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Newsletter January 21, 2006 Dealing With The Unexpected Market & Sector Review Largest Changes This Week's Economic Reports Dealing With The Unexpected In light of this weeks earnings and market activity, this may be a timely topic. Winning traders try to stay in control by not letting their emotions influence their decisions even when the unexpected crops up. It is quite normal when we are caught off guard to react emotionally, that's human nature, however, one of the best ways to handle getting caught off guard is to remain calm and logical, which in turn will reduce our psychological stress. Trading in and of itself is stressful. With each trade your money is on the line and you are aware that you may have to deal with a loss and perhaps a blow to your ego. You have to take it all in stride and not allow yourself to be overwhelmed by it all. Feeling flustered is very natural but you need to reduce as much background stress as is humanly possible. When background stress is great, even a minor setback can set you off. Instead of flying off the handle prematurely, it's better to reduce background stress, and thus, increase your ability to handle unanticipated events. An effective way to reduce background emotional stress is to make your trading environment as stress-free as possible. For example, it is critical to use proper risk management. If you risk money you can't afford to lose, or risk too much of it, you'll feel the pressure, increasing background stress. On the other hand, if you minimize the amount of money you risk on a trade, you'll be able to tell yourself that the actual downside is bearable. You'll know you can easily survive the worst-case scenario, and that will help you feel comfortable. Also it's extremely important to have a detailed trading plan with specific strategies for how you will enter and exit each trade. Taking specific precautions to gain as much control of the trading environment as possible will reduce your overall feelings of stress. In addition to managing background stress, it is also important to anticipate as many possible adverse events as possible. It's impossible to anticipate everything that can go wrong, but the more you can specify what can go wrong, and have a plan to deal with it, the more you'll be able to handle the event when it happens. For example, be aware that earnings reports, rate hikes, or major political events can impact the markets and play havoc with your trading plan. If you get caught off guard, you may not handle the situation very well. You may get overly angry or frustrated, and act on impulse, rather than calmly and rationally. But if you decide beforehand how you will deal with the event, you'll react more decisively. Being on-guard and ready to take action, and you will get through unanticipated adverse events without getting bogged down by them. The more you can reduce background stress and react to unanticipated events decisively, the more profitably you will trade in the long run. Market & Sector Review A natural extension of last week's letter on oil is to talk about another energy group, Natural Gas. Before I get started on Natural Gas a little follow up on last week's letter. I did not cover any Independent Oil and Gas Exploration and Production companies however, this past week it came once again to my attention that one, Chesapeake Energy (CHK) has been undergoing what you might consider substantial insider buying. You may check out the activity for yourself here:CHK Insiders who better to guide you than the CEO. Natural gas is primarily methane, the lightest hydrocarbon molecule. Not only is it used to heat many homes, it is also burned to drive turbines in electric generation plants, and as a feedstock to produce the agricultural fertilizer ammonia. After crude oil this may be the most important economic commodity in the U.S. Natural gas accounts for almost a quarter of United States energy consumption. Natural gas can be efficiently moved via land pipelines, undersea pipelines are uneconomical and impractical. Therefore natural gas markets remain largely regional or at the very best continental. There are vast amounts of natural gas in remote regions of the world but transporting is not as yet possible. Natural gas can be super-cooled (-260 degrees F) which shrinks it volume substantially and this LNG can then be transported from the remote regions where the natural gas exists. One day LNG tanker fleets may rival oil supertankers, however there are currently no ports set up to handle them and it will probably be 5 or 6 years before we have such ports. Thus for the foreseeable future natural-gas demand growth will exceed supply which in turn should keep prices relatively high. OK so we have a multi-year bull market in affect (an extremely volatile bull market), how do we take advantage and make money. Last week we looked to the Amex Oil Index for stock ideas, this week we will move on to the Amex Natural Gas Index (XNG) which contains 15 component companies primarily involved in natural gas exploration and production as well as natural gas pipelines. With a sector index to track as a proxy for natural-gas stocks in general, we can examine how gas stocks have tended to trade so far in this bull market. By examining their technical behavior including typical up-legs and corrections as well as their correlation with potential drivers including natural-gas prices, we can greatly improve our odds of discerning major interim lows and highs in the future. Then we can attempt to buy low and sell high and ride this gas-stock bull. Buying low and selling high is what we are all about isn't it? First let's take a look at the futures market for natural gas (Henry Hub), i.e. the raw material price of this commodity. The price is based on delivery at the Henry Hub in Louisiana, the nexus of 16 intra- and interstate natural gas pipeline systems that draw supplies from the region's prolific gas deposits. The pipelines serve markets throughout the U.S. East Coast, the Gulf Coast, the Midwest, and up to the Canadian border. It is easy to note from the above chart this is an extremely volatile marketplace and compared to crude oil or gasoline relatively thinly traded. This market is only for the most well heeled, experienced traders, willing to assume the risk inherent in it. Also notice that even with this recent collapse which could go even further the price is still about 4 1/2 times what it was only 4 years ago. Now think what that means for the profit margins of producers. In the various reports the Prudent Trader publishes is an indicator referred to as RTN or return to the 200 day moving average. If a stock or group is trading more than 20% above its 200 day moving average you receive a sell, and if it is trading 10% below its 200 day it receives a buy. This is essentially an overbought/oversold indicator. Let's convert the 200 day moving average to a 40 week moving average (essentially the same thing) and see how our sector index trades with this indicator. Note that since this bull market began the Natural Gas index has never become oversold by the very definition of this indicator on a weekly basis. It has however, made bottoms when this indicator reached the 105 or 106 level. The fact that this index has not become oversold by this indicators definition is indicative of the strength of this index. Also note that this index does not exhibit the volatility of the underlying commodity, nor does it seem to lead or to lag. A good way to anticipate and play these stocks is to wait for this indicator to approach the 105, 106 level (just divide the index closing price by the closing price of the 200-day moving average), then compare the stocks within indices and look for the strongest. In the face of the recent collapse of the commodity itself and the position of the index chart, this appears a bit overextended at the moment. What I believe you want to do is take advantage of corrections towards the points mentioned to enter advantageously with reduced risk exposure. Largest Changes This Week's Economic Reports Have A Great Week! Bill Disclaimer: Trading in securities, of any type, may not be suitable for all individuals. The contents of this newsletter are not a solicitation to buy or sell securities. The opinions expressed are solely that of the author. You must do your own research, contact your own financial advisor for suitability of any investments. Data gathered is from sources believed to be reliable, but NO guarantee as to their accuracy is made.