Trader’s Narrative

Darn, I meant to post this yesterday but, ran out of time. Now it won’t seem as brilliant but what the heck…

After the recent panic selling, the relationship between stocks and bonds got out of whack in a major way. Basically, relative to each other, stocks were very cheap and bonds very dear.

This usually happens when investors and traders panic - they flee to the “safety” of bonds, pushing their prices up. But what we saw in the recent rout was monumental. We’re talking several standard deviations.

So to answer Keith’s question whether bonds are a sell, I’d say yes, although equally important: stocks are a buy.

After today’s gap down, we have an island reversal (see chart below). I was going to write yesterday that it looks bonds spiked up to 122.81 in an exhaustion gap. After the fact, this seems obvious. Nevertheless, according to Japanese candlestick patterns, it is still bearish.

The last time I hollered that stocks were a buy and bonds a sell was at the start of December (see chart above). It was a bad call on the stocks side, but good for the bonds, since they tumbled to almost 113.

Bond prices (30 year US government) have not been this high since the summer of 2003 (high of 121.67) and the summer of 2005 (high of 119.72). So prices poke their head just above resistance (taking out a lot of stops) and then headed back down.

I didn’t lose any money in the implosion of E*Trade, but I still wanted to take a look at what happened from a technical analysis perspective to see if I could pick out any warning signs.

Here is the chart of E*Trade Financial (ETFC) prior to any nasty stuff:

Meandering with a mazy motion and rangebound - as the moving averages show by flat lining.

Moving Averages Legend
The green line is the simple 50 daily moving average, the blue the 150 daily moving average, the red line the 250 moving average.

The next important event was on July 24th, 2007 when price approached, yet again, the floor of the trading range:

Ranges occur because people come to believe that above a certain price, a stock is too “expensive” and below one, too “cheap”. The longer a trading range remains, the more investors and traders become active participants. And the more participants, the more stop-losses which accumulate near the same obvious price points.

Lesson #1
When a range is pierced to either direction, the stop losses of one side are triggered and as the “wrong” side investors and traders scramble to limit the hemorrhage to their accounts, they in effect fuel the move… creating a strong trend.

Which is exactly what happened:

Lesson #2
The rest of the market wasn’t doing that well either at this time, so E*Trade wasn’t the only stock suffering - especially in the financial sector. But the important point is that E*Trade had no relative strength compared to the market:

Lesson #3
The warning signs were there: the “death cross” on the moving averages, the lower lows and the lower highs being carved on the chart as market swatted the shares around.

So it wasn’t surprising when the insult was added to injury and a massive gap down took the shares to the low single digits and talk of bankruptcy started to float about E*Trade like vultures:

According to technical analysis, the price itself was telling you to stay away from this (at least, from the long side!). The best thing you can do if you did lose money on E*Trade (ETFC) is to learn from the experience and apply it to the next trade.