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.