The Musings of a Discretionary Technical Trader

Here are some excerpts from the commentary of a discretionary trader at Trading Stock Market. Instead of focusing on buy and hold fundamental investing principles, he implements a discretionary technical analysis.

Last week in my "Side-Way Trading" post I mentioned about a possibility of short-term up move, yet, I was skeptical about strong up-move. It appeared to be that I was wrong. We did have a strong up-move. One more time the stock-market has proved that sooner or later everybody makes mistakes in analysis and stop-loss strategy should be used not just to cut losses but to protect profit as well.

During the last four positive sessions the indexes (Nasdaq 100, S&P 500, DJI, etc) have come close to their June's and Augusts' high levels. So far, the odds are good (from technical analysis prospective) we may see the indexes third time at those levels. Twice the stock market (indexes) has bounced down from these levels and most likely we may see slow down again.

Majority of technical indicators continue to be bullish and as I already mentioned, the technical analysis suggests that we may see the indexes moving higher. There are only two negative sings from my point of view.

First thing is high volatility level. The stock market continue to be highly volatile and this is a bearish sign. In such volatile market we could have strong down move in the same short period of time as we had the current 4-day up-run.

Second negative thing, from my point of view is that the market was not strongly oversold, yet it did make strong up-move in short period of time. It is more like some institutional investors came back from vacations, they saw stocks cheaper than a month ago and they started to buy. What is going to happen when their buying power became exhausted?

Because of these two points above, it is still difficult for me to believe in strong recovery (Yet, I could be wrong). Because of that I would not be playing long at this moment. At the same time there is no bearish signals and because of that I would not be playing short either.

One of the rules in my trading strategy is staying in cash until I see a pattern. I missed the last up-move - I did not lose money on that, I just did not make as much as I could. Still, the fact is that I missed this move and now it is better to stay in cash in order to avoid another mistake. My view on the current stock market condition is that I would expect to see indexes at their June's and Augusts' high levels. Then, depending on how those levels are hit (is they are hit) I would built further analysis.

In other words, he's a chart gazer, looking into patterns and trends on charts and searching for good opportunities to get in based on momentum and reversals. This type of trader is closer to the type of strategy that we want to implement. He very likely has a system for determining when to buy and sell in his head, when to get out of a losing position to cut and run before the loss gets too big, and how big of a position to take on.

The only problem is that he doesn't sound like he has a specific set of computerized rules for any of these aspects of his internal mental trading system. So while he has a loose trading system, he might not be able to specifically distill it into set rules in order to backtest it over the past and see how profitable it is before he trades it. He can fudge the numbers one way or another according to his gut feeling about something, which makes it impossible to test over the past. Kind of this cute little comic that I just found:

Head for the Hills!

HEAD FOR THE HILLS!!.... Well, at least that's what a lot of small individual investors are doing these days, according to this article. Scarred by two crashes in two years, underperforming mutual funds, and downright scary monthly account statements, individual investors have thrown in the towel on the stock market.

That's right, they have completely given up making money on stocks. What have they decided to put their money in?

BONDS.

So what do you think? Good idea? Bad idea?

Well, I'm gonna make a ruling on this one.

Bad idea. Bad idea. BAD IDEA.

Why's that? Bonds offer consistent returns. They're safe, right? You can't lose money in them, right?

WRONG.

I'm not even gonna get into the safer argument here, because let's face it -- as much as people worry about the imminent collapse of the U.S. economy because of the enormous burden of debt that we owe to the entire world, it just ain't gonna happen. That's right, there's absolutely no way that the U.S. government will default on our debt. No one in the world wants that to happen. No one in the world will let that happen... But if it does happen, wondering what financial assets to buy is the least of our problems.

So ignoring the scenario of armageddon, let's get into the "you can't lose money in bonds" discussion.

Whoever says you can't lose money in bonds is wrong. You can.

First of all, the yield on bonds these days is so disgustingly low, I don't know why you would actually want to buy them. Everybody is afraid and is fleeing to bonds for shelter, driving the price of the bonds up and therefore driving the yield that bonds return WAY WAY down. If you keep the bonds for 10 years or 30 years (whatever the maturity is), you will make the collective yield on the bonds... however small it is. But if you decide to sell out of those bonds sometime before the maturity date, the price of the bonds could go down dramatically. This is especially the case if some government defaulting goes down.

And that's exactly what that article is talking about. They're saying that so many people are buying up bonds at such a rapid rate these days, driving the prices up so high, that a NEW BUBBLE is being created.

That's right.

You thought the stock market bubble burst in 2000 was bad. Wait till you see the government bond bubble burst. The fallout will be magnificent.

The consensus is that such an event would coincide with an enormous bull market in stocks, as people would pull their money out of bonds to put into "riskier" plays in the stock market. Others might say that people will just pull their money out of bonds and stocks altogether and put it into gold or oil or some other store of value.

Which scenario will play out?

Who knows... but we don't need to know. Whether the stock market soars in the future, or sinks like the Titanic, we trend followers will be there to reap FANTASTIC rewards from the resulting price trends. These are great times for trend followers. Big things are brewing on the horizon. You can make a LOT more money just riding price trends up and down in the stock market.

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