Friday, December 6, 2013

How to be Short While Being Long..12,6.13

Markets are reacting positively to the jobs numbers but its the season for temp worker surges, so there may be a little false sense of hope and underlying concerns about FED tapering are still lurking in the background.  For now the DOW remains below the 16,000 resistance level and the close today should serve as a tellatle for next week's likely direction. A closer examination of the technicals shows we're still in a short term downtrend so we need to be cautious going Long at this point.

Several readers want to know how to deal with the possibility of a sustained downtrend in the markets but don't want to assume short positions and don't want to be in cash.
There are a couple ways to solve that problem and the new M3 SPY Trader was actually designed with that purpose in mind.  It's instructive to run a couple of these setups on a daily basis...not necessarily to trade them, but simply to see how M3 is analyzing the momentum rankings.

First, the SPY, SDS, VIX setup.  SDS is the ultra short (x2) SPY and VIX is the S&P volatility index.
The yahoo symbol for VIX is ^VIX (that's the shift position #6 key).  The results are breathtaking (as is the risk profile BUT THE PROBLEM IS YOU CAN"T ACTUALLY TRADE THE VIX.  Sorry, but the VIX is an index and the only way to trade the VIX is using options, which have a decay function and a volatility all their own that can swing wildly both daily and intraday.  Nevertheless, the model results do reveal Long/short momentum divergence.
Next we'll look at a variation of this theme using SPY, SDS and VXX (the VIX short term ETN)
ETNs are different than ETFs in that they are based on a basket of futures and tend to exhibit an unavoidable decay factor that makes them suitable only for short term trading (2 weeks or less).
I've turned on the AUTO STOP function that I mentioned yesterday as it helps to clarify the situation.
 We get a different risk profile than using the VIX but the VXX is actually tradable on any platform and so the linearity of volatility is considerably improved.
Finally, we'll look at a moderate setup of SPY, SH (SPY Inverse) and SHY (short term bonds, which effectively serve as a proxy for cash).
This is really a market neutral model where we are looking to see which side of the bull/bear momentum is currently leading.
Once again I've turned on the AUTO STOP function to better see the risk situation.
Once again, while we may not choose to trade these setups they are useful in determining when trends are reaching exhaustion levels and new trends are emerging.  And, as always, proper application of the risk management signals can improve the net returns of these examples significantly.