Interview with Short-Seller Timothy Sykes

Q. Do you expect a crash?

Sykes: I would say there are better odds of a crash than a big spike. I am a short seller. I have a short bias. With our debt and government interventions, eventually something could happen, even if it won’t last. People get freaked out pretty fast.

I don’t know if there will be a crash. The debt and dollar would make the most sense. If we get downgraded, that could cause a crash. There’s a lot of danger on the horizon. One thing I do know: shorting is difficult. You cannot stay short or you will be crushed. It reminds me of the guy who predicted the end of the world several times. It’s no different than people who predict Dow 40,000. They are looking for attention.

Q. What are some clues that precede a crash?

Sykes: Seasonality is a big part of it. Another big clue is when you have a lot of speculative things flying. That is usually the end of a bull market. You can make the case about the Twitter, Facebook, Linked In, and Pandora valuations. It’s possibly a bubble. It sounds amazing; all these companies and their amazing business models. People think these businesses will never stop growing, but that is just bull. With all this stuff flying, it could well signal the end. A lot of IPOs are coming out and raising cash so we’ll have to see.

Q. When do crashes occur?

Sykes: First of all, historically crashes have occurred the most often in September and October, so you need to be extra aware during these two months. Crashes usually don’t happen out of the blue, although sometimes they do. Usually, a market will be downtrending, and people are selling, and then they’ll puke it up in one day. This is momentum that is usually built up over days and weeks. Always be aware of gradual downtrends where there are no bounces. This can lead to a blowoff.

Q. Are there other clues the market might crash?

Sykes: I look to see if the media says we’ve been down 10 or 12 days in a row, and that it’s a record. Even though it’s meaningless, it influences people. It causes people to want to exit in mass. It’s like a run on the bank, and people are influenced by fear. I follow the downtrend or very influential news. It’s no different than buying, that is, when you are looking for positive news.

Q. Can people call the top of the market?

Sykes: People love to call the top because they think there will be a crash from the top. Rarely do you find a specific crash at the top. You might find it failing to break out to new highs. Crashes don’t usually happen at the top, they usually happen after several days or hours of fading. Because people have their stops at the previous high, it can also create a massive short squeeze. That’s why I don’t try to pick tops.

Q. How would you trade a potential crash?

Sykes: I wait for a bounce. I don’t like shorting after a giant drop. I like shorting after a bounce or a failed bounce. If you short into a free-falling market, although you can make quick profits right away, you can also get a violent snap-back rally. That is difficult to protect yourself. But in every single crash throughout history, there has been a bounce, no matter how fleeting. It might not be huge or long, but if you can sit in cash during the crash, you have an opportunity. The best opportunities are during flash crashes.

 

Note: Part II of my interview with Timothy Sykes will be posted on this Web site in approximately two weeks.

How to predict the market’s next moves

MIAMI, Fla. (MarketWatch) — If you ask many traders which market indicator they’d use if they could only choose one, it would be moving averages.

Even if you don’t believe in technical analysis, take a look at moving averages, a powerful but simple indicator that gives important clues to market direction. The most popular are the 50-day, 100-day, and 200-day moving averages, although people use the 200-day measure as a guide to the long-term market trend.

But in a recent article, MarketWatch columnist Mark Hulbert found that a portfolio following the 200-day moving average hadn’t produced such impressive results over the past 20 years. “Even on a risk-adjusted basis over the last two decades, the 200-day moving average has lagged a simple buy-and-hold approach,” he wrote. Read more: 200-day moving average lags the market.

If you’re a buy-and-hold investor, you’re probably not interested in timing strategies, and as Hulbert concludes, the 200-day moving average may not be the ideal vehicle for timing the market. If you’re a trader, however, you can use moving averages for timing. More important, moving averages can help provide clues to market direction.

Short-term traders tend not to use the 200-day MA for timing, but prefer the 13-day, 20 or 21-day, or 50-day. For example, long-term trader Laszlo Birinyi, president of Birinyi Associates, makes his trades based in part on a stock’s 50-day moving average. Read more: Birinyi’s recent money moves.

Other traders use even shorter time frames such as the 8-day or 10-day moving average. They use it both for support and resistance, and also observe when one moving average crosses another. One popular crossover strategy: when the 8-day MA (the shorter moving average) crosses above the 13-day MA (the longer moving average), this is a signal to buy. Conversely, if the 8-day crosses below the 13-day MA, this could be a signal to sell.

Using moving averages for support and resistance

Traders, and investors, also use moving averages for support and resistance. For example, in June the S&P 500 sliced through the 50-day and 100-day moving averages. If the benchmark were to drop below its 200-day moving average, this would be a major sell signal.

Why? Because the 200-day moving average, and other moving averages, act as support (which is like a floor), or resistance (which is like a ceiling). It takes a lot of buying or selling pressure to move the market above or below a moving average.

Yet moving averages are not perfect. First, they are considered lagging indicators, which means they follow prices. In other words, they are often slow to react to market conditions. By the time the index drops below the moving average, you may already be out of luck. In addition, moving averages are not ideal during choppy trading environments. Like any indicator, you never want to make trades based solely on its results without confirming with other indicators.

Moving averages for rookie traders

If you are a rookie trader and want to know more about moving averages, here’s a brief tutorial.

Moving averages show the value of a security’s price over a period of time, such as the last 10, 20, 50, 100, or 200 days. Most people overlay the stock price over its moving average on a chart to get a good feel where the stock or market is headed.

Calculating a moving average is not difficult. For example, the 20-day simple moving average is found by taking an average of the last 20 days of the market’s closing price and dividing by 20. So as the 21st day is added, the first day is dropped off. It’s constantly moving, which is why it’s called a moving average. In addition to the simple moving average, many people use the exponential moving average, which gives more weight to the most recent time periods.

Many traders have designed strategies based on moving averages. With the help of a professional technician, last year I back-tested dozens of trading strategies. What did I find? The moving average crossover strategy (buy when the 50-day crosses over the 200-day, and sell when the 50-day crosses below the 200-day) consistently ranks high, especially when the market is trending.

The advantage of using moving averages is that it helps keep your emotions out of the trade.

Bottom line: If you are an investor or trader, you can gain valuable information by watching how stocks or indexes react when they rise above, or below, their moving averages.

Michael Sincere is the author of Start Day Trading Now (Adams Media, 2011), All About Market Indicators (McGraw-Hill, 2010), and Understanding Stocks (McGraw-Hill, 2003).