Sunday, January 25, 2009

DoctorMad Goes into Battle with his SHLD!


No, not a shield, that's SHLD as in SEARS Holding Corporation. You know, the former American icon - heck, there's still a foot peddle powered sewing maching somewhere in the family that my grandmother ordered through a Sears Catalog many years ago.

Mark, a.k.a. DoctorMad, a.k.a. “The General” is preparing his troops for battle. He has his trenchlines drawn beautifully, as you can see from the SHLD (Sears Holding Corporation) chart below:



This is a typical example of the communication we do all the time. Hey, two heads and sets of eyes are better than one!
I want to use SHLD as an example of the types of trades I think we should be looking for. I included a chart with the momentum channels shown. The more I think about it, the more the analogy of trenchlines seems useful in understanding how these work. It's just like how the battles were fought in WW I. You had key lines of defenses that the two sides (bulls and bears in this case instead of the Allies and Axis) had to hold with most of the action taking place in no man's land – the space in between the channels. Occasionally, however, one side or the other would mount a charge in an attempt to break the lines causing a general retreat taking more territory (price levels). Watching what happens and the results of the battles that take place along these lines are the key points in the market to pay attention.

Getting back to SHLD as an example. As you can see 50 dollars is the key bearish trenchline right now that the bears have to hold. The bulls have attacked it on 3 separate occasions only to be rebuffed each time. As often happened in WWI battles, once a charge fails, the side that holds the line often regains the initiative while the opponent retreats. The bulls in SHLD spent a lot of ammo to try and push prices up over 50 bucks a third time a couple of weeks ago. When they failed, they had exhausted so many resources in trying to overtake the line, that the bears are now the ones making a push. Thus far they have pushed the bulls back to the midline of 42.50. Where the bulls have now re-gathered and begun to make a stand. This is where the battle stands right now in SHLD.

There is a hierarchy of trenchlines. By that I mean as in any large battlefield there are the far more important long-term defensive lines (my blue channels), but within those there are also a number of smaller trenchlines that form during the shorter term battles. These are my yellow lines and they show the current bearish momentum as the bears make a push towards that midline. Watching how the battle plays out within the yellow channel could also give you clues as to who is going to win at the more important blue channels. You can also scale this down to say the 5 minute scale and use the pink nanochannels to show the important battlelines for the intraday action.

Now this is all an interesting analogy, but how do you apply this to trading? Right now I can see all sorts of potential interesting trades setting up on SHLD using these channel lines. The best one for next week imo would be a move north back up to 49/50 level testing those key bearish lines. Right there is where I'd want to commit bear troops to battle knowing that if we break the 50 level I'm going to pull all my troops in the likely very disorderly and chaotic retreat that would ensue. The key with retreating (stopping out) a trade is to be the first one to realize the lines have fallen and you better panic and run. Those who hang around while the rest of the army is running for the hills are the ones who really get slaughtered.

I also see another good trade setting up on a high volume break south of 42.50. If the bears manage to push the bulls back through the midline a full retreat to the 35 dollar level is very likely. Another way of looking at volume from my war perspective is to consider volume like ammo. When the volume is high that shows that the big guns are being brought to bear and you should use extra caution when that ammo is heading your direction. If you are looking to short SHLD and play the bear line holding at 50 you need to be more worried if you see a hail of ammunition coming your way as the bulls approach 49. If however you see the amount of ammunition being used fading as they approach the line then your odds are better that the line holds. I know it's usually not wise to short the hole and throw troops late into the battle, however, if a large enough and important enough trenchline is broken you can sometimes catch big gains by pursuing the enemy and shooting him in the back until he makes it to the safety of the next trenchline. 35 bucks in this case.

Trying to tie all of this together brings me back to fundamentals. Right now imo the fundamentals of SHLD are strongly in favor of the bears. I've given my fundamental reasons before so I won't go into detail here. The bottom line is SHLD is basically a real estate scam with NO customers under the age of 50. You can think of fundamentals as the supplies an army is receiving. Right now the bear army in SHLD is getting a nice steady supply of rapidly deteriorating fundamentals, a lot of debt, the acceptance that their real estate is no where near what they claim it is worth, and general worsening news as time goes on. The bull army meanwhile is being supplied with fluffy PR claims and skittles from an at best wishful thinking management and at worst a bunch of fraudulent misrepresentations of the state of the company.

Putting these kinds of technical charts together with a strong fundamental wind at the back of the trade are opportunities I'd like to find elsewhere. Basically what I'm saying is I want to find more charts and fundamental cases just like SHLD. Then we can watch how the battle unfolds on a number of different fronts (stocks) and look only for the juiciest opportunities to place our troops into battle. Again, the key with these channels is that they reduce risk. Once you have reasonable confidence where the trenchlines are you can work on only putting your troops to work when the odds are most in your favor and you have a very quick escape plan if the battle turns against you.

- DoctorMad

Thanks, General, that’s going to be an interesting battle – lol! I note the same “trenchline” setup in the SPX with the trenchlines currently at about 840/850ish on the upside and 800 on the downside. I agree that SHLD fundamentals are not strong, especially in a weakening economy with weakening commercial real estate fundamentals as well. I plan on joining Mark in this play and am waiting, like him, for the right entry.

Nate

Hey, if you're going into battle, make sure you take your brothers in arms!

Dire Straights – Brothers in Arms: