Diary of a Financier

Bottom Feeding: Nibbling at Russell 3000 with Anxiety Creeping In

In Capital Markets, Trading Desk on Wed 7 Nov 2012 at 18:07

Between StockTwits and this diary, I’ve worked hard to compile a stream of consciousness with particular focus on capital markets vis a vis the money I manage. It’s valuable for me to revisit my thought processes as they were at every market turn. I took a little nibble at the market today, and I wanted to petrify my thought process before the day’s out.

I try to only take the bets with the highest probability of success. You’d think that’d be the same for everyone on the Street, but so few managers actually do so. Few do anything but hug their index, strategically asset allocate, and/or invest “long term.” (As far as active managers go, most hang on, turning trades into investments after they’ve had their faces ripped off in a correction; others capitulate at the point of maximum pain, catching the whole downside then missing the upside as they suffer from some recent bias.) Few professionals are willing to make specific time & price calls–neither in public, nor in private (with their clients). They’ll always chase the S&P, because they’re always waiting for “certainty” before they go on the record: “Oh yea, we’ll put some money to work after the Fed meeting… after this Eurocrisis… after elections… after the fiscal cliff.”

A few things worth mentioning here. First, there’s something to be said for caution, but there’s also something to be said about the illusion of certainty. By all means, sit on the sidelines if you don’t have an edge or a read on any particular market, but don’t be the guy who’s just waiting to ride the next bull market: clients need you to help them navigate bear markets a lot more than bull. Second, index hugging is fine, because there exists a real demand for passive investing, but too many managers charge too much money for brainless strategies with no value added.

It’s my style to have conviction in capital markets’ future trajectory. I spend a lot of time at home or in the office doing research/analyzing charts/perusing historical analogues in order to establish a base case on which I can bet. I get a good idea for my odds of success, and I compile enough data to prove/disprove my theory’s null hypothesis. By “success,” I don’t just mean I’ll make money in a stock; I mean the scenario will pan out almost precisely as envisioned (again, time & price). Sometimes I get lucky; sometimes I’m wrong; surprisingly often the priceaction materializes as I had extrapolated. If I never go on the record with my expectations, I’ll never be able to go back and learn from my mistakes.

For me in my career, the most difficult facet of investment management has been the actual portfolio management. Like I said, I have conviction in my trades, but I’ve learned that implementation is a whole other beast. You can predict every undulation in SPX, but you still have to trade/implement your predictions in a suitable portfolio. There’s the necessity of diversification and risk management. You can’t just plough $200mm into the SPY and call it quits. You can’t squeeze an order that size in at the bid. Plus, what if you’re wrong? What if SPDRs flash crash or the whole fund family folds instantaneously upon scandal? To wit, I’m happy to raise cash to the heavens, hedge, or jack my beta, but I always maintain some exposure in the other direction in case I’m wrong–in case the long shot wins and I succumb to a Type I error. It’s called stress testing. I plan for the base case, but I also plan for the best and worst cases.

~~~~

That philosophical rant provides necessary background for my latest investment activity. I bought a bit of the NASDAQ ETF (QQQ) last week, when I saw the left shoulder of a Head & Shoulders bottom developing. Although that meant a lower low (head) would form thereafter, I wanted to cover the small probability that the market would run ceaselessly higher. (Indeed a left shoulder appears to have formed, as QQQ rallied for 4 days, then dumped lower.) I’ve been sitting on a pile of cash, hence we’ve only captured 54% of the S&P’s downside since September’s four-year high. I have room for a bit of error, which is why I’m fine scaling back into this market at the risk of arriving a bit too early.

We had a nice little rally after my QQQ buy. Then, in the middle of a big day yesterday, I noted that everything would reverse:

…and markets got crushed today in the wake of Barack Obama winning reelection as the President of the United States. In the middle of this rubble, I made some more observations:

  • $SPY resting on LT bull channel support @ $139.5; air pocket below down to 61.8% Fibonacci ~$137.7. $SPX Chart
    Nov. 7 at 11:56AM
  • $QQQ below LT bull channel support, riding ST bear channel sppt & resting on 61.8% Fibonacci ~$64.15. $COMPQ Chart
    Nov. 7 @ 11:53AM

…and those robust support levels stood, so I started to nibble at broad index exposure (VTI) around 3:00 today. I don’t think this is the bottom–nevermind the exact bottom–but it’s within a few days and a couple percentage points, according to my base case. I started buying, and I expect to buy more tomorrow if all fractals signal an imminent rally.

~~~~

This is what I really wanted to talk about though: the money manager’s psychology; my anxiety. You want to know what’s going to keep me awake tonight? There’s a lot. Geopolitical risks, Europe, Fiscal Cliff, Earnings Recession, Business Cycle Recession, etc. I can dispel all that with a wave of a contrarian’s hand. What really worries me is a potential complex Head & Shoulders top developing in SPY’s daily chart, which broke beneath $140 neckline support and closed there:

SPY daily- complex H&S top

It’s a weak pattern–not as pronounced or robust as a classical formation–but it’s nonetheless my null hypothesis, and it’s going to nag me until we rally back up, through right shoulder resistance (~$144) like I’ve envisioned. I’m not married to my call for this being an approximate low in a H&S bottom. I’ll be quick to change my mind if new evidence arises… and it won’t be too long until we get a verdict, because SPY’s intraday low scraped trendline support of a long term rising wedge (as noted above). A breakdown would hit a big air pocket (at least 50% retracement). I don’t expect that catastrophe yet for a few reasons, namely:

  1. The way this wedge has formed, it looks like it wants to rally up to resistance once more before collapsing since it hasn’t quite reached its vertex yet.
  2. Both the 2007 and 2q12 analogues warn of one more blowoff top.

Then again, technical indicators require three bumps of a divergence trendline before confirming a reversal, and SPX’s daily & weekly charts have indeed tested divergence thrice. As the longer term pattern in play right now, the rising wedge will determine the outcome, and it really all depends in whether or not its trendline support survives this week.

Ay. If you need me, I’ll be clicking refresh on ES futures and Asian markets all night…

–Romeo

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  1. […] wasn’t the conviction bottom call I made in 4q12 and again in June this year. I was sure to disclaim the market’s […]

  2. […] both flashing multiday bull divergences at around 12:15, and I accumulated a few more shares (15bps of exposure) of VTI yesterday before I put all trading on hold: the priceaction […]

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