Traders' Library Blog

Pairs Trading

Check out this video I made on Pairs Trading! Enjoy!

Here's the Dow Game Plan

Now that the Dow Jones ($DJI) got the breakout from the narrow price range we forecasted in our Monday analysis, here's how we'll be playing a potential down move Wednesday.

The Breakout

In Monday's analysis titled Watch the Dow for a Breakout, I wrote that price was coiling for a potential breakout opportunity that could spark the next short term move.

As it turns out, the Dow got a solid downside break through the bottom of the 7-day range at 13,500, which paved the way to a 101-point loss on the day.

The downside break indicates price could be headed to the 13,320 bear target I forecasted in my analysis within 3 to 5 days. Today's Outside Day candlestick pattern further confirms weakness ahead.

Lower Value

Today's downside move, combined with the potential for more downtrending behavior ahead, opens the door to one of my favorite setups - the Lower Value setup.

The 15-minute chart shows the Dow has formed a 2-day Lower Value relationship using the Pivot Range indicator.

The Lower Value relationship develops when the upcoming day's pivot range forms completely lower than the prior day's pivot range. In essence, this relationship indicates continued weakness ahead, especially if Wednesday's Open price confirms the setup.

This is the kind of setup that you can play over and over during a well-behaved trending market.

The Game Plan

If you missed today's move, here's how you can approach tomorrow's market to grab a piece of the action.

Since we have a Lower Value relationship, I'll be looking to sell into any modest strength tomorrow morning, with the intention of riding price to new lows within the current near-term decline, especially if price remains beneath the support-turned-resistance level of 13,520.

If price opens the session below 13,480, look to sell into strength between 13,485 and 13,515. However, if price opens the session above 13,500, look to sell into strength between 13,515 and 13, 540. Look to scale out of your position at the following targets: 13,465, 13,405, and 13,355.

If the $DJI opens the session above 13,540, then market sentiment has clearly shifted and likely means strength ahead. Keep this contingency in mind.

Let's see how this plays out!

Cheers!

Frank Ochoa

PivotBoss | Own the Market

Follow us on Twitter: http://twitter.com/PivotBoss

Watch the Dow for a Breakout

The Dow Jones Industrial Average ($DJI) continues to hold at highs above the 13,330 resistance level, suggesting further strength ahead. However, recent price activity suggests a breakout in either direction from the current range could spark the next short term move.

Narrow Range

The daily chart of the $DJI shows price continues to hold at highs after breaking through the important 13,330 resistance level a week ago. The 13,330 level had been resistance for the year until the recent breakout, which bodes well for further strength ahead.

However, current price activity indicates a breakout from the current 7-day range could spark a solid short term move, regardless of direction.

You see, the current price range has been extremely narrow, which means the index is coiling ahead of the next big breakout opportunity.

As a matter of fact, the average 5-day range in the Dow has been 289 points, while the current 5-day range is only 144 points. That's a 50% drop in price range, which is rather significant.

The Range Ratio indicator shows a current 5-day reading that is below the .75 level, which is marked in red. This reading generally alerts you to a potential breakout ahead.

Pivot Resistance

The daily chart also shows price is holding right at the monthly R2 Floor Pivot level of 13,620. Since the range congestion has formed above resistance, an upside break is to be expected. A push through 13,620 could spark a nice short term move higher.

However, If price cannot rise above this pivot level, look for a downside push back toward the monthly R1 level at 13,355 for a retest of the breakout zone between 13,330 and 13,355.

As long as the Dow remains above the monthly pivot range (pink lines), continued overall uptrending behavior is expected in the medium term. As a matter of fact, look to buy any pull-back to this zone (13,055 to 13,080) should a retracement occur.

Targets to Watch

If price breaks free from the current 7-day range, look for a move of about 180 points to occur rather swiftly. Therefore, a downside break brings the 13,320 target into play, while an upside break opens the door to 13,830.

Watch 13,500 and 13,650 closely for a breakout.

Let's see how this one plays out!

Cheers!

Frank Ochoa

PivotBoss | Own the Market

Follow us on Twitter: http://twitter.com/PivotBoss

Top 10 Forex Events Outlook: Sep. 24-28

Sep. 23, 2012 (Allthingsforex.com) – Amidst the signs of a global slowdown, economic data scheduled from the U.S. and the euro-zone will keep the U.S. dollar and the euro in the center of the market’s attention in the final days of September.

In preparation for the new trading week, here is the outlook for the Top 10 spotlight economic events that will move the markets around the globe.

1.    EUR- Germany IFO Business Climate Index, a leading indicator of economic conditions measuring the outlook of businesses, Mon., Sep. 24, 4:00 am, ET.

No significant improvement is expected in the euro-area’s largest economy as the German business climate and expectations index stays unchanged at 102.3 in September, same as the 102.3 reading in August.

2.    USD- U.S. Consumer Confidence, a measure of consumers’ outlook on the economy, Tues., Sep. 25, 10:00 am, ET.

The outlook of U.S. consumers is forecast to be a bit more optimistic, pushing the consumer confidence index higher to 62.0 in September from 60.6 in the previous month.

3.    USD- U.S. New Home Sales, an important gauge of housing market conditions measuring sales of new homes, Wed., Sep. 26, 10:00 am, ET.

Following the stronger existing home sales and housing starts data, sales of new homes in the U.S. are forecast to register a slight increase to 380K in August from 372K in July.

Top 10 Forex Events Outlook: Sep. 17-21

Sep. 17, 2012 (Allthingsforex.com) – Following a couple of busy weeks that have delivered unprecedented open-ended easing commitments by the Fed and the European Central Bank, the week ahead will provide an opportunity to gauge conditions on both sides of the Atlantic as traders focus on notable housing and economic activity reports from the U.S. and the euro-area.

In preparation for the new trading week, here is the outlook for the Top 10 spotlight economic events that will move the markets around the globe.

1.    GBP- U.K. CPI- Consumer Price Index, the main measure of inflation preferred by the Bank of England, Tues., Sep. 18, 4:30 am, ET.

In line with the Bank of England’s forecast, inflationary pressures in the U.K. have been subsiding in recent months and this trend is expected to continue with the consumer price index pulling back to 2.5% y/y in August from 2.6% y/y in July. Lower inflation would not be an obstacle to additional easing by the Bank of England.

2.    EUR- Euro-zone ZEW Economic Sentiment Index, a leading indicator of economic conditions measuring the outlook of financial experts, Tues., Sep. 18, 5:00 am, ET.

The ZEW institute survey is expected to show some improvement in economic outlook with a reading of -16.3 in September compared with -21.2 in the previous month.

3.    JPY- Bank of Japan Monetary Policy Announcement, Wed., Sep. 19, around 12:00 am, ET.

Major Breakout Ahead for the S&P 400

The S&P MidCap 400 looks poised for a major breakout ahead - one that could be felt through the end of the year and beyond. Here's more…

Massive Triangle

The weekly chart of the S&P 400 Index shows price has been winding up within the boundaries of a large developing triangle pattern since Q4 of 2010.

This ascending triangle pattern could be the spark that leads to the next major breakout in this index, which speaks volumes about the broader market, as well.

Most of the major market indexes have formed similar patterns, or are butting right up to long term resistance, so a breakout in this index could correspond very well with breakouts across the market.

Bullish Break Expected

Ascending patterns typically break to the upside, so we'll be watching resistance very closely for signs of a bullish violation ahead. Moreover, the pattern has formed at the overall highs of the recent four-year uptrend, which is also quite bullish.

Keep in mind, while I am bullish on this pattern, a breakout in either direction should spark aggressive initiative participation, so keep an eye on both sides of the triangle, as a breakout in either direction will certainly pack some punch.

Targets

Since the backend of the pattern measures 287 points, we can expect a move of about the same size once a breakout occurs. That is, look for the market to move about 287 points in the direction of the break, which after Monday's close amounts to a 28% move.

Watch the 2011 high at 1018.65 for signs of a bullish breakout. Since the yearly R1 Floor pivot is 1021.3, we'll definitely want price to clear this hurdle, as well. The Bull target looks to be around 1,305, which actually corresponds well with the yearly R3 pivot.

For a bearish break, look for a violation through 880, with additional confirmation through the bottom of the yearly pivot range at 875. The Bear target forecasts to about 595, which looks to be the yearly S2 pivot.

Given the duration of the development of the triangle, the resulting breakout could span between 6 and 12 months, so we could be in for quite a trend ahead.

Let's see how this plays out long term!

Cheers!

Frank Ochoa

PivotBoss | Own the Market

Follow us on Twitter: http://twitter.com/PivotBoss

Top 10 Forex Events Outlook: Sep. 10-14

Sep. 10, 2012 (Allthingsforex.com) – In the week ahead all eyes will be focused on the Federal Reserve’s monetary policy decision as last Friday’s disappointing U.S. employment report has increased significantly the odds of a QE3 announcement.

In preparation for the new trading week, here is a list of the Top 10 spotlight economic events that will move the markets around the globe.

1.    USD- U.S. Trade Balance of the difference between imports and exports, Tues., Sep. 11, 8:30 am, ET.

A day before the start of the FOMC meeting, the U.S. economic backdrop is not expected to instill much optimism with the trade deficit forecast to widen to $44.7 billion in July, compared with $42.9 billion in June.

2.    EUR- Germany Federal Constitutional Court Ruling on the European Stability Mechanism (ESM), Wed., Sep. 12, around 2:00 am, ET.

Germany, the biggest contributor to the permanent bailout fund in the euro-area, will see its Federal Constitutional Court vote on the validity of the European Stability Mechanism (ESM) and the country’s participation in it. The largest economy in the Euro-zone has the biggest, 27% share in the ESM and without a “blessing” by the German court the future of the fund will be in question. With the ESM activation, which was scheduled for early July, already past due, any further delays of the 500 billion-euro fund could see borrowing costs for troubled member states rising and could increase the pressure on the EUR.

3.    GBP- U.K. Jobless Claims and Unemployment Rate, the main measures of labor market conditions, Wed., Sep. 12, 4:30 am, ET.

Hiring ahead of the Olympics could lend support to the U.K. labor market numbers for another month with jobless claims rising by only 500 in July after declining by 5,900 in June, while the unemployment rate remains at 8%. An upbeat U.K. employment report could fuel further gains for the GBP against the USD as QE3 expectations weigh on the greenback.

4.    NZD- Reserve Bank of New Zealand Interest Rate Announcement, Wed., Sep. 12, 5:00 pm, ET.

The Reserve Bank of New Zealand will not change the course of its existing monetary policy and is expected to keep the benchmark interest rate at the 2.50% level. Governor Alan Bollard would probably express concerns about the persistent strength of the New Zealand dollar, but the impact on the currency from such statement would likely be limited as the recent risk-off sentiment continues to see the Kiwi attracting bids.

5.    CHF- Swiss National Bank Interest Rate Announcement, Thurs., Sep. 13, 3:30 am, ET.

Successfully defending the franc cap against the euro for the last year, the Swiss National Bank will confirm its commitment to keep the euro floor and to guard the economy from the negative effects of its strong currency. Last week’s surprising drop in the Q2 2012 GDP coupled with a number of worse than expected economic reports from Switzerland could even prompt the central bank to hint that it stands ready to consider additional measures to weaken the franc if economic conditions deteriorate further.

6.     USD- U.S. Jobless Claims, an important gauge of labor market conditions measuring first-time claims for unemployment benefits, Thurs., Sep. 13, 8:30 am, ET.

After dropping by 12K to 365K, the consensus forecasts point to an increase in the weekly claims for unemployment benefits to 370K. Although last week’s drop was the largest in a month, it might not be enough to reduce the probability of a QE3 announcement by the Fed later in the day.

7.    USD- U.S. FOMC Interest Rate Announcement, Thurs., Sep. 13, 12:30 pm, ET.

There is no question that the Fed Chairman is prepared to ease monetary policy further and the disappointing U.S. Non-Farm Payrolls data from last week could very well serve as the catalyst that triggers another round of quantitative easing. This is why it would not be surprising to witness a QE3 announcement or some other sort of monetary policy easing such as an extension of the timeframe for record low rates into 2015. The market is already pricing QE3 expectations and the USD has weakened across the board. Should the Fed stop short of deploying QE3 for the time being, the USD might be able take a breather as currency debasement worries get lifted off the greenback's shoulders.

8.    EUR- Eurogroup Meeting of Finance Ministers, Fri., Sep. 14, all day event.

Following last week’s ECB bond-buying plan outline, the ball is now in Spain’s court and the Eurogroup meeting could become the perfect venue for the Spanish government to formally request financial aid, especially considering that it was at a previous Eurogroup gathering when Spain pleaded for a bailout of its banks. With finance ministers scheduled to discuss conditions that will be imposed should Spain decide to ask for financial assistance, this two-day event could mark another important phase in the EU debt crisis, raising anxiety levels in the markets and triggering a bout of uncertainty and risk aversion.

9.    USD- U.S. Retail Sales, an important gauge of consumer spending measuring sales at retail establishments, Fri., Sep. 14, 8:30 am, ET.

Consumer spending in the U.S. is expected to pull back with retail sales registering a smaller increase by 0.5% m/m in August after rising by 0.8% m/m in July.

10.    USD- U.S. Consumer Sentiment, the University of Michigan's monthly survey of 500 households on their financial conditions and outlook of the economy, Fri., Sep. 14, 9:55 am, ET.

The outlook of U.S. consumers is forecast to get slightly worse with a preliminary sentiment index reading of 74.1 in September compared with 74.3 in July.

What About ETFs?

When I first started Parkwood Capital in 2007, my coaching clients generally did not know what an Exchange Traded Fund (ETF) was, much less why it might be a better choice than a mutual fund. ETFs have now grown dramatically with over one trillion dollars invested. More and more investors are discovering the advantages of the ETF. Essentially, an ETF is a trust, consisting of a discrete group of stocks in fixed amounts and the investor is buying shares of that static fund. Immediately you see the principal advantage of the ETF - it isn't being actively managed and thus has much lower expenses than the average mutual fund.

Should I Own ETFs In My Portfolio?

The number one advantage of the ETF is its lower cost ratio. The average ETF will have a cost ratio of about 0.5%; many will be below 0.1%. By contrast, the typical mutual fund will have an expense ratio of about 1.5% and may have sales commissions on top of those fees. And those fees add up over time. Consider investing $10,000 into three funds:

• An ETF with a 0.5% expense ratio
• A mutual fund with a 1.5% expense ratio
• A mutual fund with a 1.5% expense ratio and a 3% sales commission

If we assume the underlying assets in each fund all grow at an annual rate of 8%, then at the end of ten years, the account balances of these three investments will be $20,610, $18,771, and $18,200, respectively. Those annual expenses add up over time!

Another significant advantage of owning an ETF is the ease and low cost of entering and exiting the ETF.  ETF shares can be bought and sold exactly like stocks, and at the same low commissions. So you could buy into an ETF and then sell it the same day. You can't do that with a mutual fund, plus you will often find other restrictions placed on your exits from mutual funds.

The Advantages of Mutual Funds

The principal advantage of the ETF is also its liability: it is not actively managed, so it cannot beat the market by definition. If I buy the "SPYDRs", SPY, the performance of my investment will be identical to the S&P 500 Index. 

The manager of the mutual fund is free to zig and zag with market shifts, although the prospectus of the fund will often place significant constraints on the manager, e.g., a maximum level for cash that can be held at any given time, a maximum investment in any one stock, and so on. 

Very few mutual fund managers consistently beat the market averages. But if you believe you have found a super star, then the added expenses of her mutual fund may be a cheap price for the outstanding performance. But those super stars are a rare breed.

My Choices

I personally use a blend of SPY (the S&P 500 Index) and QQQ (the NASDAQ 100) in my most conservative investment portfolio. But I always have a trailing stop entered on these positions, so I can automatically go to cash in the event of a crash. On occasion, I also sell call options against these ETFs (another advantage). In these volatile markets, my trailing stops often trip me out of these positions. But I can buy back in if desired for a very low trading commission; this is both flexibility and a cost advantage I don't have with mutual funds.

The ETF universe has grown dramatically in recent years. You can build a portfolio out of ETFs and buy ETFs devoted to virtually any industry sector where you wish to focus your investments.

But beware of two ETF classes: leveraged ETFs and Exchange Traded Notes (ETNs). The leveraged ETFs employ internal mechanisms to leverage the underlying asset class. For example, you can buy an ETF that is ultra bullish on the price of oil; hence, a $10 increase in the oil price might result in a $20 increase in the value of your ETF. But that leverage works both ways. These are risky investments.

 

ETNs are debt securities. They usually have a limited lifetime and pay out based on the performance of some index. But investors also incur the risk that the issuer may not be able to fulfill the obligations of the ETN. I think you are better off building your own bond ladder with blue chip corporate securities or use high quality bond mutual funds.

Meet Me In Las Vegas!

I have been invited to speak at the Forex and Options Expo in Las Vegas, September 13-15. My presentation will be web cast live from the Paris Hotel.

Register here.

Why Aren't You Auto-Trading?

My Flying With The Condor™ service has now gained 40% to date in 2012. And this isn't a flash in the pan. We gained 39% in 2011 in spite of the August market crash. I know you're busy and auto-trading is the perfect solution. Whenever I send out an email alert for a trade or adjustment, the brokers at TradeMonster immediately enter that trade in your account. You still receive all email alerts and status reports, but you don't have to worry about missing my alerts or taking time to enter the trade. And Barrons rated my brokerage partner, TradeMonster.com, as the best brokerage for trading options.

Subscribe today!

Top 10 Forex Events Outlook: Sep. 3-7

Sep. 3, 2012 (Allthingsforex.com) – With the European Central Bank scheduled to announce its monetary policy decision and the U.S. Non-Farm Payrolls report to follow a day later, the week ahead could become pivotal for the future fate of the euro and the U.S. dollar as traders gauge the next moves by the two major central banks in the days leading to the ECB and the FOMC meetings.

In preparation for the new trading week, here is the outlook for the Top 10 spotlight economic events that will move the markets around the globe.

1.    AUD- Reserve Bank of Australia Interest Rate Announcement,Tues., Sep. 4, 12:30 am, ET.

As economic growth remains “close to trend” and with inflation below target, the Reserve Bank of Australia will not be in a hurry to change its existing monetary policy and is expected to keep the benchmark interest rate at the current 3.50% level. Just as he did at the previous meeting, Governor Glenn Stevens would probably express concern about the persistent strength of the Australian dollar, although the impact on the currency from such statement would likely be limited.

2.    CHF- Swiss GDP- Gross Domestic Product, the main measure of economic activity and growth, Tues., Sep. 4, 1:45 am, ET.

The Swiss economy could feel the negative impact of the contraction in the Euro-zone, which is Switzerland’s largest trading partner, with a slower 0.2% q/q growth in the second quarter of 2012 compared with 0.7% q/q in the first quarter. The economic slowdown coupled with persistent strength of the Swiss franc could prompt the Swiss National Bank to consider additional measures to weaken its currency in an effort to help exports and the tourism industry.

3.    USD- U.S. ISM Manufacturing Index, a leading indicator of economic conditions measuring activity in the manufacturing sector, Tues., Sep. 4, 10:00 am, ET.

After a move into contraction territory with a drop to 49.8 in July, the U.S. manufacturing index is forecast to climb above the 50 boom/bust line with a reading of 50.1 in August.