Mar 222013

TZA 4 hourHere are the 4 hour period charts of both TZA and IWM, which of course are near mirror images of each other.  As I expect the likely upcoming pullback to be relatively swift, I have opted to use the 3x leverage ETF as the preferred proxy for this short on the Russell 2000 index.  As often mentioned here, leveraged ETFs are often prone to decay and tracking error (compared to the index that they are attempting to track).

There are basically two primary factors that can exacerbate or minimize this decay: Time & Volatility.  Basically, the longer you hold these leveraged ETF, the greater the decay will be.  However, the volatility of the underlying index or sector can also be a very large contributing factor.  The more volatile and choppy the underlying is, the worse the decay will be on the leveraged tracking etf.  Therefore, if I were to expect a prolonged, choppy, back & forth move down to the 85-86 level in the IWM, I would most likely prefer to either directly short the IWM or use the 1x (non-leveraged) $RUT short etf, the RWM.

IWM 4 hourMany articles discussing this can be found via a quick web search but to illustrate this using a real world example, let's just dig into these 4 hour charts on TZA and IWM.  As you can see on the IWM chart to the right, my current target is that support zone defined by that very prominent gap from Jan 2nd.  If that target is hit, the mid-point of that support zone lines up nicely with the 50% Fibonacci retracement level.  In other words, the IWM will have given back half of it gains from the bull run that began with the Nov 16th lows.  However, although the TZA chart (top) is virtually a mirror image of the IWM chart, if that same gap were to be backtested from current levels, TZA will have only retraced (i.e.- "made back") 38.2% of it's losses since the Nov 16th bottom.  Had IWM moved in a straight line from the Nov 16th lows to where we are today, those retracement levels on IWM & TZA would essentially both be at 50% (not factoring in expenses, etc..)

As of now I'm going to keep things simple and use only one target, 12.30, for the TZA trade.  I have adjusted the target level down to well enough below that gap so that even if the $RUT does backtest it from above but TZA suffers from a modest amount of decay, that the odds for a fill should still be good. In otherwords, if the $RUT or IWM were to bounce of the top of that gap on a pullback, I would expect TZA to reverse just shy of it's comparable gap.  As the target on TZA is just about $3 from the entry price of 9.37, a stop $1 below entry would provide an objective 3:1 R/R ratio.

One final consideration would be to beta-adjust your position size accordingly if taking TZA.  Being that this etf is leveraged 3x, one should therefore consider only taking about a third of their typical position size.  If the $RUT were to drop 10% then TZA should be up by roughly 30% ...and this cuts both ways (regarding losses).  Also take into consideration that small cap stocks have a higher beta (are more volatile) than the broad market (S&P 500) as well.

Mar 222013

These are the daily charts of the ten largest components of the Russell 2000 Index (posted in descending order by weighting).  Rarely have I even seen such screamingly bearish patterns on nearly every top component in a major, diversified index such as this.  Of course, these stocks are also extremely overbought on the daily, weekly and even monthly time frames.  Personally, I'm expecting much more than the run-of-the-mill 3-5% pullback that most pundits on the street are calling for.  As taking screen captures and annotating 10 chart takes a considerable amount of time, my notes on the charts are minimal but I believe that most of these patterns speak clearly.

Many of these charts have some horizontal or uptrend lines drawn below current prices which would act as downside targets, for those interested in shorting or even going long any of these stocks on a pullback (the former being my preference).  Although some of the stock have just recently broken below support, typically a key uptrend line, many are still within the patterns with some towards the top of the patterns/trendlines (resistance) while others are close to the lower uptrend lines (support).  Therefore, my short on the index at this time is what I refer to as an anticipatory trade (entering the trade early in anticipation of a likely breakdown).  However, more conservative or conventional traders might choose to wait until the majority of these stocks have broken below the support levels shown on these charts before taking a full position.

Mar 222013

I often review the top 10 components of a major index or sector that seems of interest to me at the time.  In reviewing both the previously posted chart of the Russell 2000 (small cap index) as well as the top 10 components of that sector, I am adding TZA (3x short Russell 2000) as an active short here at 9.37 with targets and stops TBD.  I'm in the process of annotating the charts of the top holdings in the $RUT right now which I will post along with the TZA chart and targets asap.

For those interested, my initial final target ("initial final" sounds like a bit of an oxymoron, huh?) will be around the 13.00 level.  Initial final target means that I will probably list a few targets on trade, as I often do, with the final target somewhere around the 13.00 but could possibly extend/add additional depending on what I see once/if the markets start to correct.  Capice?

Just to clarify, since TZA is an inverse (short) etf, you would go long TZA.  However, since this is a short trade on the market, it will be added to both the Active Short Trades as well as a Short Setups category for reference.  Two other alternatives to those preferring to short the small caps using less leverage could go long TWM (2x short Russell 2k) or even RWM (1x short Russell 2k).  The longer that you expect to be in the position, typically anything more than just a couple of week, the better off you are using less (or no) leverage on the choice of your ETF as the more leveraged the ETF, the more subject it is to price decay/tracking error over time.  As for now, I plan to use TZA to short the initial move down in the $RUT, likely taking profits soon and possibly re-entering on a bounce.

Mar 222013

Of all the major US indexes, the $RUT (Russell 2000) looks poised for the largest percentage drop.  I still prefer trading the best looking individual stock setups vs. the broad indices but if I were to pick a favorite short index etf right now, it would be either TWM (2x short $RUT) or TZA (3x short $RUT).

$RUT daily