DaddyBall!

After a not-so-brief sabbatical, the Weekly Battle Plan piece is back. The past few months have brought the writing of a new book (details later) and the start and finish of my kids' Little League baseball and fast pitch softball season. My son's team won 9 consecutive games mid-year and finished in second place. Not bad, considering they started the season more interested in watching hang-gliders fly over the fields than they were in getting kids out at third base (see my March 19 column). My daughter's team did even better, making it to the championship game. And had the season ended there, I'd have been a happy man. But then came All-Stars, which makes me an even happier man. Why? Because I get a chance to be entertained! During the various tournaments my daughter played in, I was entertained watching managers getting tossed out of games, I was entertained watching two different managers erupt and then "demand" their kids leave the field (one was my daughter's manager), I was entertained watching a manager giving an umpire the finger in the middle of the game (he did this from the parking lot...he too has been tossed out of his game), and of course, what would any All-Star season be without the annual two mothers from opposing teams calling each other "b**ch and getting into a near catfight in front of hundreds of other people (NICE!).

Until this summer, I used to think that the primary purpose the kids spent half their summer practicing 2-3 hours a day, five days a week was to win the tournaments they played in each weekend. That makes sense, doesn't it? But no, I had it wrong. All wrong. I learned this year that the main reason for the kids putting in all this time was so they and their parents could be entertained watching the head coach's daughter play. That's right, 11 other kids got the chance to be "under-studies" to the head coach's daughter. When our manager's daughter wasn't the starting pitching (the team had an excellent starting pitcher, but that didn't matter in deciding who started most games), she was starting in the infield (same situation again). And of course, she batted either third or fourth in the order most games, ignoring the fact that few parents could remember her ever getting on base. And of course, after each team victory whose name was mentioned the most as key to that team's victory? One father early on dubbed it "DaddyBall" and that's the name the rest of the season took. Fortunately, the girls won their share of games and even made it to the championship round of two tournaments (and guess who was the starter in the last championship game? Can you say "down 7-0 in the second inning?"). But, like all good things, the season has come to an end. But fortunately the opportunity for us to be entertained has continued. A few days ago all the parents got an email from the head coach's wife. Guess what? The show still goes on! Here was the invitation we received...

"Are any of the team members interested in attending (her daughter's name here) GREASE play Friday night, July 16th?  She plays Sandy, and her two sisters are in the play, as well.  Let me know who would like to come and I will get tickets."

Wow! I was excited! But then I remembered. I had scheduled to rearrange my sock drawer that night and it's a commitment I just can't break. Bummer. No GREASE play for me this season. But, because our kids are the same age, and the head coach will likely be the All-Star coach in future years, they'll be plenty more opportunities like this. Man, I'm a lucky guy!

Opportunities In A Declining Market

A few weeks ago, as the S&P 500 was hovering around the 1140 level, there seemed to be a heck of a lot of prognosticators who were very bullish. We saw these bulls on TV, we read their columns on various financial sites and according to them, it was only a matter of time before the market was going to soar even higher. Now, with the S&P's a scant 4% lower two weeks later, these same bulls have found all the reasons in the world to be bearish. "The techs have broken" "the 200 day MA on the S&P's is about to give," "the NASDAQ has broken support," "no rally can repair the damage that has been done" and so on, and so on and so on.

Well who knows? Maybe the same style of "guessing" these people used to incorrectly predict prices two weeks ago will this time prove to be correct (kind of like flipping a coin). So let's today go with their assumptions. Let's today assume that the bear has arrived and we're going into a sustained declining market (I'm not saying that...they are). So what does one do? No longer trade? Go into all cash and wait for the market to stage a massive rally and re-enter to the long side (after the fact again)?

The answer fortunately, is 'no.' In fact, should we be going into a bear market, the opportunities for short-term gains will likely be greater than the opportunities that exist during a bear market.  And this week, I'll show you where those edges and opportunities have historically existed.


Finding The Best Opportunities In A Declining Market

There are many ways to trade a Bear Market. The three I'm going to show you don't have the same purported edge that the prognosticator guessers have, but they have had a statistical historical edge on the short side. Even though there is no guarantee these edges will hold in the future, these edges have held for years...

1. First, we need to define exactly what a bear market looks like. We've looked at this many different ways, but the one way that has the biggest edge is the 200-day simple moving average. We looked at nearly 1000 situations matching up likewise indicators above and below the 200-day MA. And, there's overwhelming evidence that markets behave differently below their 200-day moving average versus above their 200-day MA. One of the biggest differences is that markets under their 200-day MA tend to exhibit more volatility, which means more daily range. And more daily range usually means more opportunity.

2. When the market (and be careful here, because in our opinion there are two markets, the S&P 500 and the Nasdaq market) is below the 200-day MA, we're going to be looking for ideal times to be entering on the short side. As I am writing this (Thursday July 15) the S&P 500 is above its 200-day MA and the Nasdaq is below its 200-day. Therefore, we'll focus on the Nasdaq market.

3. Edge One:  The average weekly gain for the Nasdaq has been .37% over the 15 year period of time we studied. Yet, when the Nasdaq market has closed higher three days in a row while under its 200-day MA, the average loss has been 1.50%.

4. Edge Two: When the Nasdaq has made four consecutive higher highs (this means today's intraday was higher than yesterday's intraday high, and yesterday's intraday high was higher than the previous intraday high, etc.), this has on average been a bear trap. In spite of four straight days of strength, this strength (again on average) has disappeared and has led to average declines of 1.14% over the next week (the loss has been 1.85% for 5 days in a row). As mentioned above, this is versus the average weekly Nasdaq gain of .37%.

5. Edge Three: When the advancing issues for the Nasdaq have been greater than the declining issues for three consecutive days, (meaning more issues were rising than declining), the Nasdaq has lost on average 1.45% over the next week. Yes, maybe the buyers were coming in. But, on average, these buyers were down a week later. Those who shorted the Nasdaq (i.e. the QQQ's) profited during these times.

Going Further

Let's discuss a few things regarding these results:

1. There's no guarantee they will continue in the future.

2. None use stops and stops are always advocated.

3. These are big edges. If you can find opportunities every week that average over 1% a week, your returns have the potential to be substantial over a one year period of time.'

4. You can probably take these scenarios and increase their edge. I've just isolated these edges for you. Combining them with other things have the potential to bring even better returns.

Wrapping It Up and Where You Can Find More Information

As I mentioned earlier, we've just published a book entitled How Markets Really Work. The book looks at many of the most popular ways to look at markets and shows exactly where the edges have been. Price, Volume, Market Internals and Market Sentiment are all covered. The three edges mentioned above are just three of the more than 800 scenarios we looked at. If you would like more information on the book, go to www.TradersGalleria.com. You'll also be able to read an excerpt from chapter one. The book will be released in about three weeks and it will give you a more precise way to trade the markets as you move forward.

Have a great week trading (and if you have any questions on the above, please feel free to email me at lconnors@tradingmarkets.com)!

Larry Connors