Don't Panic

One benefit of keeping consistent breadth metrics across multiple market cycles is being able to compare and contrast the nuances and contextualize the current market structure.  The last correction of magnitude was the period of late July through August in 2011.  This was a period where there was clear evidence of forced liquidation.  As exhibited by the StockBee Market Monitor, across multiple time frames there was rapid deterioration as the 10 day differential of break outs to break downs shifted from 509 to -5566 in 8 days, the secondary indicator went from 542 to -3596, and the primary to -2050 during this stretch.

This Is Panic

In comparison it has taken 20 days for the break out to break down differential to shift from a modest -9 to -1529.  During this stretch the secondary went from 100 to -1840, and the primary from 20 to -737.

This Is Not Panic

What can be gleamed from this is that while there has been distribution and the market is currently under pressure and exhibiting a greater out flow from stocks, in relation to what a rush to exit looks like, this doesn’t even qualify.  In other words, this is far from a panic situation.  

Unfortunately, this is about as far as one can extrapolate the narrative.  Knowing what is occurring now, the only important induction is whether or not this is a tradeable environment on one’s time frame or not.  Merely because it has yet to reach panic proportions we can not assume anything further then the evidence.  We will not know when it will or how it will realign.  We do not know if there will be a tradeable bounce, a failure and retest of lows, a prolonged period of sideways consolidation, or the reemergence of V-shaped recoveries.

The best that can be done is to foreshadow scenarios and plan and act accordingly based upon our signals and set ups.  Being aware of the confluence of signals that confirm our view or the divergence that negate it and acting upon these perspectives in a probabilistic mind set with proper risk control and pedal to the metal or stop gap measures is what should be strived for when managing uncertainty.

Weekend Review October 18, 2014

A difficult task in trading is reconciliation of disparate information.  Sometimes weighing the preponderance of information can lead to conflicting views and doubt.  Often the better recourse during these times is to avoid immediate action and allow things to play out and align more favorably.  When information creates fear or uncertainty, the better course of action is often to stay on the mountain top for another three days and enjoy a hike.

When it comes to breadth I’ve chosen to remove words like oversold or extreme in favor of extended unless a signal I follow occurs as often as witnessing a dumpster diving red tail in the middle of a city.  This past week one signal did trigger such a reading and my spread sheet alerted me that the selling became so severe there was a high probability of a bounce on the near term horizon.  Whether this is just a reflexive knee jerk reaction or a key pivotal low that holds remains to be seen.  From what I see there is some good, some bad, and some ugly.

Market Monitor

Things are still murky but there are some positive signs.  It is critical however to place these within context as they could be part of a bottoming process just as they could be the result of an extended breadth bounce.  The longer the recent pivot low in the market holds and the further these indicators improve would be confirmation that market health is improving.  This will take time as price patterns on many charts are broken and the number of stocks in my momentum universe has dwindled considerably.

During a correction one of the signs I look for to determine market stabilization is when new lows stop making new lows.  This week the USHL5 has improved after putting in the lowest reading in the past three years.  So far this is a positive and worth paying attention to how this holds.

$USHL5

Another positive is that the number of stocks making new highs vs. new lows across multiple time horizons is increasing.  In context of a high probability bounce, this may just be reflexive for now and further confirmation is still required.

Daily High/Low

Additionally on a weekly chart, the level of volume this past week has been the highest in three years for the major indexes I follow.  Had price closed near the low of the range on said volume I’d be extremely cautious here, but as price closed mostly near the high of the weeks range I am cautiously optimistic.  This is a situation where pice and volume are not confirming each other.  Proceeding forward I’ll be paying particular attention to this low holding or being under cut.

Weekly COMPQ

Weekly IWM

Weekly SPX

Checks and balance of the general market aside, currently there are only 300 stocks in my trading universe of 5516 that meet my momentum requirements.  There are 254 stocks up my expected value over a five day period but only 84 over ten days.  I would require an increase in stocks up my EV over a ten day period to assure me that stocks on my time frame are performing my historical average and that there is follow through on my time horizon.  Additionally I would need to see an increase in the number of set ups that as of now are few and far between.

One of the hardest things to do is to sit and wait for one's pitch during a corrective market.  It becomes even more difficult if one exposes themselves to too much noise and information.  I've learned to avoid outside influence as much as possible and sequester myself.  There are too many people with different perspectives and styles disseminating information that may lead to second guessing my analysis in order to feel the comfort of the herd.  These are the periods where I've found it most important to rely on what I currently understand and not seek out new techniques of analysis to force the market to give me clairvoyance.  These are the times to be honest and recognize I have no idea what the market is going to do but am merely forecasting probabilities and modeling based upon past experience of what has worked for me and what has not.

Weekend Review October 10, 2014

If I were walking along a railroad track and saw an express coming at me at 60 miles an hour, I would be a damned fool not to get off the track and let the train go by. After it had passed, I could always get back on the track, if I desired"  Reminiscences Of A Stock Operator

I’ve acknowledged that for over two years the market has made a mockery of market timing.  The past two years have dismissed statistical normalcy where modest 4-5% pullbacks never eroded further.  Every gap down brought a gasp and every hiccup brought hyperventilation as anticipation built.  Each modest dip was bought and V-shaped recoveries were the norm, not the exception.  By trying to sidestep the correction that would be the sucker punch to dip buyers I often felt like the sucker as the train rolled gently along.  

Even though there have been moments of foolishness as the market exerted maximum adversity upon the majority of participants, when you’re on the tracks and you see an express coming at you, it’s best to get off  even if what passes is merely a ghost train.  The tracks will still be there tomorrow, next week, or next month.  Unfortunately the market does an excellent job of conditioning and keeping the masses comfortably numb then surprising them with the unexpected just when the majority decide to stick their neck on the line because this time is not different, just another ghost train of which they’re now a passenger.  Trades become investments, accounts blow up, and itchy fingers that fired at will are suddenly leery of pulling the trigger again.

As a swing trader I don’t underestimate the effect of panic upon market participants.  Having felt the sensation on numerous trades gone south and hesitating like a doe in head lights instead of cutting and running, I’ve amassed many unpleasant experiences that have been difficult to override.   So now I try to be more anticipatory of scenarios where I may break instead of bend and ease off the pedal.  I magnify my unpleasant experiences upon the collective unconscious of the general market and anticipate scenarios that might lead to moments of panic such as this past week.

What this past week has exemplified is that gravely ill markets arise from sickly ones.  Symptoms may start off with a cough,  but when there is a confluence as the number of new lows vs. new highs begins to increase across a multitude of time frames from monthly through 52-Week, and the number of stocks above well watched moving averages across multiple time frames decreases, and intraday index volatility increases, a proper diagnosis is in order.  When the underlying fabric of the market deteriorates one never knows if there is a floor to roughly land upon or a trap door awaiting under the surface.

When the market does begin to crack and participants panic the ensuing discount mechanism of price can result in drastic reassessments.  A current FinViz scan for price percent change monthly shows over 2400 stocks down 10% or more and 800 stocks down 20% or more with many of these declines happening in one day.  Keeping too close an eye on the major indexes may lead to the proverbial forest for the trees and over look when the market become a minefield.  When the market does turn into a minefield it’s best to stand still and allow others to clear the way.

During these periods I find time is better spent away from the hustle of the game and on going outside a little more often and catching up on a dusty book or two, or watching spiders build webs and pondering what trading lessons do they have for me today.  It’s also important to review trades, adjust plans with increased knowledge and pay attention for a shifting of the tide, but it’s also important to surf a wave.

Red Flags raise the White Flag

Conventional wisdom suggest that: bullish oriented markets shake off bad news and in bearish oriented markets there is no good news, bullish markets open weak and close strong while bearish markets open strong and close weak, and bullish markets grind up while bearish show increased volatility with some of the largest intraday index gains recoded during these periods and tendencies to viciously flush down.  The later is what I look to protect myself from by avoiding to trade the long side when the preponderance of evidence no longer suggest being bullish on stocks.

Currently I see little evidence to suggest that there is an edge to trading stocks from the long side on my time frame.  The preponderance of evidence suggest that breadth continues to deteriorate and has yet to firm enough to lead me to believe buyers have returned to the market.  Two of my standard go to indicators, the percentage of NYSE stocks above their 20 period and 40 period moving average are currently at extended readings.  However, there’s a subtle nuance about breadth extremes, particularly to the downside.  The further breadth gets extended across multiple time frames the more bullish I become, but in addition the further the weakness the more cautious I become that there may be a crack and cascading water fall effect upon stocks.  

$MTMW

T2018

Additionally the Market Monitor is  red across all time frames, but there is some evidence to suggest that this correction might be contained at these levels.  The last column is shaded green indicating that in my trading universe less that 5% of stocks are up 25% or greater over the past quarter.  Coupled with extreme downside breadth on my time frame of 5 to 10 days, the market has been correcting across longer time frames as well while the major indexes have modestly pulled back.  This is one of the few positives I've noted.

Market Monitor

From a different perspective, using BarCharts Daily New Highs/Lows we can see that across multiple time frames more stocks are down than up over a multitude of time horizons.

BarCharts New Highs/New Lows

Using Stockcharts Elder New High/Low to gauge stocks over a 5 day rolling period shows the largest negative reading in two years.

$USHL5

Of particular note and perhaps most disconcerting is the bearish stage 4 price action of the Russell 2000 which is below a declining 30-Week moving average.  This is something I am paying attention to as there appears to be a bear market in small caps if not potentially topping out action.  The Russell is a good clue to risk on/risk off mentality and has been struggling for much of this current year.

RUT 30-WK MA

Scaling out on a monthly time frame and using a 6 period moving average there has historically been a period of consolidation following a close below this average with the occasional deep correction on the Russell.  In comparison it’s evident that the SPX has not had a close on a monthly basis below this for over two years and has climbed steadily above the entire time; however take note that it is currently positioned to do so suggesting a change of character.

RUT Monthly

SPX Monthly

Looking at the COMPQ and number of stocks above their 50 and 200 period moving averages it is becoming increasingly evident that the index is beginning to catch up to this weakness.

$COMPQ

And a last perspective I bring up is the Guppy Multiple Moving Averages of the COMP and SPX.

COMP

SPX

A difficult challenge in trading is trying not to extrapolate further than necessary when creating a cohesive plan of action.  There is a fine line between allowing price action to confirm one's expectation or using confirmation bias to affirm price action.  The market as of today and for the past few weeks has been one I’ve chosen to side line.  In order for this perspective to change I’d have to note an increasing number of quality set ups on my time frame, as well as stocks breaking out and following through.  Stocks making new lows should stabilize and decrease while stocks making new highs should increase.  Additionally I'd pay attention to an increase of stocks up compared to down across  shorter term time frames carrying over into larger time frames and a number of stocks above moving averages of varied time horizons.   If this becomes more than a modest correction of 8-10% across all indexes then I'll focus on signs of panic selling and capitulation leading to exhaustion followed by a lengthy repairing of charts and a breadth flip. 

The Tao of Trading

Tao give birth to one

One gives birth to two

Two gives birth to three

Three gives birth to ten thousand beings  --Lao Tzu

If I were to describe my style of trading, the Tao would be a good place to begin.  In a nutshell I look for contraction/expansion cycles to trade a burst of momentum over a 5 to 10 day window.  The Tao is an example of a contraction/expansion cycle that begins with a burst as the Tao gives birth to one.  A recent example of this cycle is BIDU which had a burst after a prolonged period of contraction.

BIDU

Another recent example is LEAF.  This examples shows the benefit of abstracting our thought process and thinking in chunks.  Our time in the market and expectation after entry comes down to whether or not “one gives birth to two” and “two gives birth to three.”  If this does not happen, this is not Tao.  LEAF was clearly Tao over the past few sessions.

LEAF

Another means of abstraction of price movement after entry is to associate with a process outside of trading.  For myself I’ve been thinking more in terms of my opening repertoire in chess.  There is little energy or thought in my moves as they are memorized to the 10th move or further.  By chunking price moves in association with chess moves I’ve found it much easier to accept when a position is not going as intended and a surprise move has been played.   Applying this to LQ there is one situation in which price action moved in accordance to my repertoire and one when it did not.  

LQ

The only correct exit in trading is the planned exit. A great benefit of this is approach is that it assist in avoiding results oriented processing.  Another benefit of applying scenarios we have planned out and executed in other fields to trading is that it helps us associate the same neural networks we've chunked along with associating a set of procedures abstracted to price action which assist us in consistently analyzing post entry price action.  We can avoid micromanaging post trade price oscillations that are often detrimental to consistent results and move more towards thinking in terms of the Tao did not give birth to two so exit. 

Open Window, Go With the Flow

During the correction I've been keeping a list of stocks holding up well.  Many of them are recent IPOs that have broken out of flat price consolidation to new all time highs.  A few of these are also showing follow through which is a desirable quality.   If this is a rally of duration I'll be paying particular attention to how these stocks behave and if they offer an entry on pull back.  Thus far I consider this price action promising and conducive to begin exploring opportunities on the long side should they present themselves.

CMCM BO

GRUB BO

KANG BO

LQ BO

TEDU BO

TRUE BO?

ZEN BO

Now that there are some signs of life in stocks I'm following, focus returns to those yet to break up such as UA and TWTR while waiting for the market to reveal it's hand.

UA

TWTR

Equals Over Plus

I espouse the importance of not just thinking outside the box, but designing our own box and then thinking outside of it.  In trading it is of great importance to think differently and avoid the ensnaring herd mentality.  Even if our trading beliefs are influenced or pilfered from others it is still exceptionally important to return to our own knowledge, experience, and expertise for metaphor and guidance.  While the lineage of folksy wisdom passed down from generations of traders is often applicable, there is still plenty of room in trading to develop our own analogies based upon our personal and unique situation.

Over the past few months I have begun to preface my analysis with terms such as, "the market on my time frame," or the "market that I trade."  The importance of this is that I am making myself aware and reminding myself of my place in the trading ecosystem.  Continually reflecting upon my time horizon, the behavior of the market within this time slice, and how stocks are trading over this time period assist me in keeping in cadence with periods where the market is conducive.

Another technique I have started to explore is my connection with chess and what I can learn about the market through using what I know as a filter.  When viewing a position one of the first assessments to make is who is better.   Thereafter looking for imbalances, weaknesses, positional advantages and tactical exploits can be analyzed.  Recently when perceiving the market I've begun to avoid binary terms such as bullish or bearish which often lead to a biased opinion and instead have begun to add some nuances to the complexity of the situation through chess terms.

Advantage

Given the current structure of the market over my time frame I would consider this to be a plus over equals market.  Breadth as gauged by the  $MTMW and #T2108 we're both extended to the downside and a bounce was a high probability event, however there hasn't been overwhelming buying to suggest that the market is currently conducive to my time horizon.  When there is hand over fist buying the number of stocks above their 20 period moving average should accelerate rapidly, but this is clearly not the case currently.

Lack of Thrust in $MTMW

#T2108 Bounce

In addition, there is still net negative price action across multiple time frames I pay attention to with the exception of the past 5 trading session which has had more stocks breaking out than down, but just barely.  When buyers show up these numbers should rapidly accelerate as well.

MM

An argument could also be made that this is an unclear market as there has been a lack of downside traction as well, and the breadth numbers while negative are not enough so to suggest there is an exodus by those who move markets.  For that to be confirmed there would need to be a swift downside acceleration to this market.  While it's my opinion that the market has just undergone a very weak technical bounce after extended breadth on a shorter term time frame and that bounces are opportunities to short index ETFs, should there be a positional shift that moves the needle to a plus over equals market I will change my assessment accordingly.

Using Results to Determine Robust Markets

Suffice to say there are many analogies between poker and trading.  Knowing when to shift gears, probe for information and feedback, and press edges or sit out are common themes between the two.  As a swing trader using timing techniques to gauge market health, improving my awareness on a daily basis is a priority.  Avoiding periods when errors are induced and compound instead of capital is frequently in my thoughts.  Being alert to whether a market is robust or not on our horizon has a direct impact upon our returns and bottom line.

All the data we need to quantify this is available in our own records: our average gain, our average stop level, and our average holding period.  Knowing this we can scan our stock universe and determine how robust the current period is.  For example, assuming our average gain is 2R and our holding period is 10 days we can scan our universe for stocks that have had moves to this extent (whether dollar amount, percentage or a combination of the two) over 10 days.  In doing such a scan over a 5 and 10 day period I have a return of 58 and 126 stocks respectively.  As I trade 3 month momentum, stocks that meet this requirement over 5 days is 25, and 85 over 10.

Robusto or Busto Market?

The significant of using this approach is that I am merging my personal trading data with corresponding stocks in my universe that meet the same criteria.  In a robust market I should expect to see a much larger result set than I am currently.  So, clearly if my average expectation is being meet by such a small number of stocks, I in turn should not expect to achieve typical results.  if anything I should be concerned of the other spectrum of consequences by trading in this environment.   

Pullbacks Welcomed

Market pullbacks and corrections are excellent times to prune and rebuild watch list and add to our model book.  During these periods a search for stocks that meet our set up criteria can assist our edge when the dust settles and we're in sync when the next leg up occurs.  I tend to focus upon tight price patterns that are flat and have resisted the greater market undulations.  Ideally I'd like to see this occur after there has already been a leg up in the particular stock before flat lining with contracting price volatility.   To assist visually I use a 10 period moving average.  If it's static it informs me that the stock has undergone a period of price agreement and should this balance shift to the upside with range expansion and volume I want to be involved and ride the tide of the path of least resistance.

KANG

LQ

TEDU

ZEN

Weekend Review August 01, 2014

The market on my time frame had been running on fumes and sputtering.  This past week the divergences finally caught up as the major indexes cracked 2% on Thursday.  In the larger picture this is just 2%, but 2% can quickly turn into 4, especially if the underbelly of stocks is soft and the general health of the market is sickly.  The ills of the market are evident across multiple time frames as shown by the number of stocks making new highs vs. new lows across multiple time frames.

New High New Low

It is also clearly evident that market breadth has stretched to extreme levels with a bearish bias very quickly.  Looking at $MTMW, T2106, and T2108 the market is currently at zones infrequently reached that suggest near term extension from which bounces occur.  The confluence of these lead me to believe that a snap back rally is a higher probability event.  However, what also must be taken into consideration is the context.  These extended readings are occurring while multiple indexes are still in close proximity to their recent highs.  Had these occurred after a significant correction I would tend to side with the belief that a significant bottom is in place and operations on the long side should be pursued with vigor.  As this is not the cause I continue to be leery of the current market structure and until there are signs of strong buying coupled with bread and butter set ups I will pursue a strategy of looking to short 3x long biased ETFs such as TQQQ or SPXL on bounces.

$MTMW

T2018

T2106

I also consider it important to review the events over the past few weeks in order to solidify a model moving forward.  Clearly one of the first and most important clues was that the set ups I took lacked follow through and were not moving in my favor in accordance with my stats.  I can not stress enough how important this piece of information is above all else because regardless of what breadth is showing, the immediate feedback is negative.  Breadth can wane and diverge for some time before there is a downside break, and given that this is merely a tool to gauge general market health on my time frame, if there is discordance in my results I must accept that this trumps everything else.

As traders we're not always going to have the fortune of stars aligning perfectly for our quadrant to guide us.  However we can model certain guidelines for safer passage through rough seas.  When it is full speed ahead there should be alignment in breadth.  When it's patchy we should take note of the discrepancies and act accordingly.  When there are divergences the focus should be upon those that most effect our vehicle selection.  As I trade mostly Russell and Nasdaq stocks these should be my divining rod regardless of the what DOW or SP are doing.  When breadth begins to wane across multiple time frames and there is a confluence upon stocks that make up my vehicle selection I should heed the omens.

There has been a conditioning to buy the dip, and a look at the index reactions Friday suggest this is still the mentality subscribed to.  But what we also know is that at inflection points there is very slow transition and acceptance of new information.  If this was not the case there wouldn't be as many participants stuck on the wrong side of a trade.  As a swing trader with a horizon of 5 to 10 days holding period time stop, the market should be cashing me out fairly quickly when these transitional periods occur.  At this point it is up to me to recognize the market in incongruent and be disciplined and patiently wait for the window of opportunity to open again.  These are the periods not to fight and induce drawdowns.  These are the periods to honestly listen to what the market is telling me and plan accordingly.  These are the periods to avoid overtrading and fighting the tide.  These are the periods to be vigilant about squelching the noise of the Sirens.  

Weekend Review July 25th, 2014

Market Wizard Wisdom

I often write about being in cadence with the market and attempting as best as possible to trade when my time frame is in sync with the market.  Unfortunately my discipline often wanes even when all the data I follow indicates it's time to: slow down, be more selective, increase patience, or even get out of the market all together because I'm not in tune or the market is in a difficult period from my trading style.  I've become increasingly aware that these are the times to isolate myself, turn down the noise and influence, and perhaps just out right step away for a day or two.

I've also written about being a fact based trader and insisting that my trading record be the ultimate determinant of whether this (in sync or not) is true or not because it is the only factual information I have.  Much else is merely my belief about the market as I perceive it and the tools I use to hone in on periods where I can exploit my edge to maximum effectiveness.  However, even when all indications suggest it's go time, there's no unwritten rule that I have to be successful during this time and make money, just as when my indicators say lay off the gas there's no fast rule that the market should reverse.

I consider my vehicle selection to have vastly improved, but the window of opportunity I was expecting this week and attempted to take advantage of shut exceptionally quickly.  The trades I took lacked follow through and traction.  I intentionally undersized my positions to deal with a potentially chop and slop environment, but perhaps it would have been better to have stepped aside as the bigger picture seems to be having a larger influence on my time frame than I anticipated.

So, when trades are now working and I consider my selection fairly solid, and my trades are not making money, I must defer to the market itself as being unhealthy.  In commentary this week, Zortrades post In Case You Are Struggling This Month is well worth a read as he breaks down multiple data sources that inform what stocks are actually doing and not merely what we think we see they are doing.  There are times when the maxim "Trade what you see," is useful and there are times to realize that what we see has often put an innocent man in a line up behind bars for life.  We must be aware of the deception of our senses.  Merely because we see most indexes churning up to new highs doesn't mean the body of stocks underneath are behaving in a healthy manner.

Going into next week I continue to see signs of caution on my time frame and will stick to a primary cash strategy and avoid long positions until things clear up.  If anything I'm actively looking for an opportunity to go short index ETFs because there are increasing signs that the market is vacillating in a manner that suggest it is waning here and losing steam.  One sign I am looking at is the number of stocks in my universe that are breaking down has been increasing in July suggesting slow distribution.

Break Out/Break Down

There is also some vacillation on higher time frame breadth readings I follow.

MM

Primarily what I take from this is that there are fewer stocks breaking out and their potential for gains on my time frame is limited at best.  As an overall 50/50 trader in the best of times, down shifting into a 40/60 or worse during these periods is a recipe for draw downs.  I've experienced periods of explosive markets where I've struggled to make dimes, so in unhealthy markets even expecting nickels could be asking for pennies.  There are larger dynamics at work in the market currently that are not conducive to my trading and sometimes we just have to admit this to ourselves as a reminder, especially when noise around us suggest that there's gold to be vacuumed up at will.

Chart of the Moment

The following is a tale of two time periods.  In one there is a confluence of waning breadth and a declining market and in the other there is disharmony.  The definitive answer as to what is going to happen to a rising market on weakening breadth is yet to be resolved, however from a probabilistic stand point what is the more like scenario and how should we as traders prepare ourselves?  

Market Disharmony

Modest Bounce

One of the things I was looking for this week was indication that the bounce I anticipated was more than just a reflex due to extended breadth.  I was looking for signs that buyers were returning to small cap stocks.  While there has been a modest bounce on the Russell, the evidence suggest this might be short lived.  When buyers are stepping in aggressively from extended zones there's a strong tendency for the number of stocks below their respective 20 day moving average to increase from approximately 20% to 70%+ in short order.  As the following chart shows, this characteristic is lacking.

$MTMW

Additionally the breadth indicators I follow will begin to increase sharply on the lower time frame from red to green across the board and often in short order.  Instead, there is still a lack of breakouts on my time frame and higher time frames are vacillating.

MM