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Newsletter May 20, 2006 Are You Self-Confident? Market & Sector Review There is Opportunity in Crisis? Largest Changes This Week This Week's Economic Reports Are You Self-Confident? Experienced traders don't follow the crowd. They lead it. They anticipate and capitalize. Seasoned traders, make a careful assessment of the factors driving the price. With experience they have come to trust their instincts when devising and executing a trading plan. They look inward and trust their intuition. They go their own way. This is not unwarranted cockiness but confidence and intuitions gained through experience. Going your own way isn't easy. It takes guts, courage, and confidence. It's extremely difficult for most to take a risk when there's a good chance that the path may lead to a devastating blow. To take such risks and rely solely on your intuition, you must have rock solid confidence. It can't waver. This is not the confidence gained with a rise in your account balance that will fall and waiver during a drawdown. It's a confidence based on feelings that reside deep within your psyche. Self-confidence should be so ingrained within your being that nothing can shake it. The more genuine self-confidence you have, the more profitable you'll trade. Some traders appear confident, and they are to some extent, but mostly as long as everything is going their way. Few have rock solid confidence. With most people confidence waivers; it can be super high even to the point of arrogant overconfidence when they are on a roll, but it can plunge to the depths of despair during long setbacks. This is a false sense of confidence. Some will appear confident on the surface, but is it merely because they have always been "king of the hill." Much like living your entire life in a small town where everyone knows you, where all is familiar, and you feel comfortable and secure. In the end however, self confidence only comes from mastering various life experiences. Unless you've overcome life's barriers and successfully triumphed over hardship, you will never truly feel you can tackle anything. This is true in life and it is true in trading. Unfortunately many new traders' learned to trade during strong bull markets where prices go up, up, and away, and they feel they just can't lose. Remember all those long-term investors during the 1990s that thought they could trade just because, through little more than luck, they picked a company that just happened to go up due to media hype. That's not trading. If you want to be a truly robust, winning trader, you have to look at the dynamics of a stock, study the factors that underlie the price move, and go with your instincts. The more you trade in such markets, and succeed, the more genuine self-confidence you will have, and the more profitably you will trade. There is no substitute for experience. Bull markets can make one feel like a natural born trader, but when the markets change, and change they will, and profits are suddenly elusive the confidence turns to despair. This is the time you must look within you and decide whether to go away or do whatever it takes to master the markets. It will not happen over night but if you persist and gain as much experience as you can, eventually you will gain mastery. You don't need to trade like a superstar. You just need to know precisely when you can trade profitably and when you choke. When you achieve such self-knowledge you will gain the confidence to trade well. Once you have developed that rock solid confidence, you'll achieve long-term financial success. Market & Sector Review There is Opportunity in Crisis? - Confucius I'm not sure if the above quote, from memory, is exactly accurate but I think you get the point. Let me preface this week's newsletter by saying the action on Wednesday and Thursday has potential ominous implications for the market, short term moves notwithstanding. We have been discussing the internal deterioration taking place for quite some time however as we observe such things we can never know with any degree certainty, the when. The when was obviously this past week? The market is severely oversold and due for a decent rally, the big question, is will volume come in on the upside or will it be lackluster? If the volume is lackluster; the path of least resistance should be down. If the volume is large on any upswing then this will prove to be just another correction. Caution and preservation of capital should be your guideline for now. It is no secret that I believe the market to be in a topping process, a process that can take a very long time. When one suspects a major top is at hand a change in strategy is warranted. As an intermediate to longer term trader I have three choices: shorten my time frame; begin to accumulate short positions for the intermediate term; or just stand aside and collect interest at the new higher rates. The choice was simple, shorten my time frame and reduce position size regardless if longs or shorts. For most of this year I have been unable to become enamored with any sector or group on an intermediate term basis. If you are a longer term investor however, it was reported this week that Warren Buffett is initiating or adding substantial positions in: Conoco Phillips (COP), General Electric (GE) and United Parcel Service (UPS). While probably the greatest value investor of all time, Mr. Buffett has never been known for his timing. Last weekend I received an email from a good friend asking an interesting question about last week's newsletter. He was curious about the presentation of the NASDAQ-100 chart and the support lines drawn. Was I suggesting a possible low-risk trade as I did in March when the NASDAQ-100 made a third bottom? I answered simply that in essence yes, but only if the scenario I laid out of a sharp down Monday was followed by "turn around Tuesday". If you recall back then the NASDAQ-100 chart contained an obvious head and shoulder formation. Nearly everyone was focusing on that formation and anticipating a break. As Joe Granville so aptly pointed out many years ago "If it's obvious, it's obviously wrong"! At the time no other index was threatening to break down from such an obvious formation, in fact most looked as if they had just undergone a small correction and were about to rally. The observation: can the NASDAQ-100 break down while the rest of the market advances? While that was certainly possible the probability was very small. The important point at the time: a low-risk opportunity was presenting itself. Should the NASDAQ-100 break down and drag the rest of the market along we are out with a minor loss (just part of this business). However should the market rally chances are it will pull the NASDAQ-100 along. At that time we built a watch list from this index of AMLN; BRCM; CELG; CHRW; ESRX; EXPD; GILD; JOYG; LRCX; NTLID; PIXR; RHAT; SNDK; most of which had nice moves. Can we do it again? Let's try! This time we were in a similar but not exactly the same position. Since the scenario did not happen as I had hoped we need to change our outlook just a wee bit. If the assumptions are correct then I would expect: either we build a base before the next rally, or we experience a selling climax (capitulation). We decided to work together to find candidates for a rally should capitulation indeed occur and develop a strategy. Suggestion: If you do not have a good friend who shares this passion with whom you can converse freely; find one! The following is intended to take you through a thought process; not to recommend buying or selling; and certainly not to brag or cry if the following pans out or does not pan out. It's merely one trade amongst many. It is the thought process that I believe to be important. We met Tuesday evening for dinner, discussing possibilities and strategies. During our initial discussions we both were thinking of either playing the Q's or looking for stocks within the NASDAQ-100. We shared the thought that the technology sector may be attempting to bottom and could lead any new rally. Here was the initial plan before dinner basis the QQQQ: Together we perused the Index Reports: Relative Strength Tables. Here is what we noticed: the SOX (Philadelphia Semiconductor Index) ranked higher (in six month relative strength vs. the broad based New York Stock Exchange Index) than the NASDAQ-100, higher than the NASDAQ composite index, and higher than the DOW, S&P-500, and the Russell 3000. Other than the AMEX Disk Drive Index the SOX was the highest ranking technology group. We immediately became intrigued. I had recalled reading recently the semiconductor industry performance was more Intel specific than an industry problem. Let's take a look at another Prudent Trader feature (compare component stocks by selected indices) note: several columns have been eliminated so the picture will fit. Philadelphia Semiconductor Index Components: Take note of the circled items above: Relative Strength percent rank; short, intermediate and long term trends; as well as the Prudent Trader accumulation/distribution model. Two stocks come to the forefront: Freescale Semiconductor (FSL) and Infineon Technologies (IFX); Broadcom (BRCM) and Advanced Micro (AMD) also in excellent positions. Wednesday morning the CPI (Consumer Price Index) release caused the pre-market futures to virtually collapse, perhaps capitulation is at hand. Potential low risk opportunities are present? I thought so but only for the short-term nothing more. We both nibbled at these stocks near the close of Wednesday's session and during the day on Thursday. The position sizes are greatly reduced from our normal activity and the risk is small (key factor). Personally this is not my preferred style or time frame however; from time to time market conditions will force us to change our style and preferred methods. As of this writing I have no idea if our trades will work out, if we wind up losing it will not be our first or our last. If we win we will certainly have earned it. I hope you enjoyed and can understand the thought process that occurred; perhaps it will help you find opportunity in some future crises, whether or not this particular exercise works out. I think this is also a good exercise utilizing the plethora of informaton provided on this site. Let me leave you this week with an exercise that may prove useful, but you will have to look and see on your own. Pull up a chart of any major average and scroll back to March of 2003. Notice the action from March 11 through March 21 (hint: 8 consecutive up-days off the low). Now scroll forward to the present, do they look almost identical only in reverse? Note in your mind what happened subsequently then and compare it to where we are now. If you were trading then reach down into your subconscious and see if you can recall the current sentiment (bullish or bearish). Now look back into the options data; was it also and OPEX week? Draw your own conclusions but eerie isn't it. Largest Changes This Week During the past few weeks quite a few new members have come aboard. At least in part due to mentions by an excellent stock market blog. One I read quite often, The Kirk Report. If any of you wish an explanation of the following report, which appears each week in the newsletter, or any other aspects and data provided by the Prudent Trader, please send an email by clicking the contact Prudent Trader box above the heading. I will answer as soon as possible. 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.