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Newsletter February 18, 2006 Get Rid of Fear Market & Sector Review Largest Changes This Week This Week's Economic Reports Get Rid of Fear Market action is often driven by fear and greed. People acting out their emotions on an individual scale as well as the masses acting out the same emotions almost simultaneously. Dreams of wealth can drive almost anyone to take unnecessary risks the fear of losing however can be even more powerful. As man evolved he learned that unless he protected himself and his resources he wouldn't survive very long, as an individual or as a species. When fear in us is perceived we react quickly we either stand up and are ready to fight or we run away to a safe zone. These emotions also play out in trading and it's worth trying to understand and control our fears. The more you can understand and handle your fear, the more you'll be able to control it during critical moments of trading where it is more useful to stay calm and relaxed. First understand that we perceive fear when we sense a form of impending doom. Gaining a more in-depth understanding of fear may help you control it. In a classic study on emotions Dr. Craig Smith asked people to describe events where they were extremely afraid. For example, fear-provoking events included being mugged, losing control while driving in a snowstorm, or getting lost in the mountains. As might be expected, people didn't find fear to be a very pleasant emotion, but people differed on the extent to which they tried to shut it out and ignore their fear. When people are fearful, they aren't sure what will happen next. They believe that their doom is inescapable, and that they can't possibly gain control of the situation. These research findings have a direct bearing on why you may feel afraid while trading. There are many times when you make a losing trade and feel that you just can't get out of it. The loss is inevitable and you can't control the outcome. You don't know what to do. You don't want to feel the pain of taking a trading loss, but no other alternatives seem viable. Those that know me well know that I am a bit of a kidder and I used to have a saying that "everyone is a short term trader until the position goes against them, then they are in it for the long haul". That may be well and good and it might just work out (it does sometimes) but what if it doesn't are you stuck with it forever? Sometimes removing the pain of taking a loss is nothing more than changing your perspective. In my stockbroker days when I met new clients I would invariably be asked what I thought of their xyz stock that they bought at 30 and is now selling for 10. I knew what they were looking for and that was hope, they wanted to hear that yes I liked that stock and thought it would return to 30 (so they could get out even). But I never once said that, what I did say was listen, that 500 shares you own is worth $5,000, in other words you have $5,000 in cash. Now if you had $5,000 in cash in your wallet right now, with all the things you could do with it, buy a car (at that time you could), put it down on a new house, go on a nice vacation, of all the choices you have would you buy a 500 shares of this xyz stock? It was no longer a question of should I take this 20 point loss or hope, it was now a question of cash and what to do with the cash. They for the most part were no longer afraid of the pain of taking the loss, they wanted the cash. Interestingly and as an aside in all the times I presented their loss in that way I never, not once, not ever, had someone say yes I would by xyz. Events don't make you afraid. It is the interpretation of those events that make you afraid, your mental representation. You are scared because you mentally believe that you are about to get hurt, there is no way out, and that there is nothing you can do. If you were to think instead, I'm not going to get hurt, I have several alternatives I can pursue, and there is a lot I can do to get out of this, you wouldn't feel fearful at all. If you have a properly constructed plan and are following sound money management and risk control then you should not experience fear at all, unless of course, you step outside the bounds of your plan or your risk control strategies for if you do, you are stepping into the unknown and the unknown is where fear flourishes. Market & Sector Review THE GOLD CORRECTION… In the January 7 newsletter I outlined the case for what I believe to be a secular (decades long) bull move in gold and most commodities. At the time I mentioned that gold was about to enter its seasonally weak period and I would look for and then analyze that correction looking for new low risk buy opportunities. Gold has been considered many things from an inflation hedge, a disaster hedge, and a form of and hedge against paper money. I believe the gold correction is now under way. It will in all likelihood be volatile one after more than a double in price since the bear market low in 2001. Personally I am not a short seller into this correction for the simple reason that unforeseen geopolitical events can explode this market on a moments notice. In other words to me that means the risk/reward on the short side is not there. I would much rather miss an opportunity than be caught on the wrong side of a large gap. So what about getting long again? Let's take a look. If you follow the Groups, Indices, or ETF reports you have no doubt noticed that gold remains at or near the top of the 6 month relative strength rankings. Viewing the technical indicator tables on Groups, Indices, and ETF's there appears an indicator RTN, which for newer members merely means caution, we face the distinct possibility that a ReTurN to the 200-Day moving average can happen at any time. Over time you will notice that when a stock or a market advances too far from its 200-Day moving average there is a tendency for it to return towards the 200-Day moving average or at least stall until the 200-Day catches up. This indicator display states sell when the stock or market is 20% or more above its moving average and buy when it is 10% below. It is not a timing indicator it is a warning notice that the market may be entering in the case of a sell a possible reversal or stall and caution needs to be exercised. If you are not long, you are not at an advantageous price area to get long with minimal risk. In my humble opinion controlling risk is what trading is all about, regardless of your time frame and style. In any case the gold stock groups and indices have been on a sell by this indicator since early December, while the price of the physical metal did not reach that level until early January. OK so the correction should be underway, how far should it carry and for how long, ah the $64,000 question? Let's see if we can't apply some technical and seasonal analysis to come up with an outlook. First the metal itself, with a regression channel drawn from the 2001 low and 2003 high and then right extended through today. Also included on this chart two Fibonacci retracement models: first leg 2001 through 2003 high and second from 2004 low through current high. Take note of where the first Fib correction held in early 2003 and where the same level is on the current Fib correction points. Could the levels be the same? Notice how this regression channel has pretty accurately defined this market with periodic reversions to the mean (center line or below). The center line is currently just under $520, the bottom line $470. To summarize previous bottoms have occurred: The 65 week EMA (displayed on first chart) -> currently ~ $466 and rising; Price at or just under the 40-week or 200-Day SMA -> currently ~ $470 and rising; RSI – 14 week around 40 (just a bit under or over); Reversion to mean level of regression channel -> currently ~ $505 and rising; Channel bottom -> currently ~ $463 and rising; October 2005 high (old highs become new lows) -> $456; Fibonacci 38.2 % correction (Not shown) of entire move from 2001 -> $450; Fibonacci 38.2 % correction from 2004 bottom -> $498; Fibonacci 50% correction from 2004 bottom -> $472. Divide these numbers by 10 in order to equate with the gold ETF's: GLD and IAU should you wish to enter via them. How about when? Let's apply some Fibonacci time zones on a daily chart. Notice how the Fibonacci time zones were extremely accurate from March 2005 high to the through in June and again in July. Applying those same time zones to the early December top we come to possible low in the beginning of March which should bode well for at least a good rally. If the beginning of March does not hold then we have to look to the beginning of April. This gives us an interesting window to apply our favorite short term trading indicators. Remember in my humble opinion if we are prepared then we can act when the time is right instead of becoming all beared up and looking to short at precisely the time we should be buying. A potential strategy I am considering (always subject to change) is to buy a pilot position at approximately $500 (perhaps a 10% commitment) the approximate center line of the regression channel, add to that position with another 10% commitment near the bottom line of the rising regression channel (around $480 in a couple of weeks) and risk to about $450 on a close basis. The position will then be added to as the uptrend resumes, if it resumes, and above the first entry level. This is not to say events will unfold the way I currently see them but personally I like to have a plan of attack laid out, then adjust it as needed. Next let's quickly move on to and look at the gold stock indices, XAU (Philly Gold and Silver) and HUI (AMEX Gold Bugs). From the above charts you can see a similar picture to the physical metals charts but take note of one important fact. There is a tendency for the stocks to lead the metal, it is only a tendency and doesn't have to be. Outlined above are potential Fibonacci correction points along with a line representing the high points of 2003/2004, and we all know the old adage "old highs become new lows", notice how gold is attempting now to hold at the December highs. Putting it all together I am expecting (maybe hoping for) the correction to carry these indices towards XAU -> 115 to 120 and HUI -> 250 to 260. I would be very surprised if we see a V bottom but perhaps some base building in that area first. What I am attempting to do is outline a plan of attack for everyone. Things may not play out as I have them outlined, they usually don't exactly, but having a plan of attack will help you recognize when the time is right. One final point, if gold were to decisively break the $460 level we must consider the possibility that the secular bull has been interrupted with a cyclical bear. If you visit the members area under the heading Sector Analysis, Compare Stocks by Industry Group - Gold - MG135, or Compare Stocks by Indices - Philadelphia Gold and Silver XAU or AMEX Gold Bugs HUI and you will get a good list of component stocks along with a plethora of valuable information -> Use It, profit from it! Largest Changes This Week 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.