I'm a big fan of ETFs that track "conventional wisdom".  You know, always buy companies who are buying back their own shares (PKW, underperforming the market since inception, by the way), or the "wide moat" index recently introduced by Morningstar.  I wrote about both of them and their performance here.  Now there's a new one based on an old idea that seems to have some merit.  It's the Dogs of the Dow theory and if you're not familiar it goes like this.

The strategy is that blue chip companies do not alter their dividend to reflect trading conditions and, therefore, the dividend is a measure of the average worth of the company; the stock price, in contrast, fluctuates through the business cycle.  This should mean that companies with a high yield, with high dividend relative to price, are near the bottom of their business cycle and are likely to see their stock price increase faster than low yield companies. Under this model, an investor annually reinvesting in high-yield companies should out-perform the overall market.

My stock picks have no beta filter, so volatility of the stock is not a consideration.  I've been in awe of the moves posted by RIO since I first picked up the spread at the first of this month.  To this day, I'm still fairly certain that there hasn't been a move in either direction of less than 3% on the day.  What's funny is that I had an article that I had written after Tuesday's close titled "RIO - A Total Loss" after seeing RIO trade below $30 (the crystal ball article pre-empted it though).  I couldn't imagine holding a serious position this stock outright, I'd be shaking in my boots.  When RIO is at or below $32.50, my maximum loss is encountered, so it makes no sense to close the position below $32.50.  If I had owned this stock outright, the losses would continue to pile up as RIO took the elevator down.  Any "guru" would tell you about always trading with a stop.  Surely, someone holding this stock with a stop loss would've been stopped out.  It was down at one point over 15% from the purchase price.

But then there was yesterday.  RIO didn't close below $30 on Tuesday, it made up some reasonable ground and then notched a nearly 9% gain on yesterday's rally.  If someone was stopped out on Tuesday and saw what they saw over the last day and a half, they'd be pretty steamed.  This is a real time account of where stop losses can be a psychological problem and help you lock in losses.  This is where the "death by 1000 cuts" may come into play, especially when trading volatile stocks.  Even though I had gone into "maximum loss" territory, I knew my loss was capped and I could hold for a bounce back.  If RIO went to $0, who cares.

I'm not necessarily saying that one is better than the other.  If RIO went to $100, the stock holder would gain much more benefit than the put credit spread holder.

Finally, the RIO trade is not over.  Given the volatility of this stock, I'd say there's an equal chance of closing 10% higher or lower without it being considered unusual.  Naturally, I'm rooting for 10% higher.

The recession articles are coming out in full force.  The probability of a U.S. recession is over 50% depending on where you read and already here according to others.  The rally on Tuesday was likely another snap back from a very short term oversold condition.  Every chartist will tell you that the market formed a double (or even triple) top in July and October.  Sure the news wasn't exactly clear then, or maybe it was.  It's often stated that the market is a leading indicator.  All other indicators are lagging.  Could it be that in July, the market knew that the probability of recession was great? As the chart below shows, we had an impressive bull run after a slow start to the year and a sharp, panicked drop in February. The chart highlights the double top.  Since that time, the wicks on the candles have been getting longer (volatility increase) and the uptrend clearly broken.  Continue to pay attention to the clues that you can see.  The value of the dollar, corporate earnings, employment figures.  I would tend to ignore trailing figures and consumer sentiment.  While consumers drive the economy, the retail prediction can't be trusted and the sentiment index is too volatile to be all that useful.

(click to enlarge)

I wrote last week about the same old story with retailers.  In summary, I mentioned that every year they tell us how abysmal their numbers are going to be because of the economy, weather, consumer sentiment, <insert other negative reason here> and nearly every year, the numbers are fine.  Well, the first numbers from what I consider a reputable source are in.  Sales are up 8.3% over last year's black Friday, according this article on Bloomberg.

I'd be willing to bet that the trend continues throughout the rest of the buying season.

Will this mean the same for the the market?  Who knows.

The indexes had another down week, putting them further into the red for the month.  I was finally starting to see a little fear and panic on Wednesday when we shed another 200+ points and the S&P went into the red for the year.  Optimism came back on Friday as people piled through doors at their local retail stores.  It seemed like as the day progressed and it was clear that the retailers were going to make out all right (after all of their doom and gloom, as usual), the market kept floating higher.  Of course, this was on significantly lower volume.  We'll see what happens next week when the big boys get back to work.

Here are the numbers for the week.

Learned something on CNBC this morning.  The quote was "As you've seen, the open is not necessarily what the close is".  OK, I think I understand what she was getting at (i.e. 80+ futures at the open doesn't mean that we're going to even close positive for the day), but that was funny.

We now have a consistent way to explain each up and down day.  The declining dollar.  If the market is down significantly, it's because of the declining dollar, of course.  If the market is up significantly (as it appears it will be this morning), it's because of the declining dollar.  Let me explain how.  The declining dollar means our currency is less competitive, which is bad for America.  The declining dollar means that our goods are more competitively priced to the global economy which is good for America.  If you want evidence of the latter, just look at how wonderful the Japanese economy has been doing over the last 20 years.  This is what a devalued currency does for you long term.

I woke up this morning to CNBC, as usual, and I heard that the futures were extremely strong and they dwelled on how strong they were for awhile.  After finally catching the number (+70), it seems like the bulls are clinging.  70 points is a blink of an eye and I would consider this close to within the margin of unchanged.  70 points is certainly something to work from, but I wouldn't consider it extremely strong.  Even 100 points is hardly an event these days.

I hope there are not a lot of folks that listen to these people try and gauge the market.  I consider it somewhat of a news source, but that's about it.  Once they bring people who "predict" on there, whether it's the price of oil, the dow, or gold, I turn it off.  People who spout this crap should be ashamed.

On a completely unrelated note, Microsoft Visual Studio 2008 was released yesterday and I'm installing it this morning.  I expect to spend a lot of time getting acclimated with the new features.  If you're a software developer, it's like Christmas.

I had read that Interactive Brokers (IB) will close the EFP for you automatically at expiration and I thought I'd put that to the test.  Well, they did and what's more, there was no commission charged that I could see.  So my total cost for this venture was 50 cents and the position closed at a profit, of course.  Now one thing that isn't easy to find is the cost basis on the statement.  I can probably go back in the statements and see what it was, determine my basis and time in the position to get pretty close to my APR, but what a pain.  So I say if this is the best complaint I can come up with, then I would say it was quite a success.

So now I'll be scanning the EFP list this morning to find another one to enter.  Interactive Brokers has a list available to the public to look for decent EFPs.  I'm sure it's on their site somewhere, but I usually use the one here.  Of course, click on the EFP Int tab.  I believe this is only updated during market hours.

A couple of words of caution.  First, I let this one go until expiration.  I did notice during the duration of holding this that the P/L at any given point was all over the map.  I assume this is from liquidity issues on the SSF and the price of it trading at a premium or discount to the underlying.  So if you ever find that you need to exit this early, you might be in for a suprise (and it will probably be unpleasant).  Second, I'll need to do more reading, but it wasn't entirely obvious how to close this position manually.  If you have a stock, option or future position, you get a "Close Position" choice when you right click on your open position in IB TWS.  No such thing for the EFP.  I assume I can put in a limit order at the interest rate going the other and get it to close, but why make me guess?  Finally, I'll stress again, watch your cash balance.  Since SSFs are marked to market, you could show a loss on the SSF and need to come up with cash.  If you don't have the cash to settle then you're borrowing at the broker rate, which I assure you is higher than what you're getting on your EFP.  Just pay attention.

Well, it appears as if my down leg lagged the market's down leg.  The end of last week was terrible for the markets, but I was down only slightly.  Well this week is exactly the opposite and if you look at the numbers for the month, I'm pretty much right in the middle as far as performance.

The RIO pick is also down.  We picked up the 35/32.50 DEC put credit spread when RIO was about 36.75 or so and received a 0.90 credit.  RIO closed at 35.50 on Friday.  The credit spread is down $5-10 per spread.  Not bad.  I'll likely hold this until expiration and if RIO closes above $35, we'll keep the full 0.90 credit.

I'm not in the prediction business, but it's worth noting that there's a pattern emerging.  Whether or not it carries over into a sustained bear market is completely beyond my crystal ball reading capacity.  However, leaders are getting pummeled as of late and the down days are larger than the up days in both number and point size.  The volatility has been increasing for quite some time.  The "automatic" afternoon rallies that carry us up from a deficit into a positive day seem to be missing.  These are signs that happy days for the bulls may be gone for a little while.  This is just a bit reminiscent of the 2000 market.  I mean that only from a behavior standpoint.  For one thing, the magnitude of the moves were greater and the valuations were on a much dumber level.  I also see too much reassurance that everything is going to bounce back.  In other words, not enough panic.  The VIX can show you this.  It's somewhere above 25 and below 30, which is not a panic pitch on a historical scale and we're 1000 points off of our highs.

The point I'm making is that 15-20% could justifiably be shaved off the current indices before we see real panic set in.  Plan accordingly.

P.S. Usually after I come to these conclusions in my mind, the market rallies to new highs, so be sure to plan for that too!

We've got a lot going on with RightEdge this week and more importantly, we're building infrastructure to better serve our customers and prospects, which is taking a lot of my free time.  As a result, my posts may be absent or very brief for the rest of the week.  Expect a weekly wrap though.

I've been studying and to a lesser extent practicing asset allocation for a number of years.  This is where the majority of the account is held while trading system trades and speculative trading is a different and smaller portion of my account.  So who wouldn't want to maximize the returns of the majority of their holdings?  Typically my allocation has been a bit random.  A little bit of backtesting mixed with some gut feel.  It's done OK.

I came across an article a few months ago that has stuck with me.  It is labeled the "Ultimate Buy & Hold Strategy".  You can read the article here.  It puts forth some interesting ideas, but one thing that makes it hard to go all in with is that fact there is not enough data to provide a meaningful backtest for my comfort level.  Enter Marketocracy.com once again.  I've created the UBH strategy (ticker symbol UBH, no less).  I started this on October 30th which was pretty much at the top of the latest leg down.

The public profile is here.  At this point it has lost less than the major averages since inception.  This is another barometer that I'll be keeping my eye on over the next several months.  Thought I'd share.

I skipped last week's review because it was a measly two days.  So today's numbers are since November 1st.  I indicated earlier in the week that I was pleasantly suprised at how well the picks have doing since inception after hitting an important number ($13 per paper share, up over 30%).  That was probably a good contrarian signal for you to short BMF.  

The BMF closed Friday at $12.15 on Friday, down 6.7% in just a couple of short days.  I knew the numbers would be interesting this week.

* Not pictured: RIO (this is the option play which I'll go over later)

I watched RIMM and NDAQ take a beating over the last couple of days.  I was pleasantly surprised that we lost substantially less than the major averages.  I think the surge up before the last couple of days helped a great deal.

RIO also had my attention.  I got in the spread somewhere around 36.75, the underlying is now 35.70 which is down 2.8%.  The option spread is showing a loss of about $10 per spread.  If we bought 10 shares which equals about the delta of our spread, we'd be down about $10.5.

Have a good weekend.