Here we go again?

I happened to have the back jacket of “Trade Like an O'Neil Disciple” laying next to me. “What the market will do is anyone's guess. What it is doing should be anything but.” trumpets out in bold print.

Each day I try to forget what I was thinking the previous and look at what the market is doing with fresh eyes. Any prognosticating I attempt I try to keep within a 3-5 day window which coincides with my holding period as anything further than that horizon and I might as well write fantasy.

Looking at the SPX over the past 9 sessions, a lower close established on 06/15 has held. Since this date, there have been 3 days of 1% moves indicating a volatile period.

06/21 1.34%

06/24 -1.17%

06/28 1.29%

06/23 the index showed great strength powering from a low of 1262 to close at 1283 and closing down .28% for the session suggesting that there was a strong bid in the market. The following day being a 1% down day forced the question to this belief, but the low of that day held and the market SPX rebounded 2.2% over the next two sessions.

SPX 06/28

Taking a look at the $USHL5, 52 week highs have rebounded the past few sessions as well showing this move is being supported, and perhaps time will tell whether or not the new stocks beginning to populate this list will be the leaders of the next leg up.

$USHL5 06/28

One indicator that I pay closer attention to as of late the $BPNYA has crossed the 10 period MA. This is one indicator I'll be watching closely and see if this holds. I recall 05/31 and the near cross before the market dumped -2.28% the following session.

$BPNYA 06/28

Lastly I note the Market Monitor that I use daily to analyze markets analyzing for times that are conducive to my trading style. This indicator gives me pause at the moment as I am not witnessing the buying pressure that should compliment the move over the last few days. With primary and secondary indicators are still bearish although two secondary indicators are very close to flipping bullish, I would expect the number of break outs to break downs ratio which currently stands at 1.55 to be higher, but the numbers that produce this ratio have been fairly balanced the past ten days with only one 300+ break out day. 

Market Monitor 06/28

 

This is disconcerting to me because the last few times this has happened the rallies have been brief and very selective. I've taken a few positions as I believe there is a window of opportunity, however slim it might be. Thus far I've been proven to be on the correct side of the order flow, but I'm staying cautious over all and still waiting for this market to firm up and prove itself and for that I'll be looking for a series of break out days. But as the back jacket reminded me, I trade based off what I believe today, not what I will know tomorrow.

Signs of the Atop-calypse?

The market as of late has given me the sensation of being a yo-yo on a see saw being whirled by a carousel on a merry go round. For the most part I've managed to cut back my trading significantly and avoid churning my account, but I have been caught with my hand in the cookie jar a couple of times and felt the stinging reproach. I've faced the mirror and realize that currently I'm not in sync with this market and have not found it conducive to the style of trading I implement and have wisely sat aside, mostly disciplined but on occasion an impetuous pulling of the trigger.

That being said, part of my discombobulation is that I spent so much time, effort and energy towards applying myself while in the market, I didn't really address in my trading plan of what I would do during the times there was a lack of opportunity. In part, this is one reason I finally placed the energy into creating a blog so that I could externalize some of my thoughts and in turn perhaps expose some of my ideas to the light and learn to apply my time in a more pertinent and useful manner.

One of my thoughts as of late has centered around the topping process of markets and how to identify them and better understand what they mean in the context of my trading. Again, having sat out some time, I began to ponder how much longer I may expect to, and what to look for at the turning points to be prepared to take full advantage when I'm in step. For this, I returned to “How to Make Money In Stocks,” as a guide.

I've cracked the spine on HTMMIS numerous times and am coming to the conclusion that I have not done so nearly enough. The information is the exact same as the last time I peeked, but I am not and the questions that I bring this time around are more seasoned than the first time or the second time or the tenth time. For this perusal I turned to Chapter 7 “M = Market Direction: How to Determine It,” and the index looking for sections on bear/bull markets and tops/bottoms.

In HTMMIS, O'Neil gives a model of market cycles and my goal in this exercise is to cross reference his model with what is occurring in the markets at this time and see what correlations exists. On page 68 (3^rd Edition) he makes three key points:

1. “Almost always, the really big money is made in the first one or two years of a normal new bull market's upward movement....”
2. “In the first or second year of a bull market, you should have a few intermediate-term declines in the market averages usually lasting a couple of months, with the market indexes dropping 8% to 15%...”
3. “The remainder of the up cycle usually consists of back and forth movement in the market averages, followed by a bear market....”

The current bull cycle commenced on 03/23/09 after a move of 20% from the 03/09/09 close. During a period of 2 years between 03/29/09 to 04/29/11 the SP had a 65% increase, and from the 03/09/09 close, a 101.56% move.

Over the past two years there have been a few periods where the index has pulled back 8%+, 01/19/10 to 02/08/10 saw a 8.13% drop and a new 52 week high established on 03/11/10 , 04/23/10 to 06/30/10 saw a 16% drop and a new 52 week high established 11/04/10. These intermediate-term declines also correlate to the the model.

Which brings the third point, which according to the model should be the current state of the market which since 02/17/11 has been a period of back and forth movement with the SP primarily trading within a 5% range over 4 months. With the SP currently down 7.68% it remains to be seen whether or not a bear market will follow or if this is a persistent intermediate-term decline and the index continues to chop within a range.

Clearly there are correlations between his model and the current bull market but it remains to be seen if a bear phase will follow or perhaps this range, like the 56-58 market will continue for the near future. The point of this endeavor is not to be an oracle and presage what the market will do, it's an attempt to grasp what the market is doing and for that turning to the market participants and what they are doing is a logical follow up.

Dow 55-58

There are two points of reference I noted when ascertaining the mood of the market participants. 

1. “After an extended rally in the market, a tape reader may notice more defensive stocks (food and utility) cropping up on the tape. This is an indication professional money is becoming apprehensive.” pg. 211
2. “Prime defensive industries are gold, silver, tobacco, foods, grocery chains, and electrical and telephone utilities.... increased buying in a number of these stocks after a couple of years of a bull market you may be witnessing an indication that many of the bull market's groups are near a top.” pg. 228

To delve into this I used TeleChart and scanned for stocks in proximity to their 52 week high, took the top 10% and sorted them by Industry/Group and looked for the clusters. As can be seen in the following image, there are a number of stocks in the food/grocery chain/utilities sectors.

Sector Clusters

Additionally I scanned for stocks within proximity to 10 year highs and sorted them by dollar volume to see where the money is flowing and the list is primarily compromised of Big Cap Dow stocks.

KO IBM MCD MO CL GIS UNP MCK HNZ NSC.  

With big money being positioned in these sectors it can be deduced that big money is indeed becoming apprehensive at this time.. Observing whether money begins to flow into more aggressive vehicles or continues to rotate into defensive positions may give clues in the up coming weeks as a number of potential news catalyst hit the market and another earnings seasons commences.

Bottoms!

In the belly of watering holes in San Francisco from the Financial District and Chinatown to the Tenderloin the incessant rattling of die followed by a loud thwack as the lip of the cup hits the bar can be heard. Dice is a popular game often played for a few dollars, for the tab, and sometimes with the bartender for that one drink too many you said you wouldn't imbibe. Other than Liars and Ship Captain Crew, one game I partook in often is 1-4-24.

The rules could not be simpler-

6 die are rolled

At least one die must be kept after each roll

Qualification requires setting a rolled 1 and 4 aside

Failure to qualify by the end of the round doubles your stake

The remaining 4 die are tallied at the end up to 24 points

I was introduced to the game with a nuance. On the last roll “Bottoms” can be called and in so doing one takes the opposite value of the face. It's an odd rule when thought about for there really is no added advantage to doing this- none at all. 50% of the time the tally increases and 50% of the time the tally decreases. So what is the point?

The game is purely about probabilities. If this many die are pulled I have x chance of qualifying or y chance of getting 23 points and winning by one, then z should be done. But it's a gambling game, and as with many gambling games what fun is simply playing an optimal strategy. Why not add a twist to make one feel involved in the outcome and feel like the results were influenced by a critical decision at a key point in the game? By injecting this possibility a sense of drama is added when lifting up the cup exposing a face of 1, banking the 6 and taking the round. Often some slurred words are exchanged, usually “Lucky!” or “I knew it!”

Is the action over the past 4 days a bottom? I can just as easily pull a 6 as a 1 on that call, so there really is no point. What is important is to look at what I was expecting and take it from there. Regardless of what I feel about the lack of volume or how distrustful I was of the move early on and how it was not confirming in breadth soon enough for me to take action, in the end today was a 300+ day on the reading that I use and this is what I was looking for in order to commence forays into the market again. If there is any meat to this move there will be plenty of time to gorge, otherwise I'll be careful with the incisors because gristle is close to the bone.

There's a Trading Lesson Here

So it's mid-October and I'm walking towards a local cafe and suddenly notice something not merely out of place, but in every place and in the most unusual of locations: from sign post to license plate, shrubs to sidewalk, layered like flap jacks one in front of the other or stretched between the trunks of trees separated by 6 feet or more.  This was not the typical prefabricated Halloween paraphernalia of ghouls, ghost and witches that had been popping up on stoops and balconies the past few days, this was an overnight blitzkrieg of meshing giving the eerie sensation of being entombed in a cocoon.

Over the next few days I noticed from block to block, neighborhood to neighborhood the same scene unfolding like some apocalyptic paragraph in a science fiction novel as spider webs clung from the most awkward and daring spaces. I found myself entranced watching the mechanical precision of the spider dance, occasionally adrift and flowing from the improvisational wind or furiously interconnecting strands.  As I continued to be marveled I suddenly remarked to myself, “There's a trading lesson here.” 

Until this time I had been focused upon looking for resolution of trading issues through trading literature but I instantly understood after taking a moment to simply observe what is actually happening around me that not all trading problems have trading related solutions. If I sought to improve I should not expect to find answers from trading books alone but branch out into other forms of literature as well and reacquaint myself with some of the protagonist gathering dust on the shelves in proportion to the cob webs in my mind; and that I should also incorporate in my discovery process the simple query to experiences from this point forward and ask myself if there is a trading lesson here.

Over a couple of days I jotted down some notes in a journal to follow up on and the following concepts began to formalize. 

1) Know Your Cadence

The spiders did not magically appear, they were simply more obvious as Summer edged into Autumn and the older females, now plump with eggs stood out as many wove their final webs before dropping off into the Fall leaves to lay the next generation before their life cycle ended.  This crystalized the concept of market cycles and learning which are more conducive to my style of trading than others and to focus upon my rhythm and when it is in step with the market. 

This information was not new to me, but my clarity and understanding of this improved because from observation of a natural phenomena I was able to articulate a concept in my terms and from a perspective that is in tune with my way of approaching understanding and knowledge. 

2) Do One Thing Well

Spiders are specialist and their expertise is weaving.  Their web is critical to their survival and prosperity. Once the web is constructed the spider is dead center and nearly motionless except the occasional twitch of the forelegs- probing for information. 

This crystalized the point that one set up is enough to survive in the market and prosper.  When one understands their set up innately then it simple becomes a matter of sitting and waiting and probing for information and when the set up triggers like a twitching fly, it's merely a matter of execution.

3) Resiliency

Everything can be aligned: in harmony with one's cadence in the market,  a defined set up with an edge, execution of an entry signal with accepted risk parameters, but things will not always work out as expected.  This began to hit home when I saw one web was crowded by a much large web in front and pondered the repercussions of the larger web netting all the insects first.  Adjacent was a web that was half destroyed and the energy being spent to patch the damage made me think about my comfort zone and how much of my account size I should risk on a position. 

As witnessed, simply achieving an innate level of proficiency and expertise does not mean there are not hazards that can occur at any moment such as one's entry signal may be a larger traders exit moving price to stop level immediately, or slippage may skew the risk/reward, or an overnight news related event knocks price down 15% before you can blink. No matter how skilled, not everything works. 

All three of these concepts were known to me at the time, but not internalized.  There was a gap between my knowledge and acceptance of what it meant.  I had yet to develop the thinking process required for success and lacked the ability to filter and process information constructively from the traders point of view.  This takes experiences over time to hone, but that doesn't mean the learning curve can't be expedited.

One insight I gathered from this exercise is the realization that it is important to define things in a manner that makes sense to me and one way in which I've been able to do this is through allegory. Another exercise is looking for creative ways to filter trading thoughts and ideas through another medium and seeing what I can find relation to, such as changing words in a paragraph of literature.  Learning to trade involves processing a substantial amount of information and it becomes difficult at times to understand what should stick and one tool I now use to sieve information that I find valuable is to remove it from a trading context entirely, particularly if it is a concept I am frustrated with as this consumes time and energy that is better used elsewhere.

How would you like your eggs?

It is said the mark of an elite chef is their ability to cook the simple egg, so by this standard an amazing breakfast cook is truly a spectacle to watch- slightly hunched forward over a multi-burner stove and flat top innately aware of where the over medium, over hard, slightly runny, or the sunny up is situated and which ticket it belongs to while keeping two omelets going, a frittata, 6 slices of French toast and 3 pancakes going and doing this for hours as the line out the door seems only to grow until the last grumbling stomachs are seated or move elsewhere by noon.

One of the hallmarks of the breakfast cook is timing for without it everything falls apart rapidly and it takes more than a few lawn mowers and goats to get one unstuck from those weeds. Granted over time proficiency builds until the point this dance becomes second nature and simply about executing time after time, but the tempo must still be kept keeping in cadence with the ebb and flow of customers and servers.

In many walks of life timing is an important factor and trading is no different and as such I've developed the belief that market timing can be done and has been shown to work as attested by audited results of some of the elite traders, Dan Zanger, Mark Minervini, Morales and Kacher etc... as such, I have chosen to put in the effort to develop an understanding of market timing and have focused upon one in particular but have also branched out to assess a select few others as to better understand the cadence I can trade best to.

Over the past couple of weeks a marked change of character has formed and it is clear now that a correction is under way with the major indexes down 6%-8%. I believe it is therefor appropriate to begin an analysis of reversal patterns as one is currently present before it becomes a historical study as to express thoughts that are concurrent with the event, however myopic those thoughts may be. Afterwards an undertaking of the historical reversal patterns will have a model to be compared to that was experienced and further puts into context the (M)arket section of William O'Neil's “How To Make Money In Stocks.” The five indicators being addressed are $USHL5, $BPNYA, SPY, Zweig's 9-1 Breadth Thrust, and Stock Bee Market Monitor. 

SPX 12/01/10-06/10/10

 

 

 

 

 

 

 

 

 

 

First is a daily chart of the SP from the beginning of the more recent move 12/01/10 until 06/10/11. There are three key periods 12/01/10 to 02/01/11, 02/01/11 to 05/02/11 and 05/02/11 to 06/10/11.

The first section to note the move from 12/01 until is a period of 56 trading days and a move on the index of 13.76%. During this time there were 6 dates that stand out as having 1% moves to either side:

12/01/10 2.16%

12/02/10 1.28%

01/13/11 1.3%

01/19/11 -1.01%

02/18/11 1.79%

02/01/11 1.67%.

For comparison there were 10 1% moves from the time period between 02/18/11 to 05/11/11, 50days with a movement of 1.53%.

02/22/11 -2.05%

02/25/11 1.06%

03/01/11 -1.57%

03/03/11 1.72%

03/10/11 -1.89%

03/15/11 1.12%

03/16/11 1.95%

03/17/11 1.34%

03/21/11 1.50%

04/20/11 1.34%

Since the new 52 week high was established on 05/02 the index has dropped 6.63% during a period of 28 trading days and there have been 6 days with 1% movement.

05/11/11 -1.11%

05/23/11 -1.19%

05/31/11 1.06%

06/01/11 -2.28%

06/06/11 -1.08%

06/10/11 -1.40%

Looking at the chart, the three periods show marked characteristic differences, with the former being more linear and the middle being more volatile with wider price swings and the later moving in a downward price channel with 5 of 6 1%+ moves being to the downside. This area is also more congested as price compacted between the high and the higher low established on 03/16/11- whence price oscillated within those two zones until the 52 week high was broken on 04/27/11 and the last 52 week high pivot established on 05/02/11. From there price returned into the zone of congestion and formed a price channel.

One characteristic that stands out from this perspective is that during the up trend the majority of 1% moves were to the upside, during the choppy sideways market there was a mixture and during the down trend the majority of moves are to the down side and these moves have happened in a shorter time frame.

$USHL5

 

A quick glance over the $USHL5 (number of cumulative new highs and new lows over a 5 day period) shows that while the SP continued to move higher, there was an underlying divergence occurring with less highs participating and this divergence is shown in the price overlay of the SPX.  Reviewing the past year, the deepest this indicator has dropped to is -1189.  The period where this last leg being assessed started it dipped to 40 and as can be seen the subsequent move peaked lower than the prior move from the August low and each peak since than has been slightly less while many of the valleys cut deeper. The final peak was 2298 in May 02 and since then the valley has dipped to -606 as of June 10.

$BPNYA

 

Another useful and simple tool is the $BPNYA which in conjunction with the $USHL5 showed divergence as well during this time period as the the highs of the SP were occurring while the highs in the $BPNYA were declining.

General assessment of the $BPNYA is that over bought conditions are above 70 and approach extreme conditions above 80 which first occurred on 12/31/10 and peaked on 02/18/11 which coincided with the 52 week high before the market moved sideways. Additionally the divergence is evident as the index established a new 52 week high on 04/29/11 while the indicator put in a lower high. What is efficient about this indicator is by using a simple 10 period moving average, the general direction of the market move can be captured.

Zweig 9-1 Breadth Thrust

 

This chart represents the period from the peak and range that began on 02/18/11.   4 dates clearly stick out when viewing from the perspective of Martin Zwieg's 9-1 breadth thrust: 02/22/11, 03/10/11, 03/16/11, and 04/18/1; additionally they have one thing in common, they were all negative days on the index and 3 of them were 1%+ moves. During the channel formed after the most recent 52 week high on 05/23, 06/01 produced a 20-1 thrust on a down day , and 06/06 a 13-1 thrust on a down day. This vantage point offers a look at the buy/sell side volume during this time and clearly the heavier imbalance was on the sell side suggesting distribution was prominent during this period.

Stock Bee Market Monitor

The Market Monitor as discussed by Pradeep Bonde of Stock Bee is the indicator I use the most.  This is simply raw data representing breadth across multiple time frames with a couple of secondary and tertiary indicators as well. As seen from this perspective, the breadth thrust presented in the first three columns shows underlying weakness from this perspective going back to 04/07/11 (not shown here due to limitations of screen capture). Over time this weakness began to began to spread through the other indicators and on 05/23/11 they began oscillating bearish/bullish until showing consistent bearishness across all time frames on 06/05.

One primary reason I focus upon this is because I've developed (for the most part) a logical, cohesive system around these numbers and have integrated them daily, entering every number and creating a page write up about the day and going through the majority of charts that these numbers represent. Being raw data, these numbers are open to some interpretation but one of the many benefits of doing this is increased awareness of market mechanics and general market breadth which is an important foundation to build.  Some charts create a level of abstraction slightly removed from the market and mask the hidden weakness and pockets of strength that occur under the surface.

Of particular note to myself is the breadth as shown in the first three columns which I use as my primary market direction model- when it begins to decline I become more cautious and when it dips below 1 I will not swing trade. When it begins to increase from below 1 I start to become interested and when it reaches 1.5  I begin to get long. 

So what does this all mean? Really not much as these are just tools, and chimps and crows manufacture and use tools so there isn't anything special about it. The greater understanding of the tool, however, is important and understanding its proper usage, for a good tool misused is like a plumber with a hammer in the Sahara. More dangerous than using the wrong tool for the job is thinking you understand what the tool is useful for to begin with. Market timing techniques are simply a piece of the puzzle- and in some ways it is the easiest to approach for the method of piecing together a puzzle typically starts with finding all the border pieces first and completing the frame. When used with understanding each of these tools can shed light upon what is happening in the overall market and give clues as to near term conditions, but in a vacuum this means little for without a comprehensive plan to address trading conditions and a set up or method to use it will most likely be misused.

I've managed to sit aside the past few months of choppy market action not due to brains as I've found mine get in the way too often, but due to a simple pledge not to trade when the breadth thrust was under 1 and to stick to with that discipline- it's been difficult and a few times I've talked myself into just a trade or two and each time I felt myself wilting because a trade against my belief at the time will always be a poor trade no matter what the results.

The tool used isn't always the most important either as both the $USHL5 and $BPNYA are synced on most of their dates with most peaks and valleys showing on the same dates and both began to show typical divergence of making lower highs while the market made higher highs. There will be redundancy among many timing tools since many use information extracted from price and/or volume. Neither of these indicators are necessarily better, but one of them may be better suited and nearly everyone has an egg preference whether a delicate omelet, a 10 minute hard boiled or a 5 minute soft, or raw from the shell and drunk in one gulp- in the end it is still just an egg but with different timing involved. When choosing indicators, own them- know everything you can about them. Become intimate with every nuance and characteristic. And as importantly, tie them into an overall cohesive plan.

In the process of working through this, the one date that stuck out to me is 05/31- which on the market monitor was a 240 day on the breadth thrust and I had already projected the day would end above 1.5,  the $BPNYA was getting close to a cross over, the market was up 1% that day as well and I took a couple of small positions thinking this was a confluence of positives, and yet the Zweig breadth thrust came in a paltry .24.  This piques my curiosity as according to this indicator on a 1% up day there was a buy/sell balance and the next day clearly shows a sell side imbalance of 20-1 with a 2% down day on the SP.  A curiosity to carry forward.

I have no clue if this is simply a correction or something much deeper, nor is that for me to really care as it is just noise and distraction. I've come to embrace a market timing methodology and when it gives me a signal I'll be prepared to take it- that is all.