Bear Market Probability Grows, Elliot Wave Starter Kit

1. Bears Coming Out to Party?

Rawwwwwr... went the bear last night as the S&P 500 encouragingly broke the first support level that needs to be broken to indicate that the market has topped. I continue to monitor the situation. Earlier on in the week the market chugged up but its movements were laboured and insignificant. Then at the end of the week a nice, big red day.

Behold my fangs

Portfolio wise, I sustained small drawdowns as the markets chugged higher early in the week, before ending the week positive with a gain of US$1k+ thanks to the movements on Friday (as you know, I have cautiously gone net short since last week). If the markets continue to fall, I will gradually be adding to my positions as the bear market grows in probability. As I mentioned last week, I am hardly using leverage for now and hence the returns I have (even though I may be correct in my directional call) may be somewhat muted.

2. The 5 Waves in Elliot Wave

Perhaps it is time to talk a bit about Elliot Wave. In Elliot Wave theory, putting it extremely simply, waves in the trending direction (can be up or down) move in 5 waves. 

The first wave is the "first mover wave", where for instance, after a long bear market between 2007 to 2009, nobody really believed the bulls anymore when the market bottomed in March 2009 and we saw the markets start to rally initially. People were still so fearful to re-enter the markets back then that the rally was heavily doubted and there was no widespread participation.

Then comes the second wave. It is the "wave of doubt" because the second wave actually retraces the movement of the first wave. This means it wipes out most of the first wave and creates doubt in the markets about the viability of the first wave. This is the role the second wave is meant to play. In a bull market, it would get people thinking "cheh, the rally in the markets last week (i.e. the first wave up) was just a smokescreen. Better don't enter the markets first!!" 

Then we come to the famous third wave of Elliot Wave theory. It is the "wave of recognition". It is the wave that finally reveals to the mass markets (and leaves no doubt in everyone's minds) as to what the true trend in the markets is. Third waves are usually forceful and ferocious and in bear markets they can be very sudden, leaving investors with little or no chances to exit. Remember the days in 2008 when AIG and Citi ran into problems and the markets were tanking 3% on some days? That's the heart of a bear market wave 3 for you. In a bull market wave 3s tend to be more serene events. In a bull market wave 3 you tend to see the markets going up steadily by 0.5% for many, many days in a row. Then a correction once in a while to keep the bears hopeful, before more up days. Nice and steady.

Wave 4 is the wave of consolidation. It is the period where the mass market have, seduced or awed by the force of the wave 3, are thoroughly convinced about the market trend and have entered the market because they want their share of the pie now (but sadly they are usually too late)! But in Wave 4s, the markets keep ding-donging without any net movement, and can frustrate many investors. Wave 4 is usually seen as the worst period to be in the markets. Even traders can get blue-black from all the whipsaws that wave 4s can throw at them and there are quite plenty who choose to sit wave 4s out. 

Wave 5 is the final wave where all the "stupid money" comes in. This is where you see your shoeshine boys and "ah-gong ah mah" investors come out to play in the markets because they have very belatedly heard about the market movements and want to make some money. Sometime in the wave 5 the smart money would have exited with profits in the bag, leaving most of the retail market to hold the fort. And while there are returns to be had, wave 5s are usually for suckers. While wave 5s are typically never as forceful as wave 3s and are usually of the same scale as wave 1s, there is still money that can be made out of them (getting long during the 2000 NASDAQ rally where the markets went parabolic would have bagged you a ton of money, provided you exited in time) but one must tread cautiously because at the end of a wave 5 is a trend change. 

The classic application of Elliot Wave is to wait for a wave 1 to clearly pan out in order to confirm the beginning of a trend. Then enter at the end of wave 2, and ride wave 3 for maximum profits at minimal risk. Sit out wave 4, and ride wave 5 cautiously with a tight stop. 

Also, the beauty of Elliot Wave is that it is fractal in nature. Which means for instance, within a wave 1, there are actually 5 mini-waves within that wave 1. And within each of the 5 mini-waves, there are actually 5 micro-waves inside. You get the idea. It's something like SIM cards, you have mini, micro and nano. Just that in Elliot Wave we call them Cycle waves, Primary waves, Major waves, Minor waves, and so on. In addition, if you look at the insides of every wave 2 and wave 4, they very generally tend to correct in 3 waves, i.e. a wave A, wave B and wave C. And to complicate things, wave As and Cs themselves consist of 5 smaller waves, while wave B consists of 3 smaller waves.

An illustration of the fractal nature of the waves. You see how a wave [1] is actually made up of 5 smaller waves? And how there are ABCs within waves 2 and 5 of the smaller waves, and for wave [2] as well?

Ok this is all a bit "jelat" already so we end off here!

Gone Short!

1. Finally gone short

After talking and talking about it, I have finally gone short in my portfolio. This is in line with the view that: 1) if we are still in an uptrend, we are in a final leg whereby the upside is capped about about SPX 2170 and 2) there is a decent chance that the bear market has already begun (although the rally later in the week shows the bulls still want to give it a good go).

Not too much change in the portfolio. Total year-to-date profits went down by a few hundred dollars from last week. If you think about it, this can be accounted to the commission charges when I exited some of my positions. The size of the portfolio has also been scaled down (to using almost zero leverage currently) pending confirmation of the trend change. Once we are very clear that we are in the bear market. I will upsize my positions again.

Not what I meant when I told you to go short.

2. Using IG Markets

Progress continues in my plans to integrate a second broker in my trading, for counterparty risk purposes. My eventual plan is to park all my bearish positions with one broker, and all the bullish positions with another. What I have done viz-a-vis IG Markets so far is that I have parked a thousand dollars into their account and will start executing a few small trades to test out their interface. When I have suffiicent liquidity in my savings account to put up full trading positions, I will migrate half of my positions to IG Markets. This is of course assuming that I am happy with their trading platform.

3. Penang

This post comes a little late as I am actually away on a business trip in Penang. Back in Singapore tomorrow. Updating this blog had to take a step back behind other matters I had to attend to. Well the weather here is either very hot or rainy so I'm very happy to hole myself up in the hotel when I have free time to chip away at my long to-do-list, nap, get some exercise done and listen to TED talks and Eckhart Tolle whilst other colleagues are out golfing, drinking or having Penang char kway teow and Penang laksa. In the face of limited time, life is about choices huh?

Ding Donging Markets, the Quest for a New Broker and More LKYisms

Happy Good Easter long weekend to everyone!

1. Markets still in limbo

The markets tried to rally early this week but did not manage to break any significant levels. Then it slumped on Tuesday and Wednesday before bouncing somewhat on Thursday, closing just 9 points higher than where we ended last week. Which means we are kinda in no-man's land with regard to whether we are still on the bull bus or if the bear party has already started. Essentially we are in a trading range between 2120 and 2040 on S&P 500. Break to the upside and the bull continues, break to the downside and we can start getting acquainted with Mr Bear (who has become somewhat a stranger after 6 long years of not meeting him).

Hi, do I know you?

The portfolio has bounced up US$4,061.94 and recovered some of the losses I was talking about last week. But the portfolio continues to be geared bullishly until 2040 is taken out on the S&P 500. If the markets do break 2040, there is a risk of large losses being sustained. But that's what we have to live with when we have a major trend change.

2. A New Broker, At Last?

The most astute readers will recall that way way way back in end January 2015 I mentioned that I was on the lookout for a new CFD broker that I could use in conjunction with my existing broker (City Index). This is to mitigate any concentration risk in a single broker, given that currently all of my trading capital is parked with just one broker (and we all know what happened to MF Global). Well after 3 long months of done-nothingness I got off my ass on Monday to start making some calls, and given that most brokers do not allow short trading to be done for the specific instruments that I trade, I was pretty much only left with one broker to "choose" from, and that being IG Markets. I had looked at Oanda, CMC, Saxo, Kim Eng Maybank and Philip but none of them were suitable. 

The IG Markets platform (note this is not a screengrab of my account!)

I've gotten the account open and what remains to be done is to inject funds into the account, which I will be doing over the weekend. I will then play around with the platform and execute a few trades to test the interface. If all things work out, my grand plan is to open new positions with IG Markets until there is parity between the size of my positions with City Index and IG Markets. The downside to this is twofold. First, when I want to change positions, I will now need to execute both with City Index and IG Markets separately. This would be a drag on how quickly I can switch positions. Second, my paperwork involved in doing up my trading records will effectively double as I need to calculate costs incurred under 2 trading platforms now. I'm damn lazy all about efficiency and so will need to think about how best to make use of the IG Markets account. 

3. LKY Redux

I found it very poetic that it rained during LKY's funeral. You can choose to think that the heavens teared for him, or that perhaps LKY wanted to give Singaporeans a final test of their resolve and dedication to see him off in the less than comfortable conditions. 

The rain led me to think of an election rally of his in 1980 at Fullerton, where at some point it began to rain and he shrugged the raindrops off his head like a bad-ass with nary a concern. He then had some tough words to say to the SIA pilots who tried to go on a strike back then. Very potent stuff. But despite our propensity to complain about how the ruling party can do a better job here and a better job there, and sometimes we even like to use our votes to give them a kick up the backside, LKY did say something in that rally that I can't really disagree with at all. I'm paraphrasing like crazy but in effect what he said was that: Yes we screw up sometimes. E.g. in this incident and in that incident. But at the end of the day, we get 80% of our decisions right. 

Screengrab of the rally on CNA. "And I'm prepared to start all over again!" says the man, in response to SIA pilots who thought he did not dare to disband SIA and start another airline if needed. 

And I think the man has a point. You can look at it from the perspective of how often a striker in football converts his goalscoring chances. An above-50% rate is world-class, and an average EPL striker probably has a chance-conversion rate of 20 to 30%. If LKY's "conversion" rate (i.e. proportion of "right" policy decisions made) has been 80%, I think we will one day look back and think, hey, 80% was a pretty darn good rate. And I'm saying this as someone who has not exactly been the biggest PAP fan in the past.