The CATS and DOGS Theory

I had my first major success with 3C back when I was only using it on daily charts, I can't recall the name of the company as it was a  long time ago, but it was sliding and 3C daily was soaring, I had published the idea on my free site, Trade-Guild.net and took some ribbing as it slid 20% or so, then it took off for a 400% gain. The next C&D trade came within days and that also made over 400% in about a week. It's not uncommon for C&D trades to pop 10-50% in a day, thus my partial profit taking "double digit gain" rule, especially if that gain comes in a day.

After having followed many of these trades, I've found that they are the kings of parabolic moves. Often a 50% pop in a day will turn in to a 300 or 400% gain over the next several days to a week. The thing they have in common is that they are cheap, some are liquid, some are illiquid, but they are usually under $3.00 or so. They also tend to fall back down just as fast as they rise, again, my rule for taking partial profits and keeping a trailing stop on the trade to allow for the possible 300% or more move.

Another thing they have in common is that they tend to be in beat up industry groups or they are the laggards of an industry group that has been doing well. They are pretty simple to understand, they are the coffee that is served at the end of the party, kind of letting everyone know politely that it's time to leave.

Wall Street is by no means ignorant of human emotion and habit, thus after a nice move in the market or in an particular industry group, the late comers want a piece of the action, however, they can't stomach to buy a stock that has appreciated 50 or 100%, especially when those stocks are the higher quality leaders that have share prices of $20 or more, so the human habit of bargain hunting takes over and the cheap stocks come in to focus. Wall Street knows this, why else would they be accumulating them? Then the stocks see a huge price move, the buyer feels they finally got in on the market action until the bottom falls out of the C&D stock they bought, it's almost like a boiler room operation. Wall Street makes the quick money, the retail buyer thinks that these amazing gains will hold because the market or the industry group has had such an amazing run. The gains don't hold, many of these trades will take off and be over in a week.

If you have the stomach and risk management for it and you have the aptitude to understand that the chances are VERY high that the gains WILL NOT hold and as such, neither should you, then these stocks can offer some very nice returns. It is no coincidence that they are showing up in shipping and so far this morning, I've seen quite a few already moving in cheap biotechs.

Remember though, even if you don't trade them, being aware of a slew of these C&D trades all of the sudden coming to life is also a warning signal, at least fro my experience in the past. In effect, coffee is being served and those who understand that when that happens, it's a subtle way of the host telling you the party is over, enjoy the coffee and leave. Those who don't understand that subtle hint will likely stay past their welcome.

EXM C&D Trade (long)

Here's another Cats and Dogs trade, also in shipping, EXM.

 I'm not quite sure if this would be a stage 2 breakout, but it would be a breakout nonetheless, RSI is positive here as well.

 As far as stops, there's a hammer that provides some support, which would be a deeper stop, or you can use a tighter stop at Thursday's lows (just below) as that was the pivot day. Again, you want to see a move through resistance on increasing volume, the bigger the better.

 The 3C 15 min chart, accumulation through the flat area on the daily.

And the more recent 2 min accumulation.

All the same concepts apply, these are speculative trades that can really move, but again, they tend to be a warning sign for the broad market which I will explain after I get the trade idea out.

Really, you can use any stop, even if you want to use something as tight as the entry on a closing basis, you are looking for the breakout move and subsequent follow through.

Quick C&D Trade -DHT (LONG)

The effect of the Cats and Dogs trades is an interesting phenomenon that I will explain later, but it looks like we are seeing it in the shippers and particularly the dry bulk shippers, yes the same ones represented by the Baltic Dry Index which has been plummeting. As for the C&D trades, they can move very quick, but profits should be taken pretty quick as well. I generally take at least partial profits on a double digit move and trail a stop, hopefully the move is being enough that you can take your original investment off the table and let the profits run guaranteeing a profitable trade. However the arrival of these trades, especially when they are working counter the market, is a warning signal, so be careful about managing them as well as risk. These are speculative trades by nature, so I would cut the risk management  rules (If you use a 2% rule, then make it 1%, etc), the way these trades can explode will make up for it.

 DHT looking to move to stage 2 mark up, this can be short in these C&D trades, volume should increase a lot on a real stage 2 breakout today.

 The daily 3C chart, a short accumulation period, but fairly strong, it should support the pop that these trades usually see.

 On a 5 min chart, we see the accumulation at the bottom, the first run and a pullback.

On a 2 min chart, it looks like accumulation of the pullback for the next run.

I have a new swing trade template that I'm still working on, but it is at least far enough to tell you what candle/day is in the trend, what is noise and what is a reversal. If you have StockFinder I can share it with you later today.

Will the Greek PM make good on his threat and resign tomorrow?

Sunday night talks (one of many moving deadlines) have failed to bring the Greek coalition government any closer to agreeing to the Troika's demand of more fiscal austerity, in fact two of the leading coalition parties, LAOS and the New Democracy have both said they will not support the cuts the Troika is demanding. Apparently tired of the Greek drama or what they call "dithering", the Troika has demanded an answer by 11 a.m.

It doesn't look good for Papademos, who threatened to resign on Monday if the Greek coalition did not come to an agreement that would satisfy the Troika. Will see if he keeps his word.

The words from the coalition partners will certainly test Papademos's credibility to keep his word, LAOS has said the country could not afford the cuts, which would cause a "revolution of misery which will then burn down Europe", while the ND said, they would not permit anymore austerity cuts.

The Euro has opened down in this week's opening trade and ES in overnight trade is close to testing Friday's intraday lows. It should be an exciting 12 hours in Europe.

 A 3C negative divergence on Friday's close, overnight trade has broken 3 intraday support levels thus far from Friday and is close to the intraday lows.

This is a 5 min chart of the EUR/USD with the Euro opening with a mild gap down, but recently in the last 15 minutes, downside momentum has picked up. I would guess that some very long meetings in Greece may not be going very well, we'll see if some headlines pop out in the next hour or so.

Tomorrow is light on the US financial reports, Thursday and Friday will be quite a bit heavier and we still have a slew of earnings this week.

George Friedman of Stratfor says, "Eurozone’s problem isn’t Greece or Italy: it’s Germany"

Stratfor is an unbiased source of Strategic Forecasting, George Friedman (if you haven't read Stratfor or any of his books, which I highly recommend) has a grasp on world political events that are simply beyond the scope of the world media.

To understand the crisis in Europe, one must understand the German dilemma and this free article by Friedman is a must read in understanding the dynamics shaping the Euro-zone crisis and the possible ramifications.

I would say the 5 minutes it takes to read this article are essential to understanding the fundamental issue for the Euro-zone, or in other words, it is a must read.

Drudge Report from Friday

When I have a chance, I stop by the DrudgeReport just to see what the round up of news events. Imagine my surprise that Drudge on Friday was covering the (at this point) controversial Friday Non-Farms Payroll data from the BLS.

 I clicked the link thinking I'd be redirected to Bloomberg or CNBC, but instead to my surprise, it was straight to ZeroHedge, which was pretty quick to whip out a calculator and show us some basic math as to how the BLS arrived at Friday's blow-out and highly suspicious number, especially given the number of Wall Street lay-offs for the period and the number of temp jobs that were ended, which were not reported in the BLS data. Well after about 4 stories covering the BLS data and the evolution of understanding how they came to such a number, which had, as Biderman of TrimTabs pointed out (who tracks daily tax receipts and thus has a much better feel for what the true employment situation is like and uses to phony gimmicks) its beat rooted solely in a arbitrary 'seasonal adjustment' which was to say the least, shocking, ZeroHedge has put together their conclusions with all the math and data from the BLS so you can check and re-check it as many times as need be.

Once you realize how they fudged the number and apparently have been fudging the numbers for over a year, tracking Gallup's or other polling companies employment reports starts to look at lot more reliable and tells a FAR different story, but as for the great work ZeroHedge has done, not rooted in speculation, but hard facts, here is their conclusion on Friday's beat, which had it not been for the arbitrary and poorly understood seasonal adjustment, would have seen the NFP miss, just as the PMI data, ADP data and other employment data indexes have been clearly showing (employment on the decline).

You may ask, 'what does it matter?', well if the NFP was something you followed, then it would stand to reason you might want to know the truth. It also would stand to reason that Wall Street has done their own math and discounting the data is what they do, so Friday's beat may very well be discounted by Wall Street in the very near future. If nothing else, it may serve as a wake up call as to how corrupt and inept our system is, one which in this case, should not be biased in an election year, but seemingly is.

While I don't agree with everything ZH puts out (it's clear they are biased), it's hard to argue with the numbers.

THE BEAR MARKET RALLY PART 1; "SITTING TIGHT"

One of the world's most famous and successful investors, Jesse Livermore, a self made man who started on Wall Street as a boy working in a bucket shop, was quoted as saying the following:


“It never was my thinking that made the big money for me.  It always was my sitting.  Got that?  My sitting tight!  It is no trick at all to be right on the market.  You always find lots of early bulls in bull markets and early bears in bear markets.  I've known many men who were right at exactly the right time, and began buying or selling stocks when prices were at the very level which should show the greatest profit.  And their experience invariably matched mine - that is, they made no real money out of it.  Men who can both be right and sit tight are uncommon.” – Legendary speculator Jesse Livermore, “Reminiscences of a Stock Operator” by Edwin Lefevre, 1923

Livermore is talking about the importance of both patience and courage of conviction for the professional speculator.  He claims it was never his thinking that made him money, but sitting tight when he was right.

 Think about that for a second, one of the greatest speculators of all time emphatically believed that being right on the markets was relatively easy, but sitting tight was the great challenge. 

If you haven't put all my posts together in to a coherent understanding of my opinion of market action recently, let me sum it up as I believe the readings in 3C and MoneyStream as well as the market price action clearly show we are in the last stages of a bear market rally. You don't have to agree with me, but it is wise to understand at least what a bear market rally is.

 When the history of this market is written in 10 or 20 years, I also believe that the F_E_D's unprecedented intervention and manipulation of the market through QE1/QE2/POMO, etc, will also reveal a new and extreme type of bear market rally, what it will be called, how it will fit in to the doctrine of Technical Analysis and market history remains to be seen, but the 2009-2011 rally, I believe will be considered a new type of bear market rally when the market finally unfolds and we have several more years under our belts to see the extremes the market will almost certainly experience. Many of my long term members know that I think there's a good chance that we as investors, our generation, will see the first secular bear market in equities and understanding how to adjust to that will either make fortunes or lose them.

In studying many, many bear market rallies, there are 4 traits that keep popping up over and over. You may not recognize them at first because each market, bull and bear is different, different timeframes, different intensities, different fundamental drivers, etc, but human emotion is what ultimately moves markets, even the machines are programmed and by-passed by humans. I said what I said about the 2007-to present market as looking like a huge bear market rally because it has these same 4 traits that keep popping up over and over in each bear market rally I have studied, although each trait is distinctive, the concept of the 4 is the same.

First it's important to understand what a bear market rally looks like, what it actually is because during a bear market rally, very few traders will recognize one, that is why they are so insidious. 

In bear market rallies, the fear caused by the preceding sharp fall is replaced by powerful, consuming greed.  Wall Street, investors, and speculators, most of whom are biased in favor of rising markets, see a small bounce, they assume the bottom is in place, so they start buying stocks, and a mighty bear market rally ensues which quickly feeds on itself and grows larger.

Interestingly, the biggest daily rallies in market history in percentage and absolute point terms occur in the midst of raging bear markets!  The best performing NASDAQ days in history did not happen before March 2000 while the bubble mania still lived, but during the two massive bear market rallies in the first half of 2001.  

Bear market rallies are almost always extremely impressive and compelling!

When I was teaching Technical Analysis, my goal was to get students to see historical charts in an emotional light. At a quick glance of a historical stock chart, several months does not look like a long time. But when you are in the market, making profits on some longs or loosing on shorts, two months is plenty of time to be seduced by a bear market rally.

 There's no symbol or timeframe, the rally here is impressive, imagine yourself near the last days on this chart at a nearly 35% move, what would your emotions tell you about this move, would you have confidence in the market on a rally that is nearly double what we have recently seen in the market or would you be suspicious of it? Think about that, the performance here is nearly double what we have recently seen. Unfortunately as traders, we live on the right edge of the chart, we don't have the luxury of Monday morning quarterbacking.

 Here's the same period with the aftermath, a decline of  83%! This is the NASDAQ 100 from 2000 to  2003.

This is the strong bear market rally in the NASDAQ 100 of 34+%

 After nearly 5 years of a bull market, this rally to many looked like an overbought correction. Commentators on Financial cable news were still calling for Dow-$20,000.

Here's the rally to the left in the S&P-500 during 2008, with the 2007 top to the left. Most interestingly is the very small move to the right, barely noticeable on the chart, however it was an 18% move in 7 days,  almost the same as what we have seen since October to now, except in a mere 7 days! However the impressiveness of the move alone gave it away as a bear market rally.

During the 2007 top, which I had been talking about despite the CNBC pundits still screaming the DOW was headed to 20,000, I spent probably a hundred hours studying the bubbles and bear markets of history, including the Dutch Tulip Mania, the Great Railroad Mania and Crash of 1873, The South Seas Bubble of 1720/The French Mississippi Bubble of 1720, the Dot.com bubble and of course the Great Depression. Every one of these has one thing in common, the notion that, "It's different this time". We might call this era "The Great F_E_D Intervention", I think we will look back and see that it was a bubble, not supported by economic growth, innovation or any other fundamental driver of growth, but by the F_E_D's relentless manipulation of the market starting in 2008.

In studying bear market rallies resulting from the 1929 Market Crash, 1946, 1961, 1966, 1973/74, 2000 and 2007, I found that it is hard to quantify a bear market rally in terms of a normal or average percentage gain, from the bear market rallies I tracked during these bear markets, I found rallies from 7% to 48%, although I will say that the bear market rally's percentage gain seems to have a high correlation to either the length of the preceding bull market or the intensity of the preceding bull market, so in a sense, they are somewhat symmetrical. There also seems to be a connection to the market conditions, the worse they are, the stronger the bear market rally is as it needs to convince bulls that the waters are safe and that they are missing out. The average bear market move from what I have studied is around 17.33%, we are now at 19.63% off the October low, although the most dangerous looking area started on 11/28 and has gained 12.75%.

Some of the characteristics of bear market rallies:

One definite characteristic of secondary reactions is that the movement counter to the primary trend is always much faster than that which occurred during the preceding primary movement (the bull move).

The market should show a sharp decline from high to low going into the short-term bottom and a marked volume increase of well above the average on the day of the suspected bottom.

Then, the market begins to rally just as swiftly as it sold off in the coming days...

They'll throw nearly anything at you to convince you that the bear is dead, there are few rules.

The Dow 1929 Crash saw one of the most powerful bear market rallies, although there were a total of 6 during the bear market.

This was a 48% bear market rally.

Since the market is an emotional animal, it may be useful to understand some of the emotions...

Remember that traders (partly due to human nature, partly due to Wall Street brainwashing over nearly a century) are typically inherently optimistic, this is partly why bear markets do so much damage, why they may fall in 15% of the time it took to build the bull market and why they almost always take back more then the bull market made. If fear and greed drive the market (and sometimes the same event causes both emotions at the same time), clearly fear is the stronger of the 2 emotions, but hope is the most dangerous.

Does this 1969 bear market rally look particularly dangerous (at the time, not with the benefit of knowing what came next)? It was stronger technically then the pullback of late 1967-1968, it made a higher high, technically, it would be classified as having broken the downtrend and in an uptrend. I doubt there was much fear over this being a possible bear market rally at the time.

Here are the 4 market stages I describe, 1) accumulation, 2) mark up, 3) top and 4) decline...

The stealth phase is the quiet accumulation I often mention, the awareness phase is what I call mark up, we are watching several long trades right now moving in to mark up, this is when volume soars and catches traders' interest, then the volatility associated with tops followed by stage 4 decline. These stages play out in primary market moves of several years, in position trades, swing trades, and even day trades. This is why I say the market is fractal and it is no coincidence, it is just a representation of how Wall Street works and how human emotion work, just in different timeframes.

I've seen several bear markets now in my trading career, it was the 2000 tech bubble that I learned very quickly that I needed to overcome my irrational fear of selling the market short if I was to survive. I remember this bear market rally particularly well, it was later in the bear market, but caused a huge amount of disagreement as to whether the bottom had been put in. Bulls were adamant that the bottom had been put in, it hadn't though. Even in a well developed bear market, these rallies are still convincing and still cause traders a great deal of hope and often money.

Now I want to show you the 4 traits I have found in nearly every bear market rally, I tried to overlay charts from different markets and bear market rallies so you could see them, but my skills with graphic programs leave much to be desired.

Try to ignore the part to the left and just look at the overlaid chart. The green is the SPX right now and the light blue is the NASDQ 100 at the top of the Dot.Com Bubble. As I mentioned, there are 4 components, and I don't think you will read about this in any book, I had never heard of them before I started studying the market. Remember each component is unique, just as each bull/bear market is unique, but they do share the same 4 stages I mentioned, these are the 4 traits of a bear market rally. Remember that each one is unique, but do you see them?

Here they are...

I removed the symbol and date on purpose so you can see the stages rather then the market. The first characteristic is a top and a sharp decline, the second is a low followed by a new low, I assume this is a shakeout mechanism and an accumulation phase for the rally which starts at characteristic 3 and then is followed by what is an even sharper rally at characteristic 4, I suspect (4) is sharper because at this point, people's greed takes over and they finally enter the market after feeling they missed the bottom of the market and first rally.

Here the top saw a steep decline, a first bottom and then a second bottom which was relatively quicker to form then the above example, there was the initial rally at point 3 and then a very straight line, sharp rally with few pullbacks, much like the market recently, this was the end before the next leg down started, confirming this to be a bear market.

Here we see the right side of the top at point (1), it was actually larger, point 2 shows our low followed by a new low and 3 and 4 were almost imperceptible. Remember, as I said, each is unique.

Again, our top, a first low and a new lower low, the first rally and then an even stronger rally with few pullbacks.

This one is obvious, but is it a new type of super bear market rally. This is the S&P from the 2007 top at point 1, through the present.

The preceding 4 charts were:

The NASDAQ Dot.Com bubble

The Dow Crash of 1929

The S&P at the 2007 top and 2008 bear market
The Current SPX from 2011 to Friday last week

One other thing about bear market rallies is that they are often more powerful then the actual start of a true bull market, they are sharper in general.

In part 2 I'll cover in more detail why I have thought this was a bear market rally and why I think the 2007-2012 may be  a new super bear market rally. I will present you with the evidence that I have gathered, not just opinions of what I see and how it looks similar to other bear market rallies. The truth is, the indicators made me first consider the possibility of this being a bear market rally long before I discovered these similarities.

Enjoy the game, I'll be updating the market and the key events of this week later tonight; I hope you had a GREAT weekend!

Santelli on the NFP

Here it is, as we figured, pure manipulation.

End of Day Sector Rotation Gets Defensive Again

Financials, Basic Materials, and notably, Technology are all falling off, Utilities, probably the most defensive sector has been notably strong today, we don't usually see that on a risk on day as allocations tend to be more aggressive. Industrials are also picking up, which may be more of a rotation in to blue chip names. Energy has been climbing all day, I have little doubt that crude oil/USO has contributed to the turn around in Energy coming off a bad day yesterday(actually a string of bad days) as it fills the gap today.

As I expected just an hour ago or so, AAPL is showing weakness in to the close.

The NYSE Tick Index has been surprisingly mild today, after hours breadth will probably explain what's going on there.

Both GLD and SLV are down on the day, SLV has not broken it's trendline, but is very close to doing so. Other commodities have done pretty well including steel and copper, most probably as a result of the NFP print because the $USD is literally unchanged on the day.

The AEO short idea from yesterday still looks good, yesterday's long idea, GALE is up 30% on the day and up 43% since the idea yesterday and on increasing volume.

I'll give you the internals/breadth after the close.

TrimTabs Take on the Non-Farm Payroll