I noticed that gold and the sp500 are at parity today…and that got me thinking. If one happened to go long gold and short the SP500 a few years back, what would your situation be like today. Not surprisingly, you would be up 100% on your investment. Have a look at the chart, get familiar with the pattern, and pull up a chair.

Long Gold, Short S&P500

As you can plainly see, we’re in a consolidation pattern right now. Volatility is EXTREMELY low, and the chance for a gut-wrenching move in either direction is entirely possible. If you believe that things are getting better, and that prosperity is on the way, then maybe you should go long the SP500 and short gold. However, if you think we’re in for a rocky road ahead, you may want to do the opposite and get long gold and short the crap out of the SP500. As much as I despise the GLD ETF, it’s still a trading vehicle that (somewhat) tracks the price of gold enough to make it useful. At this point you can enter a neutral trade (50% upside risk, 50% downside risk) by purchasing one share of GLD and shorting one share of SPY. Depending on your risk tolerance, and your preference, you can give yourself a bias in either direction by modifying your ratio of shares long vs. shares short. Since each share is trading at roughly the same price, this is an easy trade to tweak in your favor as the trend becomes more apparent. Maybe you don’t like the SP500 and you want to short your country’s index of choice. Be my guest, the charts more or less look the same (except for Japan…the mother of all carry trades)! Don’t believe me? See for yourself:

Long Gold Short India

Long Gold Short China

Long Gold Short Korea

Long Gold Short Malaysia

Long Gold Short Singapore

Long Gold Short Taiwan

Long Gold Short France

Long Gold Short Germany

Long Gold Short The Queen

Long Gold Short Japan

It seems that the S&P 500 does not obey the laws of gravity. What goes up must come down. I believe we will see the SPY around $88.00-$90.00 sometime in the near future (3-6 months).

This article is all about failure. I don’t really know where to begin with these charts. They pretty much speak for themselves. I have annotated them slightly to demonstrate that there are some interesting correlations between who specifically failed and who specifically got bailed out. When you begin to look at these charts as a representation of the industry as a whole, you can see that the financial system is in no way any better today than it was a couple of years ago.

First up is AIG’s chart. This is one for the history books: A textbook example of failure in its purest form. From this day forth, AIG shall be known as the sacrificial lamb of the financial sector for taking the role of the ‘financial fall-guy’. There really isn’t much to be said other than: the global financial markets fell apart, AIG couldn’t pay out their derivatives contracts to Goldman Sachs (and others), they failed miserably, and the taxpayers were called upon (robbed) to bail out the beneficiaries of said derivatives contracts.

mmmm banker brains!

We are experiencing the dawn of a new era (dawn of the dead anyone?): One in which zombie banks walk amongst the living. Wikipedia defines a zombie bank as: “a financial institution with an economic net worth that is less than zero, but which continues to operate because its ability to repay its debts is shored up by implicit or explicit government credit support.” I think AIG fits the bill quite well, don’t you? In today’s financial industry, the new banker mantra should be: “Every bank dies – Not every bank truly lives,” and AIG exemplifies the start of the zombification process. For all intents and purposes they are now undead.

The Sacrificial Lamb of The Financial Sector

Another winner of the epic failure contest was/is Citigroup. I bet you that Saudi Prince Alwaleed Bin Talal is extremely happy to have invested in this company! The chart look quite similar to that of AIG’s …almost to the point where one can make a baseless guess that AIG probably wrote too many credit-default-swaps for/against Citigroup…and well, one thing led to another and both went kaput. It sure is a good thing we bailed these guys out too!

Zombies are everywhere, better get your shotguns ready.

Citigroup Failure

Yet another epic failure is Bank of America. Although the magnitude of failure is not as severe as the previous two charts, it is still pretty close. Have a look for yourself (mmm brains). Bank of America got enough of a bailout to survive the zombie-apocalypse…only slightly. They are definitely half-dead. I would venture a guess and say that Bank of America shouldn’t have been underwriting credit cards for illegal immigrants, among other things… This chart also demonstrates how taking on a failing company such as Merrill Lynch will cause you nothing but trouble. It is my personal, and purely speculative prediction, that Bank of America will officially fail or be broken up in the coming months or years ahead.

Bank of Failmerica

The next chart is that of Wells Fargo. This chart is so crazy volatile that I don’t even know what to say. In my opinion it looks like an insane pump-and-dump scheme. For most of early 2008, the stock was trading around $27.00 However, by September of 2008 the stock was flying high over $37.50 per share. In six months it was down under $8.00 (nice 80% dump). This is an epic failure if I’ve ever seen one. By May of ’08 the stock magically soared back up to ~$27.50 and has been hovering around there ever since. Chalk up another undead bank on the list please! Can you smell the bailout? If you cannot, I labeled it for you in clear red lettering on the chart.

Oh The Wells Fargo Wagon is A Failing

The Financial Crisis

JP Morgan is yet another company who was coincidentally lucky enough to receive heaping spoonfuls of bailout when the shit hit the fan. These guys took over Washington Mutual and basically gave Chase instantaneous access to the entire West Coast of the United States in the blink of an eye. Before the meltdown, Chase was predominantly an East-coast brand. I used to bank with Wamu, and I specifically recall predicting their failure to many of my coworkers. Once the FDIC announced that JP Morgan Chase was taking over, I breathed an enormous sigh of relief. These guys are THE BANKING ESTABLISHMENT. Nothing, and I mean nothing will ever take down JP Morgan Chase. They are just as bad as any other bank, but at least I know they are one of the apex predators in the financial food chain. Look at their chart, it shows you that failure is not something that JPM will accept (even if that means robbing the American taxpayers). Notice the $USD (dollar index) starts going negative at the same time JPM gets their bailout. Although correlation does not always equal causation, in this case I’d be pretty certain that the printing presses at the FED/Treasury had everything to do with the reflation of JPM stock.

JP Morgan Chase Bailout

So there you have it folks. Interpret this as you should so desire, and hopefully don’t lose your money in the process.

Have Great Strategies, and Even Greater Risk Management

These five steps will help you achieve consistent profits in any market. It doesn’t matter if the market is trending up, down, or sideways. All you need to do is keep these steps in mind.

1. Know Your Market
2. Analyze Your Outcomes
3. Plan Your Trade
4. Trade your Plan
5. Protect Your Profits

Step One: Know Your Market

The first step is to find a market you are interested in trading. Study it for a few days, weeks, or months. I have personally been known to watch a security for 2 or 3 years before making a trade. Sometimes it takes me a while to learn the fundamentals of the underlying instrument. Other times, the setup isn’t quite ready yet. Although 2 years is an extreme, sometimes I only need a few days to get comfortable with a given market. Your comfort level is truly dependent upon your skills as a trader. Patience is always a virtue.

Having intimate knowledge of the markets you trade is an advantage, not a detriment.

Furthermore, being comfortable with the liquidity, volatility, and behavior of a security is also essential to successful trading. The last thing you want to do is find yourself trading a highly illiquid option contract just because you think the underlying security is going to break out to the upside. You have to be completely comfortable with the market, otherwise you put yourself, and your money, at risk.

Step Two: Analyze Your Outcomes

The best way to make money when the market goes wherever it wants to go is to devise a strategy. If you want to make the most of your capital, formulate a hypothesis and trade it accordingly. Establish scenarios for both sides of your thesis and adjust your risk accordingly. If you chase momentum you are destined to lose. If you trade an idea, you will stand a better chance of making money.

This is where technical analysis is really important. Your technical studies will teach you about the risks on both the upside and the downside. A proper analyst will know exactly how much he/she stands to lose before executing a trade.

Make sure to analyze your probabilities of success and failure. Think about your chances of making money, and conversely, think about how much money you will lose if you are wrong. Use my trade risk calculator to help you better visualize your risk/reward scenarios.

Step Three: Plan Your Trade

Come up with a trading strategy for the security you want to trade. Write it down, and make sure you stick to it. Generally speaking, it is much harder to get caught in a losing trade when you have written your trading plan on paper. Also make sure to keep this trading plan in plain sight so you don’t forget about it. I tend to use my blog as an outlet for my trading plans, although this may not be suitable for you.

Trading Nirvana

The best traders are the ones who know how to separate emotion from trading. Losing money is a horrible feeling and planning your trade can help to keeps your emotions in check. It takes time to train yourself to remove your emotions from your trades and this skill can only come from experience. I like to call it “Trading Nirvana”. Achieving trading nirvana requires you to dislocate the money from the trade. Not every trade works. When you do take a loss, make it a small one. If you can, always try to book a gain, no matter how small. Even $1.00 is still better than nothing.

Respect Your Leverage

Avoid leverage when possible. When you are use leverage, you are no different than a big bank or a well-capitalized hedge fund. The only thing that separates you from the big boys is the amount of leverage you use, how you use it, and how you manage it (not to mention about seven or eight zeroes to the left of the decimal on your account balance).

Excessive leverage will wipe you out in the blink of an eye. The drawdown will happen so fast it will make you do a double-take You will get mad, you will not know what hit you, and you will probably throw things in a fit of trade-induced rage. In order to avoid this, make sure to respect your leverage and set some stop loss orders shortly after placing your trade. At 4:1 leverage, a 2.5% loss can equal 10% of your trading account. Don’t pull a Lehman. Don’t pull a Bear. Be smart. Be Prudent.

If you have a broker that allows you to bracket your orders, make sure you take advantage of this capability.

Bracket orders are designed to help limit your loss and lock in a profit by “bracketing” an order with two opposite-side orders. A BUY order is bracketed by a high-side sell limit order and a low-side sell stop order. A SELL order is bracketed by a high-side buy stop order and a low side buy limit order. (Interactive Brokers)

In some illiquid markets it is not wise to show your intentions since you might get taken advantage of. This is why knowing your market is so important. In this case, you can set trade triggers based on price movement so that your orders do not hit the book until the right catalyst triggers an order.

Step Four: Trade Your Plan

This step is not always as easy as it sounds. Place your orders and wait for the market to fill your requests. Make sure to always place limit orders. Market orders are for suckers. If the market runs away from you, do not chase after it. Chasing momentum is the equivalent of pissing down the drain of financial ruin.

Step Five: Protect Your Profits

In summary, if you follow these five simple steps during your trading adventures, you will be able to increase your chances for making consistent profits in any market.

The American economy is in the deepest economic depression since man started keeping track of artificially created economic events. I am pretty sure that I am not the first to tell you that the economy is not getting any better for your average person. Consequently, there are not enough retail investors who are both ready and able to prop up the markets. These same retail investors are the ones who took a hit in their retirement accounts on the way down to the print-of-the-beast: 666 on the SP500. So where is the money Lebowski?

One word, seven letters, two syllables: Bailout

I am a strong believer in the notion that the bailout money has been put to good use by propping up the markets since early March. The sad fact is that the bailout money is our money, yet it has gone to the banksters. It’s a pretty simple racket if you ask me. A bank such as Goldman Sachs, JP Morgan, Bank of America, or Wells Fargo goes to The Fed, trades some worthless collateral (mortgages, toxic assets, business cards, legal pads, office supplies) for dollars to shore up their reserves, and also uses the money to invest directly into the stock market. First they dial in some leverage at some ridiculous level…maybe 30:1 or higher like Lehman or Bear? Next, they buy low, tell all their analysts to lower their estimates, create a blitz of earnings that outperform said estimates, and then they sell high. The same stocks. Again and again. Maybe they use vector-vest for their investment advice, but I doubt it. So who are they selling the stocks to? Gullible retail investors who finally feel like the market is safe again, that’s who, and maybe some lucky foreigners too, although I think the world is waking up to the charade.

Well folks, this trend is unsustainable. In an era of throwing around buzzwords like “sustainability,” the financial industry knows not the definition of such a word. Let’s examine our trusty long-term chart of the Spider ETF (SPY) and see exactly why we’re in for some puzzling times. Ladies and Gentlemen, may I present to you: “Bernanke’s Conundrum”

Bernanke's Conundrum

We begin our charting adventure in 1994. Something happened and the market took off. They call this something “the tech bubble,” and what a bubble it was. The Spider (SPY) went from roughly 50 points to 150 points in the span of six years. Not bad, eh? A meager 200% gain in under a decade. A glance at the chart below will show you a clear picture of the tech bubble, AKA the first economic top.

SPY 1993-2009 First Top

If you will also notice, I have drawn a line from the start of the bubble to the top. The cool thing about my charting application is that it will draw these really neat little “fibonacci fans,” and sometimes they can be downright scary.

You can see that the second uptrend, which began in 2003 and topped out in 2007, coincided perfectly with the 61.8% fibonacci fan-line. It’s not really much of anything in retrospect, but it is pretty uncanny how the market oscillates along very natural and predictable patterns.

SPY 1993-2009 Second Top

We all know and love this second bubble. We love it the same way we love redheaded stepchildren. Apparently the dotcom crash was too much for The Fed to deal with and they decided it would be best to peddle adjustable-rate-mortgages to people with no prospects of ever repaying the banks who originated these loans. What a great idea that happened to be. Housing Crrrrrrrrrrash!

So here we are. We have come full circle, so let’s talk about what has happened in the last three years and try to understand what lies in store for the future. Have a gander at the chart below:

SPY 1993-2009 Support and Resistance

This final chart is Bernanke’s Conundrum. Interest rates are Bernanke’s conundrum. Inflation, Stagflation, and Deflation are Bernanke’s conundrum. This man is between a rock and a hard place that can be summed up with a Sheakspearian question that I have translated into financial-speak:

To inflate, or not to inflate: that is the question.
Whether ’tis nobler in the mind to suffer
The slings and arrows of outrageous inflation,
Or to take arms against a sea of deflation,
And by opposing end them? To go into bernankruptcy.

Based on history, The Fed has let the dollar weaken for something along the lines of 97 years. To no surprise, this also happens to be the entire history of The Fed’s existence. That’s not a bad track record for an organization whose mandate is to control inflation and maintain price stability. In essence, they are doing a wonderful job. Inflation is always there, but it’s a controlled incline, so all is well. Additionally, prices are quite stable too. As long as stable means constantly increasing over time, then yeah, The Fed is a winner. They have always chosen inflation. They live, eat, sleep, and breathe inflation. Inflation is the lifeblood of the Federal Reserve.

With that being said, if you have been reading my blog for any amount of time, you will know that I absolutely love support and resistance studies. As I have mentioned before, you do not really need much more than a good support and resistance study to come to any kind of conclusion about the state of a given security and/or market. The beauty of support and resistance is that it tells the entire story in a few simple lines on a chart, so let’s examine Bernanke’s Conundrum via the SPY ETF:

I have chosen the SP500 for this study because it is a fantastic representation of the American economy. First look at the red line. That is a visual representation of the upper limit of the American economy over the last 15+ years. We hit a peak in 2000 and we crashed to the green line (around 800 on the SP500). In 2007 we hit the economic top yet again, and we collapsed to the previously established major support zone, albeit with a tiny (and scary) breakdown to 666.

Between the red and the green lies an orange line of uncertainty. This line is the neckline of the greatest double-top the world has ever seen, and it is the defining line in Bernanke’s conundrum with regards to inflation. If Bernanke decides to continue to inflate our way out of this, and the economy picks up, we will see the SPY go up-to, and possibly past this resistance line as the market breaks out above the 200 day moving average (the wide gray channel in the chart). I personally believe that if we see the kind of inflation that pushes the market higher than the orange line, it will be hyperinflation, and nobody likes that. There is no way that the Dollar can get stronger and the market go any higher. They are inversely correlated at this point in time, and when one gets weaker, the other gets stronger, and vice versa.

On the other hand, if Bernanke decides to land his helicopter and casually deflate this mess, look to the green line for support. Should he choose the deflationary route, the market will collapse to the lows at the $80.00 price level. Should the $80.00 level break down, you better put your head in the sand because the next major support level is slightly under $50.00

In addition to the inflation and deflation outcomes, Ben Bernanke can also keep the markets deadlocked between the green and orange zone ($80-110). This could happen considering he has only one real weapon left in his inflation-assisted-arsenal: rate hikes. I would venture to guess that he will not hike rates until the market surpasses the neckline in the chart.

In conclusion, the key issue here is not if we will test these support/resistance levels, but rather, when we will test them. It’s all a matter of time. I personally believe that this scenario will pan out at some point in the next 3 years. With a long-term strategy in mind, I prefer to simply pick a side and hedge it with an inverse ETF. I generally like to hedge 50% of my investment at the bare minimum. As the market changes, I can dynamically add-to or subtract-from either side of the trade and skew my bias towards one trend or another and take advantage of profit-generating opportunities as I see fit. How would you trade this? What do you think is going to happen? Leave a comment.

The second thing that makes me want to short the Dow 30 is the rounding-top style chart pattern that is starting to unfold before our eyes. The rally is starting to get overextended and is equivalent to the effects of gravity on a rocket losing thrust. Third on the list is the Money Flow. I don’t think the money will continue to pour into the market much longer since stocks are quite overbought as a whole.

If you think about it, most stocks have seen astronomical gains in the last 2 months, and the overall fundamentally craptastic story hasn’t changed. The criminal bankers falsified their earnings recently and quite frankly, I’m surprised there weren’t riots over the kind of theft in broad daylight that we saw. The situation today is no better than it was in February before the rally. Markets are still dislocated, liquidity is dried up across the board. To me, this rally is irrational.

Dow Daily Chart

I would also like to include another chart in my analysis. This chart is focused more for the long term, but it gives a nice picture of exactly where we stand in the grand scheme of things. This is the chart that scares me.

Dow Point and Figure

This, my hope-indulgent friends, is a point-and-figure chart. These charts are all about price. No fancypants technical indicators here, no voodoo black-magic oscillators there. Just good old fashioned price patterns.

Let’s start at ’09…right about the time Obama came into power. The dow tanks from 9000 => 8000 in a glorious freefall. People stopped, thought about the nonsense for a bit, then tanked it some more…all the way down to 7000 by the beginning of March. The absolute bottom (as we currently know of it) rests at about 6450 on the Dow.

This brings us to the present, and the discussion of “where are we going?” We’ve made progress. We’ve retraced 50% of our losses from the bottom. Fibonacci patterns are in full effect. The market is at an inflection point and it can really go either way, but the market usually follows the path of least resistance, and last time I checked, gravity doesn’t make us float, does it? Say we make a recovery, where are we going? Probably up to around 8450 or so.

Now, let’s just say we don’t make a recovery any time soon (I think this is a much more likely scenario). Where could the Dow go? Stockcharts says 7400 and I say that’s plausible. It’s slightly above the 50% retracement level and also it’s roughly at support on that major market U-turn. Worst case scenario is that we go to lower…much lower, but then again, the market can only go to zero before we have nowhere to go! In all seriousness, however, I believe we could easily see 7600 without much hesitation. All it takes is a few bankruptcies (GM anyone?) and the liquidation of some assets to depress prices.

One more thing that concerns me in the P&F chart is the volume. Look at the buy volume (it’s black) and pay attention to how it is decreasing. Sell in May anyone? Also, look at the sell volume (in red) throughout this whole rally. It has been rock-solid and consistent. People have been selling into this rally and they’ve been doing it with strength and with consistency. Tread carefully and trade cautiously. The market will eat you alive if you’re not paying close attention.

The price of natural gas has been beaten down like a redheaded-stepchild who just came home from school with a bad report card. If you take a look at this chart you can see that Natural Gas has been sold off for the last 9 months. That’s a pretty strong trend and I think it’s time for a turnaround. I like the curve in price we’re seeing. It’s showing me that the rate of decline is decreasing. Seems like your typical exhaustion pattern.

UNG April 2009

Look at the technical indicators:

• CCI at -101 (oversold/at support)
• MACD nearly -5 (oversold)
• Stochastics at almost 9 (oversold) 

Here’s the thing. This is not a short-term chart. This is roughly a two-year chart we’re looking at. Give yourself some time. Inventories are at record highs, industrial production is at record lows, we’re in a depression. Oh well, who gives a shit. The fact of the matter is that natural gas is cheap as shit and there’s value to be found in buying it now and selling it during hurricane season (August).

Sure sure, you’re probably thinking to yourself “what a heartless scumbag! He’s looking to capitalize on the potential misfortune of others for his own personal financial beneft.” Let me tell you something, you’re totally right. Trading is immoral.

In the interest of disclosure and transparency, I would like to let you know that I am currently holding an out-of-the-money call option for October 2009 expiration.