Best Trade: LAMR

My best trade of the day was long LAMR.

I initially saw LAMR come across my "new high of the day filter" in the morning.  It was moving higher steadily so I kept it on my watch list, and then paid close attention after it consolidated at noon.

LAMR 9:30-12:30

A few reasons why this setup interested me:

1. There was no meaningful news affecting the stock, yet it was up 7%.  I scanned the news and saw UBS had some comments out on it and actually lowered its numbers.  This is bullish - the fact its up on seemingly bearish news.

2. This steady move up is neutral to the market action. Here's what the SPY did today:

SPY 9:30-4:00

If LAMR moved down in the morning and bounced with the market around 10:30, I would avoid trading it because it would be too influenced by the market.  One of my main strategies is to get away from the market as much as possible.  This means trading stocks that are acting independently.

3. The next question I asked myself is, does LAMR have the potential to move more than it already has? I quickly checked a daily chart and saw that it has made major moves (ie 10-20%) in the past.  In other words, LAMR has the ability to get juicy.

4. But can it continue today? I checked the short interest - 7% of the float and 6 days to cover - not an ideal candidate for a short squeeze (over 10 days to cover) but still way above average. Also, something I noticed about the daily chart - 29 is resistance and above it is a gap higher:

LAMR daily chart May 17-July 17

(note: this screen shot was taken after the close, hence the move above 29)

5.  The best thing I liked about the set up was the quality of the candles. Notice on the first 5 minute chart I posted above, several green candles have no wicks - they open at the low and close at the high.  This signals low uncertainty and the participation of algos, and more importantly, predictive of similar moves in the near future. Here is the 1 minute candle.  You can see how consistent the small green candles are, very nonhuman, especially from 11:45 to 12:

LAMR 9:30-12:45

Also notice how the stock consistently stays above the EMAs. The yellow is the 6 day EMA and the blue is the 15.  If you go back to the original 5 min chart, the candles consistently stay above the 6 day EMA.  For many traders, this means the long trade is still in tact. 

6.  Finally, this set up is a classic cup and handle. This formation consists of a strong move higher, followed by a shallow consolidation, and then a second move higher which breaks the previous high.

Even though this setup has many characteristics I look for, an important thing to realize is I did not blindly enter LAMR long at this point.  One rule I (try) to trade by is my entries are reactive and not predictive. By this I mean I try to wait for the stock to tell me what it wants to do.  At this point in the day, the stock is simply consolidating off its highs - it is not telling me it wants to go higher. It could easily break down and go below the EMAs, stopping people out and signaling the long trade is over.  What I'm looking for is a move towards the highs, signalling the potential to break higher and create a cup and handle. 

Here is my entry at 28.96:

LAMR 9:30-1:19

What I like about this is the last two 1 min candles are solid (closed at the highs).  Even though it may seem I'm buying the high here, I like the quality of the candles because I believe they will lead to the greatest chance of breaking the highs.  Also, this entry has a clear exit or stop, which I put below 28.60.  I am risking 37 cents in this trade, so my goal is to make at least 3 times this, or 1.11.  This is an important rule I (try) to follow: risk to reward ratio always has to be at least 1 to 3.  This way, less than 50 percent of trades can be winners and you can still be profitable.

Another reason I like this entry is it's at the high of the 1 min candle at 1:19 which means the 5 min candle will close at the high, creating a solid candle (a bullish signal).  Here it is:

LAMR 9:30-1:20

Now that I've entered the trade, I watched the price action and will look to sell once the trade is broken: either at my initial stop of 28.59 or if it goes higher and then breaks EMAs on the way down.  I am also looking for a spike higher on high volume to exit the trade.  This would be inconsistent with the previous price action and would signal a capitulation of the shorts covering. 

There was 20k offered out loud at 29. Once it broke through, I sat back and enjoyed the ride up.  My exit was at 30.61 after a spike higher on heavy volume (CNBC had mentioned it, causing the shorts to capitulate). Here are the 1 min and 5 min charts:

LAMR 9:30-3:00

Notice how consistent the green candles are on the way up: small and staying above the 6 EMA (yellow). As it turns out, my exit was a good one because it got rocked into the close - probably longs getting stopped out as well as fresh shorts after CNBC mentioned it.

LAMR 9:30-4:00

It was my best trade of the day - made $1.65 or 5.7%.  I liked this trade because it complied with many characteristics I try to look for in my screening process: neutral to the market, ability to run (juicy), short squeeze candidate, a break out on the daily chart, consistency above the EMAs, quality candles, and a potential cup and handle setup.

Finally, the best trades tend to defy the imagination, and this one certainly did.  It was already up 7% at my entry on pretty much no news (the UBS news was seemingly bearish!).  Many traders, including my old contrarian self a year ago, would automatically stay away from this on the long side and maybe even consider shorting it.  When looking at a stock that's at the high or low of the day, there is a cognitive bias that makes us think the edge of the screen (literally the side of the computer screen) will somehow "cage" the stock and prevent it from going higher or lower.  Looking at the first chart I posted, many would certainly agree the stock would be unlikely to move higher, yet alone another 6 percent higher.  It's only when we look at the final chart, it makes sense that the high of the day at 1:19 was actually the ideal long entry.

Take aways

My analysis Monday morning:

Bernanke is in a sticky situation because he is faced with lower growth expectations as well as elevated inflation.  The commentary I am paying attention to is whether he believes these trends are temporary or permanent.  If he emphasizes the "transitory" nature of inflation, the FOMC will be more inclined to increase quantitative easing, although I don't think they can say QE outright given the opposition from politicians like Rick Perry.  The most likely alternative in my opinion is extending the duration of their portfolio by selling short dated bonds and buying long dated bonds.  

Today Bernanke emphasized inflation is below the FOMC's target rate of 2% and will remain at these depressed levels as commodity prices have eased.  This commentary is crucial because it opens the door to additional monetary easing, although I doubt it will come in the form of QE3.  He also said the FOMC will consider a range of tools which means they are not out of options.  He may not have mentioned Operation Twist today, but he definitely laid the groundwork for it when the Fed meets September 20th.  Increased expectations for further easing may be the reason gold extended its oversold bounce to close up 3.5%.  Also no surprise the Euro is in the early stage of a major break out higher as USD breaks major support levels.

Update

We didn't get much from Bernanke, just a pledge to consider additional measures at the Sept 20 Fed meeting. Maybe that is exactly what this market needs.

Traders reacted skittishly to the lack of details from the speech but what we are seeing now is a significant bounce as Europe rallies into its close (finishing down about 1% across the board but well off the lows).  One of my favorite stocks MOS is up 3% and well off lows of 66 as it tests resistance at 69.  C rallied back to flat but the financials are relative underperformers this morning (flat while SPX is up 50 bps).

Two bearish indicators post speech:

- Gold is up about 1% to 1785 - usually up on risk aversion but I am not giving it too much weight because it's simply a short term oversold bounce.

- Although off the highs, treasuries are still elevated.  I think this has more to do with the GDP miss (1% vs. expectations od 1.1%) than anything Bernanke said.

Why I am still bullish and continue to buy dips:

+ The Euro and USD have been a bit bipolar this morning - above the 1.44 level pre mkt, selling off dramatically as Bernanke spoke, bottoming at 1.4330, and now spiking higher above 1.4450.  I have been eying this level for weeks now, and I believe we are seeing the first stages of a Euro breakout from the wedge formation I have posted in the past. I'm expecting DXY to break key support and gap down to the 52 wk lows of 73.        

Update

Friday is going to be a very important day: Q2 GDP estimates at 8:30am, and the Bernank speaking from Jackson Hole at 10am.

Gold off $100 to 1760.  If yesterday's move was in fact the market betting on a "Fed Miracle" ie QE,3 why would gold have such a dramatic sell off these past two days?  A third round of quantitative easing is about the only catalyst for gold to sustain its parabolic move to 1900.  Also, the dollar index (DXY) is slightly positive today and the Euro continues to fail @ 1.4450.  If the market truly expects QE3, the dollar should be getting crushed.

Despite lower growth expectations and continued weakness in employment and housing, the Fed cannot pull out the bazooka - not yet at least - because of rising inflationary pressures.  The money supply, a leading indicator, continues to grow - M1 increased 5.5% m/m and 20.8% YoY, and the YoY increase in the last two weeks is the highest in history (The Bonddad Blog).  So what options does the Bernank have?  The most likely scenario is not additional printing but a shift in the Fed's balance sheet from short term bonds to longer term maturities - Operation Twist Redux I mentioned a few days ago.  This will have the intended effect of lowering long term interest rates which will support the housing market.

But will implementing OT Redux have this effect?  It is important to remember what happened when the Fed initially committed to quantitative easing - rates actually shot up!  Investors sold treasuries and reallocated into risker assets (stocks), a counterintuitive move but one that makes sense given the inflationary pressure of QE.  So if the Fed commits to buying longer dates maturities (30 yr), I'm expecting the same effects - the yield curve will steepen, and money will flow from bonds into equities.  This may be why we have seen yields rise in the past couple days as the 30 yr has fallen off 4% and the oversold financial sector has bounced 5% (financials will ultimately benefit from a steepening yield curve).  A caveat: this analysis is dependent on a GDP number which is inline with estimates.  We are expecting 1.1% real annualized growth, and a miss coming in just about flat (or even negative!) would certainly send treasuries higher and spur more talk of a double dip recession.

My game plan on a inline GDP number: TBT and C

Update

Sometimes doing nothing is the best decision.  Obviously shorting the open would have been most lucrative but at least I didn't chase the market as it quickly erased 2% gains.  I watched the Euro reverse and go negative on the day - hovering around the 1.437 level and continue to watch 1.4450 as a bullish indicator. Gold continued higher finished up 2.5%.

The worrisome part of today's action is the fact we couldn't sustain any sort of a rally after Europe closed up 2%.  Also interesting to note financials continued to underperform as the weakest sector today - down 1.25%.  I still think we are in a bottoming process and testing and holding 1100 would be an important support level and a great buying opportunity. 

Monday morning

+ Europe higher across the board: CAC and FTSE up about 2.5%, DAX up 1%.  Euro is up slightly to 1.4425.  I will keep a close eye on the 1.4450 level.
+ Chicago Fed a little better than expected.  -0.06 vs -0.48 expected
+ Treasuries slightly lower

- Gold reached 1890 overnight extending the parabolic move higher.  It's off the highs but still up about 1% to 1866.  SPX futures up 1.65% pre mkt.  Less inclined to buy the open (still bullish but less so than pre mkt Friday).  If we continue to rally today, I want to see a Euro break out above 1.4450 and lower gold as bullish confirmations before I chase.

Big story this week is the Jackson Hole conference on Friday. Bernanke is in a sticky situation because he is faced with lower growth expectations as well as elevated inflation.  The commentary I am paying attention to is whether he believes these trends are temporary or permanent.  If he emphasizes the "transitory" nature of inflation, the FOMC will be more inclined to increase quantitative easing, although I don't think they can say QE outright given the opposition from politicians like Rick Perry.  The most likely alternative in my opinion is extending the duration of their portfolio by selling short dated bonds and buying long dated bonds.  This will not increase their balance sheet and will attempt to lower longer dated interest rates which will help the real estate market. The Fed did this in the early 60s and the program was coined "Operation Twist," so I'm calling for a OT Redux.  Many analysts, however, doubt the effectiveness of this plan because it only managed to lower long term rates by about 15 bps.

Update

Had about an hour of fun today.  Here's a home run trade gone wrong (keep in mind this is 100% of my book):

What I should have been watching - Euro:

Notice how the Euro peaked at 10:15 but the market peaked at 10:30.  I had 15 minutes to get out of my long position.  Also notice the Euro broke its uptrend line at 10:30, exactly the moment the market topped.  This was an easy exit point, especially given such quick gains, and in retrospect, the most lucrative one.