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.
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| 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.
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| $MTMW |
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| T2018 |
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| 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.
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