Stock Trading Review Of The Week of May 17 - 21, 2010



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Content

  1. Wrenching Volatility - Staying Sane During The Insanity

  2. Making Sense Of The Market’s Hysteria

  3. Prediction of Next Week’s Market Behavior

1. Wrenching Volatility - Staying Sane During The Insanity

The market whipsawed as volatility was the order of the week.

As the market continues to obsess over Europe, any news from Europe is viewed with suspicion and trepidation.

On Tuesday Germany announced that it would ban naked shorts (selling an instrument you do not own) of stocks and bonds.

The immediate reaction was for stocks to sell off.

If you were listening to the financial networks, you would believe that this was cataclysmic.

On Thursday, the Dow dropped another 376 points - its largest 1 day loss in over a year.

Even during the flash-crash of May 6, the market recovered sufficiently to trim its losses for that day to less than 376 points.

Thursday’s drop was due in part to :

A. the market was still reeling over the German announcement and

B. the additional fuel which was poured on by the US Government’s report that more people filed for jobless benefits which is a bearish report.

2. Making Sense Of The Market’s Hysteria

The up tick in joblessness is the first in a while but one report does not a trend make.

Also, regarding the German announcement, sure, short sellers howled as loudly as they can because they could no longer benefit from those activities.

Overall, though, banning naked shorts would be taking out some speculation and leverage from the system.

This would reduce the market’s vulnerability to rogue behavior like those that occurred during the market collapse at the end of 2008 and more recently on May 6.

There is clear precedence to the benefit of banning naked shorts.

One of the tools used to stop the destruction of the financial stocks was the ban of short selling of stocks during the financial crisis of 2008.

Short selling of financial stocks by Hedge Fund Managers, many of whom controlled more money than some nations, was akin to vultures circling and descending on their prey as they smelt death.

They destroyed financial giants like Bear Sterns and Lehman and would have destroyed the entire financial sector had not government intervention prevented it.

As soon as short sellers destroyed one company, they attacked another. Once they destroyed the stock price of a company, that company is destroyed.

Many companies were already in a death spiral and their ultimate destruction was only avoided by a concerted global governmental intervention.

The British government was the first to temporarily ban the short selling of stocks, and within a day, that ban was adopted by the US government and other governments around the world.

These massive concerted global governmental interventions as we approached the edge to the precipice in 2008 were what helped to prevent us from going over.

The Oracle of Omaha, Warren Buffet, has referred to naked shorts and derivatives as Financial Weapons of Mass Destruction.

I suspect that as calmer heads prevail over this weekend, Germany’s outlawing of short selling would not be seen as such a bearish event for the market.

It could even be recognized as an upward pull to stock prices, and maybe even unfairly so (short selling sometimes is needed to stem the rise of some frothy stocks).

Although short selling can have a correcting effect on frothy stocks that climbed too far too fast, the fact is that many giant short sellers are not too concerned about fundamentals.

3. Prediction of Next Weeks Market Behavior

Do late gains on Friday presage expectations of a better week next week.?

Friday began with the Dow dipping below 10,000 at the start. It climbed back and with a late push ended up 125 points.

Although some are making comparisons to the 2008 market collapse, I don’t think that the parallels exist, except for the fear.

The market has already pulled back 10% which is generally regarded as a healthy correction to any bull market. It has also tested the year’s lows which are crucially important technical levels.

If it breaks below the year’s lows, it would be in Bear Market territory and that would be very negative for stocks. A Bear Market is considered as a 20% or more pull back.

My own interpretation argues against a Bear Market but instead for a strengthening Bull with the usual fits and starts.

This opinion is based on the following:

  1. Interest rate is still at multi decade lows and could stay there for a while yet. Housing will continue to benefit as is already happening, even though there are still huge inventories to work off.

    The market is a discounting mechanism and home builders, though still experiencing strong headwinds, should be on the move up.

    Such reasoning are premised on the following assumptions:

    • The recovery is on its way
    • Spring is usually the best time for home builders
    • Low interest rates

    It does not hurt to start paying attention to them and look for signals of entry.

    Home builders that could be looked at include Toll Brothers (TOL), Lennar (LEN) and Hovnanian (HOV).

  2. The worst that could happen to the Euro Zone is its disintegration and even that will not be catastrophic. Each country would just revert back to it previous currency - France back to the French Franc, Germany back to German Mark , etc. England never joined the Euro Zone yet the British Pound survived.

  3. The unnerving economic conditions that existed before the 2008-2009 crash does not exist today.

  4. The Fed will be on hold indefinitely because of the continued uncertainty over a probable slowing growth in Europe and no signs of inflation in the US.

  5. Although the European condition persists, the market will pay more attention to the US economy as the market is faced with a whole hosts of US economic news to digest this coming week.

    Less obsession over Europe should result in a rosier economic outlook.

Finally

Do not try to pick market bottoms. That could be deleterious to your financial health.

Instead, be patient - and wait for confirmation of reversals. It’s better to be a little late getting in than doing so too early.

Adopt good rules for entering and exiting your positions.

Go Here To See Trading Rules>>>

Note
Academic research reveals that 70% of the average stock's performance is based on macro market conditions, 20% is due to industry circumstances, and only 10% comes from what happened to that specific company.

Some technicians believe all that is baked into the price of the stock and studying the charts will encompass and incorporate the fundamentals.

Visit the Previous Week, May 10 - 14, 2010, Trading Review >>>

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