Volatility Trading Digest - Market Forecast Strategies

Volatility Trading Digest - Market Forecast Strategies

Strategy

As for the current equity technical picture, here is what we said in our last Digest Issue. "While US equities quietly work their way higher, there are still some unresolved technical indicators including the McClellan Summation Index and the 9-week RSI divergence." Both of these technical concerns remain unchanged.

• Rising long term US interest rates, watch TLT or TLH.
• Renewed concerns about eurozone debt issues.
• China's ability to engineer a soft landing while cooling domestic inflation pressures.
• The level of US Merger & Acquisition deal activity.
• The condition of the US job market.
• US home price stability.
• Finally, important - but yet unknown risks.

While improving in the last few days the potential Head & Shoulders Tops are still operational in both the iShares MSCI Emerging Markets Index (EEM) 47.64, and iShares FTSE/Xinhua China 25 Index (FXI) 43.09. Both of these topping patterns would need to be favorably resolved to give the all clear signal for global equities.

• Agriculture and farm equipment
• Oil, gas and oil services
• Coal and rail transportation
• Rare Earth minerals and palladium
• Engineering and construction management
• Takeover arbitrage

For those unknown risks, we suggest using option spreads to maintain a 10-15% hedge, rising to as much as 50% when identified technical concerns are present. As always, we suggest using written trade plans with identified stop and/or unwind levels. Whenever you have a market scenario or idea, be particularly careful to set up your exit strategy in advance. Ask yourself what would have to happen for you to change your mind.

Returning to forecasting we suggest less effort be spent on 2011 market forecasting and more devoted to managing portfolio risk, consistent with trading what you see not what you think. Excessive reliance upon forecasting can often lead one to conclude they know the future creating beliefs and hope. Here is what well-known futures trader Joe Ross says,

"Trade the signals but have no opinion concerning them. Opinions lead to hope. Hope will destroy you in the markets. Hope has its origins in the emotions. You cannot trade emotionally. You have to trade your logical, thought-out-in-advance plan. Trading what you think is one of the greatest traps into which you can fall." - Joe Ross.

While equities continued improving in December, there remain unresolved technical issues that warrant continued vigilance while hedging long positions in the favorable sectors.

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