Trading the Short to Intermediate Time Frame

By Guest Blogger Jennifer Gorton from ForexIndicators

As an investor or trader, picking a time frame on which you plan to hold your assets is entirely up to you. There are many people out there that wish to close out their positions at the end of each day to avoid the risk of major market news effecting an open position. Recently, markets will move drastically during the overnight period due to new stories from around the world occurring during that time. If other markets like Asia and Europe are selling off there is a good chance that the U.S. stock exchanges will open lower and those who have held positions overnight will lose money. There are other traders who will take this risk because they are buying the asset to be held for longer than a few days.

If you are looking to become a short to intermediate term trader but do not want the risk of a big overnight move, trading commodities and currencies is a better option. The average investor can trade the commodities market, by way of the CME Globex electronic exchange, 23 hours a day 5 days a week. The currency markets are open 24 hours a day 5 days a week, giving you that one extra hour to place trades. Trading of commodities products and currency pairs after normal market hours will allow the trader to monitor his position in real time and close it out if necessary at anytime the market is open. He or she will not have to wait until the next day’s open outcry session when the price of the commodity he is holding might have fallen. This can allow the investor to have an intermediate time horizon for holding his investments with the safety of being able to trade most hours of the day. Many potential trades that people see occurring take time to develop. Sure you can make a few dollars day trading throughout the day but having to always watch the market might not be what you are looking for. The average investor will not want to day trade because of work related issues. They will not want to sacrifice their salary job to become a full time intraday stock trader.

The intermediate and short term investment style is for those who have a good idea but do not want to be at the computers all day. Commodities and currency trading allow you to have that investment mindset with the additional benefit of being able to have orders executed when you are asleep if necessary. Programming your trading software with predetermined buy and sell orders will allow you the ability to stop out a position if it starts to move against you. The same would also be true if hit your profit target at 2AM when you are asleep; letting your computer do all the work is the way to execute orders. Both commodities and currency brokers will allow their clients to submit limit orders at prices they want to buy and sell. This technique for the short to intermediate trader is widely used. Having a stop loss number where you will close your position and a profit target where you will take profit is a must. The various brokers will offer free forex indicators and free commodities indicators that can help you decide at what price these order should be placed. Along with the charting software that your broker will allow you to download, short to intermediate trading is the preferred style of investing. Using commodities and the foreign exchange market as a vehicle to trade is perhaps safer than the equities market because of the hours it is made available for trading to the average investor.

How to Short Sell Stocks - The Basics You Should Know

Most investors are long-only, and in my opinion, that's a big mistake. That means you can only make money when asset prices are rising. That worked great during the bull market of 1982-2000, but has not worked so great in the decade since.

And it may continue to not work that well for another 5 to 10 years, because that is the typical length of secular bear markets. (BTW some believe the current secular bear started in 2007 - in that case, you'd have a LONG ways to wait for the next bull).

Selling short stocks can be profitable anytime, but especially during bear markets, when the trend is sideways, or even down. This is the time to "short the crap" - sell the junk at inflated prices, and buy it back at lower prices in the future.

In today's guest article, Jake Weber shares the basics of short selling. If you're a long-only person, this may be a very instructive read. Also Jake has a special offer where you can pick up a subscription to The Casey Report for much cheaper than usual at the end.

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Sell Now, Buy Later – the ABCs of Short Selling

By Jake Weber, Editor, The Casey Report

The catch phrases “Buy low, sell high” and “The market fluctuates” are probably the two most frequently used clichés of the investment world. The latter statement is hardly astute, and the former far easier said than done. What both of these simplistic ideas overlook is a third concept largely ignored by the investing public, “Sell now, buy later.”

The idea of selling something that you don’t yet own is a foreign concept to many. However, in a powerful bear market, it’s an important strategy to understand and utilize, though for reasons I’ll discuss below, only as a relatively small and closely watched speculative portion of your portfolio. The concept I’m referring to, of course, is short selling.

The basic mechanics of selling short a stock are not complicated, but, as with any investment, there are risks involved, and it requires discipline to execute these trades successfully.

What Is Short Selling?

If, after carefully scrutinizing a security, you conclude that there is nowhere for the stock to go but down and want to put your money where your brain is, there are a couple of different alternatives. One way to go is the options route, selling calls or buying puts on the stock. This is certainly a viable route with plenty of opportunity to profit; however, with options, not only do you have to be right about the direction, you also have to be correct about the timing and strike price.

The other alternative is to open up a margin account and sell the stock short. That requires posting a margin – cash or securities – in your account. With that condition met, your broker will undertake to borrow the stock from someone that owns it. Once your broker has acquired it, either from another client or another brokerage firm, he or she will sell the stock and deposit the proceeds into your account. What you own now is a liability to purchase back, or “cover,” those same shares at some point in the future, hopefully at a lower price. Because there’s a loan involved with this transaction, you’ll be charged an interest rate on the amount borrowed, likely in the area of about 4.5% annualized these days.

With a short sale, your maximum gain is capped at 100%, which you would only collect if the stock goes to zero – but your loss is technically unlimited because stocks have no cap on the upside. Of course, there are ways to limit your losses, which we’ll discuss in a moment, but first let’s look at what could happen to your account should the stock fall, as you hope it will… or rise, as you hope it won’t.

For the purpose of this example, let’s say you came to the conclusion that XYZ stock is overvalued at $25 a share and so you sell short 100 shares. Here are the implications of two different scenarios subsequently unfolding:

Your maximum profit of the XYZ short sale is $2,500, but the sky is the limit for your losses and will be magnified, should you use margin. This potential for open-ended loss is enough to deter most investors from shorting, and is the reason we recommend you do so only with the speculative corner of your portfolio.

Minimizing Risk

Short selling is an aggressive strategy to pursue. There are, however, measures you can take to help mitigate risk.

Limit Your Margin

One of the ways to avoid large losses is by limiting the amount of margin used to borrow the shares. To sell short in the U.S., regulations require that the stock be “marginable,” and an initial deposit is required – 50% for stocks above $5 per share and 100% margin for stocks below $5 per share. After you borrow the shares, the rules require you maintain equity in the account worth at least 25% of the total market value of the security.

These are the regulatory minimums; individual brokerages may have additional rules and limitations for margin accounts, so be sure to carefully review your margin agreement. Even so, to avoid being “chased out” of a trade, you may want to deposit more cash than required by your broker in order to further cushion your position.

Keep in mind that the interest paid on the borrowed money will eat into your returns, reducing your potential upside, the longer you hold open a position. Also, any dividends issued while you are borrowing the stocks will be transferred from your account to the original buyer. We highly recommend that you actively monitor your account to avoid any margin calls and minimize your risk by reducing the use of margin.

Use Stop-Loss Orders

If you aren’t able to actively manage your investment accounts, then stop-loss orders can help soften the blow if the trade quickly turns against you. When the general market or sector gains upward momentum, even the fundamentally weakest stocks can catch a free ride. In order to limit your loss, consider placing orders to “buy to cover” at a price above your initial short sale price and remember to review your stop-loss orders periodically to assure you are covered.

A Few Key Terms:

· Short Interest: This is the aggregate number of short sale positions on each security. This information is published monthly by the exchanges and also offered through many other websites such as Barron’s and Yahoo Finance. It’s important to monitor how many shares have been borrowed because they will eventually have to be bought back (see Short Squeeze, below). Generally, the lower the short interest, the better.

· Days to Cover: This is another important data point to track, because it’s an estimate for how many days it will take to unwind all the outstanding short positions. It’s calculated by dividing the current short interest by the average daily trading volume of the stock. The fewer days to cover, the better.

· Short Squeeze: Should a stock appreciate by a substantial amount, it is entirely to be expected that some number of short-sellers will decide to cover their short or be forced to it by margin calls. Of course, that requires closing their positions by buying the stock back, which gives the stock further upward momentum. This may in turn force other short-sellers to cover, thus creating a rush to cover known as a short squeeze. Using stop-loss orders will help prevent getting caught on the wrong end of a short squeeze.

· Called Away: This refers to being forced to cover your short position because the lender requires delivery of the stocks. While this technically could happen at any time, it is exceedingly rare and would typically occur only if a clearing house couldn’t find shares to borrow for exchange-traded funds. This is something certainly to be aware of, but it’s not a cause for great concern, in our opinion.

Proceed with Caution…

If short selling fits within your scope of risk tolerance, it can be very profitable. Even so, it’s important you avoid being overleveraged in any position and never, ever “bet the farm” with a short position. Rather, only invest with money that you can afford to lose and consider using stop-losses.

As Jake says, short-selling can be very lucrative – if you correctly assess the broad market trends. That’s what The Casey Report does: analyzing budding trends and finding the best opportunities to profit from them. And as a special Tax Day offer – for 2 days only – you can now get The Casey Report for $150 less… PLUS one free year of our two most popular precious metals and energy advisories. Click here to learn more.

Well I'll Be Damned...The S&P Hits a 17 Month High(!)

Stocks continue to defy gravity, as the S&P finished today at a 17 month high.

Amazingly, the S&P has completely retraced it's most recent drop from January. The markets swung from quite oversold, to quite overbought, within the span of a month.

Once again, we learned (the hard way) not to bet against the S&P when it's north of the 200 day MA.

(Source: Yahoo Finance)

Where to from here? Well markets are overbought, and stocks have been rallying largely on low volume, so it's hard to see them going much higher before we see some sort of pullback.

Of course I'd have said the same thing a week ago, so take it for what's it's worth.

But I think the interesting thing to watch will be the conviction the upcoming pullback displays.

China, one of our favorite leading indicators, is NOT following the S&P's lead, however.

China on the brink - a potentially bearish divergence.

This could be a significant bearish divergence. The posterchild of the Reflation Trade, running out of gas!

As we always remind ourselves, the last time the markets crashed, China peaked before the US. History could be repeating itself here, as the US markets hit new highs, while China languishes below it's October highs.

Why The Market's Trend Hasn't Changed - It's Still Down (Probably)

A few weeks ago I glowingly declared that the bear was back in charge, and that the new trend was down.

Channeling Lee Corso - not so fast, my friend!

It's been a strong retracement of the Jan-Feb decline:

Markets have rebounded - from oversold in Feb, to overbought in March!

(Source: Yahoo finance)

BUT - until we see a poke above the 1150 mark, we can't say for sure that the uptrend in back in place.

So we're kind of in a state of limbo right now. The rally appears tired, and I'd say it's on it's last hurrah, but we've been seeing last hurrahs for the last 6 months. So anything is possible.

The bearish publications I follow have conceded that an upcoming decline must be swift and decisive to confirm that the downtrend is in place. So we'll see where the week takes us from here.

While Stocks Climb, The Dollar Rests

The dollar, which we believe continues to be the linchpin of the financial markets, is taking a breather from its recent assent, as stocks climb. So the formula that has been in place since roughly 2004 remains in place, and that formula is the inverse relationship between the dollar and stocks - dollar up, stocks down - stocks up, dollar down.

The dollar takes a breather - but it's still in an uptrend.

(Source: Yahoo Finance)

With the dollar still in an uptrend, and well north of it's December lows, I'm more inclined to think of this stock market rally as a correction in a downtrend, rather than vice versa.

If the dollar were to take out it's previous lows, I'd be nervous about this hypothesis. But the reality is that not only has the dollar rallied quite a bit since December - AND it also sits well north of its 2007 lows.

The dollar may be doomed in the long run, but it's running a helluva sprint right now.

Did We Mention This Stock Market Rally is Tired? Really Tired?

With the exception of last Friday (which throws a little bit of a curveball into the equation), this rally has largely taken place on declining volume, while the drops have occurred with on expanding volume - and hence more conviction.

Brian Hunt writes that the professionals aren't buying this rally...

I have a chart for you showing why many of the smartest traders I know are asking themselves this question... and why they expect the market to head lower, at least in the short term.

Below is a chart that displays how some professional traders view the market. It shows the past nine months of trading in the big S&P 500 fund (SPY). Many days, this is the most frequently traded security on the market. It moves in lockstep with the benchmark S&P 500 index.

You'll notice this chart has more to it than the simple "line charts" you often see on television or in the newspaper. This chart contains much more information, which you can use to make smarter trades.

You can read the rest of Brian's piece - and check out his price/volume chart - here.

But Don't Tell This to Mutual Funds - They're "All In"!

Bloomberg reports:

Equity mutual funds are burning through cash at the fastest rate in 18 years, leaving them with the smallest reserves since 2007 in a sign that gains for the Standard & Poor’s 500 Index may slow.

Cash dropped to 3.6 percent of assets from 5.7 percent in January 2009, leaving managers with $172 billion in the quickest decrease since 1991, Investment Company Institute data show. The last time stock managers held such a small proportion was September 2007, a month before the S&P 500 began a 57 percent drop, according to data compiled by Bloomberg.

Oh my.

(Hat tip to frequent guest author David Galland for finding this piece!)

Stephen Colbert Explores Credit for Kids: Kid-Owe!

One of our favorite financial analysts, Stephen Colbert, is back on the beat with his excellent coverage.

You may recall Colbert's astute recommendation to load your portfolio with gold, women, and sheep. (And I hope you heeded his advice!)

The new word on Stephen's mind is Kid-Owe - enjoy!

The Colbert Report	Mon - Thurs 11:30pm / 10:30c
The Word - Kid-Owe
www.colbertnation.com
Colbert Report Full Episodes Political Humor Skate Expectations

Save a Buck - By Not Saving???

Nevada Federal Credit Union is turning the business model of banking upside down - by paying customers to close their accounts! Mike "Mish" Shedlock reports on his excellent blog:

Nevada Federal Credit Union has too much money and does not know what to do with it. Worse yet, sitting in cash is costing the credit union money.

Insurance premiums are the culprit. On top of any deposit premium paid to customers, insurance runs .4%. Yet short term treasuries yield .25%.

Nevada Federal sees no good lending opportunities so it is paying customers to close accounts.

Sounds like a healthy economic system to me! Hat tip to friends/readers JL and Carson for the link tip on this beauty.

Another Good Way to Make Money - Sell Your Home at a Loss!

In case you weren't already in awe of the brilliance of our economic system, here's another great way for entrepreneurial-minded homeowners to make money - The New York Times reports:

In an effort to end the foreclosure crisis, the Obama administration has been trying to keep defaulting owners in their homes. Now it will take a new approach: paying some of them to leave.

This latest program, which will allow owners to sell for less than they owe and will give them a little cash to speed them on their way, is one of the administration’s most aggressive attempts to grapple with a problem that has defied solutions.

Hat tip again to friend and noted guest author Jonathan Lederer, who was ironically reading this piece when I forwarded him the following email...

Foreclosure Home Tour This Saturday!

To reserve YOUR spot, please click here - hilariously, this is not a joke - this email actually showed up in my inbox today:

Elk Grove, CA - Real Estate Broker David Jurewicz of HomeRocketRealEstate.com will be giving a tour of five high value foreclosure properties in the Elk Grove, CA area. The tour begins at a meeting place near Highway 99 and Laguna Blvd. Saturday March 13, 2010 beginning at 10:00 a.m. and lasting until 12:00 noon.

There are only 10 spots available for the tour which will keep it small and manageable. To reserve a spot on the tour, call David at (916) 682-6454. Those who call will be provided with information about where the meeting will take place as well as answer any questions. Attendees will receive a free 100-page e-book "Foreclosure Secrets," with a value of $19.95. David has also arranged well-priced financing with a local lender who can quickly pre-qualify potential foreclosure home buyers. "Most bank sellers won't even look at your offer unless you've been pre-qualified," says Jurewicz.

"This is a no-obligation opportunity for anyone seriously interested in buying a home to see what's available for their real estate dollar," says Jurewicz. "I'll choose the homes for the tour just before the tour begins to make sure the properties I show are a great value and are still for sale," he said.

I'll let you insert the punchline.

My Trading Activity - Still Short the S&P (Twice)

Ouch - it all looks obvious in the rear view mirror, so it's no use kicking myself. These shorts both looked great and perfectly timed for a little while.

I didn't want to cover them in a bear market, instead electing to "hold" all the way to the bottom. Well I may have declared the bear in control too soon...though we can't say for sure just yet.

I'm still hanging on because this rally appears quite tired, and I believe the risk from here is to the downside. We'll see!

Still double short the S&P...though these positions used to look much sexier!

The S&P has - almost - retraced it's swift decline. A poke above the 1150 mark would indicate it's still a bull market...for now at least.

(Source: Yahoo finance)

Have a great rest of the week in the markets! Comments are always welcome and very much appreciated.

Portions of this article (or the whole thing if you can't get enough) may be republished on your website, blog, or email newsletter - all we ask for is proper attribution, and a backlink to our site with the original article!