Off the Charts

One of my funds consists of a mix of long and short US-traded equities which are held for a relatively short time (about 2 weeks). During bull markets, the fund only consists of long stocks; I've found that in strong up markets I'm lucky if I break-even on the down side, so I just don't play them. The long portfolio is divided into two categories: the first consists of high-cap, more blue-chip type stocks that exhibit stable chart patterns (low beta), and the second consists of lower-cap stocks that are more risky but who are showing good momentum. These are my “rocket” stocks. They usually trade under $30 and above $2, although I have held a few penny stocks that have shown good chart patterns on decent volume and have done well with them.

I add and subtract stocks from the portfolio daily, and search through hundreds if not a thousand charts to find my candidates. Final selections are made by further scrutinizing the charts not only a daily basis, but on a weekly, monthly, and sometimes quarterly basis. I also make sure that the 5-minute chart is “behaving” in a reasonable manner. I tend to discard low volume stocks unless they exhibit a healthy looking 5 minute pattern, meaning the price is more than just a random walk. Once the field is narrowed down, I check to see if their are any potential market moving events coming up. I look at earnings dates in particular. (Earnings dates can be gotten from various financial sites. Yahoo! finance is one, but I find fulldisclosure.com easier to use.) In general, holding a stock over it's earnings release can be disastrous. It could be beneficial, too, but I'd rather not take the risk. If I have enough time, I'll check the news on a stock to see if there isn't something negative happening with the company such as pending litigation (stock holders lawsuits, accounting irregularites, etc.) or failure to file the appropriate forms with the SEC. These could all negatively impact the price.

During neutral or slightly down markets, I exit the rocket portfolio, lighten up on the big-cap long one, and initiate short positions. The number of shorts is half the number of the longs. The reason for this is that making money on the short side is riskier and the pool of potential short candidates is usually much lower than the pool of longs. During extremely volatile markets such as what we're going through now, I exit all portfolios. Cash, in this case, is king. I might play the occasional index straddle, but that's about it.

But I still surf the charts. Why, when I'm not going to be buying anything? Because perusing the charts gives me a sense of the market internals. Charts are a direct peek into the collective minds of traders.

What does this mean for today? I'm glad you asked! Today, I'm seeing a lot of upward momentum in the homebuilders and regional banks, but it's accompanied by much lower than average volume. This means the rally doesn't have legs, so if you're dying to buy into them I'd do so with a smaller percentage of capital. If the price action is subsequently supported, then you can start buying them with more conviction incrementally. Just in case.

The best homebuilder charts today are: SPF, WCI, OHB, and KBH. CHCI is the biggest percentage gainer on larger than average volume, up 62% to $1.20. There's no news to account for the dramatic price increase and it doesn't seem to be short-covering, either. But as fast as these small cap stocks can rise, they can fall even faster. I'd stay out of this one for now. WCI broke resistance yesterday and is steaming up 13% today. SPF and OHB are nearing resistance levels of 4.10 and 5.00 respectively, and if they break those on decent volume, I might be a buyer.

But beware! I still don't think the banks and homebuilders will be returning to the halycon days of recent years anytime soon. The credit mess is still unwinding and pundits such as Andrew Lahde, the current master of the universe in hedge fund world who bet big-time on just this scenario happening, believes that we've only begun to feel the pain.

On that sour note, I think I'm going to fix me a sandwich with the left-overs from that yummy pork roast Fifi made last night. (Burp) Speaking of my domestic dominatrix, she got up this morning at the crack of dawn and exited the short leg of the straddle that I knew she put on yesterday. She's out now spending some of the profits. Maybe she'll buy a little something for the person who gave her the idea...

Hope springs eternal.