It is Monday morning and the stock market is higher and that’s fine with me.  I like higher stock prices.  In fact, given the recent oversold readings from some indicators there is a chance that we have seen the “bottom” and that the next leg of the bull market is now underway.

However, as I wrote about in this article, I am “concerned” that another down leg – and a potential test of recent lows – may be in the offing for the stock market.  While I claim no ability whatsoever to “predict” the future, I do like to try to be prepared.

Keep a close eye on this current advance.  If it fails – for reasons I will detail in a moment – there is (at least in the opinion of one straining as always to remain objective writer) a chance that things could get ugly fairly quickly.  So my best advice (such as it is) at the moment is:

Pay close attention and be prepared to act

So here is what I see and one way to hedge against just such an event (some of this is updated from this article).

The Current Market Setup

Old Concern #1 – The major market averages are below their respective 200-day moving averages.Figure 1 – Major market averages all below respective 200-day moving averages (i.e., the trend is “down”

Updated Concern #2 – SPX appeared to break out to the upside from a small triangle and that breakout out may have failed.Figure 2 – A failed upside breakout often (though not always) portends trouble

Old Concern #3 – From the end of September Trading Day #13 (9/18/15) through the end of the month, the Dow has lost ground 40 times in the last 60 years with a net loss of -45%.

Figure 3 – Growth of $1,000 invested in Dow ONLY after September Trading Day #13 through the end of September (1955-Present)

New Concern #4 – Weekly Elliott Wave counts for SPY and QQQ have completed 5 waves up.Figure 4 (click to enlarge) – SPY and QQQ Weekly Elliott Wave (completed 5 waves up)

New Concern #5 – Daily Elliott Wave counts for SPY and QQQ are signaling the potential for a very sharp decline in the near term.Figure 5 (click to enlarge) – SPY and QQQ Daily Elliott Wave (projecting sharply lower)

My ability to “predict” the future is essentially non-existent.  However (and fortunately) I can recognize “potential danger” when I see it.  Given the litany above and especially with the major averages all trading below their 200-day moving averages, it is critical to respect the trend and to prepare for a possible retest of recent lows.

That being said, it is also not necessary to “bet the ranch” on the downside.  Investors and traders can use options to “risk a little” to “hedge a lot”.

In my next piece I will highlight an example of one way to “risk a little” to “hedge alot”.

Jay Kaeppel

Today’s article is an update on this oldie but goodie.

When people ask me if momentum investing “works”, at this point – because I am older and (even) crankier than I used to be – I typically refer them to the linked article above and grunt “decide for yourself.”  Sorry, it’s just my nature.

(See also: The Signpost Up Ahead: The September Danger Zone)

So today is an update picking up from the end of 2013.  Repeating from the original article:

In 2001, I published an article in “Technical Analysis of Stocks and Commodities” magazine titled “Trade Sector Funds with Pure Momentum”, which detailed one specific and simple trading method.  While in fact this is only one of many sector trading systems that I have developed over the years – and not necessarily the best one – it remains one of my favorites.  Probably because it is just so gosh darn simple.  When I was young my Momma told me to be a simple kind of man.  Or was it a Freebird she told me to be?  Well, in any event, here are the “simple kind of rules” using Fidelity Select Sector funds:

-After the close of the last trading day of the month identify the five Fidelity Select Sector funds that have the largest gain over the previous 240 trading days.

-For this system, ignore Select Gold (ticker FSAGX).  If FSAGX appears in the top 5 funds then skip it and include the 6th highest rated funds.

-If fewer than five funds showed a gain over the previous 240 trading days, then hold cash in that portion of the portfolio (i.e., if only 3 funds showed a gain, then 60% of the portfolio would be in those funds and 40% of the portfolio would be in cash).

UPDATE FROM ORIGINAL ARTICLE: I have heard from many individuals who cannot easily get access the 240-day change in price action but can easily get access to a simple 12-month change in price action. It is perfectly acceptable to use 12-month instead of 240-trading days.  There will inevitably be some differences but it should not have a meaningful impact on long-term results. So take your pick.

-If you sell more than one fund at the end of a month, then rebalance the proceeds in the new funds being purchased (example, you are selling Funds A and B and buying Funds C and D.  You have $12,000 in Fund A and $10,000 in Fund B.  Split the difference and put $11,000 each into funds C and D).

UPDATE FROM ORIGINAL ARTICLE: I had one individual claim that rebalancing the portfolio every month generated superior results.  This may be true, however, I was unable to replicate the numbers he sent me so under the category of “old dog, new tricks” I have simply stuck the original rebalancing method just described above.  You on the other hand are free to experiment with more frequent portfolio rebalancing.

And that’s all there is to it.

Year 2013

The original article was published on January 6, 2014 and the return for 2013 was reported as +48.0%.  After correcting a few mutual fund data points, it turned out that the actual result was +49.5%.

Years 2014 and 2015 to-date

During Calendar Year 2014 the Pure Momentum System gained +18.1%.  Through 9/17/15 the Calendar Year return for 2015 is +6.9%.  This compares nicely to +11.4% and -3.3% for 2014 and 2015 for the S&P 500 Index.

The Current Portfolio

Figure 1 – the current Pure Momentum Portfolio

The Important Caveats

The outsized gains registered in 2014 and the fact that the system is “Up” in 2015 while the market is “Down” will certainly curry favor in support of this as a viable investment approach.  Nevertheless, it is important for me to point out – and for you Dear Reader – to acknowledge the bad that comes with the good.

So note that:

*In 2008 this system suffered a roughly 45% drawdown so it by no means an “all weather” method that can “easily ride out bear markets.”

*In 2011 this system lost a whopping -17.5% while the S&P 500 gained +0.3%.  That’s just serious underperformance.

The Overall Picture

Still, if you are able to view and execute this strategy as a long-term approach, since at least 1990 the “good” has overall far outweighed the “bad”.  As you can see in Figure 2:

*$10,000 invested in Jay’s Pure Momentum System has grown +6,436%

*$10,000 invested in Jay’s Pure Momentum System has grown +470%

The disparity in long-term returns from this mechanical system versus simple buy-and-hold is what we “quantitative analyst types” refer to as “statistically significant.”

Figure 2 – Year-by-Year “Jay’s Pure Momentum” versus SPX Buy-and-Hold

Disclaimers:  Past results in no guarantee future results.  All figures presented in this article are generated using data from sources that are assumed to be accurate.

Jay Kaeppel

Investors may soon take a “Ride into the Danger Zone” as the middle of September passes into late September.   There are several reasons to be wary.  In terms of overall Dow performance the month of September ranks #12 (out of 12).  Also – and as we will see in a moment – performance often gets worse as the month wears on.  While there is no guarantee that things will end badly this time round, it does make sense to recognize the potential danger and to prepare accordingly.

More specifically, present concerns include:

1) The S&P 500 is below its 200-day moving average

As you can see in Figure 1, there is no reason to panic as sometimes a price break below the 200-day average is just temporary.  But the fact remains that major bear markets play out with price below the 200-day moving average.  So for the moment, the trend is “down” and investors (and traders) should respect the trend.

Figure 1 – SPX below 200-day moving average (Courtesy: AIQ TradingExpert)

2. Triangle pattern forming

As you can see in Figure 2, price action for SPX is forming an ever tighter triangle formation.  Investors and traders should pay close attention to see if price breaks to the downside.  If it does breaks out to the downside between now and the end of September, extreme caution is then in order as a sharp decline could unfold quickly.

Figure 2 – SPX Triangle – Which way the breakout? (Courtesy: ProfitSource by HUBB)

Historical Dow Performance after September Trading Day #13

Between the end of September Trading Day #13 and the end of the month, the performance of the Dow has been very poor over the past 60 years.  To wit, see Figure 3 which displays the growth (?) of $1,000 invested in the Dow Jones Industrials Average only between the close of September Trading Day #13 and the end of September, every year since 1955:

Figure 3 – Growth of $1,000 invested in Dow ONLY after September Trading Day #13 through the end of September (1955-Present)

For the record:

*$1,000 invested in the Dow only between the end of September Trading Day #13 and the end of the month declined to $553 (a loss of -44.7%)

*# Times UP = 20 (33.3% of the time)

*# Times DOWN = 40 (66.7%)

Average UP period = +1.23%

Average DOWN period = (-2.05%)

# Times UP period gain exceeded +2% = 3

# Times DOWN period loss exceeded -2% = 16

# Times UP period gain exceeded +3% = 1

# Times DOWN period loss exceeded -3% = 10

Summary

The good news is that there is no guarantee that the stock market will fall between now and the end of September.  The bad news is that it does have a pretty ugly history of doing just that.  For the record, the 13^th trading day of September 2015 is 9/18/2015.

With the price trend currently “down” and a history of “falling hard” during this time period, a break out to the downside from the current triangle forming in SPX should not be ignored as a warning sign of a “clear and present danger”.

While I am hopeful that the market will break to the upside, and that none of these concerns will matter, the truth for now is that – in the immortal words of Dorothy Gale – “I’m frightened Auntie Em, I’m frightened.”

Jay Kaeppel

Well if you follow the markets at all then you certainly don’t need me to tell you that the energy sector has been pummeled over the past 14+ months.

(See also Life Beyond Buy and Hold)

As you can see in Figure 1 (unless you are the squeamish sort, in which case may I suggest you simply avert your eyes and pick up reading after Figure 1…Oh, and definitely do NOT look at Figure 2), ticker XLE – an ETF that tracks stocks in the energy sector – has lost over 37% of its value since the high in June 2014.Figure 1 – Energy sector stocks (ticker XLE) have taken a beating (Courtesy: AIQ TradingExpert)

There is a great deal of speculation regarding the outlook for energy stocks – both in the near-term and going forward.  If you scan the internet you can find compelling arguments of why energy stocks are now a bargain – and equally compelling arguments that much worse is still to come.

I don’t have any “predictions” to offer. I mostly just stick to trying to identify the trend “right now” (which by the way works pretty well) and look for clues from the past as to what the future “may” hold.  While the energy sector has bounced off of a low in recent weeks there can be little argument that on a trend-following basis, the sector is still in a downtrend.

In addition to this, consider the following seasonal trend for energy stocks.

A Bearish Seasonal Trend for Energy Stocks

Energy stocks have demonstrated a tendency to perform poorly between:

*The end of September Trading Day #10 (in this case, September 15, 2015)

*The end of November Trading Day #14 (November 19, 2015).

How poorly, you ask?  To measure historical results we will use Fidelity Select Energy Services (ticker FSESX) which started trading in December 1985.  The growth of $1,000 invested in FSESX only between September Trading Day 10 and November Trading Day #14 every year starting in 1986 is displayed in Figure 2.Figure 2 – Growth of $1,000 invested in FSESX only from Sep Trading Day 10* through November Trading Day 14* (1986 to present)  (*As of close on designated trading day of the month)

For the record:

*$1,000 declined to $120, or a net return of -88%

*$1,000 invested in FSESX on a buy and hold basis grew to $7,994, a gain of +699%

*$1,000 invested in FSESX during all days EXCEPT this unfavorable period grew to $66,595, a gain of +6,560%

Figure 3 displays the annual gain or loss achieved by FSESX during the unfavorable September TD 10 through November TD 14 period each year since 1986.

Figure 3 – Energy “Unfavorable” period year-by-year

For the record:

*This period showed a gain 9 times (31% of the time)

*The average gain during these 9 years was +7.6%

*This period showed a loss 20 times (69% of the time)

*The average loss during these 20 years was -11.2%

Summary

So are energy prices certain to plunge between now and mid-November?  Certainly not. As badly beaten down as energy stocks are a new bull market could begin at any moment.

However:

*The trend at the momeht is inarguably “down”, and

*The seasonal tendency for the next two months has not historically been favorable.

We all make choice as investors and traders and we have to live with those choices.  At this point I am OK with waiting a little while longer before looking to play the long side of the energy sector.  If a big rally unfolds in the meantime, so be it.

The current trend of energy stocks and the historical performance of energy stocks during late fall suggest that a little bit of patience may be in order.

Jay Kaeppel

To sum up the current state of affairs in the bond market (at least as near as we can tell):

*“Everyone knows” that the Fed is “certain” to raise interest rates and soon.

*As a result, “everyone knows” that bond prices will be headed lower soon – as a rise in interest rates implies a decline in the prices for existing bonds (In fact, I wrote about one example way to play this very scenario here using options on TBT).

It is very difficult to find anyone who will argue vehemently against this scenario.  Which leads us to this:

*The current weekly and daily Elliott Wave counts for intermediate-term treasury bonds are actually suggesting higher bond price in the months ahead (shown in Figure 1 below).

OK, talk about a “contrarian” point of view.  A couple of key notes here:

*I am not necessarily agreeing with this outlook, I am only presenting it as a potential “contrarian” speculative play.

*Yes, Elliott Wave counts can be kind of a nebulous thing – i.e., one day everything is lining up bullish (or bearish) and the next day everything changes.

*Nevertheless I am relying here on ProfitSource by HUBB software which has an objective, built in mechanical method for calculating he wave counts and NOT on my own arbitrary interpretation of chart movements (which would be a really bad idea).

*Also, as I have touched on in the past, the only time I really pay attention to Elliott Wave is when the daily AND weekly counts are in agreement (which of course guarantees nothing, but has proven useful in identifying some potentially good speculative ideas in the past).

The “idea” I am about to detail I categorize as “rogue contrarian speculation” – and should be treated as such – i.e., there is the potential to look like a complete fool and end up asking yourself “what the heck as I thinking about.”

People who do not routinely speculate should not start with this one and people who do speculate should remember that only a small amount of capital (1% to 5% of trading capital) should be committed to any single speculative position.

Ticker IEF

Ticker IEF is an ETF that tracks the price of intermediate-term (7-10 years) treasury bonds.  If intermediate-term interest rates rise this ETF will decline in price.

*Since “everyone knows” that the Fed is “certain” to raise short-term rates (which FYI is the only thing they control), it would…

*Seem fairly certain that as part of a ripple effect, intermediate term rates would also rise and..

*As a result intermediate term treasury bonds will decline in price.

And I am not prescient enough to say otherwise.  Still, as you can see in Figure 1, both the weekly and daily Elliott Wave count are pointing higher. (click to enlarge)

Figure 1 – IEF Weekly and Daily Elliott Wave counts both pointing higher (Courtesy: ProfitSource by HUBB)

Given that “everyone knows” that rates are headed higher and bond prices are headed lower this is clearly a contrarian point of view.

Trading IEF

To consider entering a bullish option position in IEF is clearly a contrarian play.  To buy 100 shares of IEF at $106.97 would cost $10,697. This seems like a lot of money to commit to a “rogue” idea.  On the other hand the one problem with options on IEF is that the further out months are often thinly traded and tend to have wide bid/ask spreads.

So the prudent thing to do given all of this might simply be to walk away.  But the “rogue contrarian speculator” is not afraid to “risk a few bucks” on an idea that others shun.  So here is one “example” way to play.

One Rogue Contrarian Speculation Play in IEF

As always, I need to state that this is not a “recommendation”, only an “example”.  But for arguments sake, there are some “requirements” involved:

*First off you have to be willing to “fly in the face of conventional wisdom” (which is another way of saying “you could end up looking like a complete idiot for ignoring what everyone else already knows”, and you have to be mentally strong enough to shake it off without a second thought, rather than sitting around kicking yourself wondering “how could I be so stupid”).

*Also, you will want to consider using “limit orders” for entering this trade (which can result in you not getting filled at all).  Still given the width IEF option bid/ask spreads it is important to take steps to improve your odds as much as possible.

So one example way to play appears in Figures 2 and 3.  The gist of this trade is to buy 3 January 107 call options and to sell 2 December 108 call options to pay for part of the January option position.  Specifically:

*Buying 3 January 107 calls

*Selling 2 December 108 calls

To enter this trade with a market order you would pay $1.35 to buy the Jan. 107 and you would receive $0.60 to sell the December 108, or a spread of $0.75.  Rather than settle for paying a wide bid/ask spread, we will assume that a limit order of $0.55 (buying at $1.25 and selling $0.70) is entered (and for examples sake) is filled at that price.  Aggressive traders might consider an even smaller limit.  Assuming a trader bought a 3×2 position at this price the position would cost $235 – which is 98% less than the $10,697 needed to buy 100 shares of IEF.  $235 also represents the maximum risk for this trade as depicted in Figures 2 and 3.

Figure 2 – IEF calendar bull call spread (Courtesy www.OptionsAnalysis.com)

Figure 3 – IEF calendar bull call spread (Courtesy www.OptionsAnalysis.com)

One of several things will happen from here:

*If IEF drops back to the recent low near 103.50 this trade will lose $190 to $235, depending on how soon that price is hit.

*On the upside, if the lower Elliott Wave target of $109.51 on the daily chart is hit the trade will show a profit of $160 to $210, depending on how soon that price is hit.

*If the lower Elliott Wave target of $112.39 on the weekly chart is hit the trade will show a profit of $430 to $470, depending on how soon that price is hit.

Summary

So if this a good idea?  Well, according to conventional wisdom “everyone knows” that betting on lower interest rates at this point in time is “obviously” a terrible idea.  And again, for the record I am not offering this as a “recommendation”, but only as an example of a “rogue contrarian speculation” – how to risk a relatively small amount of capital to “bet against the crowd” (note that while “compliance types” cringe at the use of the word “bet”, in this case I believe it is the proper word choice – hey, if you aren’t willing to speculate the don’t speculate).

In other words, for a person who is willing to spit in the eye of conventional wisdom, there are usually ways available using options to “risk a couple of bucks” in return for the “potential” to make a pretty decent return if what “everyone knows” doesn’t pan out as everyone just knew it would this time around (which is pretty often when i comes to the the financial markets).

NOTE: It should be noted that the example trade detailed here and the one using TBT in the earlier link will NOT both make money at the same time.  The IEF trade is bullish on intermediate-term treasury bonds and the TBT trade is bearish on long-term bonds. Theoretically, both trades could end up profitable at different times, but just be aware that if TBT calls are making money then IEF call options will be losing money and vice versa.

The bottom line:

Given the current state of affairs it seems highly implausible to expect intermediate-term bonds to rally strongly in the months ahead.  But that’s not the real question that a rogue speculator would ask.  The question he or she would ask is:

“Am I willing to risk $235 that they might?”

Jay Kaeppel

The good news is that if you do this long enough you will eventually get something right once in awhile.  To wit, today just a quick follow-up on a couple of things I noted a short while back.

The Fall of Biotech

In this article I highlighted the concern that if the 1999-2000 advance in biotech stocks was a “blow off top”, well then what the heck just went on in biotech in recent years?  See Figure 1.Figure 1- Biotech Blow offs (Courtesy: AIQ TradingExpert)

Well the day after I published that piece ticker IBB topped out and subsequently plunged -28% before bouncing sharply.  See Figure 2.Figure 2 – IBB plunges then bounces (Courtesy: AIQ TradingExpert)

Now if I were smart I would gloat about how I “called the top with uncanny accuracy” – and I must admit there is a part of me that really wants to (sorry, it’s just my nature).  But the real lesson here is that certain “things” do repeat in the financial markets (for example, why are we all familiar with the “head-and-shoulders” chart formation?  Simple, because it happens repeatedly among all of the various financial markets).  So it does pay to learn from the past and to look for familiar events unfolding in real-time.

So where to from here for biotech?  I have no meaningful prediction other than to expect some very wide price swings for a while.  Figure 3 displays the weekly IBB Elliott Wave count in the top clip and the daily IBB Elliott Wave count in the bottom clip.  The daily is suggesting sharply lower price in the near term and the weekly is suggesting sharply higher prices. Figure 3 – Weekly and Daily Elliott Wave counts for IBB conflict (Courtesy: ProfitSource by HUBB)

So your choices are:

1) Take your pick and strap yourself in, or;

2) Stand aside for now.

One other possibility is tobuy an options straddle – i.e., buy a call and a put.  However, given the high price and large bid/ask spreads for options on IBB I can’t really suggest that as a good idea.  Not saying it can’t make money but the reward/risk outlook  is not wildly favorable.

The Fall of the Pound

In this article I highlighted the fact that the Elliott Wave counts for the British Pound (using ETF ticker FXB) generated by ProfitSource by HUBB were pointing to lower prices.  Um, so far so “bad” (“Bad” in this case is roughly defined as “good”).  As you can see in Figure 4, since topping out on 8/24 (head-and-shoulders top anyone?) FXB has declined 8 trading days in a row.  Figure 4 – FXB breaks hard to the downside (Courtesy: AIQ TradingExpert)

The option trade example I highlighted in the original article is showing a profit of 51% as I write as shown in Figure 5.Figure 5 – FXB option trade showing a profit (Courtesy www.OptionsAnalysis.com)

The real question is “what to do from here”?  Since this is a hypothetical example of a trade I will list the choices and you can decide for yourself what you believe is the best course of action.  First, two important points:

FXB options are thinly traded and typically entail very wide bid/ask spreads.  The good news is that – as this trade illustrates – it is possible to make money trading such options.  The bad news is that it reduces one’s flexibility in terms of “adjusting a position”.  In other words, where a trader might consider turning the original trade into some sort of spread and locking in a profit while letting the remaining position run, when bid/ask spreads are this wide it is usually not worthwhile.

The Weekly Elliott Wave count is still pointing to the potential for much lower prices-and much greater put option profits – as shown in Figure 6.

Figure 6 – Ticker FXB; Weekly Elliott Wave count still pointing much lower (Courtesy: ProfitSource by HUBB)

The basic choices appear in Figure 7

Figure 7 – Possible outcomes for FXB put position (Courtesy www.OptionsAnalysis.com)

If FXB does manage to fall all the way to the upper Elliott Wave channel line ($139.77), this trade may show a profit in excess of $8,000.  Of course, if FXB bounce from here, the open profit could be lost and a trader still faces a maximum loss of -$2,640.

So the a few basic choices are:

1) Sell all and take a 51% profit

2) Hold all in hopes of a really large profit

3) Sell some and let the rest ride.

There is no right or wrong answer.  The key in this exercise is to consider what your own priority would be in this situation:

1) Registers a decent profit but foregoes the potential for “the big score”

2) May result in exceptional profits, but current profit may get away and trade could still turn into a loss.

3) Reduces risk but also reduces profit potential

If you want to be a better option trader, give each of these possibilities some consideration and answer the question for yourself.

Jay Kaeppel

If you have been in the markets for any length of time, then you have seen this movie before:

(See also How NOT to Lose -97.5% in Semiconductors (Part II))

*The market is moving along swimmingly.  A few brave souls shout “The End is Near” as the Dow catapults a couple thousand points higher and then starts to level off.

*Suddenly [the financial press agrees on] one or more “causes” (circa 2015, think “China”), um, “cause” the market to plummet.

*We see the obligatory BOLD HEADLINES reading “Dow Down [-xxx] Points” accompanied by the also obligatory pictures of “worried traders” (who are these guys anymore anyway, hired actors?  I thought everyone traded electronically now? Seems like they should show a picture of a guy sitting at his computer with his mouth wide open, palm to forehead, with that WTF look on his face) standing and staring up at some distant screen, dumbfounded.

*Soon comes the (I am thinking about trademarking this phrase)“Obligatory Technical Bounce”, accompanied by  the equally obligatory “Dow [+xxx] Points – Is the Worst Over?” headline.

*Shortly thereafter we see the resounding answer – “No, the worst is not over”!

*And over a period of months the stock market becomes an endless roller-coaster, alternating with extreme volatility between “swooning and soaring”.

*Each “soar” is accompanied by more “Is The Worst is Over?” headlines and a lot of “Brace for more trouble” articles.

*Each “swoon” is accompanied by more “Dow Down [-point value here]” headlines and more “forlorn trader” photos.

And so it goes and so it goes.  To wit:Figure 1 – 2002 (Courtesy: AIQ TradingExpert)

Figure 2 – 2006 (Courtesy: AIQ TradingExpert)

Figure 3 – 2007 (Courtesy: AIQ TradingExpert)

Figure 4 – 2008 (Courtesy: AIQ TradingExpert)

Figure 5 – 2010 (Courtesy: AIQ TradingExpert)

Figure 6 – 2011 (Courtesy: AIQ TradingExpert)

As you can see in Figure 7, the 2015 decline is “off to a good start” (“off to a good start” being  defined as “big drop” followed by “soar” followed by “swoon”).

Figure 7 – 2015 (Courtesy: AIQ TradingExpert)

Summary

Expect big prices swings by the major stock market averages.  Also expect to have the financial press raise your hopes that “The Worst is Over” each time the averages “soar” and to attempt to scare the crud out of you each time the averages “swoon.”

In the meantime:

*If you are an excellent short-term trader then there is the opportunity to make a lot of money.

*If you are a poor short-term trader then there is the opportunity to lose shocking sums of money in an incredibly short period of time (so assess your skills carefully before attempting to ride each “swoon” and/or “soar”).

*If you are a more traditional investor then the reality is that you should continue to follow your investment plan (you do have one, right?  Right?) and not “react” every time you see a picture of a dumbfounded trader juxtaposed to be staring at the latest “Dow Down [xxxx] Points” headline.  Remember:

Jay’s Trading Maxim #29: If you had a trading plan that you were following yesterday, you should continue following it today.

Jay Kaeppel

In Part 1, I highlighted the fact that semiconductor stocks (using ticker FSELX as a proxy) have displayed three distinct periods within each month that have significantly underperformed all other days by, ahem, a “significant” margin (in this instance, “significant” is defined as -83.5% for the “Bad Days” versus +17,805% for the “Good Days’).

I also dropped the slightly depressing news that you can’t actually use this strategy with ticker FSELX due to Fidelity’s switching restrictions.  There are two primary alternatives – the ETF ticker SMH or Profunds ticker SMPIX.  For our purposes we will use SMPIX for several reasons:

*A slightly higher correlation to FSELX

*No commissions or slippage

*The ability to invest a specific dollar amount (rather than having to buy a specific number of shares).

*SMPIX uses leverage of 1.5-to-1 so offers more “bang for the buck” (albeit with a commensurately higher degree of risk)

Trading with SMPIX

SMPIX started trading on April 30^th, 2001. So let’s run the same test using SMPIX that we did in the last article with FSELX.  Specifically:

*During TDMs 5, 6, 7, 13, 14, -7, -6 and -5 our system will be in cash.

*During all other day the system will hold SMPIX

The results appear in Figure 1.

Figure 1 – Growth of $1,000 in SMPIX: TDM 5, 6, 7, 13, 14, -7, -6 and -5 (top clip) versus all other days (bottom clip); 5/1/2001-8/26/15

*$1,000 invested only on TDM 5, 6, 7, 13, 14, -7, -6 and -5 declined to $25 (-97.5%)

*$1,000 invested during all other days grew to $16,812 (+1,581%)

Now the Caveats

There are certainly a few caveats to ponder in all of this:

*These results certainly appear to fall into the “too good to be true” category (but they are mathematically correct)

*The real question is “what is the likelihood that future results will resemble past performance?”  Unfortunately, there simply is no way to predict this.  So a large “leap of faith” is required.

*Trading three times every single month can be a little “grinding” for those who are not used to shorter-term trading, especially since…..

*….There can be no second-guessing (“Hmmm, things look pretty good, maybe I won’t bother selling this time around”)

*Also, while this “system” has sidestepped a lot of pain, no one should assume that the “Good Days” are guaranteed to be a blissfully painless way to generate profits beyond the Dreams of Avarice.

To illustrate this last caveat take a close look at Figure 2.  This is the same chart that appeared in the bottom clip in Figure 1, only with a few not inconsequential drawdowns highlighted.Figure 2 – “Good Days” aren’t always so good

As you can see, even the “Good Days” took some huge hits along the way.

Summary

So is trading in and out of SMPIX three times a month a viable strategy?  For the record, I am not recommending this as a strategy; I am simply reporting the results I’ve found.  I leave you to decide for yourself what – if anything – to do with it.

Remember that the title was not “How to Make Easy Money with No Risk in Semiconductors”, but “How NOT to lose 97.5% in Semiconductors.”

As it turns out, there is a difference.

Jay Kaeppel

Alright, I will admit that this one is a little “out there”, even by my highly flexible standards.  As you may know I follow a lot of seasonal patterns and trends among various financial markets, indexes, commodities and even some individual stocks.

(See also Life Beyond Buy and Hold)

The good news regarding seasonal trends is that some of them have shown to be surprisingly (and amazingly) consistent.  The bad news regarding seasonal trends is twofold:

1) There is never any guarantee that a given trend will work “this time around” (or even “ever again” for that matter).

2) Hence, a certain “leap of faith” is required in order to put real money at risk based solely on the date on the calendar

Trading Days of the Month

The stock market as a whole has showed a propensity to be more bullish during the first/last few days of the month (and also roughly mid-month) than during other days of the month.  And although this idea was first popularized by Norman Fosback in his market classic “Market Logic” way back in 1975, this trend has persisted.

The same is true for many other stock market related securities.  The one caveat to considering trading days of the month (TDM) is that one should put more faith in “clumps” of days that tend to rise (or fall) consistently than in random individual days.  That being said, let’s turn our attention to semiconductor stocks. We will use Fidelity Select Electronics (FSELX) as our proxy for the sector and start our test on 10/3/1988.

For comparison sake, from 9/30/1988 through 8/24/15 $1,000 invested in FSELX grew to $29,518 (or +2,851.8%).

Trading Days 5, 6 and 7

The top clip in Figure 1 displays the growth of $1,000 invested in FSELX only during trading days #5, 6 and 7 every month since 1988.  The bottom clip shows the results from investing in FSELX during all other days.Figure 1 – FSELX TDM 5, 6 and 7 (top clip) versus all other days (bottom clip); 10/3/88-8/24/15

*$1,000 invested only on TDM 5, 6 and 7 declined to $607 (-39.7%)

*$1,000 invested during all other days grew to $48,640 (+4,764)

Trading Days 13 and 14

The top clip in Figure 2 displays the growth of $1,000 invested in FSELX only during trading days #13 and 14 every month since 1988.  The bottom clip shows the results from investing in FSELX during all other days.Figure 2 – FSELX TDM 13 and 14 (top clip) versus all other days (bottom clip); 10/3/88-8/24/15

*$1,000 invested only on TDM 13 and 14 declined to $343 (-65.7%)

*$1,000 invested during all other days grew to $86,128 (+8,513)

Trading Days -7, -6 and -5

This requires a little explanation.  For this sequence we start counting on the last trading day of the month which is TDM -1.  So technically we are looking at the 6^th, 5^th and 4^th from last trading day of the month.  Also note that there can be overlap between TDM 13 or 14 and TDM -7, -6 and -5.  But for now we are looking at each period separately.

Figure 3 – FSELX TDM -7, -6 and -5 (top clip) versus all other days (bottom clip); 10/3/88-8/24/15

*$1,000 invested only on TDM -7, -6 and -5 declined to $314 (-68.6%)

*$1,000 invested during all other days grew to $97,743 (+9,674.3%)

Putting It All Together

Now at this point many serious students of the markets will shout “Curve Fitting.”  And there is something to that.  As a proud graduate of “The School of Whatever Works” I personally am rarely distracting by those charges.  But I certainly respect each trader’s right to look skeptically at the results presented here.  Still, the numbers are what they are.  And just to make it interesting, let’s now put all three of the monthly periods together.

The following test assumes a lot of trading as follows:

*During TDMs 5, 6, 7, 13, 14, -7, -6 and -5 our system will be in cash.

*During all other day the system will hold FSELX

The results appear in Figure 4.

Figure 4 – FSELX TDM 5, 6, 7, 13, 14, -7, -6 and -5 (top clop) versus all other days (bottom clip); 10/3/88-8/24/15

$1,000 invested only on TDM 5, 6, 7, 13, 14, -7, -6 and -5 declined to $165 (-83.5%)

$1,000 invested during all other days grew to $179,058 (+17,805.8)

Figure 5 displays the results of the “System” versus buying and holding ticker FSELX.

Figure 5 – FSELX avoiding TDM 5, 6, 7, 13, 14, -7, -6, -5 (blue) versus buy-and-hold (red); 10/3/88-8/24/15

Summary

So is this just another crackpot curve-fit idea, or is there something to this?  I leave you to decide for yourself. One important thing to note for anyone who is intrigued – you cannot actually use this “system” with ticker FSELX.  If you were to try, after a very short time you would receive a very terse communication from the fine folks at Fidelity informing you, a) that they have very specific switching restrictions, b) that you are in violation of said restrictions and, c) that if you attempt to persist they may be required to send a few burly customer reps to your home and wrestle you to the ground before you can hit “Enter” to place your next trade.  Or something to that effect.

Also, what about that -97.5% figure in the title?

Check back for Part II.

Disclaimer: OK, I made up part c) above.  And I am a Fidelity investor.

Jay Kaeppel

On occasions in the past I have mentioned the idea of using Daily and Weekly Elliott Wave counts that are in sync as a tool to identify trading opportunities.

(See also JayOnTheMarkets.com: Life Beyond Buy and Hold)

Most recently, silver (using the ETF ticker SLV) came up as a bearish candidate back in ??. Following a plunge and then a rally, SLV has resumed its downtrend, breaking down to  new lows in the process.

Figure 1 displays the daily and weekly Elliott Wave counts.  A trader paying attention to these two counts acting in concert might have considered using the recent rally in SLV as an opportunity to sell short or to establish a bearish options position using options on SLV.

Figure 1 – Daily and Weekly Elliott Wave counts for SLV remain bearish (Courtesy: ProfitSource by HUBB)

Summary

The purpose of this article is not necessarily to trigger you to take some sort of action in SLV.  It may be getting a little late to start getting bearish on SLV (although a break to new lows is obviously not bullish).  The point of this is not to tell you what to do or not to do in silver.

The point is simply to highlight the potential usefulness of dueling bullish (or bearish) Elliott Wave counts in identifying trading opportunities.  As far as SLV is concerned, its “Mission Accomplished”.

Jay Kaeppel