Fertilizer rally

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Above is a chart of CF. Far sooner than we thought, it is approaching the top of its channel once again. The ideal scenario would be if these fertilizer stocks reached the tops of their channels before earnings are released next week. We could then sell them and avoid potential disaster. If you're a frequent reader, then you already know our take on the effects of earnings... it depends more on where the stock is trading ahead of them than it does on what they report.

The logic behind selling ahead of earnings is as follows: It is easier to overcome a missed opportunity than lost capital. This is one of the cardinal rules of trading/investing.

Below the chart of CF is a pie chart courtesy of TDameritrade showing the current positions in one of our accounts. Cramer, are we diversified? We would love for someone to call into his show and ask that question:)

Ok, so if the fertilizer stocks get overextended ahead of earnings and we sell, what do we do next? It all depends on what happens next. Although we're getting ahead of ourselves talking about the next trade while still in the current one, we like to have a theoretical game plan so that we're prepared to act should opportunites arise. If the fertilizer stocks sell off enough after reporting, we will simply buy them back. If not, we are looking at loading up on DDM (Ultralong Dow) if the market capitulates. We believe we are very near a short term bottom in the Dow, but it may require a capitulation day to seal the deal. This could easily be provided this week after the financial companies report. We would like to see C drop to 11, and the Dow drop to its 2006 lows of 10700. At that point, we would be willing to enter into a substantial long position in DDM.

We cannot answer all of the emails we receive. Many of you know, we do not even respond to all comments on this board. It's just a matter of how little free time there is in a day. One email, though, hits at an important point, and we would like to share our answer with everyone...

"Snot, I am an avid reader of your blog and I have been watching your trading strategy and learning from it every day. I have heard many times that no one can time the market. Yet you seem to do it pretty well, and you make it look easy using your channels and averages. I believe that you really do have the results you claim because you mention your trades when they are happening instead of after the fact. Your approach to trading yields from my estimate about 50% a year. How is that possible that you can do that when all of the professionals can't? Especially in this crappy market! What am I missing? It seems too good to be true. I am happy I have found your blog because your basic principles have helped my trading a lot. I hope you continue to post every day because I'm sure many people enjoy and benefit from your market commentary as much as I do. Thanks! Greg, WA"

Greg,

First, thanks for the kind words, and we're very glad that you and many others enjoy our blog. We do this largely for fun, but if we help people to understand a different approach to trading, then all the better. The answer to your question is very simple. In fact, it's answered in that little pie chart above. The professionals surely could beat us at this game. But their hands are tied. Faced with billions of dollars to invest, professional fund managers are forced to choose their 40 or 50 favorite stocks. Fortunately, the small investor does not have to. The pie chart above shows that by buying just 4 or 5 stocks, you can leave the pros in the dust.

As far as being able to pull this off in a "crappy" market, it really doesn't matter what the market is doing. As Cramer says, there's always a bull market somewhere. It's very true. Opportunity is not found in the direction of the market, but in the volatility. Up or down is irrelevant.

Best of luck with your trades, and please do not blame us when we someday get it wrong! The best any trader can do is put the odds in their favor over the long term. But short term, errors are inevitable, which is why we have developed a plan for damage control! -Snot, NY

Citigroup

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Although we do not short individual stocks, we have a list of stocks that we believe are headed lower. On this list for some time have been C, BCSI and CROX. Above is a chart of C (Citigroup), which we believe is headed for $11 or lower in the near future.

Our general theory is that investors should buy stocks when they are in uptrends, defined by charts trading above an uptrending moving average, and simultaneously short stocks in downtrends, charts trading below their downtrending moving average. A portfolio of 4 to 5 uptrending stocks held long, and 4 to 5 downtrending stocks held short would put the odds heavily in the favor of the investor regardless of the broad market's direction.

Despite the recent selloff in the market (particularly in financials), you'll see in our previous post that we are not convinced a bottom has been put in just yet. In this spirit, there are charts that still look very bearish. C fits the bill to a tee. MER, C, and JPM report earnings this week, which of course is a major catalyst for movement. We are not betting on C's earnings when we say it's a good candidate for a short. We would prefer their earnings not be on the agenda. We are basing our call to short C purely on its chart. A stock that repeatedly hits the same new high or low eventually breaks through it. In the case of C, a break of short term support at 15.75 could easily lead to a drop of about 30%, earnings aside.

Broad market

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There are several legitimate reasons to call a market bottom here. Let's review the many very significant milestones of last week.

1.) OIL spiked (it could still go further, to 90. see chart above)

2.) FRE and FNM failed. (Though saved by government intervention, still MAJOR failures)

3.) The Dow broke 11,000 intraday

4.) The Nasdaq and the S&P corrected 20%

5.) VIX (the fear index) nears 30

By all means, one could not be laughed at for calling a bottom right here. All the stars are aligned, and we even have the element of fear. We could easily see a bottom forming here, and a formidable rally to the Dow's 200dma (currently at 12765) already underway.

First, let us preface our next comment by saying that we do not attempt to outright "time" the market, and only guess at its next move for fun. We are long fertilizer and that will not change regardless of the broader market's action. This is the first time since the start of this recent downturn which began in mid May that we feel a bottom could be in place. We would not feel shortchanged if the market rallied from here. While we feel the market is only days from a bottom, we still feel it may be several hundred points away. So, on to our fun prediction, for what it's worth...

Despite all of the signs that a bottom is in place, including the technical fact that the Dow is as far below its 200dma as it was at January's bottom, we predict a retest of Friday's low at a minimum, and more downside as a likelyhood.

Here's why... while the government provided a safety net for FRE and FNM, they explicitly said that they would not provide a safety net for any other financial institutions. (Unless they're lying again). It is not far fetched to predict the collapse of one or more substantial financial institutions in the days ahead. With earnings season starting in force this week, all it would take is for one bank to report lower than expected earnings, sparking rumors of failure which would lead to a run on the institution. A run on a bank is simply a mass rush by its customers to withdraw funds fearing the worst. The rumored failure quickly becomes self-fulfilling. This happened to IndyMac Bank on Friday. The government shut it down in order to stop the panic and allow people to regain their confidence in the company over the weekend.

When we predicted a bankruptcy, we were thinking along the lines of an airline, not Fannie and Freddie. The speed and depth of our economy's deterioration is shocking. In light of Friday's events, it would come as no suprise if LEH collapses this week. C, MER and JPM report this week.

Ag rally

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Seems too much too soon to us, but the Ag stocks are in rally mode, so we aren't complaining. We "only" got 60% of our capital in this time around, and we rarely if ever chase stocks as they rally, so 60% it is. If these stocks continue to rally strongly over a very short period of time, we may take a little off the table. Perhaps back to a 50% exposure. While the support of the broader market is not required for Ag to run up, we are troubled by OIL's drop to the bottom of its channel. The slightest news story and OIL could tack on a quick 10%, which could take the Dow down below 11000.

The chart above is a chart of CF. It stopped falling at the bottom of its trend channel and its 100dma yesterday. We added more CF yesterday at 136. We should have backed up the truck, but only hindsight has 20/20. The Ag stocks report earnings in two weeks. Where they go after reporting has 90% to do with where they are trading prior to reporting, and 10% to do with the contents of the reports themselves. If they rally to the tops of their channels (unlikely), they will surely get slammed after reporting, regardless of how well they do. If they drop back down ahead of earnings, we expect a substantial rally after they report, as long as earnings are not terrible. We will determine the best exposure before the reports based on their locations in their respective channels. Holding a stock through an earnings report is generally not a good idea, but each scenario is unique.

In other news, although we do not short individual stocks, our short picks (BCSI, CROX and C) are all doing as expected. They are heading for $0 until an equal and opposite force turns them around.

Ag breakdown?

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The chart at the top is all-important OIL. It just fell back to the middle of its channel to 84.91, after hitting a low of 83.60. Meanwhile, the Dow didn't rally. It's not a good scenario. Now OIL has room to run to the top of its channel, currently at 89, sending the Dow on another leg down. We're predicting a sharp jump in OIL to the top of its channel triggering a capitulative washout move in the Dow, allowing at least a short term bottom to be put in. But when?

Meanwhile, the chart of MOS (bottom chart) is getting too "comfortable" hanging out near its support. Charts usually bounce off of support levels quickly. When they hover over them for extended periods of time, it's often (but not always) a warning sign. If MOS does break down, it will not be a slow, multi-day event. It will be a sharp drop, gaining momentum as more and more traders realize that support has been decisively broken. It does not mean that Ag is dead. As long as the majority of the stocks in a sector remain in their channels, we can have a new move to the upside. CF is nearing the bottom, but POT and AGU are far from a breakdown. If a break of the channel happens, we're going to treat it as a buying opportunity, loading up primarily on shares of AGU. We would normally be more heavily invested at this stage of the game, but the action of the broader market makes us cautious. We're only 51% invested, and hedged with a healthy dose of SMN to boot.

Channel trading unfortunately is sometimes not as simple as it appears. Every time stocks approach the bottoms of their channels, you have to prepare for the worst, and try to get in with the least possible damage. Even when our timing is excellent, our portfolio spends some time under water before making new highs. Let's just hope we get that OIL spike soon to stop this slow bleed, which is never a comfortable market to be long in.

Mosaic - MOS

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Above is an updated chart of MOS showing its reaction to support at the bottom of its channel and its 100dma. So far, this is all business as usual. If the Ag names go much lower, their p/e's will slip below 10, at which point we'll have to advertise ourselves as being value investors, a title which we would rather avoid. "Growth investor" just has a nicer ring to it. Whether or not the support holds is up to the broader market, which is up to OIL, which is up to the Bush/Cheney administration. We have yet to receive our check from Dick Cheney's Halliburton stock option profits that would allow us to offset our exorbitant fuel bills. Our readers will be the first to know when it arrives.

Where's the bottom?

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The chart at the top is CF. All of the Ag charts are similar right now, so there's no need to post more than one of them. The chart below CF is a chart of OIL, and the chart at the bottom is a chart of DRYS (more on that later). We've long been predicting an end to the bleeding once OIL tops out, even if just briefly. One more spike in OIL, to 88, and we could get a capitulation day that puts an end to the current selloff (at least for a while).

The selloff today was focused on commodities across the board. Commodities have been the market's leaders lately. When the leaders finally give in to the selling pressure, it indicates that an end is near because fear is taking hold. Think of SMN as the VIX of the commodity sector. Today, it spiked. Look at charts of WLT, MEE, MTL, SID, and the Ag names to see where the damage took place today. Another day or two of this and SMN will be at 40. Warren Buffett says that you should be fearful when others are greedy and greedy when others are fearful. On this advice, SMN at 40 would indicate that it's time to be greedy.

We sold MTL and SID on a break of their channels and moving averages today. We did this mostly to raise more capital to buy additional shares of the Ag names as they drop. We lost a point on SID and 3 points on MTL, but these were small positions that we were not committed to which were more than offset by our hedge, SMN. We bought some MOS, POT, CF and AGU today, bringing our total portfolio to 45% Ag, 55% cash and SMN.

The question arises "What if the Ag names break the bottoms of their channels and plunge?" It's a very valid concern, and there is no guarantee that it won't happen. If we traded just one cycle, we would either make or lose 20%. We could not tell you which. If we traded 10 cycles, we would make 150%. The best we can do is put the odds in our favor over time. By focusing the majority of our buying in the leading stocks when they reach the bottoms of their channels, we profit over time. We do not profit every time.

When we do get into a trade that goes the wrong way, we approach it in the following way:

First, most of our buying is done at the bottom of the channel to start with. We have cash waiting just in case the stocks we own break support and drop hard. Case in point; we're only 45% invested and the stocks we're buying are near the bottoms of their channels. We also have some cash in hedges that can be sold (at a profit) to be invested in stocks that have broken their supports. At some point after breaking a support line, a plunging stock will bounce strongly. This bounce is the opportunity for you to do damage control on these positions. If you continue to buy into the plunge, at some point, your entire position can be sold at a break even price, or a small loss or gain. If we make an error large enough to put us in "damage control" mode, we quickly admit that we made an error, plan our escape, get out at an opportune moment, and await the next trade.

Look at the bottom chart of the three above. It's a chart of DRYS from back when the drybulk sector's run finally came to an end. In early November 07, it broke its moving average and its trendline. As scary as it is to hold a stock while it breaks support and plunges, look at what happened later that month. The stock was actually trading higher than where it was when it broke down. The best thing to do in a situation like that is to bail when you have the chance to break even. Stocks don't go straight down. Whether the broader trend is up or down, they are always fluxuating. Our current Ag trade may well turn into "damage control", but considering no one knows where the market will go next, we have to work our way back into the Ag names as they approach the bottoms of their channels because this discipline works over time.

Speaking of working our way back into the Ag names, it is times like this that you get the opportunity to see which stocks the pros aren't selling. Of the Ag names, AGU has been putting in the most resilient performance. The best stocks are always the hardest to buy because they never give you the opportunity. It will take a while longer to play out, but our guess is that AGU may be the best percentage gainer after this correction if the Ag names go for another run to new highs.

Intentional non sequitur: Does anyone find it odd how absent the government has been in the market's latest plunge considering how active they were earlier in the year? Isn't it time for some kind of intervention? Perhaps they've given in to just letting the market find its own bottom?