Sidelines Continue Looking Good

Sidelines Continue Looking Good

In our last article we suggested taking profits on dollar longs and short commodities and moving fully to the sidelines.  One of the beautiful things about investing in markets is that you can pick and choose when to take a risk, and WHEN NOT TO.  One of our favorite rules of trading is summarized in a quote from the legendary W.D. Gann - "when in doubt stay out, and don't get back in until you're sure." 

Imagine you have come up with the ultimate card counting system for a three-deck shoe of black jack.  If you bet 10 times the minimum bet when the card counting tells you that you have the highest statistical odds, and scale between 1 and 10 units of the minimum in between, over the long run you will make money.  Now you have to get so good at counting that you can do it in your sleep.  You get a team together, with counters at each table so that when really good hands develop they signal you and you bet big money to maximize the edge.  Suddenly the house just starts losing every single hand on every single table repeatedly but the card-counting odds remain unfavorable.  Do you bet because there is so much money changing hands?  Of course not.  You stick to your strategy and only bet when the odds are favorable.

In stocks it's even better.  You don't have to bet the minimum to have someone keep count of the cards.  You can just wait and wait patiently until the odds and the reward/risk of trading become favorable according to your strategy and then pounce - staying on the sidelines the rest of the time.  Jimmy Rogers once said that he only invests when they are practically giving money away its so clear and easy.  That ain't now folks!

The markets are not even fully functional with short-sales prohibited on over 7200 stocks globally.  Markets are trading on rumor.  Washington's actions are dominating trade.  The volatility is historic.  Credit markets are melting as interbank rates soar both here and in Europe.  It is not clear that even a belated Congressional vote is not too late to avert a complete market meltdown.  Yet the VIX and many capitulation tools are at overdone levels which could mark a bottom at any time.  What to do?  Wait until we get a valid signal of a capitulation low (90% up-day or close from here) and then a valid follow-through day with strong volume and breadth, and only then start looking for breakouts and new leadership.  Until then the cards are not in your favor.  Watch the carnage without getting hurt and be glad you're avoiding it!

It's often hard for traders and investors to sit on the sidelines in T-bills.  We've been suggesting caution and heavy t-bill and alternative asset classes all year.  Our Top 5 Rate/Index RS model has been in cash virtually all year.  Smile!  The sidelines are a wonderful place to be here.  Yes they pay little, but the opportunities for substantial gain once the market clearly shows a bottom grow daily, the worse the market situation gets.  Now you just have to wait for the incredible opportunities now building to ripen on the vine before picking and eating them.

We've suggested that an RTC-type systemic bailout of the mortgage/housing market was likely to be required before this bear market ended since August of 2007.  We strongly suspect that even this dysfunctional Congress will actually pass something, though the question now has become whether it is too little too late.  This will help prevent a complete financial meltdown of the excessive debts that a fractional reserve central bank system creates over decades.  Otherwise a negative debt spiral will unravel into global depression.  That's just unlikely to be allowed politically in a mixed economy.  This weekend we are publishing PSL for October and we discuss the global financial crisis, its origins and solutions, as well as the likely market reactions from what will be passed in substantial detail.  Readers of this column can email us at staff@investmentresearchassociates.com to request a free copy.   This is the most critical market crisis since the 1930's and understanding it fully is absolutely critical to investing in the period ahead for many years.  We cannot cover this vast subject in this small column, but suggest that those reading this get a free copy of our PSL newsletter to get a clear understanding of what's happening and what it is likely to mean and what to watch to determine how to invest ahead in this massive global crisis.

Our long/short strategy remains happily 100% in T-bills awaiting new trades.  Since our last update we got close calls on the buy side from nothing, with close calls on the short-side from GNW, AMAT, AXP, LRCX, HTCH, SKS, CBG, CBEY, and no valid signals either short or long.  Check out www.midasresourcegroup.com for daily listings of Top EPS/RS New Highs and Bottom EPS/RS New Lows to make sure you catch all potential breakouts meeting our criteria.  As the chart at the bottom of the page illustrates, we do not have top RS/EPS new highs or bottom RS/EPS new lows in a clearly dominant position (40 over the other for 5 or more days in a row) to signal a good environment for either long-side or short-side dominated activity. This is often the most dangerous, volatile, and tricky phase of a bear market and with neither breadth nor volume or leadership strong in any direction right now, we suggest the sidelines heavily.

For those not familiar with our long/short strategies, we suggest you
review my book "The Hedge Fund Edge," my course "The Science of Trading," my video seminar, where I discuss many new techniques, and my latest educational product, the interactive training module. Basically, we have rigorous criteria for potential long stocks that we call "upfuel," as well as rigorous criteria for potential short
 stocks that we call "down-fuel." Each day we review the list of new highs on our "Top RS and EPS New High List" published
on www.midasresourcegroup.com for breakouts of four-week or longer flags, or of valid cup-and handles of more than four weeks. Buy trades are taken only on valid breakouts of stocks that also meet our up-fuel criteria. Shorts are similarly taken only in stocks meeting our
down-fuel criteria that have valid breakdowns of four-plus-week flags
 or cup and handles on the downside. We then continue to buy new long signals and sell short new short signals until our portfolio is
100% long and 100% short (less aggressive investors stop at 50% long
 and 50% short).   We keep capital in T-bill cash while waiting for more trades.  We have been 100% cash for some time now, and very glad of it in this incredibly dangerous and volatile market period.

The chart below shows that Bottom EPS/RS New Lows are more than 40 over Top RS new highs (available on www.midasresourcegroup.com< /a>), but have not been so for a period of over 5 days in a row which would signal a good short-sale environment.  Short-sales are prohibited on many stocks, they are increasingly difficult to borrow, and since we are not getting blatantly clear valid short sales, we'll stand on the sidelines until the market stabilizes some.  Remember not even surfers try to ride hurricane waves!  Heavy cash T-bill defense remains warranted as opportunities build.