Beware of DOW

I rarely speak of the DOW because I rarely think of the DOW. It doesn't really exist to me because none of its components are in my trading universe. Ignoring it however is a mistake in my analysis because it is the granddaddy of all indexes. It is the one every John Doe Retail listening to the nightly news will hear about hitting a new all time high today. It is the index that will have them going to sleep tonight believing all is well in the market, but it's also the index that informs when something isn't quite right.

I consider a leading DOW as an indicator that my trading universe is lagging and since it is compromised mostly of small cap and momentum stocks it suggest that in the least it is currently a risk off environment or a period of distribution. With only 30 components a smaller amount of effort is required to misdirect the eye by pushing the needle and nudging the DOW to new highs while masking the relative weakness in the Russell and Nasdaq.

$INDU:$RUT

$INDU:$COMPQ

These are the times to be more alert and vigilant to a potential change of character in the market. A number of high fliers have been having some extreme volume sell-offs after earnings and many others are showing wide ranging intraday price movements indicating increased volatility which is a sign of distribution. Today TSLA, QUAD, MELI, and JCOM got to visit the woodshed and after hours it looks like SCTY, NDLS, and WFM will be joining them tomorrow morning. At this juncture market risk is beginning to increase and playing with this awareness is prudent speculation.

All is not foreboding however, as the leadership of tomorrow is taking shape today. Two that have been entered into my watch list are ECOM, and VOYA.

ECOM

VOYA

FadeBook?

FB

In October the entire float of Facebook turned over which coincided with the highest monthly volume in its trading history.  However, price closed below September's by 2 cents, and the open/close differential for October was only 26 cents.  Relating this to Wyckoff's third law of effort vs. result, the price/volume relationship is not in harmony on this time frame since price remained basically unchanged even though there appears to be a changing of the guard underway.  It's too early to say if this changing of the guard is from the strong to the weak or a shake out from the week to the strong, but the first price point to be hit, the October high of 54.83 or the October low of 45.26, may be the evidence required to make this call.

Weekend Review 11/01/2103

Had one sold in May and went away, one would have missed an 18% move in the Russel and Nasdaq, an 11% move in the SPX, and a 6% move in the DOW. The theme since May has been marginal high and shallow pullback which is most pronounced on a chart of the DOW, but can also bee seen with subtle variations across the other three as well.

$RUT

COMPQ

$SPX

$INDU

Part of the challenge of swing trading with market timing during this environment has been the sharp V-shaped rallies from the lows that swiftly surge breadth readings from one side of the pendulum to the other on a shorter time frame while keeping the longer term breadth trends extreme. There's a small window of opportunity to exploit from the pivot low of the correction to the pivot high, and if not already positioned much of the move is missed. The problem of waiting for the move to digest setting up tighter chart patterns is that by the time they break out the tendency to fade has been high due to the general market being extended with fewer stocks participating. One of the adjustments I've continued to make is moving away from swing trades on a shorter duration and switching to catalyst and earnings based trades with a longer holding period.   

Looking at the breadth numbers I follow a similar situation is arising yet again. The medium and longer term breadth readings for the most part are extended here, but the shorter term readings have begun to move towards the other end of the specturm.

This has been the character and nature of the market since May 2013. The last lengthy correction that wiped the breadth slate clean was September through November of last year before a linear and persistent up trend ensued. Perhaps there's a repeat and the recent October highs top ticked the market and a meaningful 5%-7% correction begins or perhaps this is just a shimmy shake to put some fear into a psychologically complacent and never ending bull story line and a spine for the bears before ripping to a marginal high yet again.

When I reflect upon the market of 2013 and what it has affirmed to me is to be alert to the harpy like lure that seduces traders to change their core methods and chase the market instead of allowing markets to come to them.  This market has forced me to rethink some of my (mis)conceptions about trading, entry/exit rules, vehicle selection and many other thoughts too numerous to lay out, however the one thing that I've held steadfastly to like a mast has been my core belief in momentum, that the market cycles from range contraction to expansion, and that there is an edge to be found here.  Some of my tactics have fluctuated but my overall strategic approach has not.  

YELP, I Need Somebody

During this past month I returned to the classics and have spent some time rethinking what I learned from Livermore and Wyckoff in particular. I find great value in reading the same book 10 times in a row, however I often find greater value in returning for the 11th reading after time has passed and experience has been gained, even if it is one sentence or a turn of phrase that resonates. As it is the end of the month and I am reviewing a number of charts, I had a sudden connection between one of them and a concept I've been pondering as of late, the Three Wyckoff Laws.

The three laws are as as follows:

The Law of Supply and Demand: When demand is greater than supply, price will rise to meet this demand, and when supply is greater than demand, price will fall until it has been absorbed.

The Law of Effort vs. Results: Every action must have an equal and opposite reaction. Price action on a chart must reflect the volume action below and the two should always be in harmony. Divergences and disharmonious price and volume often presage a change in direction.

The Law of Cause and Effect: In order to have an effect there must be a cause. Further, the effect will be in direct proportion to the cause. In other words, a small amount of volume will result in a small amount of price movement and a large amount of volume will result in a large price move.

One chart that stood out today when doing one of my month end scans was YELP. I wanted to keep the chart clean so I kept it sparse with 4 points of interest in this analysis.

YELP

The green line is the high of the IPO date in March 2012 that was unbroken until May 2013 at point 1)

1) My philosophy about IPOs that I've adopted from Dr. Wish is that the break of an all-time-high after 3 months is a significant price point. Given that this took well over a year adds to its importance. That it did so on the highest volume on a monthly basis outside of the IPO debut strengthens the validity of it. Filtering this price volume action through the three laws I walk away with the following thoughts:

Supply and Demand: There is a supply/demand imbalance here as price is rising

Effort vs. Results: Is there harmony between price and volume? To verify this two questions to ask is what is the width of open to close and high to low. If there is effort which in this case the largest volume over the past 12 months, then there should be an equivalent result, a candle with a wider range and a close nearer the high

Cause and Effect: For the month of May 2013 there was a 14.5% appreciation in price from the previous month. To verify whether this is harmonious action it is important to view the relationship to the preceding months. November 2012 established a pivot low that stood firm and on a percentage basis May had the highest price appreciation and the highest volume thereafter.

2)

Supply and Demand: There is a demand imbalance as price is still rising.

Effort vs. Result: Is there harmony between price and volume? In this situation price closed well below the high, however there was also a large gap up which on a monthly chart will be rare because the gap can only occur on the first day for this to be so. In essence this can be viewed as strong but also cautionary action which switching down to lower time frames could give clues about.

Cause and Effect: As this is the highest monthly volume of all time there should be corresponding price action which in this case is verified by the closing up 24% from the previous month which at one time was a much higher 36%.

3)

Supply and Demand: Price closed higher so there is still a demand imbalance

Effort vs. Result: Is there harmony between price and volume? In this situation there is obvious concern as the difference between the open and the close is only 39 cents. Further there are wicks high and low suggestion indecision on the part of traders at this price level, so the consensus as of now is balanced.  Given the volume and price action, is balanced what one would expect to see in this effort vs. result situation or is this a red flag even though the candle is green?

Cause and Effect: This is the largest volume on a monthly basis in the trading history of YELP and yet price only appreciated 2.37% on a closing basis. Therefor this is an anomaly and not the expected price effect given the volume cause. The float turned over 3 times so this churning may very well be distribution from strong hands to weak hands and reason to be cautious and on alert for declining prices moving forward.

One of the things I've learned from going back for the 11th time is being more observant of the price action on higher time frames and approaching the price/volume action without prejudice and with a set of rules for interpretation. After all, price and volume are just data points and a chart is an abstraction of them, nothing more or less.  My knowing that this chart is YELP elicits certain responses and biases that are difficult to ignore, but in having a process and filtration system some of that can be alleviated.  Based on the evidence I'd say there is reason to be on watch for a change in character and direction for YELP.

Weekend Review 10/18/2013

With a debt ceiling reprieve the market continued to march along, but in reality it never really showed much concern to begin with. So, for the folks paying attention to the market alone and ignoring the news it was a very good week indeed. For folks waiting until afterward it was a very good couple of days. Now that the anxiety has expired and the jubilation has commenced, is there reason to be cautious here in the midst of exuberance?

Looking at the breadth numbers I follow the market is heavily extended here and the probabilities lean towards a correction. Will this be through time, rotation, or price remains to be seen. Will there be one at all remains to be answered, but it looks likely.  Coupled with these readings, the COMP, RUT, and SPX popped outside their Bollinger Band today and since indexes have a strong tendency to mean revert, this event is confirming from my view point.

Extreme Readings

% of NYSE > 10MA

% of NYSE > 20MA

T2108

$ NASDAQ > 50MA

NASDAQ BB

RUT BB

SPX BB

The data suggest I should be cautious over the next 5 days. Putting this information into context and a plan based upon my experience, I'll be less likely to trade break outs on shorter time frames and near their highs.  The rational behind this is that follow through during a pullback becomes an issue so avoiding extended stocks and looking for pullback candidates that are breaking out will take priority.  Additionally I'll be more focused on A-grade set ups and whittle my watch list down to stocks on a weekly time frame that are setting up near their 10-period moving average. Some candidates I'm eyeing:

AVG

DGLY

DWCH

ENTA

MKTG

TUES

Also, the meat of earnings season is underway and I'll be dedicating time this week tracking those that meet my requirement and fleshing out a core watch list to trade off of for the next 3 to 6 months. One stock I'll be keeping a close eye upon and look at building a position is ZHNE.  I have a higher degree of conviction in the potential of this candidate and will look to commit some size and hold as a position.

ZHNE

I'm With These Guys

There's an old adage, you are only as good as the company you keep. When it comes to my trading I've come to the conclusion that I want to be with these guys.

NBG

RVLT

SCTY

More and more I focus upon trading plans that put me in the company of these guys and honing how I can exploit this on my time frame. These guys be found on the daily, weekly, or monthly charts, but they have tendencies and nuances that are particular to the time frame referenced. A recent example is a previous post about my trading plan for RVLT. A current trading plan is one I drew up a few days back for SCTY.

SCTY Model Book

Going into the last half of the month, 53 momentum stocks are currently running at their highest 12 period volume on the monthly time frame. This is my hunting ground for some more of these guys.  These Guys (Finviz Screen)

Trading Is Not A Zero-Sum Game, It Is -EV

Trading and Poker as a zero-sum game is the new efficient market theory. I can't count the number of times I've heard that trading is a zero-sum game repeated without any fact based evidence what-so-ever. Let's look at the definition of a zero-sum game first:

a zero-sum game is a mathematical representation of a situation in which a participant's gain (or loss) of utility is exactly balanced by the losses (or gains) of the utility of the other participant(s). If the total gains of the participants are added up, and the total losses are subtracted, they will sum to zero.

So first let's disprove poker.

Buy into a 2/4 limit hold 'em with a $100 rack and post on the big blind. For sake of argument let's assume this is a 2-1-1 blind situation. If the first three hands are discarded, 4% of the rack is gone. If this is a full game of ~8 players and a hand count per hour of 35 you should be blinded 4 times. Without playing a single hand approximately 16% of equity will be lost in an hour.

Now to disprove trading.

I have a $1500 account. I buy 100 shares of XYZ at $10 for a total of $1000 and a commission of $7. I now have $1000 of stock and $493 in cash. I sell $XYZ the next day for $10 and a commission of $7 to you who has a $1500 account but with $1 commission. After this trade I have $1486 and you have $1000 in stock and $499 in cash. Let's repeat. I now have $1000 in stock and $479 in cash and you have $1498 in cash. If this repetition continued further, even though I bought and sold the same number of shares for the same price, soon enough I won't even be able to buy the same number of shares.

As long as there is a rake in poker and commissions in trading the game will always be -EV. The typical claim that trading is a zero-sum game is concluded briefly with, “For every winner there is a loser.” However, even this is not completely true as shown in the trading example. Further there is plenty of evidence that the game of trading is really a wealth transfer from the many to the few. A number of account studies have shown unequivocally that 90% of them are net negative and the owners of these accounts have a strong tendency towards the disposition effect: cutting winners short, letting losers run, and adding to losers but not to winners.

This is just one of many market maxims that when not vetted and taken at face value can lead to erroneous conclusions and outcomes, poor habits and thinking. One that I've recently thought about is “Trade what you see, not what you think.” The problem with this is that we now know through behavioral sciences that both are faulty and can not be relied upon unquestioned. When looking at a chart our eyes are subject to optical illusions and blind spots, and our thinking is subject to misidentify a trend based upon a sequence of 2 in a row among other behavioral biases.  Not only are they problematic individually, they can become more so when used in tandem. The moral of this story is: question first, verify second, believe third.  Reality based, evident backed trading trumps assumptions and maxims.