Saturday, 19 July 2008

Naked Gun

Not in my trader's conscious mind (or even the subconscious) would I have ever imagined that the US market was also prone to some of the dirtiest tricks in the book but to a greater degree.

I'm talking about what they call naked short selling. No, it's not short selling while wearing your birthday suit. That's kind of kinky but that's not what it is. For those who are not familiar, short selling is a legal way for traders to make money in a market that's going down. You will first borrow shares (normally from your broker) and then sell this to the market when you perceive that the stock is going to fall. In order to realize your gains when the stock does go down is you buy back what you borrowed to cover your position. This is the legal way.

Naked short selling is simply short selling short but without borrowing the shares. This is the illegal way and this is what the US Securities and Exchange Commission is cracking down against. There were reports that the biggest victims of this practice have been Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE), the two biggest mortgage lenders to the American public. Others have been financial institutions like Lehman Brothers (NYSE:LEH). If you noticed, what's common with these stocks are they are all in the financial sector. This industry has been battered starting with the subprime problem, housing sector, and now every financial institution has been slowly reporting that they exposed too much money in the said areas. Fundamentally we know that's a recipe for disaster and that you would expect their shares to drop. But unfortunately, unscrupulous traders have taken it upon themselves to make money out of the situation without going through the proper channels.

It is for this reason alone, the US SEC is said to be imposing a one-month ban on short selling to prevent what could be a massive collapse in the sector which could spill over to the economy.

On the local front, the timing of the PSE seems to be impeccable. They're just about to introduce the short selling program as another tool to spur liquidity in the market. What timing indeed. It's like kicking a man when he's down. The market is already bearish and when this is now introduced, what's going to stop the shares from falling further?

To my knowledge, not all shares will be qualified for short selling. Only selected companies will be part of this. But I believe these are also index issues. There also seems to be a lack of education regarding this program for the investing public. Our investors/traders are not the most mature, some even qualify to be considered goons. So it's quite dangerous to allow these people access to short selling as they could just sell the shares without even thinking of buying it back at a lower price.

The timing of introducing short selling to the PSE is wrong. All investors & traders must be given a proper education about how to use this before it's launched. Otherwise, you could be looking at chaos right in the eyes and it will be translated to anarchy in the market.

Wednesday, 9 July 2008

Cashing In, Even on a Bear Market

Don't believe everyone telling you that there's no way to make money in a bear market. It's just harder.

Take for example Office Depot (NYSE:ODP). Although it's very clear that it's been going downhill for the past year, It decided to go sideways since January. It's been in a tight range until recently. Some view the range as a possible descending triangle. Seeing that ODP has already had a very hard time rising from underneath the moving averages, and the MACD kept pointing downwards, it was only a matter of time before the stock would break down. And break down it did.

As like any good, disciplined soldier, we took to the battlefield of trading 2 nights ago and placed an order to short sell ODP at 10.45. So we went in bravely with both feet and braced a bad news report that ODP's year-on-year sales dropped by 10%. We knew this kind of news would drive the price down but by how much? We were quite pleased to see that we were able to achieve our target and more in just one night as ODP dropped around 40% due to the bad news. We were able to cover our short position immediately around 7.20 and search for a new opportunity.

Once in a while, these jackpots do come, even when things look wrong. Patience is really the name of the game.

Thursday, 3 July 2008

Bleeding Dry

FINALLY! The US has recognized that they are now in a bear market. They had to wait for the DJIA to drop to a 20% decline from the highs before they would acknowledge it. But guess what? According to another article tracking the state of the US market, more blood is to be shed.

Aside from looking at the bigger picture of the DJIA and the other indices, they also look into the volatility index, which is inversely correlated with the S&P 500 and serves as a measure of market uncertainty. The index measures the variability in options prices, which tend to rise as the fundamental backdrop becomes less certain. Of course, this means the opposite is also true: The index falls as complacency sets in, which is conventionally interpreted as a bearish indicator. So in a nutshell, extreme highs are interpreted as a bullish signal, while extreme lows are taken as a bearish indicator. In this case, the volatility index is in limbo. Since it's neither bullish nor bearish, it only means that this downtrend we're currently experiencing is not over. This could only mean that it's possible that we'll see the levels of 10,500 or even 10,000 for the DJIA soon.

A commentator even said that these days, a drop of over 100 points is already not nerve wracking anymore. In order for the market to rebound from this downtrend, what they'd like to see is that there would be a 500 point drop in one day to shock the people into going into the bullish mentality. I guess this would be their way of saying that things would be ridiculously cheap that it's going to be very hard to ignore them.

In our case, we only follow one of the Dow theories. The trend is presumed to be in effect until there is a clear sign of reversal. Right now, there is no reversal signal. So the bleeding continues for the market. To the permabulls, it's best to stay on the sidelines. For the other traders, short the weak industries like airlines and the financial sector.