Gee, Think.

I’m back with another chart of my favorite financial instrument, the NASDAQ 100 trust QQQQ, better known as the Qs!

First of all, I am astounded at the way that they rallied since July 21st. I mean, wow! I thought that the Qs were going to be headed down even further, but no! They really surprised me there! They fell roughly 16.6% from May 8th to July 21st, and subsequently rallied 25% from July 21st to November 24th 2006. That’s an amazing range in 6 months! I certainly didn’t see that kind of recovery coming. However I am relentless, and will try to make another prediction of where the Qs are headed over the next 20 trading days. See the chart below:

Here we can see that the Qs were in a undeniable 45 degree uptrend for a good 4 months.  Two months since November 24th, we are essentially flat.  This means that the trend has died. The angle of ascent has disappeared.  It now seems that the Qs are facing resistance from a  line that was first touched back on April 4th 2001 as the day’s low at approximately 33.83.  On that day it was support.  Since then this line has been resitance on January 20th 2004, December 3rd & 15th 2004, and broken briefly on January 11th & 12th 2006.  It was tested again November 22nd and 24th 2006.  More recently we hit the line again on January 12th and 16th.  Suffice it to say that this line has been significant in the geometry of the Qs over the past years.  It has never been soundly broken since becoming resistance.  I venture that the Qs will not break this trendline.  They have been pushed quite hard over the last 7 months, and I think they’re ready for a retracement to at least the 42.20 area over the next 20 trading days.  However, we can see that the relative strength of the Qs is still respectable at the 58% level.  I see a coming advance to test the long time resistance line hitting at least 45.30 before turning lower.

I won’t have the time to actually trade this, but I’m still considering what options plays would be best based on this opinion of the market.  Deciding which way the market is going is one thing, but choosing the right options strategy is another entirely.  Something that crossed my mind was selling one-point options spreads.  Selling n out of the money a put spread as the Qs turn up from support, and then selling an out of the money call spread as the Qs turn down from resistance.  based on this analysis, I would choose something like the 43/44 put spread and the 45/46 call spread.

Remember, this is not an endorsement, just my own humble amatuer opinion.

20-Day 30-minute Candle Chart with Trendlines and Historic Resitance. 

 

The QQQQs Fund is seen here to be finding support in the lower trendline from July 21st of this summer’s sharp rise.  We can also see tha the QQQQs made a run at the 43.31 high from January 1st, but could not maintain the high ground.  The Trendline from July 21st was an especially important line of support over the past week.  It held the Qs up a good three times.  The price also bounced against 43.31 twice, and even broke through briefly.  It looks like we are coming to a turning point for the Qs as the Summer Trendline approaches the Resistance from the winter high of 43.31 on January 14th.

Here’s that illustration I was hoping to provide:

 

 

Click for a full size image.

What does it mean to be a good forecaster? In short, it means that you are right more than you are wrong. That’s the most relaxed and most basic qualification for being able to call yourself a forecaster.

A good forecaster is someone who’s right significantly more than they’re wrong. Being right 80% of the time is a good place to start. So let’s say I’m forecasting the weather for you each night. Each night I tell you whether the following day will be sunny, or cloudy. If I’m right on Monday, Tuesday, Wednesday, and Thursday but get it wrong on Friday I’d be performing with an 80% success rate. Would you employ me as a weather forecaster if I could keep up that kind of performance? I would hope so because 80% accuracy is pretty darn good when you’re essentially telling the future.

Now when I’m wrong, how do we measure how wrong I am? It’s pretty simple when you’re just predicting sunny or cloudy, heads or tails. Most forecasting situations are a little more complicated. Let’s add a little more detail to the previous example and say that instead of just telling you that tomorrow’s weather will be sunny or cloudy I also tell you the expected high temperature. So it’s Sunday night I and I tell you that Monday will be Sunny and the high temperature will be 66 degrees. Monday rolls around and it is Sunny but the high temperature is actually 70 degrees! Whoops! I got the sun forecast but missed the temperature by 4 degrees. I was 100% correct on my sunlight call but only 94% correct on my temperature call. That gives me a solid average of 97% for Monday. Not Bad!

Let’s consider another example. It’s Monday night and I tell you that Tuesday is going to be sunny again, and the high temperature will be 72 degrees. When all is said and done, Tuesday turned out to be a cloudy day and the high was only 51 degrees. Now I’ve really done it. My success in the sunlight call is 0% and I was off by 21 degrees, 30% error in my temperature call. When we average the success percentages of 0% for the sunlight call and 70% for the temperature call we get an overall success rate of 35% for Tuesday. That’s not too great, but every forecaster will have those days. Every forecaster will be wrong. It’s part of the job.

Now I’d like to consider financial forecasting in light of the examples above.

I’ve been trying to understand the stock market for about a year now. I’ve read a bunch of books, looked at a lot of charts, and dabbled in some methods of technical analysis. I’ve learned about reading charts for short term trading, and long term trading as well. On August 14th I signed up for a forecast service which will remain unnamed for this post. Since I started reading their forecasts, they were by and large wrong.

I expect forecasting services to be wrong sometimes, but when I am a customer of the service, I would like to understand what went into the decision making process that lead to an incorrect forecast. I want to know what happened, and why the forecaster thought the way that he did. This is not because I want to see him hung for making a mistake, but I see myself as his student, and I would like to learn how he does what he does by understanding his reasoning. It’s useful to know what reasoning has lead to success and what reasoning has lead to failure. You have to know both sides.

So after reading these forecasts for two months and watching the predictions fail time and time again I wrote a detailed email to the people that run the service.  I cited sentences, phrases, and numbers from their forecasts and calculated the percentage of error they had shown on several occassions. This was all meant to show that I was earnestly trying to understand their work.  I asked what sort of percentage of accuracy they were aiming for and what success rate I should expect as a subscriber.  I also asked what went wrong in their reasoning.

I was very disappointed to see that the only email I recieved was a vague and defensive response cited that they “aim for 100%” accuracy and “all forecasters are wrong sometimes.”  They dropped the ball on that one.  I was expecting better customer service than that.  As a forecaster, when you’re wrong whoops isn’t good enough.

My work schedule is demanding. The work load has increased recently.  My work day lasts about an hour longer each day, which translates into an hour less at home enjoying the domestic scene. Is it worth it? Is it necessary? Will sacrificing those extra hours now pay off for me and my family in the future?  These are the questions I’m asking myself. I have not yet come to the conclusions. There is no doubt that the extra hours result in extra compensation. In certain ways, that makes our lives easier. At the same time, although I am compensated additionally for the extra hours, I am not as able to keep up with the household chores or get enough rest.  This puts strain on my relationships and health as I become less rested, less energetic, and have less time to get everything done. So how do I find the balance? I expect there to be some amount of sacrifice and toil in my life. From
what I hear, life is not just a walk in the park. Actually it’s quite hard to get by, even in a land of opportunity. So the question really is: how hard is too hard? I don’t want to sacrifice my health, physical or mental, for success and
comfort. I don’t want to sacrifice my realtionships either. Those things are worth much more than a salary. That’s definitely true. At the same time I accept gladly that life is not all peaches and cream. I take my work seriously and work hard to get it done. But how will I know when I am working to hard? I’m guessing it’s like love; when you know you just know. It’s nothing someone can give you a formula for. For the time being I am going to keep on working hard because I don’t think I’ve quite reached that danger point where work and personal life are imbalanced. I’m going to
be conscious of the trade offs and strains that I see forming. If I get too wrapped up in it I hope I’ll see it before it creates problems.

Is it too late for my poor QQQUJ options? It could be. I hear that
these last two weeks are really when the time value gets sucked out of
the options. So out of the money options are not really the place to
have your money. Well, all I can do at this point is hope that the
market falls hard enough tomorrow and the day after to see if I can
recover my 8 cent cost basis.
My trading account is hanging in the balance here. If I am able to exit
the position with some scrap of captial still remaining, I will
definitely not buy current month options again. I was really playing
with too short a time frame.
If I end up losing all the money in this position, I’l have to wait
until I’ve done some more saving before I can practice again.
I think one of the biggest lessons to learn is patience. I rushed into
some poor quality options because they were cheap and I was too eager to
play the downside. Now I realize that it would have been much better to
wait until the direction of the market was more certain. Then I could
have profited more from today’s striking 70 cent loss in the Qs.
Instead I’ve lost money in my trade and also in the opportunity to
capitalize on such a dramtic move.

Why is all the recent data which shows that the economy is slowing
talked about as benign? I think the logic is that a slowing economy
will cause the Federal Reserve to stop and possibly reverse their
interest rate policy. While lower short term interest rates will make
bonds less competitive to stocks in terms of yield, the fact the the
federal reserve is lowering rates is a bad sign for the economy. The
Fed tends to lower rates in an effort to stimulate economic growth and
increase the speed at which money flows through our economy. The only
reason for stimulating the economy, however, is that the economy is
already slowing.
So how can a slowing economy be a good thing for stocks? I think the
only answer is that traders believe the economic slowdown will be of
minor scale. They believe it will be a period of slowing growth for a
short period, followed by a resumption of a roaring economy. I tend to
think we are in for more of a shake-up than that.
The housing market is in really bad shape as of late. I read recently
that there is a record high number of sellers in the market. Sellers
have far out numbered the buyers and so prices are falling. Falling
prices encourage potential buyers to wait further until prices fall even
further.
Falling real estate prices are not just bad for the sellers though, they
are also bad for the overextended “owners” who have an overall negative
equity position. For these owners, the value of their home may fall,
but the size of their equity loan will remain the same. They will need
to continue making the same payments, and may even need to increase the
payments as mortage rates rise. Specifically, those with adjustable
rate mortgages may need to prepare for higher payments due to higher
interest rates.
If the economy does go through a significant slowdown, wages will fall.
If wages fall, making mortgage payments will become more difficult.
So what happens if a number of borrowers default on their home
mortgages? Banks will become less willing to lend to new borrowers. I
can’t speak from experience, but my best guess is that lender will
express an unwillingness to extend credit by offering loans at
unattractively high interest rates. What does this do to the adjustable
rate mortgage holder? It increases their interest payments. This could
in turn cause more foreclosures in a vicious cycle. We call this credit
contraction.
As mortgages defaults occur in a falling real estate market, the lender
will lose money on the sale of the home in cases where the borrower had
built little equity. For example, a borrower who had built 30% equity
in their home defaults on their payments. The bank recovers the
property and they can break even on the loan they extended if they can
sell the house for 70% of its value. It is possible for a lending
institution to profit from froeclose in a stable or rising housing
market. Falling markets however, can actaully hurt the lender. If the
price of the home has fallen to 50% of its value at the time the
mortgage was taken, the bank will only be able to secure, at best, a 20%
loss by selling the house for 50% and keeping the borrower’s 30%
equity. This returns 80% of the loan to the lender through the
foreclosure process, which is also quite time consuming.
So in summary, since we have an all time high level of credit in this
country, and a negative savings rate, I think any sign of a slowdown
could be very bad news. The last question is what will cause the real
slowdown? Will it be something obvious such as a political event? Or
perhaps the slow effects of globalization? I’m not sure, but as we say
in the northeast, I’m keeping my eyes peeled.

For those of us watching the elliot wave progression in the Dow, S&P, and especailly Nasdaq 100, this rally is a real fake out.  The recent rise in stock prices is part of a second wave up, during which investors believe that the market really could recover.  It’s some kind of denial psychology, or a back last from the exceeding optimism of recent years that just won’t quit.  So we get this uptick over the past couple days, but if my sources are correct, it won’t be sustainable. For more commentary on the “but” rally, read tickersense.typepad.com

It’s only been two days that I’ve had a subscription to the Elliot Wave
Financial Forecast service and already I am sold. This could have
something to do with the fact that their forecast suggests what I need
in order to exit my option position profitably, but let’s just assume
that I’m objective for a moment.
I’ve read through Frost and Pretcher’s “Elliot Wave Principle” over the
last couple months. It was by no means a light read. It was filled,
make that jam packed, with rules, guidelines, ratios, and plenty of
chart examples. I re-read most of it and found that I absorbed much
more on the second time around.
After my second reading I decided to try and put the theory into
practice. This was a triumphant day for me. I was quite pleased. If I
remember right, my very first wave count was no correct, who would
expect it to be? I thought to myself that I would practice the
art/science of wave counting until I become proficient enough to publish
my own forecasting service.
I knew that Robert Pretcher was still actively forecasting the markets,
however, and I was quite curious to see HIS wave counts.
I have since subscribed and so far I love it.
In the half dozen issues inlcuded with my subscription, I have found
incredible detail in the elliotwave.com team’s analysis of the financial
markets. They set specific targets and also include when to asume
they’ve been wrong. Even better, they don’t forecast when the aren’t
certain what the market’s next move will be. If they cannot find a
satisfactory wave count they admit it. I think this is much better than
constantly forecasting whether or not you are sure.
It remains to be seen if I am able to correctly interpret their reports
and put them to profitable trading use consistently.
I am really impressed with the ammount of work that must go into these
reports. It looks much better than something that ibcould manage to
create on a part time basis. However I am still holding out that if I
continue to study the application of the wave theory through this
newsletter, I will one day be able to use it on my own.

I just adjusted my bearish spetember Qs position. My cost basis went
from 0.98 to 0.82. So far the trade has gone like this:
1. 7/24 Buy to open 10 QQQUJ at 1.00
2. 7/25 Buy to open 6 QQQUJ at 0.95
3. 8/3 Sell to close 6 QQQUJ at 0.75 (ouch!)
4. 8/9 Buy to open 7 QQQUJ at 0.60
I’m bearish on stocks in general and the Naz in particular. I believe
there will be significant movement downward over the next four weeks.
To avoid significant time decay, my exit date is September 1st.