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Trading Psychology Weblog

 

In this weblog, I follow research and trading ideas designed to catch intermediate moves in the equities markets.  My general practice is to post to the Weblog on Sundays, with additional articles and trading performance postsPlease note that the Weblog is my trading diary and is not intended as a data service or as a source of trading recommendations.  By placing the diary online, I hope to stimulate other traders to conduct and share their own market research.

 

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Archived Weblog Entries for May 2007/April 2007/March 2007/February 2007/January 2007/December 2006/November 2006/October 2006/September 2006/August 2006/July 2006/June 2006/May 2006/April 2006/March 2006/February 2006/January 2006/December 2005/November 2005/October 2005/September 2005/August 2005/July 2005/June 2005/May 2005/April 2005/March 2005/February 2005/January 2005/December 2004/November 2004/October 2004/September 2004/August 2004/July 2004/June, 2004/May,2004/April, 2004/March, 2004/February, 2004/January, 2004/December, 2003        

     

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Note:  I'm in the process of reorganizing this site.  During this time, market updates will be available via the TraderFeed blog.

 

Week of December 24 - December 28, 2007

 

A Bounce, But With Mixed Conviction

Small caps and NASDAQ issues took the lead over the course of the week, rallying solidly.  Large caps remained in a three-day range before breaking out to the upside on Friday.  Momentum numbers improved steadily over the week; on Friday my measure of Demand (number of stocks closing above the volatility envelope surrounding their short and intermediate-term moving averages) was 198; Supply was 26.  This means that stocks with significant upside momentum outnumbered those with downside momentum by 7:1.

We also saw improvements in the new high/low data, but not as much as the rally might lead one to believe.  By Friday's close, we had 1015 stocks across the NYSE, NASDAQ, and AMEX making fresh 20-day highs, against a surprisingly high 782 new lows.  The chart below shows how this indicator is revealing tepid strength across the broad market.

The weakness in the high/low data is matched by very weak readings in the Cumulative Adjusted NYSE TICK.  Going into Friday's rise, we had eight consecutive sessions in which the day's Adjusted TICK was negative (below the 20-day average).  While Friday gave us a positive reading, at +236 it was hardly rousing.  The chart of the Cumulative Adjusted TICK shows this lack of strength:

We need to see continued strength in the TICK and improvements in the new high/low data to sustain this rally.  I am especially keeping an eye on the large cap banking and financial issues; these have remained quite weak even with the rally and with various central bank efforts to relieve the credit crunch.  If we continue to see weakness in the TICK and new low data and an inability of the financial sector to rally, I will be looking for a fresh leg downward in this market.  Conversely, continued market strength will have us testing the early December highs.  As it stands at present, any such test will likely be accompanied by considerable divergences.

 

Week of December 17 - December 21, 2007

 

Inflation and a Stock Market Reversal

A restrained Fed decision on interest rates, prompted no doubt by what we found out later in two inflation reports, turned last week's strong market around on a dime.  The Cumulative Adjusted NYSE TICK (below), which had been positive for 10 days running, moved steadily lower for the last four days of the week, reflecting consistent selling pressure.  

New highs/lows on a 20-day basis also deteriorated steadily through the week, as we closed with 304 new highs and 1132 new lows.  While this is far from the 2700+ new lows registered in November, it is also quite a reversal from Monday's reading of 1628 new highs and 441 new lows.

Leading the way lower have been the usual suspects:  housing, financial stocks, and consumer discretionary issues.  The market is sending a strong signal that Fed steps to this point are not sufficient to eliminate concerns over credit and recession.

Still, it's the emergence of the inflation theme that may be most significant in the current market.  In the recent decline, we saw stock market losses accompanied by a flight to quality in Treasuries and an unwinding of the carry trade.  Both of those were not to be seen during the latter part of the week: bonds fell, rates rose, and the dollar rose against the Yen (and Euro).  The market is increasingly concerned that the Fed's hands will be tied, caught between the need to ease/stimulate the economy and the need to fight inflation.

My best assessment is that, when push comes to shove, the Fed will need to keep markets orderly, even if that courts inflation.  If that is the case, it would not surprise me to see continued bond weakness, especially at the longer end of the curve.  We may need to see further weakness and actual market turmoil, however, to prompt such a Fed response.  With one eye toward divergences as we approach the November lows and the other eye on the above indicators of growing weakness, I am not inclined to be a buyer in the face of potential turmoil.

 

Week of December 10 - December 14, 2007

 

The Buyers Remain in Control

Perhaps no indicator so well summarizes what has been happening in the market as the Cumulative Adjusted NYSE TICK.  As of Friday, we've had nine consecutive positive daily readings of this measure.  That means that, relative to the 20-day average, we've seen greater lifting of offers than hitting of bids across the broad range of NYSE stocks.  A chart of that indicator shows how it not only anticipated the market bottom, but has been pointing the way toward continued strength:

During this period of TICK strength, new 20-day highs have consistently expanded.  These usually top out ahead of price, so I'm expecting us to digest the current overbought condition and move higher from here.  

All in all, the large cap indexes have been in a broad range bound mode from the March lows to the bull market highs.  This consolidation strikes me as similar to what we saw in 2000-2001, where some of the highest-flying sectors went into bear market mode, even as the more defensive large caps held their own.  I think it is quite likely that, before this consolidation is over, we will at least test the bull market highs in the Dow.  At that point, I'll be looking closely for divergences vs. signs of expanding strength among small caps, financials, etc.  

For now, my immediate strategy is to wait for pull backs to find buying opportunities on the way to tests of the large cap highs.  I consider it premature to sell a market that is displaying positive TICK and expanding new highs.

 

Week of November 26 - November 30, 2007

 

Continued Risk Aversion, Continued Market Weakness

We finished the holiday-shortened week on an up note, but we saw further spread of weakness among stocks overall.  Tuesday registered 154 fresh 65-day highs across the three exchanges and 1944 new lows, a significant expansion of new lows from prior weeks.  Indeed, among NYSE common issues on Tuesday, we saw over 300 new 52-week lows, exceeding the level registered this past August.  Among SPX issues, we had over 100 fresh 52-week lows, also well beyond the August levels.  In a bull market, we want to see an expansion of new highs and fewer new lows from "cycle" to "cycle".  We're no longer getting that.  

The risk aversion themes are a major reason why.  We're seeing new price highs in the Yen/Dollar, and the 10-year Treasury note rate has been steadily moving lower, breaching 4% during the week.  Despite major declines, we're not yet seeing sustained bargain buying among bank and homebuilder issues.  In fact, weakness has expanded across sectors:  the advance-decline line specific to NYSE common stocks hit a new low--and moved well below August's low--during the week.  

We also saw the percentage of NYSE stocks trading above their 50-day moving averages get as low as 19% last week, a level that has been associated with intermediate-term bottoms during this bull market.  Interestingly, however, we have 37% of NYSE stocks trading above their 200-day moving averages, and that is higher than the sub-20% levels we've seen at bear market lows.  In other words, if this is more of a correction in a bull market than an outright bear market, we should begin seeing solid support for stocks very shortly.  Failure to sustain buying after the recent declines raises the possibility of a classic capitulation decline. 

The Cumulative NYSE TICK is trying to put in a low here, and this is something I'm watching carefully.  A move in the TICK to multiweek highs would suggest that we are at last getting some bargain hunting among smaller cap issues, which have led the way down.  Conversely, if we fail to get follow through to Friday's rally and instead see weakness spread to sectors that have been relative safe havens--consumer staples and energy--that's when the classic capitulation scenario becomes plausible.  Until we see evidence that Friday was more than short-covering--and especially see an abatement of the risk-aversion trades--I continue to keep powder dry.

As I mentioned in my recent blog post, this is a time to ensure that, above all else, we do no harm.

 

 

Week of November 19 - November 23, 2007

 

Mixed Signals

On Friday I ended my Twitter posts during the trading session by saying, "Can't say I'm impressed thus far with the market's upside follow through."  That's exactly how I felt during my Friday trading.  I was buying weakness all day long, making money on the trades, but having to exit the trades when selling returned to the market.  The break to the upside that I was looking for never materialized.  

We're seeing some signs of firming in the Cumulative NYSE TICK measure, which has been net positive over the past six trading sessions.  Staying above the recent low, even if we get some follow through weakness this coming week, would be a plus for the bulls.

Still, my Friday intuition about unimpressive market strength is not without grounding in the indicators.  New 20 day lows expanded to 1625 on Thursday and then again to 1717 on Friday.  Even more troublesome, we saw 1131 fresh 65-day lows across the exchanges on Friday, the weakest reading since August.  I have a pretty firm policy of not buying markets for more than a short-term trade when new lows are expanding.  It was when new lows dried up that we saw the impressive rally on Tuesday.  Now we are seeing the reverse: price is holding its own, but new lows are expanding.

The signals are mixed:  new 52-week lows among NYSE common stocks rose on Friday to 154, against 28 new highs.  Still, that is well off the more than 250 new lows registered a little over a week ago.  The Advance-Decline line for NYSE common stocks is hovering just above its August lows; the same is true for the S&P 500 A/D line.  The A/D line for the S&P 600 small caps, however, is below its August levels and hovering at its recent lows.  We actually moved to new A/D lows among the S&P 400 mid caps.  The A/D lines for the Dow 30 Industrials and NASDAQ 100 stocks are well off their August lows.

So where does that leave us?  In the big picture, I continue to look at the March, August, and present markets as part of a multi-month correction that will lead to higher prices in 2008.  I'll need to see us violate some of those August lows in my indicators to change that primary (bull market) scenario.  That doesn't mean, however, that we'll necessarily rocket higher from here.  Indeed, the expansion of 20-day and 65-day lows suggests that we could see further bottoming action (weakness) this week.  I will be watching the Cumulative TICK and the 20-day new highs and lows to gauge market action from here.  A rise above the 276 new 20-day lows registered on 11/6 would suggest growing market strength.  A move of the Cumulative NYSE TICK to new lows would add to the bear case.  I'm playing this one day by day until the indicators offer a more consistent picture.

 

Week of November 12 - November 16, 2007

 

Weakness Takes Its Toll

Last week I noted that, "It is difficult to imagine this market sustaining a bull run while financial stocks remain under heavy selling pressure.  Risk aversion themes have returned to the market, with the flight to Treasuries, unwinding of the carry trade, and selling of stocks.  Most of my measures say we're weakening, but not yet at levels commensurate with a market bottom."  With the continuing weakness among financial issues, the continued rise in the Yen, and the continued flight to quality among Treasury instruments, it was indeed impossible to sustain a bull run and we headed lower through the week.  The weakness spread to the strongest sectors, including the NASDAQ, and--as a result--we see the weakest Technical Strength numbers since the August lows.  Of the 40 stocks I monitor across eight S&P sectors, only 5 qualify as technically strong, 4 as neutral, and 31 as weak.  The Technical Strength Index reading of -2140 tells us that the majority of stocks are in short-to-intermediate term downtrends.

My Cumulative TICK data made further lows this week, and the cumulative data for my Demand/Supply numbers are approaching levels that have been associated with intermediate market bottoms, as the chart below indicates.  As I've outlined in my Twitter posts, we've been seeing expanding new 52-week lows among NYSE common stocks--indeed, the highest levels since the August lows.

Are there any glimmers of bullish hope in the data?  Late in the week, we began to see some buying in those weak financials.  Friday was a weak day, but new 20-day lows across all exchanges and new 52 week lows among NYSE common stocks actually retreated.  My Demand/Supply measure, while still tilted to the bears, has also been making higher lows of late.  That's not a lot to hang a bullish hat on, but it was enough to make me not chase the market lower late on Friday.  If we can hold some relative strength in those key banking stocks, see an improvement in the NYSE TICK figures, and continue with fewer stocks making fresh new lows, the ingredients for market bottoming will be in place.  

Note that we're near the March and August bottoms among the small cap indexes, such as the Russell and S&P 600.  This, I believe, is key to the issue of whether we're seeing a relatively flat correction extending from March to August to November--one that would vault us to new index highs in 2008--or whether this is a bona fide bear market that will decisively take out the August lows.  My primary scenario is the first one; that Fed liquidity will keep the bull going--albeit selectively--to a 2008 peak.  If, however, we see further weakening among the above indicators, continued selling among financials, and continued risk aversion, the alternate scenario should not be discounted.  

 

Week of November 5 - November 9, 2007

 

Following the Banks Lower

The previous post documented the market's very mixed picture and concluded that, if we got selective strength rather than a broad pickup in demand, we could expect a retreat into the market's long-term trading range.  That is exactly what transpired this past week, as the short-lived Fed rally failed to bring a large number of stocks off their 20-day lows.  Indeed, even as we saw 1109 new 20-day highs on Wednesday, we also registered 748 new lows.  With the weakness of Thursday and Friday, we made 1972 new 20-day lows by week's end and 714 new 65-day lows.  The latter is the highest number of 65-day new lows since the August bottom, suggesting a broadening of weakness.  We've tended to begin intermediate-term lows when new 20-day lows have exceeded -2000.  We're rapidly approaching that level.

We've also been seeing weakness in the Demand/Supply index, which tracks the number of stocks closing above and below the volatility envelopes surrounding their short- and intermediate-term moving averages.  Below we see a chart of the Cumulative Demand/Supply Index, which takes each day's reading and adds it to a running total.  We've tended of late to see intermediate-term lows when the cumulative total has dipped below 15.  While we've weakened significantly from the recent peak, we're not yet at that trough level.

Perhaps the most impressive weakness in the current market has been displayed by the Cumulative Adjusted NYSE TICK.  This has shown persistent weakness, as institutions have not been stepping up and lifting offers across the broad universe of NYSE issues.  This particularly reflects relative weakness among small cap issues.

The last two trading days of the week also took their toll on the 40 stocks that I follow across the eight S&P 500 sectors.  As of Friday's close, only 7 issues qualified as technically strong, 13 as neutral, and 20 as week.  Those figures were almost exactly reversed following the Fed rally.  The Technical Strength Index closed at -800; much weaker than the readings earlier in the weak, but not at levels we've tended to see at intermediate-term market bottoms.

It is difficult to imagine this market sustaining a bull run while financial stocks remain under heavy selling pressure.  Risk aversion themes have returned to the market, with the flight to Treasuries, unwinding of the carry trade, and selling of stocks.  Most of my measures say we're weakening, but not yet at levels commensurate with a market bottom.  I need to see a drying up of new lows and improvement in buying sentiment (NYSE TICK) before stepping in to by this market for anything more than a short-term trade.   

 

Week of October 29 - November 2, 2007

 

The Market's Mixed Messages

After the prior week's bout of risk aversion, we bounced back last week, but the strength has been quite selective.  My recent blog post, breaking down Technical Strength (a quantification of short-intermediate term trending) by sector, shows a mixed picture, with strength in Consumer Staples and Materials issues, weakness in Industrials, and much of the rest pretty neutral.  

This mixed strength can also be seen in the 20-day new high/new low data, which cuts across the NYSE, NASDAQ, and ASE issues.  Friday's rally left us about 2% away from bull market highs, but we had 925 stocks making fresh 20-day highs and 761 registering new lows.  I expect some range bound action prior to the Fed announcement on Wednesday, and the market's reaction to the Fed news may say a lot as to whether we can test those highs and sustain a breakout move.  At this juncture, I have my doubts and am viewing this as a longer-term range bound market.

The mixed strength shows up in other indicators as well.  On Friday we had 56% of NYSE stocks closing above their 50-day moving average.  That's down from 78% three weeks ago.  Only 45% of S&P 600 small caps are trading above their MA benchmark, down from 75% three weeks ago.  Among SPX stocks, 53% are trading above their 50-day MA, down from 80% three weeks ago.  Even among the NASDAQ 100 Index stocks, which have been strong as a group, only 53% are trading above their 50 day MA, down from 85% three weeks ago.  In short, we are quite possibly setting up for the possibility of divergences on any tests of index peaks.

Ultimately, I'll be looking for market strength to pull the majority of shares off their 20-day lows.  It's when we get solid advances in the new highs and sharp reductions in new lows that rallies tend to continue.  Very selective rallies that leave us with a large number of issues making new lows are more likely to fade.  My short-term Demand/Supply measure of momentum shows us as having more room to run on the upside, but how we get there will be the key.  If we continue to get selective strength rather than a broad pickup in demand, I will continue to view this as a range market and will regard tests of index highs as opportunities to lighten up on positions and even fade weaker sectors and indexes.

 

Week of October 22 - October 26, 2007

 

Return of Risk Aversion

Last week's Weblog entry noted divergences in the indicators--never a great sign when you're making price highs--and we quickly returned to the prior trading range.  See the chart in my blog post for a particularly good view of these divergences and the trading range.  Friday's trading was particularly noteworthy in that it repeated many of the risk aversion patterns from the August market: strong Yen, rising Treasury prices (falling yields), and weak financial stocks.

The indicators weakened significantly during the past week; let's take a look at where we stack up:

The 20-day new highs/lows shows major deterioration, though is well off the August lows.  The same is true of 52-week new lows among NYSE common stocks.  On Friday we had 51 new annual highs and 123 new lows.  By comparison, we had 300 new 52-week lows among NYSE common stocks in August.  I'm looking to see if we hold above that level during the current pullback.

Looking at the advance-decline data, we find that, at this juncture, the line specific to NYSE common stocks also is holding above its August lows.  Even stronger are the advance-decline lines specific to the S&P 500 stocks, NASDAQ 100 stocks, and Dow Industrial stocks.  Interestingly, however, we're seeing new lows in the advance-decline lines specific to the S&P 600 small caps, the S&P 500 financial stocks, and the S&P 500 consumer discretionaries.  The advance-decline lines specific to the other S&P 500 sectors are well above their August lows.  What this tells us is that, once again, we have a mixed market.  Sectors affected by the credit and housing woes are significantly weaker than the broad market, and large caps are outperforming small caps.

The selling sentiment was quite strong during the past week, as we can see from the chart of the Cumulative Adjusted TICK:

My Adjusted TICK data specific to the Dow Industrial stocks are much stronger than the above, once again highlighting selling sentiment among the smaller stocks.

My technical strength data have similarly weakened.  Recall that I track trending behavior across 40 stocks evenly divided among eight S&P 500 sectors.  As of Friday, 6 stocks qualified as strong, 3 as neutral, and 31 as weak--a dramatic turnaround from just a week or two ago.  The Technical Strength Index plummeted to -1360, clearly weak but also not at August lows.

I am viewing the present market as in a broad trading range, and I expect any tests of the August lows to ultimately hold and bring their own set of divergences.  Still, one of my principles is to not bottom pick while we're seeing expanding numbers of stocks make 20-day new lows and while we're seeing heavy selling pressure and weakening momentum.  The bull market appears to be aging, as upside participation narrows.  It will take a broadening of downside participation, however, to convince me that a bear market is actually beginning.

 

Week of October 15 - October 19, 2007

 

Divergences Showing Up

The S&P 500 Index ground higher during the week, selling off late Thursday and partially recovering on Friday.  Despite the new price highs for the week, we continue to see a number of divergences, including the sector divergences noted in my recent TraderFeed post.  

We can see below that the Cumulative NYSE TICK is stalling out, suggesting that large traders are not using higher prices to justify the lifting of offers.

The 20-day new highs/lows displayed strength during the week, though we saw some expansion of new lows Thursday and Friday.  A continued expansion of 20-day lows would turn me outright bearish near-term.  Interestingly, new 65-day highs hit a bull recovery high on Thursday, suggesting that we're not yet seeing broad loss of strength.

Meanwhile, technical strength remains positive, though off recent highs.  Of the 40 stocks evenly divided among eight sectors that I follow, 23 are strong, 10 neutral, and 7 weak.  That puts our Technical Strength Index at +1460--strong, but quite a bit weaker from readings shortly after the Fed rally.

We're seeing 73% of SPX stocks trading above their 50-day MA, down from 80% earlier in the week--a strong reading, and one that typically precedes price peaks.  We have 63% of S&P 600 small caps trading above their 50-day MA and 77% of Nasdaq 100 stocks.  

Thursday showed the highest level of new 52-week highs among NYSE common stocks since the market decline, with 239 new highs and 25 new lows.  This indicator also tends to top out ahead of price, suggesting we could see higher prices ahead.

In sum, we have divergences and waning momentum, and it wouldn't surprise me to see some weakness in the near term.  Unless we start seeing a pattern of rising new 20-day lows and divergences in the new high/low data, I don't expect a full-fledged bear swing to emerge from the current market picture.

 

Week of October 8 - October 12, 2007

 

Continued Market Firmness

Revelations of losses among investment banks were not enough to derail the market rally as a firmer job report contributed to record bull market highs for the large cap Dow, NASDAQ 100, and S&P 500 Indexes.  

Take a look at such stocks as GE, GM, MMM, PG, and JNJ.  All are above their July peaks and helping the Dow move to new highs, as the weak dollar creates favorable sales outlooks for such large multinationals.

That isn't to say that the broad market is weak.  On Friday, we had 2241 new 20-day highs and only 322 new lows.  As long as the 20-day lows stay above the 728 recorded on 9/25, it's difficult to see this as a deteriorating market.  Indeed, as the chart below indicates, surges in new highs have tended to precede price peaks.  Note also that expansions of 20-day lows have marked excellent intermediate-term buying opportunities and have occurred at successively higher price lows.  That is consistent with bull market action.

Still, the market rally is uneven.  Banking stocks ($BKX) remain well below their July peaks, and we're also seeing tepid price action in the semiconductors (SMH).  The homebuilders ($HGX) have barely budged above their August lows, and--despite a nice showing on Friday--the consumer discretionary stocks within the S&P 500 universe (XLY) are off their July highs.  

My Cumulative Adjusted TICK measure has been decidedly tame during the market rally, as the chart below graphically illustrates.  This has manifested itself in an advance-decline line for NYSE common stocks that is well below its July levels.  Among those NYSE common issues, we had 173 new 52-week highs on Friday against only 6 lows.  While that is hardly a weak reading, it is well below the 300 new highs that we saw this past summer prior to the July-August correction.  Interestingly, it is also below the 200 new highs registered just a week earlier.   

What that tells us is that we remain in bull market mode, but one that is becoming increasingly selective.  For that reason, I would not be surprised at all if we consolidate near present levels prior to any sustained breakout move to the upside.  At this juncture, I am not seeing any expansion of stocks making new lows that would lead me to believe that an important correction is upon us.  Friday, in fact, showed some broadening of strength among such weak sectors as the financials and the consumer discretionaries.  While I may not be chasing highs here, neither am I shorting a market that has made 1000+ new 20-day highs for eight days running.

 

Week of September 24 - September 28, 2007

 

Interest Rate Cut and a Rally

A vigorous rally greeted the Fed news of a rate cut, breaking stocks out of a multiday range.  The rally was for real:  every one of my indicators suggested broad participation in the strength.  New 20-day highs across the three exchanges, for example, soared to 1933 on Tuesday--and then soared again to 2765 on Wednesday.  My Demand measure--an index of the number of stocks closing above the volatility envelope surrounding their intermediate-term moving averages--exploded to 292 on Tuesday, with Supply falling to 25.  Such a ratio of strong upside to downside momentum has tended to precede rising prices over the following three weeks.

Though we saw some consolidation on Thursday and Friday, new 20 day highs have remained strong (1456 on Friday) and well over 60% of S&P 500 issues are trading above their 50-day moving averages.  That's quite a turnaround from the sub-20% readings in August.  Indeed, my Technical Strength Index, which tracks trending behavior among stocks in eight S&P 500 sectors, hit multi-week highs on Wednesday and stayed quite strong for the remainder of the week.  Of the 40 stocks in those sectors, fully 34 qualify as technically strong at Friday's close, 3 neutral, and 3 weak.

As a rule, markets don't show such strength and then turnaround and become bear markets overnight.  Typically there's a period in between of stable to rising prices with growing divergences among the indicators and among market sectors.  We're not seeing such weakness at this time.  The evidence suggests that we put in an intermediate-term low during that August decline.  

Still, there is one fly in the bull ointment.  My Cumulative TICK stats are lagging here, although we've seen positive readings three of the last four trading sessions.  In fact, the Cumulative TICK was down for the week as a whole.  We're well off the prior highs in the cumulative measure, and that suggests to me that, even if we get new bull highs in the major large-cap indices, those might well be accompanied by divergences in the broad market (especially among small caps).  Too, we continue to see relative weakness in financial and housing issues, suggesting we're not entirely out of the woods with respect to those concerns.

I will be watching the market closely on further strength to see if we continue to see broad participation or begin to see divergences in the new highs/lows and momentum data.  The bears are hoping for one more run at the lows, but so far the momentum and strength have belonged to the bulls.

 

Week of September 17 - September 21, 2007

 

Awaiting The Fed

Markets generally turned in a positive performance in the past week, despite rising oil prices and a very weak dollar.  Expectations are for a quarter point rate cut at Tuesday's Fed meeting and for another quarter point cut thereafter.  A number of observers, however, are calling for a larger, half-point cut, while still others make the case for standing pat and fighting inflation.  I don't pretend to have any grand insight into the Fed's thinking, but my leaning is to think that stocks are more poised for disappointment than enthusiasm at the meeting's outcome.  It's hard for me to believe that a relatively new Fed Chair would cut rates sharply in the face of inflationary pressures and a weak dollar.  Indeed, I find the interesting scenario to be one in which the Fed doesn't cut rates.  That would lead to an initial selloff in stocks, but it is not clear to me that this disappointment would be sustained.

That having been said, it's clear that recessionary themes are influencing equities.  I took a sector-by-sector look at the S&P 500 stock universe and found that Materials and Financial stocks have been especially weak.  The strongest sector has been Consumer Staples, a common haven during times of recessionary concern.  I'll be posting my sector research shortly to the TraderFeed blog. 

Despite the rally during the week, there are signs that stocks are weakening.  Friday saw the highest level of new 20-day lows in several weeks.  Much of that is attributable to weakness among small caps.  This weakness also shows up in my TICK statistics: the Cumulative Adjusted TICK has been negative five of the past six trading sessions.  Note the recent downward slope in the TICK line (below).

Until we see stock strength extend to the small caps and financial issues, I am reluctant to carry the torch for the bulls.  We've rallied on the rumor; let's see how we trade on the news.  The weakening of my indicators during this rally leads me to approach the Fed meeting with caution.

 

Week of September 10 - September 14, 2007

 

Economic Weakness Dominates the News

A very weak jobs report on Friday abruptly halted the market rebound, sending us back into a month-long trading range.  This range is most clearly observed in the Russell 2000 (ER2) futures; indeed, the Russell never made it out of its range during the market rally.  Clearly we are not out of the bearish woods as long as we see the risk aversion themes dominate: buying of Treasuries, unusually wide credit spreads between commercial paper and T-Bills, buying of Yen vs. Dollar (unwinding of carry trades), etc.  

One measure of market health that has served me well during the recent market turmoil is relative strength and weakness among the financial stocks within the S&P 500 universe.  Below we see a chart of the financials (XLF) vs. the energy stocks (XLE); the mixed nature of this market is evident.  Some sectors are not that far off their bull highs; others have broken below their March lows.

While it would not surprise me to see a follow through of weakness in this week's trading, I'm also alert to the possibilities of divergences as part of an extended bottoming process.  Two places I would look for such divergences are in the Cumulative Adjusted TICK Line and in the 20-day new highs/lows (charts below).  

Note that both indicators are still well off their recent lows, Friday's weakness notwithstanding.  Bottoming processes in 1987 and 1998--two periods that have been compared to the current one--took place over a period of months, and the current market may be similar in that respect.  As long as risk aversion dominates trader behavior and financial stocks show relative weakness, it is going to be difficult to sustain rallies.

 

Week of September 3 - September 7, 2007

 

Continued Buying Interest Lifts Stocks Further Off Lows

If you just examine the titles of my past several weekly entries, you can track the evolution of this market turnaround.  What makes a bear market is that bounces become opportunities for further selling.  That is not what we've been seeing in the recent market.  Rather, we've seen buying, pausing, then more buying.  

Let's take a look at the indicators.  First, we see that 20-day new highs minus lows are expanding across the broad universe of listed stocks.  Indeed, we're at the highest levels in high/low strength since the decline began:

Another window onto market buying pressure is provided by the NYSE TICK.  Three of five days this past week gave us positive Cumulative TICK readings, and we've had positive readings 9 of the last 11 days.  Note the upward slope of our Cumulative TICK Line:

Momentum numbers also look quite strong.  At +61, my Cumulative Demand/Supply Index is definitely overbought, so it would not be at all unusual to see a pause here.  Nonetheless, Friday provided us with a Demand reading of 172 and a Supply reading of only 20.  This follows very strong Demand/Supply readings on Wednesday.  When we see very strong readings in succession, it generally signifies considerable buying momentum.

We're near important multiday resistance levels in the ES contract; these may help to constrain gains near term.  I'm watching the stocks of investment banks carefully; they're underperforming the market and are the one place I would look if we were going to have further credit-related problems.  For now, however, as long as we're seeing strong buying pressure, positive momentum, and expanding new highs, you have to respect the long side.

 

Week of August 27 - August 31, 2007

 

Buyers Enter the Market

Last week's entry observed diminished selling but not yet a sustained influx of buying.  That changed in spades this past week, as we saw very strong Cumulative Adjusted TICK readings every trading session.  It's when initial buying off oversold lows leads to continued buying that we have reasonable assurance that an intermediate-term bottom has been made.  It's certainly possible that we'll get some retracement of the recent strength--many of my indicators, such as the Cumulative Demand/Supply Index, are at upside extremes and we're looking a bit tired in the small caps--but unless another shoe drops in the credit markets, I expect that pullbacks from here will provide buying opportunities.

We also see strength in the 20-day new high/low data, though this has leveled off in recent sessions, providing a short-term yellow flag of caution.  My data suggests that large caps have outperformed small caps in the past few days; we've also seen relatively tepid action from the financial stocks during that period.  I will be watching carefully early in the week to see if we get some catch up from small caps, or if the market is ready for a bit of retracement.

We now see 40% of NYSE stocks above their 50-day moving averages and 44% of SPX stocks and S&P 600 small caps.  That is well off the lows we saw last week and suggests that the broad list of stocks has found support.  

Among NYSE common stocks, we had 16 new 52-week highs on Friday against 7 new lows.  We had three new annual highs among SPX stocks and no new lows.  Again, we see that the broad list of stocks has bounced from recent lows.

Short-term, given the difficulty surmounting multi-day highs in the ER2 futures and the stalling of the 20-day new highs, I expect some pullback from recent strength.  Longer-term I expect this to provide buying opportunities.  I'm looking at the broad market (NYSE Composite) and seeing us in a range between the bull highs and the March, 2007 and recent lows.  It would not at all surprise me to see us test the upper end of that range in coming months, with highs in selected sectors/indexes. 

 

Week of August 20 - August 24, 2007

 

The Fed Offers Support

Last week I noted diminished selling and an effort at stabilization, but not yet an influx of buying interest.  That lack of buying continued, encouraging sellers to push us to yet further price lows.  As we sold off, interest rates signaled a certain intrameeting Fed easing, and the market rallied sharply off its lows.  After overnight selling continued, the Fed indeed announced its reduction of the Discount Rate and the market rallied further on Friday.  As a result, we now see stocks nicely off their lows; especially financial issues.  

We're hearing considerable speculation as to whether a bottom has been put in.  Market experience tells us that bottoming after such a broad decline is a process, not a single point on a chart.  It is not at all uncommon to see markets make price lows weeks after a momentum low; the May-July, 2006 period was a recent example.  

It's when highly oversold conditions transition to periods of sustained upside momentum that we mark important transitions.  Below we see a chart of the cumulative Demand/Supply Index; note how drops toward the zero level followed by sharp rises in sentiment have marked recent shifts from corrective to bullish modes.  While Friday pulled us higher, we've yet to see the sustained momentum that tells us a bottoming process is behind us.

Similarly, our cumulative adjusted NYSE TICK line has bounced higher with Friday's strength, but is yet to find an uptrend.  Indeed, Friday was the only positive day out of the week in the cumulative TICK.  We need to see buyers *sustain* a lifting of offers across a range of shares to achieve a bottoming.

Finally, our count of fresh 20-day new highs/lows finds a lifting of most stocks from their lows and the first reading in which new highs have approached the level of new lows since 7/19.  If we can hold above prior price lows on subsequent dips in the new high/new low index, I would lean toward buying.  

In short, the Fed has accomplished a degree of stabilization, but the historical record suggests that markets do not typically turn around from great weakness in a V pattern.  Rather, there is sustained buying and upside momentum followed by subsequent price lows and multiple divergences (among sectors, indicators) at those lows.  If we are indeed in a bottoming process, I would expect to see follow up buying interest (NYSE TICK) early this coming week and further strength in the new highs/lows (with 20-day highs exceeding lows) prior to any significant, sustained renewal of selling.

 

Week of August 13 - August 17, 2007

 

Trying to Stabilize

We've seen considerable gyrations in the past week, with both bears and bulls ultimately frustrated as we could neither hold fresh highs or lows.  I was hoping to update money flows by sector, but problems with my data feed prevent my posting at this time.  Still, I have enough flow data to add to observations below.

We're seeing considerable variation in performance by sector.  The S&P Industrials, for example (XLI), hit new price lows on Friday, as did Consumer Discretionary stocks (XLY) and Technology issues (XLK).  Consumer Staples (XLP) and Utilities (XLU) remain well above their lows.  

Below we can see that 20-day new highs vs. lows have been making a series of higher lows as we've gyrated in SPY.  A close look at the data, however, shows that we have had 16 consecutive sessions in which new lows have outnumbered new highs and all of these have featured new lows at levels exceeding 1000 across NYSE, ASE, and NASDAQ.  We had similar stretches of new lows exceeding new highs during June, 2006 and October, 2005, but not with such a skew toward new lows.  If this market is, indeed bottoming and is indeed a correction within a bull market and not something worse, we should see now what we saw at those two previous occasions: significant buying that ends the string of new 20-day lows exceeding new highs.    

Below we can also see a chart of the Cumulative Adjusted TICK Line for the NYSE; this, too, shows that the recent move toward lows has come at higher TICK lows.  Both the 20-day new lows and the TICK suggest at this juncture a waning of selling pressure.  A waning of selling, however, is not the same as an influx of buying.  Four of the past six sessions have shown negative Adjusted TICK; it's just less negative than earlier in the decline.  Once again, we need to see an influx of buying interest to confirm that we're in a bottoming process.  The limited money flow data I've been able to collect confirm what we see in the TICK: less outflows of capital from stocks in the past week, but no broad influx of money.  

The pattern of rising bottoms in new lows also extends to the 52-week lows among NYSE common stocks.  This is a particularly useful measure, because it weeds out ETFs, preferred issues, and other potential sources of distortion.  On Thursday we had 130 new lows and on Friday we had 125 new lows.  That compares with about 300 new lows the previous week.

All in all this tells us that one precondition of a market turnaround is present:  we are seeing waning selling at oversold levels.  Now we need to see evidence of sustained buying.  I am watching homebuilders carefully ($RUF), as well as banking stocks ($BKX)--especially the issues of the investment banks.  Homebuilders benefited from a rally last week related to the unwinding of positions among quant funds; the investment bank shares have not been so fortunate, though most remain above their lows.  If this market is going to regain confidence, that should be reflected in the shares of such stalwarts as Goldman Sachs (GS), JP Morgan (JPM), Merrill Lynch (MER), Bear Stearns (BSC), Lehman Brothers (LEH), and Morgan Stanley (MS).  As long as institutions aren't finding sustained interest in their own shares, I'm reluctant to be the pioneer buyer who will wind up with an arrow in the back.

 

Week of August 6 - August 10, 2007

 

And the Weakness Continues

Oversold conditions have become more oversold, one of the surest signs of a downtrend.  Last week I suggested we had seen a momentum low and that the odds were good we'd see further price lows.  That is exactly what happened this past week.

While markets closed lower--we're now down over 7% in the S&P 500 Index over the past three weeks--several of the indicators are off their momentum lows.  New 65 day lows were 1761 on Friday, stronger than the 2065 on Wednesday, and stronger than the 2751 registered on July 26th.  The same pattern can be seen among the 20-day new lows.  There's been no expansion of 20-day new highs, however.

Similarly, we had Demand at 31 and Supply at 77 on Friday.  That's the weakest momentum levels of the week, but stronger than we saw from July 24-26th.  The strongest momentum level of the week came on Tuesday, with Demand at 58 and Supply at 24--hardly earth shattering numbers.

And therein lies the rub for the bulls.  While we've seen some diminished new lows  and downside momentum, we also haven't seen any significant or sustained influx of buying.  As a result, there hasn't been the kind of bargain-hunting rally to pull (and keep) a large number of issues off their lows.  That not only suggests that we could see further price weakness, but raises the uneasy possibility that momentum lows have not, in fact, been made.

Two of my most important indicators support this analysis.  First, in the chart below, we see the Cumulative NYSE TICK Line.  Note that we're making new lows, with bounces in the line quickly retraced.

Below we can also see a chart of raw Money Flow into the Dow 30 Industrial stocks.  That continues weak as well, with net money outflows for the past six trading sessions.  This suggests that there is not broad-based buying of stocks among institutions, as one might expect if we were bottoming and hitting attractive levels of valuation.

If we, indeed, have not yet put in momentum lows, I would expect a washout in stocks this week.  If those proposed momentum lows from late July remain intact, we should see a very significant snapback of buying this week.  Either scenario calls for meaningful volatility.  I will be tracking the indicators closely intraday and handicapping the unfolding scenario with blog and Twitter posts.

 

Week of July 30 - August 3, 2007

 

Meltdown

Stocks are sustaining a broad correction, driving us to oversold levels that, since the 2000-2002 bear market, have been associated with superior intermediate-term and longer-term returns.  The normal course for such corrections is to first make momentum lows, in which we see a maximum number of issues trade below their volatility envelopes and moving averages with a maximum number of stocks making new lows, and then make subsequent price lows on lower momentum and strength readings.  There is much evidence to suggest that we are still in the phase of forming momentum lows.  If this is the case, we can expect a solid bounce from those lows, but can also expect further price weakness to come.  It is not common for markets to endure sustained declines (such as we've had), then turn on a dime and enter bull phases.  More often, there is a transitional period between.  In my view, this market has further work to do to put in such a transition.

Let's look at the evidence.  New 20-day lows soared to 4392 on Thursday and finished at 3047 on Friday, vs. 281 and 217 new highs, respectively.  These are weaker figures than we've seen during recent declines, suggesting that selling is hitting all sectors.  Demand bottomed out on Friday at 34; Supply topped out on Tuesday at 202.  What that tells us is that, while fewer stocks are closing beneath the volatility envelopes surrounding their intermediate-term moving averages, we are not yet seeing signs of positive momentum.  Reduced selling will not stop the bear; we need to see evidence of concerted buying.

The chart below shows the NYSE TICK during the decline.  I've adjusted the TICK to a zero mean (rather than the usual 20-day mean) to correct for biases created by the end of the uptick rule.  We can see the extreme weakness in the Cumulative TICK Line: even when we had bounces in the ES futures over the last few days, the TICK line remained weak.  This is because the bounces represented short covering and not concerted fresh buying.  We did see some positive TICK enter the day late on Friday and will look to see if the TICK line can hold those lows early Monday.  As long as we're making fresh lows in the TICK line, I am unwilling to bottom-pick.

Among S&P 500 stocks, we had 13 new 52-week highs on Thursday against 47 fresh annual lows.  Friday, the new highs dropped to 2, but new lows also dropped to 33.  This was a pattern seen among many of the sectors: we had fewer new lows on Friday than Thursday, despite hitting new price lows Friday.  The market averages dropped precipitously late on Friday, however, so I will be watching carefully to see if we get a fresh peak in stocks making new lows.  If so, I will continue to look for near-term price weakness, despite the oversold conditions.  

One area of concern is the new lows among small cap stocks.  We had 93 new 52-week lows among the S&P 600 stocks on Thursday and 84 on Friday.  This is much weaker than the number of new lows seen during market declines over the past year.  This suggests that many small cap issues have violated long-term uptrends.  One possible implication is that the broad market is transitioning from a long-term uptrend to a more neutral, range-bound mode.

I'm in the process of reconfiguring my money flow indicators to adjust for the change in the data due to the repeal of the uptick rule.  Hope to have those data for you next week.  The absence of flows into stocks was a great signal for this market weakness, and I expect to see positive flows into stocks as we transition to a bottoming process.

 

Week of July 23 - July 27, 2007

 

Becoming Risk Averse

The selectivity of the rise outlined in last week's entry caught up to the market by week's end and we finished on a risk averse note, with money flowing toward the safety of Treasury yields.  The big question going forward is whether the risk aversion that is showing up in some sectors--such as housing and the banking/finance stocks--will spread to other sectors (materials, energy) that have held up relatively well thanks to a falling dollar supporting commodity prices.

Money flows have been skewed by the end of the uptick rule, the same factor that has shifted the distribution of the NYSE TICK.  As a result, both the Dow and S&P 500 stocks are showing 10-day flows well below their 200-day moving averages.  Nonetheless, if we try to adjust for the downward shift in the flow data due to short-sellers' newfound ability to hit bids, we can see that the money flow picture is quite mixed.  Among the Dow issues, we're seeing negative flows from AA, DD, DIS, HD, IBM, JPM, KO, MCD, MO, PFE, UTX, WMT, and XOM.  Flows, however, are quite positive--even with the downward skew of the data--in such stocks as BA, GE, HPQ, INTC, PG, T, and VZ.  

Nor are vestiges of strength limited to the large caps.  While Friday was certainly a weak day, the number of stocks across the NYSE, NASDAQ, and ASE made fewer new 20-day and 65-day lows on Friday than they had on Wednesday.  What that tells me is that we need to hold the Friday lows--or at the very least test them with a reduced number of new lows--to right this market.  A break below Friday lows that expands the number of stocks registering fresh 20-day lows would target the early July lows in ES and NQ and June lows in ER2.  The key to such a scenario, once again, is the continuation/spread of risk aversion.

This post summarizes the weakness in many of the market indicators I follow.  With my Demand measure closing Friday at 27 and Supply ending at 163, my usual expectation is for some downside follow through early in the week.  Too, with 52% of SPX stocks trading above their 50-day moving averages, we are nowhere near the sub-30% levels that have characterized important market lows over the past several years.  Further, the Advance-Decline lines for NYSE common stocks and SPX stocks continue to remain below their early June peaks, as do the lines for the S&P small caps and mid caps.  I'll need to see evidence of expanded strength before I abandon my skepticism of the bull.

 

Week of July 16 - July 20, 2007

 

Making New Highs...Selectively

In my last Weblog post I found that the market strength was not confirmed by many of the indicators that I track.  That led to a selloff during this past week, but then yet another rally to bull market highs that--once again--shows considerable divergences with the indicators.  The key issue going forward remains whether the market strength will broaden out or follow its historical pattern of reversal.

Let's take a look at the evidence.  First, my Adjusted NYSE TICK measure (which looks at the number of NYSE issues trading at bid vs. offer each day relative to a 20-day average) has been negative all five days this past week despite the late week rally.  This reflects relative weakness among the small cap issues; despite the rise to new highs, only 1421 stocks made fresh 20-day highs on Friday vs. a surprisingly elevated 612 new 20-day lows.  When we look at 65-day new highs, we can see that the maximum level reached last week (921) remains below the level reached at the beginning of June (1129).  This doesn't mean the market is outright weak; it simply indicates that the strength is more selective than appears on the surface.  

Interestingly, going back to July, 2003 (N = 991; when I first began collecting these data), we've only had 13 occasions in which the S&P 500 Index (SPY) was up more than 1% on the week, but the average Cumulative Adjusted TICK for the week was below -100.  Ten days later, SPY averaged a healthy *gain* of 1.00% (11 up, 2 down), considerably stronger than the average two-week gain over the entire period (.44%).  What this tells us is that a market that keeps rising in the face of selling pressure (NYSE TICK) has tended to persist in its strength over the near term.  Given that we hit a seeming momentum peak on Thursday (Demand = 178; Supply = 32), further price highs in the near term would not be unusual. 

The most notable aspect of the recent market strength, I find, is the relative weakness in money flows (mirroring the Adjusted TICK data).  For much of the bull rise to date, we've seen surges in money flow as the averages have powered higher.  This was emphatically not the case this past week.  My data show surprisingly tepid institutional participation in the rally.  Below is a chart of the S&P 500 Index (SPY) vs. the raw money flows for 40 highly weighted stocks in the index that are evenly divided among eight sectors.

Note how money flows have really tailed off over the last two weeks, even as we've seen bull highs in the large cap indices.  This not only comports with the NYSE TICK data and the new high/low data, but is also reflected in the flow data for the 30 Dow stocks (chart here).  Indeed, this pattern of weakened flows extends to one of the market's strongest sectors: energy (chart here).  

Of course, the big question is:  How do markets behave when they've exhibited strength during periods of weak money flow?  I went back to 2004 (N = 875 trading days) and found 49 occasions in which the S&P 500 Index (SPY) was up more than 1% on the week, but average money flow for the week was below the 200-day moving average at that time.  Not surprisingly, returns were weak looking one week out.  SPY averaged a loss of -.37% (18 up, 31 down), much weaker than the average five-day gain of .21% (486 up, 340 down) for the remainder of the sample.  

So what's the takeaway?  Following a rally with expanding short-term new highs and momentum, we normally experience further price strength prior to any sustained correction.  My expectation, however, is that, unless we see institutions buy into this recent bull move (via expanded NYSE TICK and money flows), further gains are likely to be constrained.  Indeed, my leaning on Monday will be to fade strength if we cannot surmount the Friday highs.  While money flows remain net positive, they are well below the levels associated with the strength through much of this bull market.  I will be tracking them carefully to see if this represents a sea change in investor sentiment or a temporary pullback.

 

Week of July 9 - July 13, 2007

 

Probing the Highs

Last week I noted that money flows looked too healthy for a market breakdown.  We also were not seeing an expansion of new lows on declines.  As a result, the market has continued its rangebound action and now is close to testing its bull market highs.  In many ways, however, the recent action is a mirror image of what we saw last week.  Just as the weakness was not confirmed by many of the indicators I track, the recent strength finds only modest support among these indicators.

Below we can see the raw money flows into the Dow 30 stocks.  Note how the recent bounce has occurred on very modest dollar inflows.  Unlike past rises during this bull market, we're not seeing strong institutional participation on the upside.  That has me questioning whether the current bounce will lead to a fresh new bull market leg.

Supporting this view is my tracking of the number of stocks making fresh 20-day highs on the NYSE, NASDAQ, and ASE.  While the number of new highs at 1211 was the strongest level of the week on Friday, it remains below the level recorded in mid June.  We want to see new highs continue to expand--and break the mid-June peak--to sustain the bull move.  

Similarly, 65% of NYSE issues are trading above their 50-day moving averages, down from 80% in June.  We see 64% of S&P 500 stocks above their 50-day averages, down from 85%.  Very similar figures apply to the NASDAQ 100 Index despite its recent strength.  Indeed, only 14 of the NASDAQ 100 stocks made annual highs on Friday despite new highs in the index.  This suggests that, thus far, the strength has been selective and limited to highly weighted issues.

On a shorter-term basis, we see that my measure of Demand (stocks closing above their volatility envelopes) was 75 on Friday vs. 48 for Supply.  That is considerably weaker than the Demand levels registered on Monday and Tuesday of this past week.  

In sum, we're seeing signs among money flows and momentum and strength measures that the current bounce may not be vigorous enough to vault us to a new bull leg.  I will be watching efforts to make new highs this week and looking carefully to see if such moves are accompanied by expansions of new highs and money flows.  If not, my leaning will be to pick my spots to fade the strength.

 

Week of July 2 - July 6, 2007

 

Continued Consolidation

The market has provided some excellent intraday volatility, but on a longer-term basis has sustained its rangebound ways.  SPY, for example, is relatively unchanged since early May; the same is true of the Russell ETF, IWM.  To this point, I've been viewing this as a flat corrective period relative to the prior market rise.  While I think it's entirely possible that this consolidation will last longer, I am not expecting a full-fledged bear market leg at this juncture.

One reason for this is that we're not seeing an expansion in the number of stocks registering fresh 65-day lows.  We had 900 such new lows on 6/7 and 917 on 6/12.  This past week, at the market lows, we saw 846 fresh 65-day lows.  Should we break out and expand new lows, that would have significant near-term bearish implications.  Continued drying up of new lows would suggest that we are putting in an intermediate term bottom during this June period.

Another reason I'm not expecting this market to fall apart is that money flows in the Dow stocks continue to look orderly.  Below we see the adjusted relative dollar flows for the 30 Dow issues.  Note that flows have been below their 200-day average (below the zero line), a level that has represented good buying opportunities over the past several years.  Moreover, we continue to see these pullbacks in relative flows at higher price levels, a hallmark of a good bull market.  While those flows are below their recent average, they continue to be positive.

The only stocks showing net dollar outflows over the past two weeks of trading are DIS, HD, INTC, JNJ, MSFT, and PFE.

We're seeing above average inflows over the last two weeks in DD, GE, GM, HPQ, JPM, PG, UTX, and WMT.

And now for the flies in the bullish ointment.  We've yet to see a day during the recent correction in which equity put option volume has exceeded equity call option volume.  That has been a highlight of recent corrections.  Similarly, we're still seeing 50% of S&P 500 stocks trading above their 50-day moving averages.  That proportion has dipped below 30% during recent intermediate-term corrections.  While I am not seeing the makings of a bear market at this time, neither am I seeing the bearish extremes that have recently suggested an intermediate-term bottom is imminent.  Even as I note the drying up of new lows and the solid price action on the pullback in money flows, I'm keeping open to the possibility that we may need to break the June lows and wash out the weak longs before resuming the upside.

 

Week of June 25 - June 29, 2007

 

Flat Correction Amid Selective Weakness; The Money Continues to Flow

The market has continued its corrective mode, a choppy affair which actually began with a momentum peak in mid-April, followed by price peaks in May and June at higher prices, but with diminished participation.  Indeed, if we look at the number of fresh 20-day highs during May and June and the number of new 20-day lows, we see those are relatively in balance.

While the week ended with price weakness, note that new 20-day lows registered on Thursday (1226) and Friday (1244) were well below the levels achieved on June 7th (1995) and 8th (1735).  Note, too, that the elevated 65-day lows seen from June 7th through 12th have been associated with rising prices 50 days out per the recent trader performance post.

A look at the three major averages (SPY, QQQQ, IWM) and their equivalent in the futures markets suggests that, despite some strong selling (very negative NYSE TICK) during the 6/5 - 6/7 period and now again to a lesser degree late last week, prices are holding up well.  This supports a contention I advanced a while back: that the correction would be more extended in time than price.  In other words, we may be seeing a relatively flat corrective movement that ultimately will serve as a launching pad for the next bull leg.

I will take the above scenario particularly seriously if selling early this coming week fails to expand new lows beyond those levels seen on 6/7 - 6/8.  Conversely, very weak NYSE TICK readings, a shift of weakness toward NASDAQ and Russell issues, and very weak intraday advance-decline numbers would place me in a more defensive posture.

The fact remains, however, that the risk structure of this market does not support the bear.  Small caps and technology issues are holding up quite well, as are leading sectors such as Energy.  Materials, and Industrials and emerging markets.  The weakness we've seen has been most notable among Healthcare, Financial, and especially Utilities issues within the S&P 500 universe--the latter two a victim of interest rate rises and subprime loan woes.  

A closer look at sector winners and losers finds that the strongest sectors include oil and oil services, networking, cyclicals, natural gas, defense, internet issues, chemicals, and computer stocks.  Behaving weaker have been consumer stocks, financials, healthcare, biotech, pharmaceuticals, housing, airlines, and real estate.

If I had to lump the themes of weakness, they would be twofold:  1) fear of a Democratic presidential victory and health care reform; and 2) rising rates and oil prices affecting the consumer.  As long as those two themes (and their associated weakness) don't spread to the broad market, I'm continuing to lean to the long side.  

Below we can see a chart of the S&P 500 Index and money flow for the 40 highly-weighted S&P issues that I track.  These are evenly divided among eight S&P sectors, providing a good view of the entire index.  We can see that flows have remained strong; that pullbacks in money flow have occurred at successively higher prices.  As long as this is the case, it is difficult to fade this market on anything but a short time frame.

 

Week of June 11 - June 15, 2007

 

Market Pullback on Interest Rate Rises

We saw a stiff market pullback during the week as 10-year interest rates approached 5.25% before dropping back on Friday and facilitating a market snapback.  Adjusted NYSE TICK readings were very week on Tuesday, Wednesday, and Thursday at -833, -870, and -1468.  Going back to 2004 (N = 844 trading days), we've only had 14 occasions in which the three-day Adjusted TICK was -2000 or lower.  Interestingly, the market tended to bounce five days after such broad weakness, with the S&P 500 Index (SPY) averaging a gain of .39% (9 up, 5 down).  That compares favorably with the average five-day gain for the remainder of the sample of .18% (480 up, 350 down).  When we look 15 days out, however, a different picture emerges.  Following the very weak 3-day Adjusted TICK, SPY averaged a loss of -.16% (5 up, 9 down)--much weaker than the average 15-day gain of .56% (532 up, 298 down).  This suggests that a bounce from such broad weakness tends to retrace prior to any sustained rally.

Money flow in the eight S&P 500 sectors that I track pulled back this past week as well, as we're now seeing Adjusted Relative Dollar Flows below the 200 day moving average.  As we can see from the chart below, such dips have tended to occur during excellent buying opportunities.  As long as these pullbacks in money flow occur at higher price lows, we have to consider the uptrend to be intact.  Note that the dip below the zero line in the chart does *not* mean that money flows have turned negative (i.e., that dollars are flowing out of the S&P sectors).  Rather, it tells us that flows over the past 10 trading sessions are below the 200-day average.    

 

For those interested in the specific sector money flows, here are the sectors, links to charts of their Adjusted Relative Dollar Volume Flows, and the five stocks from each sector that I track both for money flow and for the intraday new highs/lows recently mentioned on the TraderFeed blog.  Note that flows have held up quite well in the Materials Sector and have stayed close to average in Energy, Staples, and Technology. 

XLB - Materials Sector:  DD, DOW, AA, IP, WY

XLI - Industrials Sector:  GE, UPS, BA, UTX, MMM

XLY - Consumer Discretionary Sector:  CMCSK, TWX, HD, DIS, MCD

XLP - Consumer Staples Sector:  PG, MO, WMT, KO, WAG

XLE - Energy Sector:  XOM, CVX, COP, SLB, OXY

XLV - Healthcare Sector:  PFE, JNJ, MRK, LLY, AMGN

XLF - Financial Sector:  C, AIG, BAC, WFC, JPM

XLK - Technology Sector: MSFT, INTC, IBM, CSCO, VZ

On Thursday we saw 1995 stocks make fresh 20-day lows; on Friday that number was 1735.  Going back to 2004, such broad weakness has been associated with positive returns over the next 20 trading days.  It would not surprise me if the current correction has further to go, and it would not surprise me if this correction is more extended in time than in price.  If we see fresh lows for this move with improving new low figures, improving money flow numbers, and improving momentum numbers (Demand/Supply), I'll start putting money to work on the long side with an eye toward at least testing the bull market highs.  

 

June 5, 2007

 

Addressing the Issue of Trader Discipline

Among the dozens of submissions for the Trading Coach Project, the issue of discipline--sticking to plans/stops--was far and away the most common problem reported by traders.  My general experience is that lapses of discipline are usually the result of a problem, not a cause.  A key challenge, then, for work on oneself is identifying the cause of the departures from prudent trading.

There are three frequent causes worth investigating:

1)  Personality Traits - Some people score low on a trait called Conscientiousness.  They do not plan and follow through well, and they can be impulsive.  This, of course, can manifest itself as a problem with discipline in trading.  The key to identifying whether or not personality is a cause of discipline problems is determining whether a similar loss of discipline occurs in other facets of life (outside trading).  If a person is disorganized and lacking in conscientiousness in their work, social relations, personal finances, etc., then it makes sense that this trait would carry over to their trading.  Such individuals frequently need external brakes on their trading, such as risk managers at a firm who will enforce a "drop dead" level (and prevent further trading) once a loss limit is hit.  Individual traders with impulsivity and low conscientiousness benefit from very explicit, structured rules that they follow without variation and reinforce with mental rehearsals.  If the lack of discipline is so great that even such rules and rehearsals can't work, I personally do not believe such individuals should be trading.  This includes traders with clearly addictive patterns of behavior, both in their trading and in other facets of their lives.  

2)  Market Volatility - Many, many times traders are quite conscientious and self-controlled in most areas of their lives, but experience lapses of discipline specific to trading.  When this happens, it's often the case that the trading itself--*how* they're trading--is artificially creating the failure to follow trading rules.  A key culprit in all this is market volatility.  Volatility changes from day to day and week to week.  It also varies as a function of time of day.  Frequently, traders trade a fixed size and set fixed targets and stops, heedless of the underlying market volatility.  In a low volatility environment, they fail to hit their targets and get stopped out, criticizing themselves for leaving money on the table.  In an environment of enhanced volatility, the market will blow through their stops or exceed their targets, leaving them feeling that they did not trade well.  This is especially true when traders find themselves unable to take what is normal heat in an environment of raised volatility.  In such cases, it really isn't a lapse of discipline causing the problem.  Rather, the trader is not adapting to market conditions.  Adhering to fixed rules in a variable environment is not necessarily a virtue.  Changing markets can prevent us from enacting those fixed rules.

3)  Position Sizing - It is very common that smaller traders or aggressive traders will see a good trade and place too large a bet (i.e., a bet that is large relative to their account size).  This makes it difficult to ride out normal movements against the position and leads to frustration and emotional arousal that result in loss of discipline.  A good way of determining whether or not this is the case is to compare your largest trades with your smaller ones.  If discipline problems tend to occur on the largest positions, you know that the increased perceptions of risk are interfering with consistency.  The answer to this problem is to size all positions in such a way that individual losses in a trade cannot prevent you from making money on the day; losses during a day won't prevent you from being green on the week.  Large trades relative to position size run the risk of ruin: a series of losing trades can dig a monstrous hole for the trader and cause significant emotional damage.  In a sense, trades should be boring--not so large as to create undue fear *or* excitement.  It is easiest being consistent and maintaining discipline when those emotional factors don't kick in.

It is common for trading psychologists to emphasize that our psyches affect our trading.  Equally true, however, our trading affects our emotions.  Trading inflexible strategies with inflexible targets and stops; trading size that is too large for our personal risk tolerance and account sizes: both of these can create "discipline" problems even for conscientious traders.  Trading well is often the best psychological strategy of all.

 

June 4, 2007

 

Trader Selected for the Trading Coach Project

The first trader selected for the Project is a full-time professional trader at a proprietary firm.  He trades a variety of interesting strategies and is working on improving the consistency of his results.  I think this will be an educational experience for all concerned, as we will see how a successful trader--one who has traded for a living for years--makes use of psychology to improve his performance.  I cannot accept further applications from traders at this time, but will be happy to consider those who have already expressed interest for future coaching as part of the educational project.  Thanks to all who have responded!

 

Key Trading Patterns for the Short-Term Trader

Much of success in short-term trading is training your eye to notice patterns in which there are significant shifts in demand/supply.  Most often, these patterns are more complex than following price alone, which is the downfall of many traders.  This chart integrates the action of price, NYSE TICK (sentiment), and volume to illustrate an opening range breakout and then a transitional structure in which buying dries up and eventually returns us to a prior value range.  Once Blogger has TraderFeed up and running again, I'll elaborate on the trade.  Studying each day's action and identifying these shifts in market dynamics is an excellent start toward recognizing them in real time.  The breakout trade--a trade in which the market is rangebound and then breaks out of the range on increased volume and extreme NYSE TICK--and the mean reversion trade (drying up of buying or selling when trading above or below a value area) are my two favorite trades.  I definitely believe a trader can be successful just mastering those two patterns--and being patient enough to wait for their setups.

 

Week of June 4 - June 8, 2007

 

Market Perspective:  Money Continues to Flow Into Stocks

We saw a broadening out of the rally over the past week, as four of the past five trading sessions have given us positive readings in the Cumulative Adjusted TICK.  That means that we've had above average lifting of offers across the broad universe of NYSE stocks.  This in turn expanded new highs, providing us with 1660 new 20-day highs and 1129 new 65-day highs across the NYSE, NASDAQ, and ASE.  These are the highest numbers seen since mid-April.  My Institutional Momentum score of +1020 is in overbought territory; gains have tended to be restrained once we exceed +1000.  At 100, my Friday Demand measure is quite strong, against 33 for Supply, but these numbers trail the Thursday levels, again suggesting a pause could be in the offing.

Still, the rally continues--and we can attribute this to strong money flows.  Here is a chart of current adjusted relative dollar volume flows for the 30 Dow Industrial stocks.  Note that, while levels have tailed off recently, they have remained above the zero line.   That means that money flow into the Dow stocks has been above the 200-day moving average: an average which, itself, has been part of a bull market.  Very difficult to sustain a correction when money flows are above an average that is bullish itself.

Here are charts displaying yet another dynamic behind the market strength.  Note the inverse relationship between the S&P 500 futures and the Yen futures.  The weak Yen is spurring the carry trade, encouraging investors to borrow the cheap currency and buy either high-yielding assets or ones with risk but reward.  It is difficult to believe that as long as the weak dollar and even weaker Yen provide liquidity to the markets that we'll see a meaningful market downturn.

I expect we'll see consolidations and bull market corrections along the way and will be monitoring the indicators for signs of these.  Indeed, with some slowing of money flow and overbought indicators, it would not surprise me to see some pause in the market rise forthcoming.  Until the basic drivers of the bull market abate, however, I expect further gains in equities.

 

Week of May 29-June 1, 2007

 

Market Perspective:  Interest Rates Up, Stocks Fall Back

As 10-year interest rates briefly touched 4.9%, stocks sold off and turned many of my indicators oversold.  We've seen very weak NYSE TICK readings both on a daily basis and over the past 20 trading sessions.  Additionally, we hit a downside momentum extreme on Thursday with Demand at 23 and Supply at 210.  This means that about 9 times as many stocks closed with significant downside momentum as upside momentum.  The general pattern has been for momentum to peak and trough ahead of price, so that it wouldn't surprise me to see further price weakness on reduced downside momentum.  If that turns out to be the case, we could see a buying opportunity over the near term.

I was particularly interested to see that the new 20 day lows on Thursday (1217) held above the level registered on 5/16; the same is true of 65-day lows.  The reason for this is that small caps had bounced nicely early in the week.  I will be watching closely to see if this level of new lows turns out to be a bottom for this indicator.  If we see fresh price lows with a lower level of stocks making new lows, I'll be leaning to the buy side.

Finally, an updated review of my eight S&P 500 sectors (Materials, Industrials, Consumer Discretionary, Consumer Staples, Energy, Healthcare, Financial, and Technology) suggests that money flows continue to remain healthy among large caps.  I assembled 40 highly-weighted stocks from the eight sectors and combined their adjusted dollar volume flow readings into a single measure for the S&P 500 Index.  You can see how flows have weakened as we've made recent price highs, but those flows still are not below their 200-day moving average and are solidly positive.

It would not at all surprise me to see new price highs in SPY accompanied by lower peaks in Adjusted Relative Dollar Volume flow as part of an extended topping process.  We saw this pattern in the early part of 2006 and then again during the runup to the sharp market decline in late February/early March, 2007.

At this juncture, according to Decision Point, we still have 69% of S&P 500 stocks trading above their 50-day moving averages--nowhere near the 20-30% levels that have typified recent intermediate-term lows.  That level is 55% among S&P 600 small caps and 58% among the NASDAQ 100 stocks.  A whopping 100% of S&P energy sector stocks are trading above their 50-day moving averages; 85% of industrial sector stocks; and 79% of materials stocks.  

The Utilities sector took quite a hit during the week, as we now have only 34% of the stocks trading above their 50-day moving averages, down from well over 90% just recently.  Rising rates appear to be the culprit.  We're also seeing weakness in the real estate ETF (IYR), thanks to rising rates affecting the REITs.  I would expect the market to show further weakness if those 10-year rates breach 5%.  We're in a situation in which rising rates may be necessary to encourage international investors to hold dollars, given the weakness of the currency (see below), the lack of relative strength among U.S. equities, and the desire to diversify reserves on the part of China, the oil producers in the Middle East, and others.  

 

Week of May 21-25, 2007

 

Market Perspective:  The Rally Continues Among Large Caps

I recently presented several statistics that show how the recent market rally has narrowed its base to a core group of large cap sectors.  Specifically, money has been flowing into hard assets and physical capital rather than consumer assets and intellectual capital.    

Despite the narrowness of the rally, there is no questioning that money has been flowing into those large caps.  Of the eight S&P sectors I track, five are currently displaying relative dollar volume flows above their 200-day average over the past 10 trading sessions.  Only two are below average--and these still display net dollar inflows.

The Energy, Industrials, and Materials stocks continue to lead the inflows; the two sectors with below average inflows are Financials and Consumer Staples.

In short, I don't think this rally will be derailed until we see investors give up on these large cap/physical capital sectors.  

What would derail such a rally?  My hunch is that it might be a firming dollar that dampens ardor for physical assets.  That, in turn, might result from higher U.S. interest rates.  Note that ten-year rates have been on a tear lately, rising from a low around 4.61% to over 4.8% in the past two weeks.  As long as there is lots of liquidity around and an implicit weak dollar policy by the Fed, I see no reason for capital to not seek "things" that will appreciate relative to the dollar and companies that stand to benefit from the trade benefits of a weak dollar.     

Here's a chart of Adjusted Relative Dollar volume flow for the 30 Dow stocks.  We're still not seeing outright below average money flows in those stocks.  That has kept me from going short this market despite recent divergences, and so far that stance has paid off.  At some point that dynamic will change; I will be tracking the data closely to see if the broad market weakness spills over to the strongest of the large caps.

 

 

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Week of May 14-18, 2007

 

Market Perspective:  Stealth Correction, Bull Market

We've been going through a stealth correction in equities, although you wouldn't know it from the price action of the major indices.  Despite Friday's rally, we saw 666 stocks make fresh 20 day highs and 775 make 20 day lows across the three main exchanges.  Money flow in the Dow stocks has been below the 200 day average for four of the last six sessions, including Friday.  While this tailing off of money flow does *not* mean we're seeing net outflows from stocks, it does represent a tailing off of buying, as we can see below.  (Note: This chart tracks 10-day flows vs DIA).

Another indication of the stealth correction is that the Adjusted NYSE TICK has now been in negative territory (meaning that we're seeing below average transactions at the offer among NYSE issues) for five of the past seven trading sessions and 13 of the past 20.  

We can see that dips in the Dow money flow below the zero line (representing the 200 day moving average of flow) have represented good intermediate-term buying opportunities.  I suspect we'll see another such dip before this consolidation ends.  At this point, I have no reason to believe that such a dip would be anything other than a correction within the upward market trend.  The vast majority of Dow issues are displaying above average money flows over the past 20 trading sessions:  29 out of 30 to be exact (with DIS the only exception).  That is not a scenario that suggests a bear market around the corner.

Dow stocks with particularly strong relative dollar inflows over the past 20 sessions include JNJ, KO, HON, INTC, AIG, and AA.  The weaker 20-day flows are seen in DIS, T, MO, MSFT, HD, XOM, and C.  

Options-based sentiment is relatively bullish.  Friday's equity put/call ratio was below the five day average; the five-day average was below the 20-day average; and the 20-day average was below the 200-day average.  This indicates a solid trend toward bullish sentiment.  When this has occurred since 2005 (N = 573 trading days), the S&P 500 Index (SPY) has been down by an average of -.08% over the next ten trading sessions (22 up, 21 down).  Conversely, when we've had a consistent uptrend in the equity put/call ratio, the next ten days in SPY have averaged a gain of .61% (49 up, 26 down).  When sentiment has been steadily improving, as has been the case recently, there has been no bullish edge whatsoever and, indeed, the market has tended to underperform.  That is one of the factors lying behind my expectation for further consolidation near term.

My overall perspective has not changed, however.  We are in the midst of a global liquidity boom that is fueling major gains in international equity markets, with the U.S. at the tail end of this trend.  I am content to use short-term pullbacks as opportunities to add to long positions until I see evidence that institutions are no longer committing funds to stocks.  Those short-term pullbacks should be signaled nicely by the 20-day highs minus lows (see below), which have been waning despite the recent market rise.

In the big picture, I view this market as most like the post 1994 market, in which a low volatility market made a relatively flat correction and then took off to the upside.  Our four-year flat correction ended in mid-2006, and we now see a fresh bull market in the broad buying of global equities.  Interest rate, currency, and money flow trends will need to shift markedly to put an end to this market strength.

 

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