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

Weekend Review 07/18/2014

Is that all there is?  This is a familiar refrain I've continued to ask myself over the past year and a half.  Each time the market reaches a level of exuberance and extended breadth across multiple time frames there's a shake out.  With each one I position myself on the defensive because it can never be known at the time which one is the Redd Foxx.  Looking at nearly two years of data from the primary breadth indicator I use it's clearly evident that this has never really been an issue, but one never knows, and by looking at the damage done to individual stocks in April of this year, it's often best not to find out.

Primary

One of my core instructions is to align my time frame when the market affirms that there is a window of opportunity to exploit on my horizon.  One of the means in which I do this is to track the number of stocks that are breaking out and down over a 5 and 10 day period.  When the balance tips in my favor I increase my aggressiveness and when the balance tips against me I begin to lay off the gas.  My risk tolerance is dynamic to market conditions.  The number of positions held, the position size,  and risk of 1% or perhaps .05% per trade will increase or decrease in accordance to the current market conditions.

Market Monitor

Currently the market according to my metrics is red across multiple time frames, however as shown in the first image posted, there have only been two periods where there was significant enough damage to stocks suggesting a much larger correction may be looming.  In both of these situations the length was short in duration.  Granted there are some macro conditions hanging over the market and there are some indications that money is rotating into defensive sectors, but this is still a bullish leaning market until a guilty verdict is handed down.  Until then, pockets of opportunity should be exploited and waning breadth must be respected.

There are two indications that there may be a pocket of opportunity in the near term.  This may be very short in duration and tactics adjusted accordingly, but there is evidence that the market may experience a bounce here.  First, the percentage of NYSE stocks above their 20 period moving average has reached a level where bottoms have formed.  This may just be a technical relief bounce of a few days, hence my general caution about the longer term relevance.

$MTMW

In conjunction the number above their 40 period average have bounced from 43% to 51%.  As we can observe from the following chart, whenever there has been a decline followed by a significant increase over a one to two day period, the market had a rally.  There was a bit more complex bottoming in the August of 2013 which merely affirms that while there is a "tendency", anything can happen.

T2108

If a door opens this week, a few patterns on my watch list are:

GBX

$PAH

$VEEV

$VHI

Lastly, earnings season offers opportunities for catalyst based trades with their own merits regardless of market and macro conditions.  For the next couple of weeks there will be a plethora of releases offering opportunities to find the beginning stage of the next major winner.

No Gnews is Good Gnews

Market Breadth

Breadth continues to erode on higher time frames.  This has been occurring over the past 12 trading sessions but for some reason the news today is the reason.  There is a subtle point here, however; when news is perceived as bad and the market does not shrug it off, there is a deeper underlying problem occurring under the surface to pay attention to.

The Market I Trade Suggest Caution Here

One of these indexes is not like the other.

$INDU

$SPX

$RUT

Since the beginning of July there has been a significant underperformance by the small caps in comparison to their more mature siblings.  Burrowing a little deeper, the divergence between the $RUT is move evident as a ratio to the $SPX.  The following chart clearly indicates that this has been a continuing issue since February and that the brief period from May through June was more of a mirage than an actual change in small cap leadership.

$RUT:$SPX

More distressing to me is that the more heavily discussed and psychological bellwether indexes continue to show great strength on the surface and make headlines while underneath the number of free range stocks unburdened by placement in an index further weaken on numerous time frames.  What the numbers are telling me is that there is erosion spreading from weekly to the monthly, and that from a peak of 1291 in 8 trading days an even higher time frame indicator is about to flip negative.

From my perspective the current state of the market is better to be observed from afar than as a participant.  The market that I trade is not healthy for breakout trades on a 5 to 10 day time horizon especially given that the ratio of stocks moving on this time frame continues to weaken as more break down than out.  I continue to affirm the belief that we all trade our own markets and that my analysis works with my personal trading psychology and may not be applicable on a different time horizon.  It's merely my opinion here that this is a period to be cautious for swing traders.

Divorcing Time Frames

Knowing our time in the market can greatly assist us as traders in our timing of the market. One of the errors that traders compound is working off of two different time frames. This can result in unnecessary conflict as the emerging emotions of one time period may supersede the disciplined required on another. Recently I underwent this experience when a longer term holding period was pressured on a shorter term time frame and I sold the position only to watch it rebound to new highs. I allowed a shorter term time horizon bearishness to override the a plan that thus far kept me pat for 3 months.

If you are a short-term trader, recognize that selling a stock for a quick profit only to watch it go on to double in price is of no real concern to you. You operate in a particular zone of a stock’s price continuum, and someone else may operate in a totally different area of the curve. However, if you’re a longer-term investor, there will be many times when you make a decent short-term gain only to give it all back in the pursuit of a larger move.  --Mark Minervini

Over time traders begin to develop default behaviorism arising from experience and intuition. One of the things to be cautious of is that the default capital preservation of a system devised for a shorter time time frame of 5 days can override a longer time horizon system which can in turn become an exceptional costly mistake. The longer capital is tied up in a position the more crucial it is that this position be allowed an opportunity for an outsized gain on this horizon.

Time Slice Analysis

Lately I've been increasing effort in the study and analysis of what stocks do on my time frame.  My standard time horizon is between 5 to 10 days.  In placing effort into the actual behavior of what stocks are doing new insights can be gleamed about what is actually working such as: sector themes, patterns, are stocks near highs or beaten down, are they highly shorted etc...

Looking at the past ten days from a sector perspective, more defensive oriented stocks are beginning to populate the 52 Week High list.

Sectors on the Move

Looking at sizable moves over the past five days we can note that there are a cluster of Latin American Regional Banks to pay attention to, as well as some defensive plays in Silver and Utilities.

5 Day Moves

The list for 10 days is slightly larger, but two segments worth noting are Gold and Minerals and Mining are in play.

10 Day Moves

Keeping aware of what is moving on our time frame can assist in trade ideas by finding sectors that money is flowing into, the stocks that are in play, and give a clue as to general market sentiment based upon the action of aggressive or defensive stocks populating the list and not opinions. From my perspective I'll begin investigating the metal related stocks for set ups.

ANV

$PPP

RGLD

TAHO

Hiccups and Hyperventilation

With the Russell down nearly 2% today the cacophony of collapse reverberated yet again.  A familiar theme has been when the market hiccups the masses hyperventilate, and today was no different.  Is this a cause to be alarmed or is this merely the ebb, flow and the natural order of things?  How many licks does it take to get to the center of a tootsie roll pop?

There were warning signs that the market was becoming extended from a breadth perspective and that it might be wise to in the least anticipate anticipation and be on alert.  One of the more pertinent and reliable indicators that I use in my tool box is the $MTMW which informs us of the number of stocks on the $NYSE that are above their 20 period moving average.  On a shorter term horizon this suggest that there is an extension of breadth that historically is not tenable on this time frame and we should expect some reversion in stocks.

$MTMW July 07, 2014

On a longer term time frame the primary indicator I use reached a level that in the recent past has acted as a ceiling to broader rallies and led to a lesser number of participating stocks which increased the significance of proper vehicle selection or even avoidance due to an increased risk of churning.

Primary

In addition there were signs in the overall Market Monitor suggestion that the current bullish move was losing steam.

Market Monitor

Under the current environment I consider the prudent form of speculation is increasing cautiousness and decreasing risk.  From a swing trading perspective, time in the market is not time on my side.  Being aggressive has not paid well under these scenarios so trading under my normal position size and expected value should be muted.  Cons aside, there are still a number of set ups that are piquing my interest and a number of stocks on my watch are still valid in formation even with today's dip in small caps.  Two of note are CODE and PEGA.

$CODE

$PEGA