Well the stock market just seems to keep chugging along.  Despite the shaky economy, the national debt, the political discord, the terrorists on the march and the price of – well, just about everything made in China. And as a dutiful trend-follower I continue to “ride the ride” all the while repeating the ever apt phrase, “What, me worry?”

Three things for the record:

1) The stock market is in a clearly established uptrend and who am I to say otherwise?

2) Personally I still expect a serious “something” between now and the end of September

3) Arguably the most important bullish seasonal trend of all kicks in at the close on September 30, 2014.

Huh?

Yes folks, as of the close on September 30^th it will be time for “the Mid Decade Rally”

Defining the Mid-Decade Rally

For the purposes of this article we will break each decade into two periods:

*Period 1 (i.e., the “Bullish 18”) = the 18 months extending from the end of September of Year “4” (2014, 2004, 1994, etc.)

*Period 2 (i.e., the “Other 102”) = the other 102 months of every decade.

So in a nutshell, Period 1 comprises 15% of each decade while Period 2 comprises 85% of each decade.  Given that Period 2 is 5.67 times as long as Period 1 it would seem likely that an investor would make more money being in the stock market during Period 2 than during Period 1.

I mean if you had to choose – particularly given the long-term overall upward bias of the stock market – would you choose to be in the market 85% of the time or only 15% of the time.  Safe to say most investors would answer the former.  But if you are among those who chose this answer, perhaps you should read a little further.

Period 1: The “Bullish 18 Months” of the Decade

In Figure 1 you see the growth of $1,000 invested  in the Dow Jones Industrials Average only during the middle 18 months (Sep. 30, Year 4 through Mar. 31, Year 6) of every decade starting in 1900.  See if anything at all jumps out at you from the chart.Figure 1 – Growth of $1,000 invested in Dow only during “Bullish 18” months of each decade; 1900-present

Does the word “consistency” come to mind? For the record, $1,000 invested only during this 18-month period grew to $40,948, or +3,994%.  Now this all looks and sounds pretty good, but surely an investor would have made a lot more money investing in the stock market during the other 102 months of each decade, right? Well, not exactly. In fact, a more accurate statement might be, “not at all.”

Period 2: The “Other 102” Months of the Decade

Figure 2 displays the growth of $1,000 invested in the Dow Jones Industrials Average only during the other 102 months of each decade.  $1,000 invested in the market 85% of the time – but excluding the mid-decade bullish period – would have grown to $6,166, or +517%.Figure 2 – Growth of $1,000 invested in the Dow only during the “Other 102” months of each decade; 1900-present

Now for the record, +517% is +517% and no one is saying that you should simply mechanically sit out the 102 “other” months. But the point is simply that the “Bullish 18” made 7.73 times as much money – while invested only 15% of the time – as the “Other 102” – which was invested in stocks 85% of the time.

The difference is even clearer when the two lines are drawn on the same chart as shown in Figure 3. Figure 3 – Growth of $1,000 during “Bullish 18” month (blue line) versus “Other 102” months (red line); 1900-present

Mid Decade “Bullish 18” Performance

Figure 3 – “Bullish 18” month performance

For the record:

*The average % gain for the Bullish 18 was +41.7%

*The median % gain for the Bullish 18 was +42.5%

On the other hand:

*The average % gain for the Other 102 was +34.3%

*The median % gain for the Bullish 18 was -2.2%

So you see why I am marking September 30, 2014 on my calendar.

By the way, if you like this one, in the immortal words of Jimmy Durante, “I got a million of ’em.”

Jay Kaeppel

No one likes to waste time so I will give it to you straight.  If you have no interest whatsoever in trading options and/or if either this, this or this cause your eyes to glaze over, I’m going to suggest that you stop reading right here.

But thank you for checking in and have a nice day.

Alright, now that they’re gone…..one of the things I like to (try) to do is to go beyond teaching people “about trading” (“this is what a risk curve for a butterfly spread looks like”) and get more into “how to trade” (“this looks like a good time to use/adjust a butterfly spread because…”).

In the articles linked above I wrote about a hypothetical bearish on gold trade using put options in GLD.  That trade will expire at the close on 6/20.  Before that happens I am going to add one more update.

The Current State of Gold Affairs

In Figure 1 you see the risk curves for the original (adjusted) trade.

 Figure 1 – Risk curves for Out-of-the-money GLD put butterfly spread (Courtesy: www.OptionsAnalysis.com)

The good news is that:

a) The trade cannot lose money

b) There is still additional upside potential if GLD declines towards 119 between now and the close on 6/20.

The bad news is that most of the open profit can still vanish if GLD advances towards 125 between now and the close on 6/20.

So several choices available to a trader are:

a) Hold on if you think GLD will move sideways to lower in the next 48 hours

b) Exit the position if you think GLD will move higher in the next 48 hours

c) Adjust the current position

No surprise, I choose “C”. Here’s why:

1) First off I don’t have a clue what GLD will do in the next 48 hours.  I do know that after holding this trade since March 6, I don’t want to end up with a meager profit (which would be the case if GLD rallies above 125.  But I don’t necessarily want to exit because there is still a lot of additional profit potential available of GLD does happen to sell off in the next 48 hours.

2) Additionally I think you can make a bullish case for GLD going forward.  As you can see in Figures 2 and 3, the Elliott Wave count on both the daily and weekly charts show a completed 5 wave down pattern (to all of you “non Elliott Heads” this implies that downside momentum is waning and that a new up move may begin).  Now I am not a true Elliott believer but I do pay attention when both the daily and weekly counts point in the same direction.   Figure 2 – Daily GLD with completed Elliot Wave 5 (Courtesy: ProfitSource by HUBB)Figure 3 – Weekly GLD with possible completed Elliot Wave 5 (Courtesy: ProfitSource by HUBB)

So let’s survey the situation:

1) I have an open position with an open profit that could get bigger or smaller in the next 48 hours and I have no opinion which way it might go during that time.

2) I have an open profit of $544 “burning a hole in my pocket”.

3) I have some reason to believe that GLD may advance in price moving forward.

What to do, what to do?

Well, in reality the choices are limitless.  But here’s what I’ve come up with:

*Continue to hold the trade but also spend some of the open profit to position myself for a potential up move in gold.  How to accomplish this?  Relatively simple: Buy 1 March 2015 GLD 130 call option for $3.10, or $310.  The risk curves for this newly adjusted trade appear in Figure 4.

Figure 4 – OTM Put Butterfly PLUS long March 2015 130 call option (Courtesy: www.OptionsAnalysis.com)

A few things to note:

1) If GLD somehow happens to fall below 119 between now and June expiration, the put portion should be exited as this trade would start to lose profit and could even turn into a loss if GLD plummeted.

2) On the upside, the smallest profit we would have at June expiration is $100.  But even in that worst case we still hold a “free” March 2015 130 call option.

The risk curves for this position after June expiration appears in Figure 5. In essence we made $234 on the put butterfly and were able to buy a free long-term call option.

Figure 5 – Risk curve for Long GLD 2015 130 call option (after June expiration) (Courtesy: www.OptionsAnalysis.com)

Summary

Is this option trading stuff fun or what?  A couple things to note.  First, figuring out which trade to put on initially is only one part of the equation.  Other considerations are:

*When to exit with a loss?

*When to exit with a profit?

*Can the trade be adjusted to increase potential and/or reduce or eliminate risk of loss?

The trade and adjustments covered in this series of articles serve merely as an example of “how to trade” options.  Another trader may well have come up with a different (and yes, possibly better) initial trade, and an entirely different series of adjustments (or no adjustments at all).

The key thing to take away is the potential to use options to create positions that offer opportunities not available to traders who focus only on individual stocks, indexes and ETFs.

Jay Kaeppel

With the Fed “pumpin’” and the economy “thumpin’” (as in “thumping along like a flat tire”) it seems unlikely that interest rates would rise.  Still, sometimes is makes sense to go against the grain if enough evidence presents itself.  So let me show you what I am looking at in the bond market.

EWJ vs. T-Bonds     

As I wrote about in a previous article (T-Bonds and Japanese Stocks, Inversely….), for whatever reason, t-bonds have long exhibited a strong inverse correlation to Japanese stocks (no, seriously).  In Figure 1 we see EWJ (the ETF that tracks Japanese stocks) with a 5 week and 30 week moving average drawn in the top clip.  In the bottom clip we see ticker TLT (the ETF that tracks the 30-year t-bond). You can see that – using highly technical terms that we quantitative analysts types like to use to impress others with how much we know about the markets – when EWJ “zigs”, TLT tends to “zag”, and vice versa.Figure 1 – EWJ with 5-30 week moving averages versus TLT (Courtesy: AIQ TradingExpert)

This past weekend the 5-week moving average for EWJ once again rose back above the 30-week moving average for EWJ.  If history is an accurate guide then this may be a negative sign for t-bonds.  Although I would be remiss if I did not invoke:

Jay’s Trading Maxim #216: History is not always an accurate guide (but it beats flipping a coin).

Figure 2 displays the raw dollar gain or loss from:

a) Holding a long position in t-bond futures (1 point movement = $1,000) when EWJ 5-week is below EWJ 30-week (red line)

b) Holding a long position in t-bond futures (1 point movement = $1,000) when EWJ 5-week is above EWJ 30-week (blue line)Figure 2 – $(-) from a long position in t-bonds futures when EWJ 5-week MA is BELOW EWJ 30-week MA (red line) and $(-) from a long position in t-bonds futures when EWJ 5-week MA is ABOVE EWJ 30-week MA (blue line) (12/31/1997 to present)

Obviously this indicator is not perfect, but equally obvious is the fact that bonds have typically performed better when the EWJ 5-week MA is below that EWJ 30-week MA. So let’s call this – if nothing else – a potentially negative sign.

TLT vs. Elliott Wave

I am not a true “ElliottHead” but I do tend to pay attention to the Elliott Wave count for a given market when the daily and weekly counts point in the same direction.  Figures 3 and 4 present the latest daily and weekly Elliott Wave counts for TLT as figured by ProfitSource by HUBB.

The daily count just completed a bullish Wave 5 (i.e., implying that the latest rally has run its course) and the weekly count is signaling a potentially Bearish Wave 4 sell signal.  For the record, I do not believe in the “magic” of Elliott Wave.  But I do like when daily and weekly signs for just about any indicator appear to confirm one another.Figure 3 – Daily Elliott Wave Count for TLT; Completed Wave 5 suggests rally is over (Courtesy: ProfitSource by HUBB)Figure 4 – Weekly Elliott Wave Count for TLT; signaling potentially Bearish Wave 5 signal (Courtesy: ProfitSource by HUBB)

Ways to Play

So if a trader buys the idea that t-bonds will decline in price in the months ahead, there are lots of way to play.  A trader could:

*Sell short 100 shares of ticker TLT.  This would require roughly $5850 of margin money and would technically entail unlimited risk. 

*Trader could buy 100 shares of ticker TBT, an inverse leveraged ETF that is designed to track t-bonds times minus 2 (In other words, if bonds decline -1%, then ticker TBT should rally roughly +2%).  This would require roughly $6,200.

*Buy a put option on ticker TLT.

*Buy a call option on ticker TBT.

There are pros and cons to each, but the trade that I want to highlight is buying a call on ticker TBT.

Call on TBT

If t-bonds do decline, then TBT would be expected to advance, hence the reason for considering a call option on TBT.  The reason I am looking at this trade is simply because it offers the most “bang for the buck.”  Not only are TBT shares leveraged 2 to 1, but by buying a call option we can obtain even more leverage with limited risk.  As you can see in Figure 5, TBT has support at roughly $56 and resistance at roughly $80. Figure 5 – TBT; support near $56, resistance near $80 (Courtesy: AIQ TradingExpert)

So let’s look at buying the September 62 call for $281 (NOTE: the bid/ask is fairly wide at $2.62/$2.81.  For illustrative purpose I am simply assuming a market order and a fill at $2.81.  An astute trade might consider a limit order that splits the difference).  Figure 6 displays the risk curves for buying the Sep TBT 62 call at $2.81. Figure 6 – Risk Curves for TBT Sep 62 call (Courtesy: www.OptionsAnalysis.com)

As you can see, in the worst case the maximum loss is $281.  In the best case – i.e., TBT rallies all the way back up to $80, the trade can generate a profit in excess of $1,500.  Also there are three months for “something” to happen. 

Summary

As always, I am not “recommending” this trade.  I am simply pointing out some potentially bearish evidence that I have found in regards to t-bonds and have highlighted “one way” to play such a situation using the limited risk associated with options.

So will t-bonds take a tumble and in turn, will TBT soar, thus generating an excellent rate of return?    As always, “It beats the heck out of me.”

But from a trader’s perspective, the real question is, “Am I willing to risk $281 to find out?”

Jay Kaeppel

OK, I will admit I am acting a bit schizophrenic of late.  Yesterday I write an article titled “One Sign That the Bull May Still Have Legs” and today I am writing an article that seemingly suggests that you sell tomorrow.  So what gives?

First off a friendly reminder that everything I write on this blog is for “educational purposes only” and I do not make formal “recommendations.” In other words, “I report (whatever I see – or to be technically correct, whatever I think I see), you decide.”  (This is slightly but importantly different from most of today’s main stream media whose motto more closely resembles “We decide, then we report.”)

So the Bullish Outside Month I detailed in my last piece remains a bullish factor. But today, let’s look at the other side of the coin by combining two indicators.

The Coppock Guide

Because I am hoping to avoid having too many readers suffer “My God This Sure Seems Complicated – Not to Mention Boring” syndrome, I am going to skip the description of the steps involved in calculating the Coppock Guide (may I suggest Google.com or better yet here).  Long story short, the Coppock Guide is a momentum indicator which in this case is updated once a month using the closing price each month for the Dow Jones Industrials Average.  Also in this case we are looking at the 2-month rate-of-change in the Coppock Guide Indicator value itself.  Interpretation works as follows:

*Current Coppock Guide value > Coppock Guide value two months ago = GOOD

*Current Coppock Guide value < Coppock Guide value two months ago = BAD

For the record, starting in August of 1900 (and assuming no interest while out of the market):

*$1,000 invested in the Dow only when conditions were GOOD is now worth $379,378.

*$1,000 invested in the Dow only when conditions were BAD is now worth $764

That’s +37,838% versus -23.6% (which is what we “quantitative analyst types” refer to as “statistically significant”).

For the record, the Coppock Guide 2-month rate-of-change is now negative, i.e., bearish.

The 40-Week Cycle

The 40-week cycle can be traced back to April 21, 1967 (no seriously).  Since that date, the first 140 calendar day period (20 weeks times 7 days a week) is deemed the “bullish phase” and the next 20 weeks is deemed the “bearish phase.”

One refinement I’ve added is a 12.5% stop-loss.  If the Dow drops 12.5% or more on a closing basis from its closing price at the start of a bullish phase, then the cycle is deemed bearish until the end of the current 40-week cycle.  Recent cycle phases appear in Figure 1.Figure 1 – The 40-week cycle (20 weeks bullish; 20 weeks bearish) Courtesy: ProfitSource by HUBB

For the record, starting on 4/21/1967 (and assuming no interest earned while out of the market):

*$1,000 invested in the Dow only when 40-week Cycle is bullish is now worth $28,896.

*$1,000 invested in the Dow only when 40-week Cycle is bearish is now worth $664.

That’s +2,790% versus -34% (again, “statistically significant”).

For the record, the 40-Week Cycle reverts to a bearish phase as of the close on 6/13/14.

One thing to note: As you can see in Figure 1 it is not like the Dow necessarily begins to decline the minute a new 40-week bearish phase  (marked by “-” signs in Figure 1) begins.  So let’s combine the Coppock Guide and the 40-week cycle.

Combining Coppock Guide and 40-Week Cycle

So let’s now take the obvious next step and combine these two indicators.  For our purpose, if either indicator is bullish we will call this a “combined bullish phase.”  On the other hand of BOTH indicators are bearish – which will be the case starting at the close on 6/13/14 – we will call this a “combined bearish phase.”

Figure 2 displays the growth of $1,000 invested in the Dow when either or both of the indicators are bullish, i.e., in a “combined bullish phase.”Figure  2 – $1,000 invested only during a “combined bullish phase” (blue line) grew to $30,221 versus $19,187 for buy-and-hold (red line); 1967-present

On the flip side, Figure 3 displays the growth of $1,000 invested in the Dow when both indicators are bearish, i.e., in a “combined bearish phase” (again, this will be the case as of the close on 6/13/14).Figure 3 – $1,000 invested only during a “bearish phase is now worth just $635; 1967-present

Summary

So will the Bullish Outside Month propel stock prices higher still?  Or does the combined bearish phase for the Coppock Guide and the 40-Week Cycle portend that a market decline is finally in the offing?

As usual I have to go with my stock answer of “It beats me.”  But my basic plan remains unchanged.  Unless and until the major market averages start to break down I continue to give the bullish case the benefit of the doubt.

After June 13^th I will however, be keeping an ever more vigilant “eye on the exits.”

Jay Kaeppel

For the record, I am now – and have for some time been – a “reluctant bull.”  I can look at a dozen different things – including the fact that they economy still shows no signs of the robustness that would typically justify the run that the stock market has enjoyed in recent years – and make an argument that the stock market is way overdue to run out of steam.

But the timeless, well-worn phrase, “The Trend is Your Friend” didn’t become a timeless, well-worn phrase for nothing. 

And so I continue to “ride the ride”.  But as I have mentioned more frequently of late, I am keeping a close eye on the exit.  Given my present “bad attitude” I tend to focus on and point out a lot more potentially bearish developments than bullish.  But what the heck, I might as well let the sun shine through on occasion.  So this time out, let’s highlight one development that suggests that “The End Is (Not Necessarily) Near!”

This is one of the things that has prompted me to “sit tight” and not listen to “those voices in my head” (No not those voices, the other ones…..), despite the fact that a meaningful correction could begin at any moment.

The Bullish Outside Month

Just as it takes a lot of “thrust” to get a rocket off of the ground, a large thrust upward in the stock market can be a sign that a particular rally is in the early stages rather than the late stages.  So here is a pattern to consider:

A) This month’s low is less than or equal to last month’s low

B) This month’s close is greater than last month’s high

That’s it.  In Figure 1 we see the S&P 500 monthly bar chart from 1996 to the present with these “Bullish Outside Months” highlighted in green.  The first one occurred in October 1998 and launched the final surge in great bull market of the 1990’s (or as most of us above a certain age refer to it – “The Good Old Days”). 

Figure 1 – Bullish Outside Months for SPX since 1996

The most recent signal occurred at the end of February of this year.  This was only the 19^th signal since 1970.  The action of the S&P 500 index following previous signals – looking out 3 months, 6 months and 12 months after each signal – appears in Figure 2.  Figure 2 – SPX Results 3, 6 and 12 months after Bullish Outside Months (1970-Present)

As you can see, on a 3-month, 6-month and 12-month basis, the S&P 500 has been higher at least 77% of the time following previous signals.  Which creates something on a conundrum.

Summary

In my mind’s eye the stock market is ridiculously overbought and “due” for a good solid “whack” sometime between now and the end of September.  But this particular indicator suggests that that “whack” may not come. So for now my own primary investment strategy remains to play the long side of the market unless and until the major averages (Dow, SPX, Nasdaq 100 and Russell 2000) drop below their respective 200-day moving averages.  Fairly boring yes, but it pays to mind:

Jay’s Trading Maxim #72: Boring and effective is much better than exciting and AAAAAHHHHHH!!

Jay Kaeppel

Watching Weekly Dow Momentum

The stock market – like the Energizer Bunny – just keeps chugging along, with the Dow, the S&P 500 and the Nasdaq 100 all touching new highs in the last week (the Russell 2000 small-cap index is another story, and may ultimately serve as the “canary in the coal mine”, but for now “majority rules”).  So for now, disciplined trend-followers (“Hi my name is Jay – although it is a little difficult to speak at the moment as my teeth remain tightly clenched”) have done well to avoid all of the “Sell in May” warnings from all of those so called experts (“Um, hi my name is Jay?”).   But there is one sign that I think investors should follow that has historically proven useful during the middle months of mid-term election years.  

I first wrote about this on 5/6/2014 in an article titled “A Warning Sign to Watch“.  For full details I suggest you read that article, but for now let me give you the gist.

-Between May and October of mid-term election years, a warning sign occurs when the MACD Oscillator (many traders refer to it as the MACD Histogram) drops into negative territory.Figure 1 – Weekly Dow Industrials with MACD Oscillator (watch for drop to negative territory)

For the record, the MACD Oscillator was below 0 during early May, but was in a rising trend along with the Dow itself.  The Oscillator returned to positive territory on 5/23 and remains there still.  So let me sum up my advice as succinctly as possible:

*KEEP AN EYE ON THE WEEKLY MACD OSCILLATOR FOR THE DOW JONES INDUSTRIALS AVERAGE.  If it drops into negative territory be prepared to take defensive action.

If you have even the most basic charting software, checking the status of the weekly Dow MACD Oscillator after the close each week will take up approximately 12 seconds of your time.  Per the 5/6/14 article, if history is any guide, the 12 seconds a week time investment may prove to be very useful.

Looking for a Reversal in T-Bonds

As I write, t-bonds are in the middle of a nasty short-term sell off.  But there is hope.  As I wrote about on 4/8/14 in an article titled “A Simple Signal for Bond Traders”, a short-term bullish setup may be forming at the moment.  In a nutshell:

*When the 25-day moving average for ticker EWJ is below the 150-day moving average for ticker EWJ (long story short, t-bonds tend to trade inveersely to Japanese stocks – go figure), then

*Wait for the 10-day CCI (Commodity Channel Index) for ticker TLT to drop below -100 and then turn up for one day.

Once that occurs a trader might consider buying the call option with at least 40 days left until expiration and the highest gamma among call options for that expiration.

In Figure 2 you can see that this setup is presently “locked and loaded” and will be triggered when the 10-day CCI for ticker TLT reverses back to the upside. Figure 2 – TLT forming a potentially bullish setup

Traders should always remember that there is never any guarantee that the next signal will generate a profit, and should always have some sort of stop-loss or risk limiting planin place at the time that any new trade is entered.

Jay Kaeppel