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Stocks hanging tough

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Stocks are hinging tough this morning as there is some economic data to digest along with the JDS Uniphase (NASDAQ:JDSU) debacle last night. That JDS Uniphase news doesn't seem to have too many participants spooked and we're not surprised. As pointed out in some recent articles I've written for the Premier Investor Network, the point and figure chart of JDSU had that stock giving seven sell signals without a buy signal since the $18.50 level back in April. You get the feeling the MARKET knew things were bad for that company, but maybe just not knowing how bad. Now the MARKET knows and it goes on with its business. So shall we.

Bond YIELDS are lower today, but stocks are holding in there. We haven't seen much progression past yesterday's highs for the major indexes and this would be expected. One reason I think stocks are holding tough is that bonds aren't all that much weaker on YIELD (stronger in price) than levels found over the past 6 session. If we understand that the 5-year bond is "less risky" than the 30-year bond only due to the shorter time until maturity, then perhaps we can draw some conclusions from current action in the bond market. My thinking is that we're not seeing enough buying of bonds on the long end (30-year) to have traders thinking doom and gloom. When you think about risk/reward, then the current YIELD of 5.539% on the 30-year YIELD ($TYX.X) and holding above the 5.504% level low found on July 20th is perhaps a statement by the bond market that "I'm not willing to buy this bond aggressively enough here at 5.539% as the information I have at hand right now doesn't warrant that action."

On the other hand, we did see the 5-year YIELD dip below a recent relative low of 4.594% and that makes some sense based on risk. While there is a fairly wide gap between the YIELDS of the 5-year and 30-year, the pure "reward" trader would obviously buy the 30- year YIELD as it offers the higher YIELD, but we know too well that a smart trader must always offset that purchase decision by looking at the risk side of the equation. At current YIELD levels, there is much greater perceived risk in the 30-year for a bond trader at 5.535% than at 6%. I do think the 30-year YIELD staying above recent relative lows is of comfort to equity bulls as it relates to the current perception of how the MARKET is certainly weighing the risk/reward scenario there and that of stocks. While my downside alert for YIELD has been triggered on the 5-year at 5.494% today, my relative low downside alerts for the 10-year ($TNX.X) at 5.066% (50.66 on q-charts) and 30-year ($TYX.X) at 5.504% (55.04 on q-charts) have yet to be triggered.

In today's "hot list" on OptionInvestor.com, I thought a good trading strategy for the QQQ might be this. Lets assume your job is to only trade the QQQ and manage a $10,000,000 account that is only invested in the QQQ. Lets assume you were net long the QQQ by $10,000,000 at the opening of trading. When the 5-year YIELD broke below recent relative low, your past trading observations of how YIELDS between the 5, 10 and 30-year all related, might have you liquidating 1/3rd of you net long in the QQQ and establishing a net 1/3rd short in the QQQ. Your account would now be 1/3rd short and 2/3rds long the QQQ. If that occurred at $41.75 and the 10-year YIELD broke below recent relative low, you would then check the price of the QQQ and only short 1/3rd position if the QQQ were trading below $41.75. This would systematically have you trading QQQ as it relates to bond YIELDS. The strategy of ALWAYS focusing on the underlying security and the QQQ makes you only short the direction your trading scenario calls for. Remember, the scenario here is that lower bond YIELD will result in lower QQQ.

What's interesting about this set up is this. By dividing things into "thirds" you are in essence taking a stance on the market. A trader that is 1/3rd short and 2/3rds long is in essence showing a market bias to the bullish side, but he/she didn't make that market call based on emotion, but only based on previous observations of how bond YIELDS affected stock prices as correlated with the QQQ.

What I also like about this strategy is this. If you're managing your account properly and only working off the base amount (example was $10,000,000 as an institutional trader would do), then you can begin testing your strategy over time. If the account grows to $11,00,000, you are NOT basing your 1/3rd off of that number. You ONLY use $10,000,000. That $1,000,000 is your profit and rainy day fund from your hard work.

Now, if you're $10,000,000 becomes $9,000,000 guess what? Something is wrong with your trading scenario and things aren't working as you thought they should. It's either time to understand what is going wrong, or fine tune your action points.

For example, if I'm short 1/3rd today at $41.75 and the QQQ moves to $43 because YIELDS have turned higher, then I don't need to panic as 2/3rd of my money is on the right side of the market. I could have made more money had I been 3/3rds net long. OK, so where is that point at? As a trader, you understand that you're going to have losses from time to time. The key to maximizing return is to manage the portfolio has a whole.

Right now I think it is a good idea to be mixing in some shorts with some longs. I've established a portfolio based on the above scenario and it will help keep me on the right side of things. I did this yesterday when I thought a short-term traders would be in the QQQ at the $40.20 level on the bullish side. This morning, when the 5-year YIELD dipped below it's relative low, I switched the portfolio tracker to short 1/3rd, but still long 2/3rds. See how if you can implement this into your trading.

So, right now I guess you'd have to say I'm 66% bullish and 33% bearish on the QQQ. Ooops! I can never be neutral.

Jeff Bailey
Senior Market Technician

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