Stock Market Crash! Blog

The Homebuilder Stock Crash: I Told You So

On April 14th, I made a post called "How To Profit From the Interest Rate Ascent (Pt. 1)", in which I exposed an important bearish head & shoulders chart pattern in homebuilder stocks as well as a corresponding bullish head & shoulders in bond yields. The bullish pattern in interest rates signified more downside in housing related stocks, as higher interest rates put a damper on the housing market. Since that point, even Alan Greenspan's conceded that "the "extraordinary" boom in the U.S. housing market in recent years is over."

Essentially, this post provided information about how to profit from the housing bubble bust that we've heard so much about. My recommendation was to short stocks that were in the Dow Jones US Home Construction Index, such as "Beazer Homes, Hovanian Enterprises, Lennar Corp., Centex Corp., Pulte Homes., and D.R. Horton Inc., to name a few."

How did my predictions fare? Why not take a look at the charts yourself:

Dow Jones US Home Construction Index, (April 14th) before:



Dow Jones US Home Construction Index, (May 24th) after:



I suggested short selling individual homebuilder stocks upon a signal that consisted of the Dow Jones US Home Construction Index breaking below the "neckline" support level at 830, giving a minimum target of 530 to be reached. A little more than a month later, and the index is now at 724, or 12.7 percent lower. According to my targets, we still have some more downside until we hit 530.

Even more dramatic were the losses accrued by the individual homebuilder stocks:

Lennar Corp, down 12.3 percent:



Beazer Homes, down 16.6 percent:



Centex Corp, down 16.6 percent:



DR Horton Inc., down 15.6 percent:



Hovanian Enterprises, down 24.5 percent:



So, you would have made some nice profits by shorting any one of these. By short selling $10,000 worth, you could have made anywhere from $1,230 to $2,450. Not bad, considering the lackluster market environment. Keep in mind, WE STILL HAVE MORE DOWNSIDE!

How have interest rates played out?

30-Year Treasury Bond yield, (April 14th) before:



30-Year Treasury Bond yield, (May 24th) after:



The importance of the Bond yield charts, is their inverse relationship with homebuilder stocks, and the strong recent correlation between the right & left shoulders and head, in their respective head & shoulders patterns. The 30-Year had soared as high as 5.3 percent, before consolidating to 5.13 percent. This seems to be a short-term consolidation pattern, as market takes a pause before resuming its trend up to 5.5 or more, as per the price target. This further upside will help propel the Homebuilders index down to the target of around 530.

Intermarket analysis is one of the most overlooked parts of technical analysis, in my opinion. Markets don't move in isolation, they all have an effect on each other. The benefit of intermarket analysis is that sometimes, one market will lead another, as was the case with the 30-Year Yield breaking its "neckline" first, foreshadowing the breaking of the Homebuilders neckline.

I expect the Homebuilders to consolidate upwards for a few days before the oversold condition is rectified.

Dow 11,400: Failure, Look Out Below!

One month ago, I created a post highlighting the significance of the Dow level 11,400, which we were rapidly approaching. I expounded upon two possible scenarios that were likely to occur at such a critical juncture, either the start of a strong bull market or bear market.

Dow 11,400 was "the level that stopped the 1990's bull market right in its tracks, resulting in a terrible bear market that ended at 7,200. From 1999 to 2001, the Dow attempted to break 11,400 four different times, only to come crashing down again. Another time, in early 2000, the Dow briefly passed 11,400 for a few weeks, then dropped 2,000 points." The following chart shows the Dow and its multiple failures, old and recent, at 11,400. Click on the chart for a larger version:



After several attempts, the Dow finally breached 11,400 in late April, causing many a bull to rear his horns as the market surged to 11,709, only a mere 200 points below the all-time high reached in January 2000. Unfortunately, the similarities with the year 2000 didn't end here, as the market promptly dropped below 11,400, indicating the potential for a bear market. The Dow dropped 600 points to 11,100. If this is anything like the false breakout in January 2000, the Dow might fall 2000 points. Even worse, if its like the false attempt in the spring of 2001, we might see a 3,300 point drop. Scary, isn't it? Its quite scary looking at the charts of the past few weeks:

The Dow Jones Industrial Average, down 609 points or 5.2 percent:



The SP 500, down 75 points, or 5.6 percent:



The Nasdaq Composite, down 220, or a staggering 9.2 percent:



England's FTSE crashed 550 points, or 9 percent:



Japan's Nikkei, down 1,900 points, or 10.8 percent:



Emerging markets experienced the most dramatic slide, some experiencing actual stock market crashes, giving back some of their impressive gains won this year. This correction isn't surprising, given the stellar performance these markets had.

India's Sensex Index, had an actual stock market crash, dropping 2,500 points, or 20 percent within 2 weeks:



Brazil's Bovespa, down 6,000 points, or 14 percent:



The Korean Seoul Composite, down 140 points, or 9.5 percent:



The Hong Kong Hang Seng Index, down 1,550 points, or 8.9 percent:



Singapore's Straits Times Index, down 250 points, or 9.4 percent:



Taiwan's Weighted Index, down 700 points, or 9.3 percent:



A Confluence of Bearish Catalysts

In my first Dow 11,400 blog post, I described several fundamental reasons why we might see a severe correction, upon a false breakout in the Dow. Now that a false breakout has occurred, I'd like to revisit this bearish scenario and publish a more detailed list explaining several catalysts for a further drop in stock prices.

1)The Dow's rejection of the 11,400 resistance is highly bearish, as the failure to breach this level resulted in the 2000-2002 bear market. 11,400 is a psychological barrier, and the failure to break shows the underlying weakness of this market. Such a weak market is vulnerable to dramatic drops upon even the slightest hint of negative news.

The current Dow MAY be experiencing a similar pattern to its sideways pattern that lasted from the mid-1960's until 1982, as the Dow repeatedly attempted to breach the 1,000 level, only to result in four different bear markets. A 20-year stagnation ensued as the Dow stayed flat.

Barry Ritholz, of The Big Picture Blog, created a post comparing the present with 1973-74 cycle, using a chart to show that today's Dow is following the 1970's Dow's pattern with a 60 percent correlation. If the comparison holds true, 2006 is now equivalent to 1973, a year that marked the start of a bear market that finally ended in 1975, with a 40 percent loss. Lets hope we don't see a repeat of that action, as it would imply the Dow hitting 6,700. Make sure you pay Barry a visit, as his analysis is extremely cogent and insightful. Here is his chart:



2)We're late into the interest rate cycle, with the Fed having lifted the benchmark lending rate 16 times since June 2004. Bull markets have tendency to start right after the Fed has a series of rate cuts, while many bear markets have started after a series of rate hikes, causing a slowdown in business conditions. Additionally, during periods of monetary tightening, the Fed has tended to overshoot and tighten too much, often resulting in hard landings or recessions.

A selloff in bonds, and consequent rise in bond yields, portends a decline in stocks, which is what happened in 1929, the 1987 crash and the year 2000 bear market. Now bonds have decline and yields have increased, as I've posted here. In that post, I signaled that we have further to go in the bond decline, and I still feel this is the case today.

The yield curve, or the difference between short & long term interest rates, has flattened lately, a harbinger of slower future economic growth. A steep yield curve, with short term rates at a much lower level than long term rates, implies strong economic growth in the near future.

At one point earlier this year, the yield curve even inverted briefly, a development that has "presaged each of the last six recessions, without a single false alarm," as explained in the article, "Inverted yield curve spurs recession concern." The article further states, "typically, the warnings operate on a lag of about 12 to 18 months and need to remain in place for about a month to be meaningful." Either way, a flat or inverted yield curve isn't exactly the most bullish sign. You can check Stockharts.com's Dynamic Yield Curve, to see the recent flattening. Note that the steep yield curve in 2002 forecasted a healthy stock market rally.

To make matters worse, the Fed has raised the discount rate to 6 percent, a level that has caused severe stock market crashes a full seven out of seven times since the early 1900's, according to Peter Eliades, a well-known market cycle theorist. How severe were these crashes? Let's just say the stock market crash of 1929, the 1974 bear market, the stock market crash of 1987 and the Y2K tech crash were some of the more well-known ones. And here we are again. Take a look at Eliades' explanation of the "6 percent" phenomenon. Here is the chart showing the impact when discount rates hit 6 percent:



3)"Sell in May, and Go Away" so goes the old adage warning of the seasonal weak time in stocks, starting on May 1 and ending October 31. According to Yale Hirsch of the Stock Trader's Almanac, most of the gain's in the stock market tend to be made between November and April, with the summer months tending to be flat or negative as Wall Street heads to the Hamptons for vacation. According to Hirsch, "there were twenty-one losing periods since 1950 from May to October, but only twelve for November to April."

In Harry S. Dent's book, "The Next Great Bubble Boom," he posits that "an investor starting with $10,000 in 1950 would have seen it grow to $467,100 by April 2002 if it was invested only between November and April, but would have had a slight loss to $9,923 if it were invested only from May through October each year."

So there you have it, we are in the stock market's bad season, further increasing the probability of a bear market from this point on.

4)We are due for a crash in the well-known eight year stock cycle. According to Dent, the eight year cycle involved strong declines in 1958, 1966, 1974, 1982, 1990 and 1998, with 20 percent corrections the norm for the SP and Dow. 2006 is eight years after 1998, meaning we should see a strong decline if the theory holds up.

5)The current run in global stocks appears stretched when compared to past bull markets, according to a report by BCA Research. BCA explains that the bull market in global equities is entering its fourth year, now exceeding the median duration and magnitude of past major up-cycles since 1970, suggesting that the risk/reward trade-off is deteriorating. Click on the BCA article to see an excellent chart displaying the duration of the historic up cycles.

6)From what I wrote in my first Dow 11,400 post,

"Higher interest rates which will pop the housing bubble. Once the housing bubble implodes, foreclosures will increase and consumers who use their homes as ATM machines will feel the pinch and curtail their spending. Now the housing wealth effect which has made home owners feel very wealthy, will run in reverse.

The homeowners who will be hurt the most, with the rise in mortage rates, are the ones who let themselves get duped into taking on adjustable rate mortgages or ARM's. With an ARM, monthly mortgage payments rise as interest rates rise. Homeowners who overleveraged themselves with jumbo-mortgages will face dramatic increases in monthly payments, forcing many to foreclose- especially if the job market weakens. According to the Mortgage Bankers Association, ARM's constituted 34 percent of mortgage applications in 2004, a staggering figure indicating many people who think interest rates will be low forever and housing "always goes up." Sounds alot like the other historic bubbles I wrote about for this site.

More worriesome is the statistic from the National Associations of Realtors, saying that 36 % of the home sales in 2004 were second home purchases, ie. mostly speculative buying and "flipping." As housing deflates, these speculators will add more fuel to the fire as they attempt to unload their houses."

This development will lower consumer spending and the overall vitality of our economy.

7)The options volatility indexes, VIX and VXN, are at all time lows, indicating investor complacency that has historically led to strong bear markets. A VIX reading below 20 signifies a dangerous level of complacency. Within the past year, the VIX reached as low as 9.88 and is still at a low level of 17. The chart below from Investopedia shows what can happen when the VIX is below 20:



The stock market may drop until the VIX reads as high as 35 or more.

8)There is a possibility of oil reaching in the low $80 range or even more, as I've written in a post a few days ago. Oil at these prices would roil the stock markets causing a severe crash. A military confrontation with Iran could easily push oil prices to these lofty heights, scenario that looks possible with the ever-defiant Mahmoud Ahmadinejad at the Middle Eastern nation's helm. Goldman Sachs even believes that Oil Could Spike to $105, in a 1970's-style surge. That projection certainly brings more credibility to Barry Ritholz's view that 2006 is equivalent to 1973.

Profit From the Decline

To summarize, there seems to be a reliable confluence of negative catalysts which could lead the stock market down a slippery slope in 2006-7.

How can you profit from this? Unfortunately, the recent decline was so terribly sudden and steep, with the Dow and SP down 5 percent and the Nasdaq down nearly 10 percent within two weeks, making it a difficult market to trade in. With each day's drop, the market is getting more and more oversold on the short term, leaving us overdue for an upside swing, before resuming the downtrend. I wouldn't short the market just yet, as its more prudent to wait for the upswing.

For those not willing to short stocks, there are plenty of inverse market ETF's and mutual funds that will short the market for you, without your risking a margin call. Some are even leveraged to give 2X the return of a simple inverse fund. Here is a list of short funds.

I'll keep posting about developments regarding an upside swing and how to profit from the market's decline.

The Commodity Boom's End is Near

In the four years starting in 2002, commodities as a group, have experienced the longest, most powerful bull market since the late 1970's, with the Commodities Research Bureau (CRB) Index nearly doubling. Aluminum prices have doubled, gold is up 150%, platinum up 180%, crude oil up 300% and copper up an astounding 450%. The performance comparison chart below is from Stockcharts.com. Click on the chart to see a larger version:



This raw materials bull market was fueled by the US Dollar Index's 32% decline, insatiable demand from the fast growing economies of China and India, and the oil price shock which was spurred on by terrorism fears, war in Iraq, hurricane Katrina and the Iran crisis.

(It's worth noting that agricultural commodities haven't experienced any unusual behavior, helping to temper some of the CRB Index's rise. Agricultural markets are driven by a different set of dynamics than the more commercial metals and petroleum products.)

Though this bull market has its roots in strong industrial demand, the recent white-hot nature of this trend can be attributed to pure speculation, especially by hedge-funds. Indeed, economist Howard Simons from theStreet.com quips, "the industrial-metals markets are anything but conservative these days. They are bubblier than a shaken can of warm beer", in his article, "Metals Bubble is a Lead Balloon."

Simons purports that the commodities markets are experiencing an overheated bubble, not unlike that in internet stocks in the late 1990's. And we all know how that ended.

According to Simons:

"All bubbles begin in reality: We did invent and bring to market a few things in the information technology world in the 1990s, none of which could justify the excesses seen by the end of the decade. We do have growing demand in China and elsewhere today; once again, none of these developments can account for the speed and magnitude of the price gains witnessed.

Given the growing fears of inflation, it is tempting to blame these conjoined rallies as investors seeking protection against currency debasement. It would also be laughably wrong. Copper and zinc are up more than 88% and 94%, respectively, year to date, and while inflation may be rising, that's a little bit of overkill on the protection side, don't you think?"

Amidst lackluster US stock returns for the past 6 years, hedge funds have searched far and wide for trending markets, piling into the commodity markets since 2002, and serving to dramatically amplify any movement caused by industrial demand alone. The impact of hedge funds in the commodity markets should not be underestimated, as they account for "one-half of the (trading in the) commodities sector", according to the article "Demystifying Hedge Funds".

Over the past few years, hedge funds have seen greater than 13% annual returns, trouncing the performance of stocks and helping to supercharge the growth of the hedge fund industry. Indeed, hedge funds have garnered "$1.5 trillion in assets, double the level in 2000," as reported in "Demystifying Hedge Funds."

Such record growth has helped the highly-secretive hedge fund sector enter the more mainstream retail investment market, now enabling investors with as little as $25,000 to invest in "funds of hedge funds." Once the domain of those with millions to invest, such hedge funds now provide small investors with the ability to profit from a decline in the stocks as well as participate in a wide array of markets including grains, metals, bonds, currencies, petroleum products and foreign stocks and bonds. Standard mutual funds, which can only buy and hold stocks and bonds, may see increased competiton from the increasingly accessible hedge funds, especially if stocks continue their trend of mediocre returns.

Hedge funds' contribution to the commodity bubble stems largely from their trend-following trading methodology. Trend following doesn't entail calling a top or bottom in market, but rather seeking to gain a big piece of the middle of a long trend. For this reason, trend following hedge funds tend to extend the length of market trends as they plow billions of dollars into relatively small markets such as commodities, causing them to achieve bubble-level valuations. Many pundits are attributing recent commodity action as being the result of "Chindia's" demand, but the reality is that funds are inflating the commodity markets like an elephant jumping into a kiddy-pool.

Trend following hedge funds don't usually bail out at tops, preferring to sell their holdings only upon a clear confirmation that the uptrend is over, serving to further exacerbate the markets descent. The commodity markets will experience a violent free-fall as some funds take on short-positions, anticipating a multi-year downtrend.

There are several indications that the commodity market bubble is nearing its end, likely within the next two months:

1)Prices are beyond over-extended, with many markets going nearly vertical since January 2006. This action isn't justified by fundamental demand, but rather caused by excessive speculation. Several articles from BCA Research back this claim, such as "Gold: Mania Phase", "Be Wary Of Materials Stocks" and "Commodity Prices: Following Natural Gas Prices Up, And Down?", calling the present market environment a "mania."

2)The Dollar's five year bear market, which helped fuel the commodity boom, seems to be ending as I've written in this post. A decline in the Dollar helps boost gold and precious metals prices upward, due to their inverse relationship. In general, a weakening Dollar is bullish for commodities, and vice versa.

3)Global bond yields and interest rates will continue their upward trend for a bit longer, helping to temper some of the strong economic growth that led to such strong commodity demand in the firstplace. Read my post explaining why bond yields have further upside ahead. Even though rates have been increasing for a while, there is likely a delayed effect before the economy feels the impact.

4)The US economy has already begun to show signs of a slowdown, with more to come, according to April's Leading Economic Indicators which fell by a greater amount that expected, foretelling slower growth environment 3 to 6 months in the future. The article says of the Indicators:

"It is saying what we all know: second quarter growth will fall short of the first quarter," said Stuart Hoffman, chief economist at PNC Financial Services Group. "And growth for the second half of the year, will be slower than the first."

Hoffman expects GDP growth will be between 3 percent and 3.5 percent in the second quarter, and no more than 3 percent in the second half of the year.

Gary Thayer, chief economist at A.G. Edwards & Sons Inc., said several recent economic reports point toward a slowdown. For example, earlier this month the Commerce Department reported that the number of new housing projects in April dropped by 7.4 percent to a seasonally adjusted annual rate of 1.849 million units."

Additionally, BCA Research reports that theU.S. Consumer Slowdown Is On Its Way and that there are Signs That Global Growth Momentum Is Peaking found.

5)The housing bubble has popped and that homebuilding activity and prices will continue to decline, causing a decrease in demand for building materials such as copper, cement, wood and sheetrock. Even Alan Greenspan has capitulated, saying "the housing boom has ended." In a post a while ago, I detailed why the housing market and related stocks are entering a bear market.

6)The emergence of commodity exchange traded funds likely signifies that the commodity trend is over, as these types of developments tend to occur too late, created in response to the commodity speculation fever. There is now an oil ETF, symbol USO, a gold ETF, symbol IAU, a silver ETF, symbol SLV and rumors that a copper ETF is receiving SEC approval soon. Once the little guy has a chance to get into such a trend, its usually over, according to contrarian thought.

There are a plenty of ways to profit from the commodity collapse, and investors should look forward to this event with just as much alacrity as with a bull market in stocks. Not surprisingly, the strategy involves shorting commodity stocks that have benefited from the long commodity bull market. Take a look at the following chart from Stockcharts.com:



One great stock to short is BHP Billington, symbol BHP, which is the world's largest metals miner, and deals in a wide range of commodities. Phelps Dodge, symbol PD is a great play on copper as is Aluminum Corp. of China -Chalco, symbol ACH, a play on aluminum.

As far as gold stocks go, some great short candidates include AngloGold Ashanti-AU, Newmont Mining Corp.- NEM and Barrick Gold Corp.-ABX.

I am bearish on oil on the intermediate term perspective, however, I wouldn't short oil stocks just yet. My reason for this is a potentially bullish pattern in oil, that I mentioned here.

Before shorting commodity stocks, I would wait for a topping-type chart pattern, which I will post if and when it arrives.

The Dollar Declined.....What Comes Next?

The US Dollar has plummeted by 8.6 percent since December 2005 on concerns running the gamut from the end of Fed rate tightening, Iran-related worries, alarming growth of the twin US deficits and rising interest rates overseas, especially Japan. As a consequence, the Euro has risen 11.1%, the British Pound 10.4%, and the Japanese Yen 11.5%.

The Dollar's decline to near 10-year lows has raised the ire of Asian exporters, like Sony, Canon, Toyota and Samsung, who's overseas earnings erode as their home currency strengthens, while helping to precipitate a panic on the Asian bourses, with Japan's Nikkei taking a 1,500 point, or 8.5%, haircut. Similarly, the Korean market lost 6.8%, Taiwan 6.6% and Singapore 6.4%, all within a week. So far, Japan has only made attempts at verbal intervention, not yet resorting to cashing in their Yen for the greenback.

The escalation of the Iran crisis since January 2006 has caused investors to shun the US Dollar in favor of the traditional safe-havens, gold and silver, helping them to rise an bubble-esque 35% and 55%, respectively. Copper has almost doubled, having risen an unsustainable90% since January. We'll go into more depth about the commodity boom and its implications in the next post.

I'm of the opinion that the Dollar is due for a rebound very soon, and I have some pieces of evidence backing my claims. Of course, I could end up completely mistaken, but thats why I trade with stop losses. There are times when my forecasts end up being mistaken, I take a small loss, and sometimes even reverse my position ending in a profitable trade. Its critical to be nimble and flexible in your trading, admitting that you were wrong and not marrying a particular position or market viewpoint. Pride ≠ Profit !!!

Here is why the Dollar is likely to rise:

1) Widespread Pessimism: The public's sentiment for the greenback is overwhelmingly bearish at the moment, as everyone ranging from news reporters to finance ministers to retail salespeople are convinced that "the dollar's going to crash." This widespread pessimism perks up my contrarian ears, knowing that "the crowd is always wrong."

In markets, whenever a majority of participants carry a strong belief about a market's direction, the opposite tends to happen. The reason for this comes from simple logic: if everyone is bearish, and has presumably taken bearish positions in the market, who else is left to keep up the selling that is necessary for the decline to continue? Thrown into the mix is the fact that the crowd has strong inclination to overreact after long trends, and you have fertile ground for a rally. In short order, some participants buy back their positions, eventually culminating in an avalanch of short covering as the market rebounds in the most vigorous manner. At this point, traders on the sidelines start to pile on long positions looking for more gains on the upside, until the whole process repeats itself! Obviously, doing the opposite of the crowd is very profitable.

Here are just some of the many recent editorials showcasing such extreme pessimism:

Dollar May Extend Decline to Longest Since August, Survey Says

The Dollar is set for a large decline, here's why

A New Phase in the Dollar's Decline

ETFs For The Dollar's Decline

Free Special Report: "Currency Crash"

2) Asian central banks are likely to intervene by selling their currencies and buying dollars in an attempt to stem the Dollar's decline and preserve their countries' business climate.

3) There appears to be a bullish head & shoulders bottom chart pattern being formed:



The head & shoulders bottom provides a minimum price target to be reached upon the pattern's completion. You can find this target by measuring the vertical distance at the widest point in the pattern, from the low of the "head" to the "neckline resistance level" and then adding this measurement to the value at the neckline. In this case, the vertical distance is 12 and the neckline is 92, giving a minimum price target of 104. At this level, the Dollar may level off before resuming its previous uptrend. If the Dollar falls much below the right shoulder at 83, however, I would disregard this pattern.

You can continue to track the progression of this pattern at here at Stockcharts.com.

4) The Creation of ETF's To Hedge Against The Dollar's Decline: Financial companies have created investment instruments for the retail investor to take advantage of their bearish forecasts for the Dollar. This is bullish, in the same vein of the contrarian philosophy discussed before. Don't get me wrong, its about time these instruments were created- they're brilliant, but the fact is that they came about late into the game, a strong indication the trend is over.

According to an International Herald Tribune article:

"The Franklin Templeton Hard Currency is the largest in the field, with $214 million in assets. It essentially bets against the dollar, with holdings in short-term, foreign-denominated, fixed-income securities from a variety of countries. It is designed to rise sharply when the dollar takes a big fall."

"A fund with a similar strategy, the Merk Hard Currency fund, began trading last May and has garnered about $11 million in assets. It has returned 2.1 percent this year."

"Other currency mutual funds introduced last year by ProFunds and Rydex follow the riskier strategy of using leverage to magnify their returns. The ProFunds Falling Dollar fund and the Rydex Weakening Dollar fund both use derivatives so that they will rise twice as much as the dollar falls."

There is "yet another alternative for investing in foreign currencies that was introduced last year: the Euro Currency Trust, an exchange-traded fund that began trading on the New York Stock Exchange in December."

According to The Street.Com's Roger Nusbaum: "There are two gold exchange-traded funds in the U.S., with a silver ETF and a crude oil ETF on the way. I expect a copper ETF will be created soon as well." Commodities, especially precious metals, have a inverse relationship with the Dollar and represent ways of profiting from a falling Dollar.

5) The smart money is buying the Dollar, while selling the Yen, Euro and Pound: This information was gleaned from the Commitment of Traders weekly futures reports that show the futures market position sizes of three different trading groups, the small traders, large traders and commercial traders.

The commercial traders are large banks and other "insiders" or "smart money" who have an extremely strong track record of predicting market turning points. When the commercials take on large long futures positions, the market tends to rally not much long after. When they take large short positions, the market tends to fall, often violently. The charts have red dots corresponding with commercial sell signals, and green dots corresponding with commercial buy signals.

Consequently, the large and small traders end up on the wrong side of the market at turning points, tending to trade in an opposite fashion to the commercials. Whenever these two take an extreme position, do the opposite!

The following charts show commercial positions in blue, small traders in red and large traders in green. Please visit Timingcharts.com to see other charts like this.

Here is the US Dollar Index. Commercials are taking a very large bullish position, while large and small traders are heavily short. Click on the chart for a larger version:



Here is the Japanese Yen, which trades inversely with the Dollar. Commercials are heavily short, while large and small traders expect much more upside. Click on the chart for a larger version:



Here is the British Pound, which trades inversely with the Dollar. Commercials are heavily short, while large and small traders expect much more upside. Click on the chart for a larger version:



Here is the Euro, which trades inversely with the Dollar. Commercials are heavily short, while large and small traders expect much more upside. Interestingly, commercials are short a staggering 100,000 contracts, making for the most bearish commercial position ever held in the Euro. These people know something. Click on the chart for a larger version:



How can you take advantage of a rising Dollar?

One is to actually buy the Dollar with a forex account which can be opened at FXCM, where they allow you to leverage your position up to 100x you initial investment. This leverage can create fantastic gains or losses, so use a stop-loss, and only trade with a small percentage of your account value.

Another technique is to short sell futures contracts on Yen, Pound or Euro, also an inherently leveraged position.

There are even some mutual funds that track the Dollar, while incorporating some leverage. The ProFunds Rising Dollar (symbol RDPIX) and Rydex Strengthening Dollar (symbol RYSDX) funds aim to rise twice as much as the dollar when it is rising.

A rising Dollar is also bearish for precious metals and precious metal stocks, so taking profit in these assets is a smart move.

I'll keep posting on any further developments.

Oil Taking a Pause (Update 1)

In a previous post, I postulated that the oil market was taking a breather after its explosive move to an all time high of $75 per barrel, leaving the whole world stunned in the process.

Im that post, I even took a stab at what type of consolidation pattern the market would create, concluding that a rising pennant formation might be in the works. Sure enough, several weeks later, it now appears that we have rising pennant formation! :

One year chart:



Six month chart:



My joy of having forecasted this pattern was quickly overpowered when I realized what this pattern actually implies. In another post, Is Oil Approaching $82? I used well-known chart patterns to determine price targets for oil's rally, arriving at a harrowing $82 per barrel or more.

The recent rising pennant formation lends further credibility to the price targets determined in April. A breakout above the pennant's overhead resistance will likely lead oil over $82 per barrel. The rising pennant's price target is obtained by measuring rally's dollar value before the pennant consolidation began and adding this to the price level at the overhead resistance, which is $74. Measured conservatively, oil climbed $12 since late March 2006. Adding the two figures gives an estimated target of $86. Its best to be conservative and stick with the $82 figure, while still realizing the potential for an even greater upside.

As the cold war between Iran and the West escalates, oil will attempt to breach its triangular-shaped confinement, eventually breaking out if both sides start mobilizing for a "hot war".

The best way to trade oil's impeding breakout is to enter in a trade upon a successful breakout above the resistance level at $74.

Previously, I had recommended buying a oil stocks as an excellent method of gaining exposure to oil. I even purchased quite a bit myself. And now I'd like to rescind that recommendation, as I found myself breaking even, despite the fact that oil was experiencing one of its most vigorous surges. After some thought, I realized that although oil stocks will rise as oil increases, some of that rise is offset by the across-the-board bearish sentiment towards stocks that accompanies such a move in oil. Not exactly the best proposition.

For the next move, I recommend a more pure oil-play, in the form of Amex's new Oil Fund, symbol USO, an ETF that moves in lockstep with the price of oil. Buying oil futures is another option, for those inclined to do so.

For this trade, keep a stop-loss order just underneath the $74 resistance level. Even though some trading scenarios sound like a "sure-thing", they can still break down in the most surprising fashion. The key to successful trading isn't being right all the time, but rather increasing the percentage of the time you are right, while aggresively preserving your capital for the times you will be wrong.

The best traders take many small losses while in pursuit of "the big one" or a highly profitable trend. You can still be highly profitable even if the majority of your trades are losers. The aim is to "cut your losses and let your winners run", a simple adage that is rarely adhered to when the powerful emotions of greed and fear take over in real-life trading. Following this risk management strategy is easier said than done, as it takes much discipline and emotional control, but is a skill that can be honed through practice and experience.