange" series when feasible. Send your ideas to “etf at newarc dot com." Also, we will share additional information about the models, including test data, with those interested in investing. Suggestions and comments about this weekly “Stock Exchange" report are welcome.

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