Bear Trap

Below is the daily chart of Apple (AAPL) with price in the upper pane and # of shares traded in the lower.

You can see after testing the $105 level 3 times back in December and January, it used that last test as a springboard to propel higher as it climbed ~25% in a month, topping in late February. Since then it has been in a choppy, sideways consolidation zone bouncing between its top and bottom (red) rail.

If you look closely at the blue circled area you can see price closed below the support rail on a 50% increase above the average daily volume. Areas of consolidation are stalking grounds for technicians, momentum traders and institutional investors as they are patiently watching for a break out of consolidation, signaling the possibility that a new trend has started. As such when you see a breakout (up or down), volume usually spikes as the quickest jump on the direction of the newly established trend.  The earlier you get on the more money you make.  That is, of course, it wasn’t a head fake.

You see, the market makers (MM’s) in a stock are playing a chess game against all investors.  They are in the business to make money and have survived by knowing crowd behavior and capitalizing on it. Knowing the levels of support are closely watched, especially on a company as well-known as Apple, they have been known to create traps for investors/traders. Let’s use the AAPL example at hand to illustrate a bear trap in action. As price approached the bottom rail the MM’s pushed the market down by selling enough shares out of their massive AAPL holding to have it break below that very important support level (~$122). Those watching the support levels noticed the breakdown and exited their long positions.  Additionally some jumped on the other side of the trade in an attempt to catch what they believed was the start of a new trend (down) and piled on short.  Since this is normal behavior what do those wily (rich) market makers do? Yup, they reverse it higher the next day above the support line trapping all those who went short the day before. Those that were not in the trade noticed the reversal and jumped on board the long side adding buyers and pushing prices higher. Additionally those that did short were forced to buy back shares to close out their short positions adding a whole lot more fuel to the rally. In the meantime the MM’s sold a few of his massive pile of shares to propel prices higher, in this case it has risen almost $12 in 7 days. 

The MM’s got rich ….  $12 x a whole bunch of shares is a big wad of cash …… in a very short time.  All in a day’s work. This, my friends, is a great example of a bear trap. 

In case you were wondering, yes there is a bull trap and many other ways the market can eat you alive. It’s a jungle out there with big game hunters (MMs) armed to take out both bulls and bears.

Oops

Up almost 1400% in 3 years, Netflix (NFLX) has been a stock juggernaut. And to think in 2000, Blockbuster refused to buy Netflix for $50M. Today, Blockbuster doesn't exist and NFLX is worth a paltry $43B

And I thought my Betamax VCR purchase was a bad decision

A Splash of Cold Water

The fact we held above the very important 2040 support line on the SP500 and rallied strongly since is very constructive on a technical basis.  But we still need to be cautious here as we still have the possibility to form a lower high and thereby have all the necessary elements of a trend reversal in place.  A close above 2126 would invalidate that reversal possibility (for now) so that becomes our key level to watch.

As we wait to see what actually develops for the second half of the month, we have the backdrop of poor seasonality patterns as a tailwind. As you can see below, July has tended to be the worst month for the US stock market with only 45% of past July’s closing higher than it opened.

Desperately Seeking Superman

In case the name doesn’t ring the bell, Green Mountain Coffee Roasters (GMCR) manufactures the Keurig brand of coffee makers.  Its stock was a darling of Wall St. rising more than 900% in 2 ½ years, topping out in October of last year as you can see in the chart below. GMCR was consistently on every analysts buy list and made savvy investors a ton of money during the stock’s ascent. After topping, the stock began to fall and formed a text book, beautifully symmetric, head and shoulders reversal pattern. At the time, I personally bailed out of the stock and warned investors to sell because of the pattern target (highlighted and labeled with the blue horizontal line) downside was indicating the potential for a huge loss. I remember thinking at the time the decline, the potential for a 50% hair cut seemed completely unrealistic. This seemed especially true when considering the backdrop of it being such a strong company producing excellent results, loved by institutional investors and the overall market was still very bullish. As you would expect, as they are typically late to the party, and in spite of the technical warnings, analysts continued to push the stock.

One of the benefits of my training as a market technicians is I learned to not spit into the wind, tug on Superman’s cape, pull the mask off the Lone Ranger and most importantly not short a Wall St. darling stock in a bull market. As such I did not, in spite of it being perfect setup.  I was too chicken.

Fast forwarding to today let’s check in to see what has transpired over the past 2 months since forming the right shoulder of the head and shoulders pattern. In the chart below you can see we have fallen almost 40% from the neckline of the pattern and it does not appear we are done. You can see in the upper pane, which shows momentum, we are so deeply oversold (it has never been this oversold in its history) that I expect to see a bounce higher over the next few weeks as it needs to unwind this condition. Once the unwinding is complete I expect the stock to follow a similar path to what I have illustrated on the right hand side of the chart by bouncing higher and then ultimately finishing its decline down to the pattern target around the 56-58 level. Where it goes from there is anybody’s guess and we will just have to wait and see what develops between now and then. The bottom line is those that were brave enough to take the  short are now up 40% in 2 months. I don’t need to remind anyone that is more than a 200% annual return.

Clearly, those who were bold enough to hold the position the entire way up and then short the breakdown have profited immensely. There are two things readers should take from this analysis 1) trend followers can make money in both up and down markets (if they aren’t chicken) and 2) every stock (even those who are revered by the Wall St pundits) have their days, weeks and months in the dog house – as such don’t fall in love with your investments.

Now that I have proven to myself making money shorting a Wall St darling is possible can anyone tell me where I can find Superman or The Lone Ranger?

Don't Fear the Reaper

The emotional scars from the past financial crisis still run deep and never really seem to go away.  This past week I received an email asking – “Will you protect me in the next bear market?” I am asked this so often that I should take a moment to comment.

When we lose money in any endeavor, including investing in the markets, it is not easily forgotten. Over the years, we all have taken our fair share of beatings in the market including me and 2008 still haunts. However, over time and, in spite of those past failures, I have figured out a way to move past it, carry on and get better.

Without risk, there is no reward. That’s the bottom line. While none of us will be able to reach the point that everything we do in the market is correct. Or, discover the holy grail of investing since no such thing exists. We can do some things that increase our ability to be successful. In my experience, it comes down to taking advantage of as many opportunities available while managing the risk properly to help us overcome when we are wrong.  Being wrong is ok, staying wrong is not.

Ten years from now, there will be many investors who will be filled with incredible regret - being hurt in the prior financial crisis and selling out and abandoning sound long-term investment strategies. Including failing to take full advantage of one of the greatest bull markets we may see in our entire lifetime. This cycle never seems to change. It’s those human fears and emotions which are our biggest obstacles to investment success.

It still saddens me greatly how many succumb to their emotions. Those who allow their feelings of fear and mistrust, prevent them from seeing opportunities that are right in front of them. Far too much money has been lost by people preparing for and fearing the worst, than simply focusing on what is actually happening. How do I know this?  Because some years back, that was me.

Without a doubt, things will change at some point and the bears will come to rule Wall Street once again. I am actually looking forward to that day, as I know all too well how to profit from such a bearish scenario. And when it comes the decline will happen very, very fast.  It always does.  But, until that next day arrives, my job is to focus on the market that lay right in front of us, right now in the present day. To learn from past mistakes and to focus on opportunities right now. If there is one thing you must do to do succeed in the markets, it is this.

Once you learn how to do that, you will be far ahead of those who are constantly expecting and looking for the reaper to come and ruin their life and take all of their money away. Remember, scared money never makes money and fortune favors the bold. This will always be true no matter what the market does next!