Trader’s Narrative

Here’s a short video from Adam Hewison going over the intra-day 15 minute chart of the S&P 500 Index (SPX). Watch it, then read my comments below:

As Adam mentions this is a very common pattern. The way I would trade it would be to go short as price comes back up from below to the resistance level (the level which used to be support but was broken to the downside).

The all important stop loss - never forget it! - would be placed in the middle of the two extremes, say around 835. And the target, as mentioned in the video would be 812.

My logic is that a breakdown rarely happens without a retracement. So I’m trying to enter into this shallow retracement, which may even take price above the new resistance line. But if the double top is valid, then price will break down anew. As well, I would be short because of all the myriad reasons I’ve outlined in the past few days on where the market is right now. I’m assuming you’ve kept up with the required reading

How would you play this? where would you enter, long or short? and where would your stop loss and targets be?

If you’re interested in patterns, then check out “The Great New Pattern“. And GNP with another specific example (VNT).

Trading is basically about finding and exploiting patterns which don’t change. Why don’t they change? Because we humans, as participants and creators of the market, don’t change.

Last week I briefly mentioned in the weekly sentiment overview that aggregate hedge fund equity exposure was actually short.

Just a few weeks ago this metric from Carpenter Analytics dropped close to the low in 2004. But it has since recovered and is now just below the zero line again.

This is a tough indicator to interpret not only because it doesn’t seem to have a pattern, but also because it is difficult to know how accurate it is (since it is “reverse engineered” rather than compiled from source like a survey). In any case, I wanted to share it with you for what its worth.

I received this question from a reader (Jim) on March 13th, 2008:

I love your updates, please keep up the good work!

My question is the following: Obviously we are in one of the worst bear markets (stocks) we have seen in a long time and all of the experts tell us novices that you MUST go with the major trend of the market and not fight the urge to go the other way. Yet it seems you have been looking for places to go long all the way down INSTEAD of trying to find places to go short (go with the MAJOR TREND) and I can’t figure out why? I’m sure you don’t care how you make $$ whether it be long or short….During the bull trend you looked for buying opportunities and yet in this bear trend you also looking for buying opportunities….

what would it take for you to write about looking for shorting opportunities? what would the market have to do for you to see every rally as a selling opportunity instead of every decline being a potential buying opportunity?

Thanks Jim. I took a short hiatus for the Easter holidays but I’m back. So let’s see about “keeping up the good work” and answering your questions.

First of all, you are right. Following the trend is a good idea. Especially if you’re just starting out. But let’s take a step back and realize that there are really only three types of trades.

Either method is fine, as long as you have positive expectancy and good money/risk management.

I don’t agree with what you say about this decline though. We can barely call it a true bear market since we just grazed the -19% mark from the top in October to the recent low. In any case, although it certainly feels brutal because of all the bad news flying around, I don’t think we are anywhere near the necessary proportions to call this the worst bear market we have seen in a long time.

So the short answer is that it comes down to style which of the three methods you want to pursue. The long answer is that I’m a masochist (kidding!).

As for what would it take for me to go short in this market climate, that’s a good question also.

I would be trying to short rallies and sell into down trends if the technical and sentiment measures I watch show that even as the market has declined, it has room to decline further.

Here’s what I mean. Let’s say we have a serious move down but the put call ratio doesn’t really budge. Or horror of horrors, it actually moves down slightly! Or let’s pretend that after a waterfall decline, retail investor’s sentiment either doesn’t get gloomy or actually improves! Those kinds of things would make me reassess how I see the market.

But today we are seeing the opposite. We already know that sentiment is absolutely horrible with the complete spectrum of market participants disgusted with the current market. We already know that people are afraid due to the put call spike we saw and we know that the market reached “washed-out” levels of oversold.

On top of that, when we do rally strongly for a few days, we immediately see people question it or dismiss it outright. Take a look at this recent article from BusinessWeek: “Stocks: Beware the Sucker’s Rally” Again, this confirms the abysmal sentiment out there. And in the crazy upside down world of contrarian analysis, it is exactly the sort of thing we’d prefer seeing (as longs).

Hope that answers your question Jim

And if you have a question or comment, please remember to write it on the relevant blog post… unless it has nothing to do specifically with what I have written. In which case, you can contact me.

As a student of sentiment, I try to keep a sharp lookout for new, wacky ways of taking the mood of the crowd. There are the traditional methods. And then there are other more unorthodox ways of seeing sentiment.

Just recently I’ve been paying more attention to the keywords that people use to find my trading blog. Just a few days ago I started noticing something interesting. Quite a few people were googling: “I Hate Vonage!” and “We Hate Vonage”… which would take them to my post, Vonage: Please Don’t Leave Us!

Not only has Vonage had a very difficult time over the past year to make money and retain customers, recently insult was added to injury when a judge ruled that they had infringed on patents held by Verizon and ordered them to stop taking on new clients. Ironically, this might be just the thing Vonage needs since every new client brings with it much more expenses than concomitant income But the market was ruthless in punishing the stock as it gapped down to reach just below $3.

Tangentially, since I’ve promised to hold myself accountable in my previous opinions, I’ll take this opportunity to give myself an A+ for this call. The red arrow is when I made my first post about Vonage. The next day it gapped down and fell into the ~$9 area, consolidated and fell further. Never to see that level except when it came back a few months later to ‘kiss’ the resistance level.

Getting back to sentiment, when I see people actually typing in ‘I hate Vonage’, the contrarian in me feels an almost irresistable temptation to go long. I’m not sure though if these people are customers or shareholders (or both!). As Rothschild said, ‘Buy when there’s blood on the street!’. There isn’t any blood on the street perse, but definitely it is splattered all over the Vonage chart.

The MarketWatch’s individual stock sentiment measure is slightly negative (52% bears and 48% bulls) but the sample size is very small at slightly above 100 respondants. At the very least, I think that Vonage’s stock has reached a crescendo of negativity. So if you’re still short, I wouldn’t press it. And if you have no position, crazy as it might sound, it just might be smarter to go long than short.

By the way, we’re into the last days of my first trading blog contest. If you’re interested in sentiment, and you haven’t entered yet, hurry!

Bloomberg reported recently that Greenfield, an analyst at Pali Securities, downgraded Vonage to a sell after he called to cancel and was given a special lower price to stay on as a customer.

Greenfield is jumping the gun a bit if he downgraded Vonage to a ‘Sell’ just because they have a bit of a separation anxiety. After all, following such a criteria, all cable and telecom companies would also have to be downgraded.

But in the case of Vonage, this is a tell for a much more serious issue. We already know that each new customer costs them on average $270+. This means that it takes them more than a year to break even on that new customer.

The voip sector is also getting crowded with every established carrier and cable company rolling out their own. Established companies have the advantage of being able to bundle their voip with other services like satellite tv, cable tv, cell phone packages and other goodies. As well, they have a headstart with an existing customer base.

Then you there are the computer based voip services like skype and gizmo which the more tech savvy tend to use. I’ve recently taken advantage of skype’s special promotion to make free calls to landlines within North America. The quality of the calls are surprisingly good and the price isn’t bad either.

So with all this competition, what is Vonage going to end up doing? Pay clients to use their services?

Another challenge for Vonage is their churn rate. They need a lot of new customers to replace those that are leaving… so they have to keep running to stay in the same place. And with clients leaving right, left and center, they have no pricing power:

Source: GigaOM

Leaving aside fundymental concerns (they give me a headache), we see that technical analysis draws a similarly negative picture:

As you can see, Vonage is getting crushed. I know, I know, the market hasn’t been doing too well lately. But still, Vonage’s relative strength is nill. Even on the days when the general market rallied strongly there is almost no discernible response on its chart.

Notice how the price has contracted just below the round number $10 and on Friday managed to breakdown below the congestion. People might think that Vonage is ‘cheap’ here as it is below $10. But beware! a stocks can always get cheaper.

I just checked and IB has VG available for borrow - Hmmm…