Financials

With Financial Credit, both Senior and Subordinated in both Europe and the US taking a turn for the worse and considering Financials recent relative performance (which has been high), it's time to take a closer look at what's going on there.

I consider Financials, Energy and Technology the 3 essential Industry groups, so a change in any one of them is important to see coming.

It also should be noted, that the ECB is gearing up for the second LTRO this week (Long Term Repo Operation in which they take bank assets as collateral for a 3 year, 1% loan) which is expected to be much larger then the first. The idea of the LTRO was that banks in the EU who desperately need to shore up their tier 1 capital as required by mandate, would use the 3 year loan to buy sovereign debt which has been in the recent past, yielding 6-7% in some countries. This is known as a carry trade, unfortunately for Sarkozy who trumpeted how successful the LTRO would be at doing that (being the ECB is banned, just like the F_E_D from participating in direct primary debt auctions), almost all of the money went right back in to the ECB's deposit facility which yields .75%, so banks were taking the money, but rather then financing carry trades (although there have been a few, but far from what was envisioned) they were getting it OUT of the financial system and in to the safety of the ECB's deposit facility to..... you probably guessed it as it was predictable, to shore up their tier 1 capital base rather then issuing new shares at depressed prices. The important thing to note (and EU financial institutions have been trumpeting this like a badge if honor, making sure everyone knows they didn't take LTRO cash) is the banks that did take the LTRO cash are being hit 4x harder then the ones that did not. This too was predictable as we saw the same thing happen in the US to banks that borrowed from the F_E_D's discount window. The market assumes that the banks taking the money are the ones in the worst shape and probably accurately. As the ECB has lowered collateral standards below the last LTRO's single A rating, the next take up is expected to be enormous, however with the banks who took the money being punished in the market, it will be interesting to see just how big the take up is vs. consensus. Also what we should be paying attention to is the Deposit facility and how much of the cash goes in to it, Greece has become a real problem for the banks and I suspect they will choose to hold onto the cash rather then finance carry trades as Greece becomes an "unknown, unknown". Furthermore, the Greek PSI deal, if it gets done, could set some very dangerous precedents for bond buyers, especially now that they realize the ECB will not participate in any write down. This means the more debt the ECB holds of any particular sovereign, the bigger the private creditor potential write down will be when Portugal, Spain, Italy, or Ireland seek to get equal and fair treatment and look to have their debt restructured.

It may sound a little complicated, but if you read it once more, I think the gist will be clear. It's a pretty simple market dynamic that as always comes down to the balance between fear and greed and there's no doubt that fear is the stronger of the two drivers of the market; just look at the 2003-2007 bull market, the bulk of the gains and then some were erased in 8 months, after taking 5 years to build them.

On to Financials...

 Today financials are an under-performer as you can see on this 1 min sector rotation chart as compared to yesterday.

 Longer term they have come in and out of rotation a couple of time, but most recently they have been in rotation since December or so.


Starting from the short end and working to the longer timeframes...

 This shows, much like the market update, late day distribution yesterday in financials, much like what we saw last Thursday afternoon before Friday's drop.

 On the close up 2 min chart we see the same negative leading divergence in to afternoon trade and in a flat environment.

 Longer term, it seems there's been distribution since the NFP on Feb. 3rd, I suppose either smart money didn't believe the ridiculous and arbitrary seasonal adjustment or treated it as "sell the news" XLF is now leading negative on the short term going back before the Non-Farm Payrolls.

 The same is seen on the 5 min chart with a head fake at the yellow box, which was also the top for financials.

 The longer term charts have shown a deep and long leading negative divergence on this 15 min chart.

 The same on the 30 min, although this does show an accumulation and mark up cycle before distribution.

And on this hourly chart.

3C usually responds to these divergences within days, (during the early Aug to late September 2011 choppy market, 3C responded so quickly that the MP made 80%)  there have only been a few times when they went on and I only see it in major market once or twice a year, it happened at the end of the G.W. Bush administration after a 5+ year rally in oil that took it from $20 a barrel to over $145 a barrel, that divergence went on for a while and started somewhere around 3 months before Crude topped and then saw an 80% decline in 7 months, bringing crude down to the low $30 area. The same happened with the US dollar in 2008 and 2009, both runs higher made significantly more gains then when the divergence first started, so if you had bought when the divergence first started and sat through the drawdown, you still made huge money (considering the Dollar Index's beta). It's happened with several stocks as well, but in all of these major divergences, they have accompanied major moves that went well beyond where the divergences first started.

Early Market Update

I try to separate early from regular market updates as the early action is usually full of games to take advantage of limit orders/stops, etc placed by retail that has to head off to work, in fact many professional traders don't even pay attention to the market until after 11:00 a.m. with the pros really coming in to the market right around 3:30 through the close as the day traders tend to exit around 3:30-3:45.

However, yesterday's closing activity had a lot in common with Thursday's closing activity before the Friday gap down.

We already know volume and the Price/Volume relationships from yesterday were bunk, so the way I see it, yesterday was a noise day that was only good for filling a gap.

 The DIA, note the dates. Last Thursday it went leading negative in to the close and Friday we saw the fall. Yesterday was already leading negative,  but got worse in to the close.

 The same is true of the QQQ

As well as the SPY.

Actual Crude Futures / CL

The actual Crude Futures seem to verify the USO readings.

 This is CL (Crude Futures) yesterday

This is overnight and in to the open.

USO Update

I haven't seen the final verdict on the Crude Future trading halt imposed by the CME as of yet, but NANEX that does great work in tracking algos verified there was an algo running that stuffed so many quotes in to /CL that it caused the memory on the software to fill up and halted the day's trade for 75 minutes. That being the case, it looks like manipulation of the market by some predatory HFT, so I'm not taking the break above the channel too seriously as of yet, being it occurred under intense algo activity that was most likely predatory in going after another big player or a bunch of them. We saw something like this happen several months back when I believe it was the NYSE had so much quote stuffing that the system reached capacity and had to be reset during the trading day rather then overnight as each order carries a number and there is a finite limit.

 With this channel being so obvious in one of the biggest markets out there, it was only a matter of time before the algos took advantage of it, whether for volume rebates, whether predatory activity upon finding an iceberg, who knows, but the channel/trend were too clean and obvious for it not to be shaken out.

 The short term 3C is leading negative today and was negative yesterday, which seems to indicate this wasn't accumulation of oil, rather an algo stuffing quotes.

 Here's a close up of the same chart, now leading negative.

 The 5 min chart also leading negative.

This is why I preferred the 2-day Trend Channel which would have a stop at $38.96 ON the CLOSE.

Yesterday' Internals and Overnight

Yesterday's internals were pretty much what I expected to find with a few surprises. As I mentioned yesterday, the trade was insignificant; it didn't do anything more then fill a gap which is about what we expect to see about 90% of the time, so it wasn't special in even that.

Volume dropped off on the NYSE to new lows for a non-holiday trading day that stretch beyond a decade and ES volume just missed multi-year new lows and was off by 30% of its 50-day moving average of volume.

The Cats and Dogs were the leaders again yesterday (which is usually telling us something in and of itself as the C&D trades tend to pop at the end of a bull run. The top 15 highest percent gainers were all Cats and Dogs and 19 of the 25 highest percent gainers were all Cats and Dogs. I didn't look through the usual 150 other then to skim through and saw a majority of gainers were again, Cats and Dogs.

The Dominant Price Volume Relationship should come as no surprise...

 Dow -30 Components

 NASDAQ 100 Components

S&P-500

At just about 50% in all of the major averages, Price Up / Volume Down was the winner, which is also the most bearish of the 4 possible relations and even more so making a 10+ year low in volume.

Even the top performing Sub-Industry groups were generally recent under-performers, including:

Consumer Services, Paper and Paper Products, Drug Delivery, Pollution and Treatment Control, Metal Fabrication, Drug Related Products, REIT Hotel/Motel, Small Tools and Accessories, Beverage and Brewers and Diagnostic Substances.

Credit underperformed as did risk assets, there was simply nothing to get excited about in the internals. Crude trade was interesting on the CME halt, but that was about it.

As for overnight news, nothing too surprising there either:
As expected and as Draghi has repeated twice, the last time just last week, the ECB will not take losses on their Greek bonds, which means the Private Creditor losses will be even bigger, which has a lot of ramifications for sovereign debt, depending on whether Greece can close the sale without CACs. Draghi seems to be the only EU figure that says what he means and means what he says. There is a sense that the Greek PSI deal will not get done or is not credible.

Schaeuble, repeated again that a Greek default will not be as bad as it would have been a year ago, he's clearly focused on fixing the problem with Greece, just not to Greece's benefit.

On the eco-news, European Industrial output declined 1.1% with Germany being a leading contributor to the decline at a 2.7% decline after November's .3% decline (remember that the EU benefits Germany more then any other country in that they have a free trade zone). EU troubles are having a clear impact on the German Production dynamo. Perhaps Germany should be punished for such a nasty decline, after all, it was WORSE then Greece's at 2.4%!  Also in the data, employers are cutting jobs 3 time faster then in 2011. Recession? I think the question is when if it is not already on now?

Greek Q4 GDP data came in at a disappointing -7% making this a 4th consecutive year of a worsening recession. The unemployment rate is over 20%, it should be noted Spain's UE rate is 23%. In other word, there are a lot of potential rioters available.

After Spain was cut by two notches by Moody's last night, there's news that the EU intends on "Punishing Spain" for its deficits and inaction. Perhaps Germany is looking to reshape the EU?

In the US, Retail Sales Miss, this makes 3 months in a row coming in at .4% on consensus of .8% and that on a downward revision (formerly .1% revised to 0%). Take away the seasonal adjustment and retail sales saw their largest 1 month decline EVER! The last time Retail Sales missed 3 months in a row, was in 2008, not a great vintage for the market. Remember AEO and other retailers I brought up as trade ideas, saying, "There's something wrong in the sector" just last week.

The Euro overnight looked horrible a did ES, but we'll get to updated charts of those in a moment.

FX is leading the way while the EU spins in mind-boggling circles

Just as the Euro led the market today by gapping up on the passage of the Greek vote, as I suspected, it's now leading the way down and for more then 1 reason.

First the market HATES uncertainty and the lack of comments or at least constructive comments from Greece's task masters today, caused the initial uncertainty in the FX market which effected the stock market (by killing momentum and sending the market lower in to the close). If you are familiar with candlestick charting (If you are not and you want to learn, Steve Nissan's books are excellent), you understand that the market is very much like physics in certain ways, such as "A body in motion...." and when a market loses momentum, it opens itself up to a change in direction. Candlesticks like the Harami, Doji, Hammer, Shooting Star, are all examples of a market losing momentum either to the upside or downside. If you use candlestick chart, be sure to look not only at the daily, but the weekly, monthly and yearly as well, you'll uncover some clues to the market by looking where few others look.

Now we have some more news and at a brisk pace, although not unexpected as we touched on it today. Specifically, my gut feeling is that the Trokia (which at this point I consider to be more then the EU/ECB/IMF, but the northern countries such as Finland, the Netherlands, Luxembourg and last but certainly far from least, Germany) will keep making demands until they break Greece and force them out of the Euro-zone and in to default. The Troika as a whole has expressed on numerous occasions that they have no intention of forcing Greece out of the Euro, but just like a coward manager, rather then being direct and firing an employee, they choose to make that employee's life unbearable until the employee quits. That's not an elegant analogy, but I think it's pretty close to accurate. I pretty much said this today when I mentioned I thought they (Troika) would keep moving the line in the sand to ultimately save face and say "We did everything we could, but they just wouldn't go along".

As for the events that are causing the Euro to look like this...

 At this point the EUR/$USD pair (or the Euro long) has now retraced all of Sunday's opening gap and is lingering around Friday's New York close around 4 p.m. (the red trendline represents Friday's close).

Here is what the Euro has done since 4 p.m. EDT today, the red arrow is the break below Friday's close, note the momentum to the downside just before the break as the candlesticks are red and longer.

As for the news, and after a slow day, it's coming in fast and furious:

From Kathimerini:


"Finland may sign a deal on securing collateral in exchange for its commitment to Greece’s second bailout in the “next few days,” Finance Minister Jutta Urpilainen said on Monday."


"A vote in parliament on Finland’s participation in the bailout could follow next week"  Tick, Tick, Tick, the clock is running out. Greece does not have until March 20th to get a deal done, the deal must be done yesterday to get all of the bailout logistics in place. 


"Finland, one of four AAA-rated euro members, last year became the only nation in the currency bloc to secure extra assurances that its commitments to a second Greek rescue be repaid by insisting on collateral.

In return, Finland agreed to pay its contribution to the permanent rescue facility, the so-called European Stability Mechanism, up-front.

“I hope we could sign the collateral agreement in the next few days,” Urpilainen said. “These conditions must be fulfilled before Finland’s parliament can give a green light” to a second Greek bailout."

Other then the delay in negotiating yet another deal on collateral, getting Finland's approval and Greece's approval (Lord only knows what they will demand- I say the Pantheon/ Acropolis  is a starting point-nothing like stripping away Greek pride and identity), the next issue will be what Germany and the others in the Northern Alliance will ask for= FURTHER DELAYS.

Apparently the finance ministers who meet on Wednesday, which was supposed to be the day that they approved or didn't approve the Greek bailout (my head is spinning with these dates as Germany is supposed to vote on it, Finland is now set for a vote, so how can the finance minister approve something that the individual respective countries haven't even completed votes on?) are now demanding that additional conditions be met by Greece before the finance ministers take up the topic. Exactly what these new demands are, who knows, but they are in some part seeking evidence that Greece has started to implement reforms. What the conditions are, how they are deemed to be met and how Greece can do that in such a short period of time are mind-numbing, which just reminds me not to get too caught up in all of the drama because it seems the Euro-zone has already decided the Greek's fate. And what was Samaras doing today when he voted for the measures last night and then said today that they would be re-negotiated after April elections? That alone would seem to be a deal killer if there ever was a real deal on the table. All I can think of is he's setting himself up for the election as a populace leader, despite the fact he voted for the reforms. It's just too surreal to believe.

In any case, the bottom line of the additional demands which have not been formally spelled out yet, seem to rule out any decision on Wednesday's finance minister meeting. 

Moving away from Greece, I expected some more downgrades, but I expected them to be financial and from the S&P, imagine my surprise when Moody's just let loose:

From CNBC:

Rating agency Moody's warned on Monday it may cut the triple-A ratings of France, the United Kingdom and Austria, while it downgraded the ratings of Italy, Portugal, Spain, Slovakia, Slovenia and Malta. (Spain was cut by 2 notches, the rest by 1)

And to round things out, Luxembourg's Finance Minister made a slew of comments about how Greece doesn't belong in the Euro-zone if they can't comply, that if they default now it won't be as serious an issue as it would have been a year ago and finally that the US should contribute more to the IMF, which as we all know, is a NON-STARTER.


And to think, I haven't even started on the internals today which weren't very good.

CL Crude, See any thing out of place?

Pay attention to the timestamp on the chart...

9, 10, 11, 12, 13, 15, 16, 17

Uh, where's 14 (2 p.m.)?

The chart goes right up to 14:04 then jumps to 14:21 then to 15:15 (2:04 p.m. EDT / 2:21 / 3:15)

CME, where CL (Crude Futures) trade, went berserk apparently from an algo. They shut down the system, cancelled all open orders and restarted. As far as we know right now, it looks like an HFT algo was responsible, there was unusual trade in USO just before it shut down the data stream.

I've been meaning to cover this topic for a while, although I'm no expert, I do know that these algos/HFT firms can flash and pull mindboggling numbers of quotes and bids in nano-sconds. This is not what valuations and discounting in the market is about.

In fact, way back in the low tech year of 1987, there's good evidence to suggest computers were caught in a spiral of selling in response to falling prices causing the '87 crash. Now imagine how much further they have come, they are literally trading at the speed of light. Several very well respected institutions including the Wharton School of Business think HFT has the potential to crash the market.

It may have started in a benign way, some of you probably remember when prices were quoted at the nearest 1/16 of a dollar. Computers allowed bis/ask spreads to be quoted to the nearest penny, which helped many traders. When the SEC mandated that prices be quoted nationally instead of on individual exchanges in 2005, computers could play the arbitrage game and take advantage of price discrepancies between two different exchanges.

One thing HFT can do is earn volume rebates and while they may be small ($.005 per share), when they are executed millions of times, it adds up. Imagine what they can earn churning a stock (basically buying and selling for no other reason then to earn volume rebates) and none of that action has to do with price discovery or valuation.

Advocates of HFT say that HFT provides liquidity to the market, BUT, unlike a traditional market maker or specialist that MUST, by law, provide a market for any orders at market, even if a stock is in free fall, they must buy, HFT firms have no such obligation. They can provide immense liquidity on day and when a stock starts crashing, just turn and walk away leaving what ever is left of the market making community to try to provide liquidity. As you can probably imagine, this can lead to some incredible flash crashes, something I have a keen interest in and try to document whenever I see them One thing I have noted with 3C, is there always seems to be a set up just before a flash crash, I don't think I've sen one yet that didn't have a set up in which 3C shows distribution in the minute of hour leading up to the flash crash.

When the SEC banned short selling in 19 financial stocks, the spreads increased dramatically and volume fell off dramatically, why? Because the HFT firms couldn't short sell and therefore couldn't arbitrage their trades. So we have already seen proof of what happens when these so called, "providers of liquidity" step out of the market and the impact it has had on liquidity is large, where traditional specialists on the NYSE use to make up 80%of the transactional volume, they now make up 25% or less, this means they don't carry the same inventory levels that they use to. If a crash happens and the HFTs step out of the market, the specialists will be in a bad position as their inventory will swell from what they are now use to, to whatever they MUST take on by law. This could easily set them up to be taken advantage of and cause huge volatility swings that effect the entire market.

When the Dow fell 700 points in 5 minutes on May 6th 2010, it was a warning of what HFT can do.

Several years back, a cousin of mine was and I assume still is working on what I knew as a Black-box system, I didn't know exactly what they were doing and he wasn't a trader, but a technology /IT guy so he couldn't really explain it to me other then to tell me that they made thousands of roundtrip trades in a few stocks every day and that they were setting up hubs very close to the major market centers. I now know what they were doing was high frequency trading. Their information/trades, are traveling over fiber optic cables at the speed of light, but to get an edge, they needed to be as close as possible to the actual trading center, so in effect, they were spending millions of dollars to reduce latency by fractions of a millisecond!

Many High Frequency Trading Firms are "Predatory". One of the tactics they specialize in is pinging for Icebergs, or large institutional orders near... you may have guessed it, VWAP!  They can do this by sending out multiple bids or asks in nano seconds and seeing if they get a bite, then they have an idea there's a large hedge fund order out there and they work to find it and jump in front of it, thereby driving price against the hedge fund. It's more complicated then that, but that is the gist of it.

Another example is HFTs buying large numbers of stocks at the same time, triggering large institutional orders, they can then sell them the stocks or even short them before the institutions get a complete fill, and whatever was filled, becomes a loss to the institutional trader.

However I still think the real danger is that HFT have largely displaced traditional market makers, but when the market plunges and the HFT firms step out of the equation, what you end up with is a May 6 2010 700 point fall in 5 minutes. Although since these HFTs are getting faster and faster and taking more market share away from market makers who unlike HFTs, are regulated and must be in the market, the next plunge could be even worse.

The C&D Trades and Why I have my Rules

Every time I present you with a Cats and Dogs trade, which don't get me wrong, I have no problem taking a 20% 1 day profit, I try to explain the rules.

When you make 10 or 20% in a stock in 1 day, you can really start to like that stock and assume  that there's more coming. With C&D trades which I have noticed and traded for years even though I prefer higher quality stocks (I believe in taking what the market offers), I have found they can move incredibly, 300-400% in a run or 20 to 100% in a day, but they are there for a reason and if you want to profit from them, you have to understand the reason.

In my experience in trading several seasons of Cats and Dogs, they tend to pop up when bullish sentiment is high and especially after an impressive move in the market. People who saw the late July decline and lost money on it are gun shy. This is also part of the psychology of a bear market rally. To get these gun-shy traders back in the market, they need to be impressed, they need to have their emotional buttons pushed and feel the emotion of greed. Greed is much harder to create then fear is to overcome, so as I said, they need to be impressed.

The Cats and Dogs almost always have clear accumulation so its my opinion that as I explain this emotional phenomeon to you, Wall Street understands it 10x better then I do, after all, they accumulate these cheap stocks and make huge profits on them. They know once they get a trader to feel left out, that trader's greed will kick in. Human nature being what it is, we all like a bargain. If you are really honest with yourself, how would you feel about buying a stock that has already run for several months and is up maybe 50-200%? Or how would you feel buying on a breakout day when the stock is already up 15%? Probably not too good and that's what happens to these traders, they search for the bargains and Wall Street gives them clues of where to look by flashing volume surges. Momentum traders watch and scan all day long for volum surges because the mistakenly believe that what they are seeing is smart money buying the stock. Smart money doesn't let you see what they are doing, they certainly don't announce it with a 1000% volume surge and drive price 15% against their entry, but they do know what average traders think.

So the Cats and Dogs look like a bargain, they are flashing big volume, traders think Wall Street is buying and they jump in to a $1-$5 stock rather then a $50 or $60 stock. These moves as I said, happen fast and they can be huge, but on the way up, Wall Street who bought the stock when no one was looking and no one cared, is selling in to that strength the entire time.

This is why I have a personal rule that if a C&D stock gives me a return of more then 10% in a day, I will take either partial or complete profits. Ideally I'd like to let the stock run and see if I can get a 15% gain to turn to a 300% gain, but I know these are not the next Microsofts, they are a play on traders emotions and the proof is in 3C where you can see then accumulated when they are cheap and no one cares.

So I posted EXM and DHT this afternoon, I thought EXN probably has more to go, but DHT has had a pretty good run.

From the time I posted these two to the close which was less then an hour, look what happened in EXM...

 Today's close, 13.76%, but when I posted it...

21.16%. Looking at the volume, you can see that it wasn't as strong of a day as Feb 6 on a 26% move.

This is why I take those partial profits no matter what or even total profits. IDeally you can make enough to take your original investment completely off the table and only have profits at risk with a tight trailing stop, those do come around.

I don't think we can complain though about making 13% in a day, that's more then most hedge funds made all last year. In any case, just understand what the trade is, why it's there and you should be able to make some nice, quick profits.

The Close and Predictability of Traders

I keep mentioning the predictability of traders not to point out something interesting, but to help give you an edge. Wall Street knows how predictable technical traders are and they use that against them, so if you understand what traders will do, where they will place their stop, what will cause them to buy/sell/short/cover, then you have a good idea of how Wall Street will react.

 This is the SPY vs the Euro (red) as you can see, the Euro making a lower high was also the top of today's intraday trade and with the 3C divegences in place, it was very unlikely the market could keep up momentum and more likely it would start to sell of a bit into the close. As mentioned earlier, today did nothing of technical importance other then fill a gap.

 The same chart as above, just for the entire day. Again, the Euro failed to make a higher high this a.m.  and the market reached an intraday high. When the Euro started trending up again, it boosted the market, when the Euro failed to make a higher high, that was the top for the market today and it roughly followed the Euro lower, although on an arbitrage basis, the market is a bit over-valued.

 Here's the trend line I showed you earlier, with no more momentum, that support was broken.

 As far as obvious goes, look at the break of the trendline (the two larger down candles) and then resistance at the trend line, this is what I mean by obvious. At the very least, you should see that you shouldn't place stops at these obvious levels.

The 50 bar m.a. on a 5 min chart, this is as old as the concept of day trading itself and look at volume when the moving average is broken-a lot of stops triggered.

I'm updating now, I'll be checking internals, industry groups, the C&Ds and anything else I can find of interest.

AEO Trade Update

AEO was a short trade idea from Feb. 2

Thus far, especially on a swing basis, AEO is acting very well.

AEO is still in good shorting position. The idea was at the red arrow, which as a swing trade, it continues to make lower lows with only 1 noise candle thus far.

The real trade we are looking for would be this...

This would start the next leg down, the first leg down was on that sharp gap down which is a breakaway gap and very bearish.  Thus far, the consolidation pattern after the first leg has failed and that's where we entered the trade, so the next leg down is what we are looking for here.


Here are the updated stops...

 This is the 2-day trend channel which is wider and is what I prefer initially...

Here's the 1 day, which is tighter and guarantees a profit is you entered on the day it was featured. AEO is just about breaking the trend channel to the downside which should accelerate the downside move.

I would just be patient with this one, especially if you are already at a profit, give it some time to do it's thing as it is moving in our favor and as we wanted to see. if you are considering this as a new position, which would give you exposure to discretionary if you are looking to diversify, I would prefer the wider stop at $14.25, but even there you still have a pretty good looking risk:reward profile. The tighter stop can certainly be used, or if you are treating this as a swing trade, it's already a swing short, the current swing stop would be a daily close with a low above $13.81