Thursday, October 15, 2009

How Do You Get There From Here?

One our readers in the comment section of the blog suggested that I had a nice "call" on oil. Compliments are always great, but in the markets, sometimes, I think it is better to be lucky than good. No matter how much we back test or think we have an edge, the next hand could be a losing one. To make that good "call", a lot of effort has gone into understanding what works and what doesn't, and this is what I try to convey in my writing. However, I still cannot help myself and think that some degree of luck was involved. I guess it is the nature of this trader's mind to remain grounded.

But let's get real for a second and suggest that I have only made half a "call". I have said nothing about when to sell. We all know that tomorrow morning we could wake up and find crude oil down 10%. And then my good "call" becomes a bad "call".

One thing I learned early on in the stock market analysis game was that a "call" should have 4 components to it: 1) the entry; 2) the exit; 3) how much draw down one should tolerate to achieve their goal; and 4) how long it may take to achieve that goal. After doing this in a very public way for over 5 years, I am still amazed at how few analysts and pundits include these factors in their market "calls". I am even guilty of this at times.

People who write about the markets can do better. Period. Oddly, our readers don't demand they do so.

What piques my interest are markets or assets that have the potential for a significant, sustainable rally. These are the kinds of rallies that last months and generally have the secular winds at their backs. (As a side note and for another discussion at some other time, it seems that these kind of price moves are compressed into shorter and shorter time frames.) I have found that strategies -such as day trading or swing trading - that require me to thread the needle (i.e., buy exactly at the open or on the close) are difficult to execute.

I am always asking myself "how do I get there from here?". If I can find an asset or market that has those secular winds and isn't too loved by the investing masses, then all the better. These are the things that go into making a good "call". This is the way to make money.

Let's take the current equity rally. It has come an awful long way in a short time period, and there are a lot of folks invested at this point. This is not my cup of tea, and I am involved in a limited way. On the other hand, crude oil has been consolidating its gains for 4 months; it appears to have those technical, secular tailwinds that I favor; and it isn't loved by investors as sentiment towards crude oil is moderately bearish.

So I ask: How will I get there from here? What is the best way for me to make money at this point? Which hand do I want to play? Crude oil over US equities of course. It may not turn out to be right this time, but over time, it should. If I stay true to my style, things should work out.

This is a bit of a long way for me to get to two contrasting charts. Figure 1 is a daily chart of the S&P Depository Receipts (symbol: SPY). Figure 2 is a daily chart of the United States Oil Fund (symbol: USO). Volume is in the middle panel and the on balance volume indicator (with a 40 day moving average) is in the lower panel.

Figure 1. SPY/ daily

Figure 2. USO/ daily

Now this is just good old fashioned technical analysis. Looking at the SPY chart, the first thing to notice is all the red volume bars (in the middle panel) over the past month. Clearly, the volume on down days is much more significant then the volume on up days. The on balance volume indicator is below its 40 day moving average while price is probing new highs. This is distribution.

In contrast, the USO shows increasing or above average volume on up days. The on balance volume indicator is making new highs along with price. This is solid accumulation.

So once again I ask: how do we get there from here? Looking at these charts, I think USO has a greater probability of doing that for me than SPY.

Lastly, figure 3 is a weekly chart of the USO. The move from the low in February, 2009 to the high in June measures approximately 17 USO points. Adding this to the low of the current base at 31 gives a measured move of 48. Therefore, from a good old fashion TA perspective, USO has a chance of trading to $48.

Figure 3. USO/ weekly

Ok, I will take $50. This is a good round number that I like. This would make a very good "call" indeed.

10 comments:

brian said...

Did you not know that USO is a flawed ETF? Since it is composed of future contracts which must be rolled over, the contango is killing it right now. That is why it hasn't kept up with spot oil. I'd ignore the technical analysis from these flawed instruments like the USO, UNG and the 2x/3x levered ETFs (FAS, FAZ)

Guy M. Lerner said...

brian

I thought that was UNG only....can you reference me a link here so I can learn more

thanks

dave said...

"Oddly, our readers don't demand they do so."

That's because many readers aren't truly seeking profits. They're seeking that warm fuzzy, guru, Daddy, psychological validation, identify with, true religion feeling. Sad to say. Why else would bear blogs have so much traffic after 7 months of bull mkt ?

"...it seems that these kind of price moves are compressed into shorter and shorter time frames"

That wasn't the case before direct access trading - left click mouse. Trends took longer to unfold in those days.

"...for another discussion at some other time"

Guy, let's have that discussion. Look forward to it. Have lots of thoughts about that subject. I don't like having "to thread the needle" either.

Anonymous said...

Here are two links about issues with USO:

http://seekingalpha.com/article/117315-using-dbo-uso-and-oil-to-play-crude-oil

http://www.philstockworld.com/2009/06/06/uso-all-of-the-drop-some-of-the-gain/

I liked XOM's decent base (and what should be limited downside) and bought about the time you made your call. I missed out on adding DKA and TSO early this week but will wait for a pullback if I get one or else will pass.

Guy M. Lerner said...

Thanks for the links

I am long XLE -not as a proxy for USO - but more as a proxy to the SPY--these two have been highly correlated thus my reference to being involved with the market in a peripheral kind of way

Of note, large cap oil actually has moderate insider buying which is rare in this market

Of note #2, I remember looking at TSO several weeks ago and thinking I like the looks of that

Al said... said...

"One thing I learned early on in the stock market analysis game was that a "call" should have 4 components to it: 1) the entry; 2) the exit; 3) how much draw down one should tolerate to achieve their goal; and 4) how long it may take to achieve that goal. After doing this in a very public way for over 5 years, I am still amazed at how few analysts and pundits include these factors in their market "calls". I am even guilty of this at times."

AMEN! Having worked as a sell side analyst for years I see this all the time and it sickens me more each year. Consider this - when you leave the 'TIME' component of the call wide open it GREATLY increases your chances of being right some day. Thus allowing you to 'sell' your research as valuable. Many Technical Analysts you see on CNBC, Bloomberg (and that even show up in II rankings) do this ALL the time. They are simply salesmen.

dave said...

Al,

"when you leave the 'TIME' component of the call wide open it GREATLY increases your chances of being right some day"

That is especially true of cyclists. Price is a horizontal component; cycles are a vertical component. If you're long or short based on price you'd better know at what horizontal level that you're wrong.

With the cyclists, they never draw that vertical time component about where the Rubicon lies. They just say the cycle inverted or that it was influenced by another cycle. Without the price component, one would get creamed.

I have never heard or seen a cyclist say that they were "wrong". A popular prominent one this week looking for a top betw the 12th & 14th just updated that it may be the 19th. And price went against him the entire time. But his followers should give him more (vertical) time without a (horizonatl) price component.

Your thoughts ?

Al said...

@dave

I agree on your thoughts regarding cyclists.

Another lovely one is the self proclaimed "Trend Follower". An example of an exchange:

Media: So you are constructive on Gold, when do you think it will hit $1200?

TA: Time is always the difficult component of a call. I will say that the 200-day MA is upward sloping and thus the trend is positive at this time.

Note nothing truly concrete is said for fear of being held to the call at a later date. Gold could drop 25% then rally and the TA said he was right. Meantime you have to decide what to do when you are down 15%.

Another beauty of sell side TA is the fact that a person can be Right on one call and be considered 'great'. Never mind that they were dead wrong on their previous calls - they got one right.

My question - if a guy is right on calling Copper but wrong on the market or interest rates or the USD/EUR - isn't it just a coin toss?

That is why I enjoyed the comments made here:
Make a Call
Give a Reason for the Call
Entry, Exit, Max Loss for the call
Time component.

IF you think Stock X is going up because of Inflation and it climbs during a deflationary spiral - you are what I would call Lucky. Being Lucky is good but it doesn't mean your analysis was worth anything.

JB said...

Wanted to follow up on my comment on TSO and your reply... another thing to look at for refiners is the crack spread. Please see following links if interested:

http://www.hardassetsinvestor.com/component/content/article/918.html

http://www.bloomberg.com/apps/cbuilder?ticker1=CRK321M1%3AIND

dave said...

Al,

I only disagree with you on one thing "...fear of being held to the call at a later date."

Nobody (the media has the only 'real' voice) calls them on their mistakes.

Prime example: Charles Nenner goes on CNBC & everytime proclaims his perfection. Nobody ever calls him on it...either because they're too lazy to do their homework or it's against Rolodex journalism.

"Meantime you have to decide what to do when you are down 15%."

Tim Ord has been short the SPX since 883.92. Every subsequent article has been another reason why the mkt was going down. No guidance about where the exit is for the less sophisticated.

Btw, i am very technically inclined, but our criticisms are still valid.