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Fear of the Unknown (Earnings)
The earnings season kicked off this week and there were contrasting reactions depending on which bellwether stock happened to report that day. On Friday, General Electric shocked the market with a lower-than-expected profit report and the market headed south in a big way. This played right into the hands of the recessionists, as GE's businesses represent a large swath of the US and international economies. By contrast, Tuesday's optimistic outlook by Intel is likely to propel equities upward on Wednesday, and bring out the global growth groupies in force (Intel derives about three quarters of their revenues from foreign customers). Also, on the earnings docket this week: IBM, Google, JPMorgan Chase, and Caterpillar, just to mention a few. The key for traders is to be cognizant that any of these leadership stocks can move the market, thus being prepared for such events is imperative.
To continue on last week's theme on finding low risk trades, I'm going to share with readers a simple rule that I follow that helps me stay in harmony with the ongoing trend of the market – assuming there is a discernable direction. In the past, I've cited my use of moving averages as a sort of compass, but haven't really gone into specifics. Today, I'll give examples and particulars that perhaps may be useful to some of you.
First, on a 3-minute Globex (24 hour) chart, I employ a set of three Exponential moving averages (15, 30, 60 periods). My rule states that if the ER2 trades above these EMA's, I will only buy (go long) pullbacks at support. Conversely, if ER2 trades below these same EMA's, then I will only (sell short) into rallies, when resistance is reached. The two examples shown below are what these set-ups look like in both an uptrend, and a downtrend.
Most of the time I try to place my trades in the direction of the general trend. Nevertheless, trends don't last forever. Therefore, attention must be paid to signs of a weakening, or exhausting, trend. The Keltner bands (chronicled in the previous newsletter) can help sometimes in spotting these turning points. For this reason, the only time I trade countertrend is when the Keltner bands are "in play".
I received quite a bit of emails inquiring about the Keltner bands. Apparently, not many of you are familiar with these bands. The question that seemed to come up most frequently was how the Keltner bands compare to the popular Bollinger bands. If you would like a more detailed explanation of the main differences between the two, I cover it in my January 30th article "The Bottom Fishing Expedition".
Another question I often get - particularly when it has to do with an indicator that few have seen - is of course, how often does it work? This is because everyone is secretly looking for that "magic" indicator – the silver bullet - that black box that will throw off signals that are profitable 95% of the time without having to do any work. Now, I'm being a bit facetious, but regrettably, there is a booming industry out there that markets to the public with similar claims. A better question would be "what is the worst drawdown I can expect before I turn profitable?" Alternatively, "what is the profit versus loss ratio?" The irony is that the answers to these questions have absolutely no bearing on how often it will be right or wrong. Some of the most profitable – AUDITED - strategies only have a 40% percent win-to-loss ratio. That's correct, only four winning trades out of ten. The reason these methodologies are so profitable is because they adhere to the basic tenet of keeping losses very SMALL and only taking BIG profits!
In reviewing the technical picture of the e-mini Russell, the recent selling has not come as a big surprise to me. The conditions were ripe for some type of corrective action. Readers may recall in last week's newsletter I wrote that the market was overbought and pushing up against a major resistance level. The daily chart below shows how the ER2 has come down to the lower end of the trading range that has been in place for most of 2008.
The critical levels to watch for in the next few days are 683 to 681. These have been strong support levels so far. However, too many trips down to any support level tend to weaken that area. We'll have to observe price action, if it revisits this neighborhood, to gauge if it will hold.
In summary: The unknown factor of how the earnings turn out is going to be a drag on the market in the short run. Therefore, my view remains the same – rangebound for the next several weeks - until the end of the reporting season. As I write early Wednesday morning, the Futures are up strongly in reaction to the aforementioned Intel news. In recent days though, the up- gaps have been faded (sold into) and I suspect this one will be no different. The more significant question is not how the market opens, but how it closes. In addition, with every new day comes the uncertainty that another behemoth company will match, exceed, or miss their respective profit target. Keep in mind, that the only certainty in the market is change.
Until next time, I hope everyone has a profitable week.
If you have questions, comments or you'd like a specific topic covered, please email me at gvelazquez@tradingacademy.com
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Gabe Velazquez is a professional
trader with 14 years of experience. His focus is intra-day and swing trading the
ER2 (Russell 2000 e-mini) using technical analysis as his primary tool. Gabe has
managed both stocks and futures accounts as well as conducted educational seminars
on technical analysis for the past ten years. He is a frequent guest on Biz radio,
where he shares his market knowledge and utilization of technical indicators.
Gabe also teaches the