Wednesday, January 7, 2004
Issue Contents:
| 08:45 | Good Morning Headlines and reaction. |
| 08:52 | Daily Swing Trade Today's stock setup. |
| 14:59 | The Price of Gold Dreaded yellow metal. |
| 16:16 | Active Trader Transcript Real time forum log. |
| 16:17 | Gold Futures vs. Indices Tale of two tapes. |
A quick scan of the usual websites didn't gather too many interesting headlines. Perhaps the absence of breathless hype is indicative of market particpants waiting to exhale. The only headline of note at WSJ was this one:
The weak dollar is prompting some European car makers to expand manufacturing capacity in the U.S., Mexico and Brazil. Japanese officials reiterated their resolve to fight a yen surge and manufacturers voiced concern about the weak dollar.
It's interesting, because all we're used to hearing are one-sided stories of how the lower Dollar will spell Doom. Quite often, people forget that the world's economy is a big food chain, rather than some sort of flat earth thing where one simply falls off the edge to nowhere.
In the summer, we had the discussion that what's bad for the Dollar is good for gold, and good for the U.S. economy, because it makes goods and services produced in the U.S. relatively cheaper to people in countries whose currencies surge against it, sort of like Newton's Third Law of Motion. Unfortunately, relationships in the financial world are not all clearly labelled with force vectors.
This brings us back to gold, which we'll go into later today.
Here's the daily chart of the $INDU, Dow Jones Industrial Average.
I don't know if my brain is failing, but I can't really remember the last time I saw broad indices such as the Dow Industrials or the S&P 500 register an ADX reading of over 50 on the upside.
What does this mean? It means it's been going up in a nearly vertical trajectory. What does that mean? It means that short positions have been repeatedly forced to cover while buyers chase and pile in. The result? Not enough shorts to provide bids on any reversal, while loads of nervous buyers wait to exit.
When we find conditions like this, quite often what is made is what we call a Spike Top. This pattern can be traded, but we do not expect the trade to last for more than two or three bars on whatever timeframe the setups is found.
This is the daily chart of the DJ futures. You can see clearly that after the big up day on Monday, yesterday produced a pause. This is a two-candlestick pattern called the harami. If you look at many Japanese candlestick reversal patterns, quite a few are made up of three candlesticks, preceded by a two-candlestick hesitation formation such as the harami pattern. The third candlestick is what they call a confirmation candle.
Swing traders can use the harami to anticipate and place orders in advance of the confirmation candle.
This is the daily chart of the Dow Diamonds, which is the stock proxy of the $INDU. Note that this upswing began on December 5, 2003. No matter how we slice it, it's overdone on the upside. As usual, to get short in an upswing, the plan is to place a trailing sell stop under the up bars (higher high and higher low than the day before) so that if the pattern of higher lows is broken, we sell short in anticipation of a pullback, if not an outright reversal.
If our sell stop is hit, and we short the DIA itself, we would like to see a close in our favor before taking it home overnight. The alternative is to use in-the-money options to assume the position. The complete theory is in the Knowledge Base.
This is our plan. If $INDU 10499 is broken to the downside in today's trading, we will wait a few minutes for the smoke to clear, and then purchase JANUARY 106 PUTS. We usually enter with a limit order intended to avoid a price spike, but don't set the limit too tight, since we want to be filled. The initial stop loss will be a break of yesterday's high, around $INDU 10550. We will go full size on our trade.
This analysis is applicable to the $SPX as well, but traders will have to use options on the index itself.
Most people who visit TrendVue are not aware that I began my trading life on the Vancouver Stock Exchange trading junior and senior gold stocks going back to 1987.
For my entire career in the brokerage business, the price of gold (POG) went in one direction. Of course, there were many amazing bear market rallies along the way, but the net direction was down, down, down. The downtrend started way before that, because as a teenager, I recall seeing footage of people lining up around the block at the bank to buy bullion, and how masses were ruined in the early 1980s when gold did the Mother of All Spikes.
By the time I left the office in 1998, the situation had not changed much, but of course, we knew that gold was in what technicians call a secular bear market, a timeframe that stretches for a generation of traders. I reckoned that since I was only 22 when I started, I would live long enough to see the day that POG would be up again.
The plan was that after the sell of a generation came for stocks and bonds, it would be the buy of a generation for gold, commodities and real estate, based on the work of my mentor, Ian Notley.
It was with Notley's roadmap that I watched and traded gold for years. In fact, I dubbed it the dreaded yellow metal because it was forever going down, and while it was at it, it would have moments where it would gap up or gap down, giving indigestion to us traders who carried big positions in the majors like Barrick and Newmont. In fact, I busted twice trading the dreaded yellow metal. The adventures are documented in Art Collins' book, When Supertraders Meet Kryptonite. The eventual upside to the early blowout is that years down the road, I was not sucked in by the dot com mania.
I've been told that depending on when a person came to play the market, their perception of price is forever imprinted. Since I arrived in 1987, I am keenly aware of how fast prices can move down. I also know that before the fall, the final phase of the bubble du jour goes up in a nearly vertical ascent, blasting out all the shorts, sucking in the longs and then explodes in mid-air like the Shuttle Challenger.
The pattern is tried and true, but the problem is that the end stage of a parabolic move is often very treacherous, because in the heat of the moment, people do crazy things such as bet insane size without accounting for the expanded trading range of the bars and wild volatility. Because the price is already way up after a long move, there is less than zero room for error.
Back in July 2003, I wrote a piece on gold, bonds and the Dollar. At the time, the weekly chart was in a big pennant formation that was easily measured using the Edwards and Magee formula. The monthly chart featured a classic head and shoulders bottom. We said:
And now, after the biggest move up in POG, let's take a look at what is in store for us next...As for gold, I know all the bugs are hot under the collar, insisting that deflation, weakness in the Dollar and the economy is going to drive it back to $1000 an ounce. I'm trying to imagine what the explanation will be if gold goes up as they expect, but on a recovery! One thing I learned a long time ago is that if you believe in fundamentals, it's cool. If you believe in technicals, it's cool. Just don't try to explain one with the other, as if one can be used to justify the other, and we won't look foolish when one part of the argument goes one way, and the other goes the other way.
Next. In December 2001, we did a couple of e*Trade radio shows, and discussed the Dollar's test the 120 level. We didn't think that it would pass the test and our strategy for the long-term was to shift into gold and the Swiss Franc. It's been a long slide all the way back to just over 90, and we can see that the Dollar is finding sellers here at the 20-week moving average.
Real time forum log.
Click on the title above to expand this document.
This is the daily chart of gold futures, continuous contract. Back in July, we marked out the big pennant on the weekly chart.
Using the standard Edwards and Magee measurement formula, the pennant measures approximately $65.30. Add that to the point of breakout at approximately $367.10, we arrive at a projected upside target for the weekly chart of $432.40. The high for February Comex gold so far is $431.50, so we have to say that the upside target has been hit.
This is the daily chart of the AMEX Goldbugs index. When I traded gold for a living, the prevailing wisdom was that gold stocks should lead the metal. In this case, there is a glaring divergence in the price action between the metal and the stocks.
The volume that is shown in this chart belongs to Newmont Gold, a big unhedged producer. In today's action, we saw heavy volume as NEM retreated while the $HUI does a big huge test of top.
If we look closely at the daily chart of February Comex Gold, Monday and Tuesday featured a price range of nearly $10 per day, and formed a harami pattern.
While this may not be The End of the move, it is certainly entering the territory where it is gyrating wildly. Add this to the divergence observed between POG and the indices, plus the fact that they are in a Test of Top formation on the daily and weekly charts, this is certainly a critical juncture after a multi-year rally.