Weekend Review 11/16/2012

My use of breadth indicators is not so much to identify the top and bottoms, but rather to avoid the period in between a top and a bottom. There are 2784 of 5813 stocks in the Worden database that meet my liquidity criteria and of those:

Number of Stocks Down	% Change as of 09/04
49	-50% or more
258	-25% to -50%
810	-10% to -25%
Number of Stocks Up	% Change as of 09/04
12	+50% or more
17	25% to 50%
113	10% to 25%

In total, only 21% of my stock universe has been positive. From a swing trading perspective this  approximates to the Mendoza line and I prefer a slightly better average. By sitting aside and saving capital for opportune moments I can avoid slides like the one the market is currently undergoing and having capital locked up trying to recoup on the next up trend instead of compound.

Market breadth is not so much a script though, as a story board. It's not always an easy fit like insert tab A into slot B as each cycle will have it's unique characteristics, nuances, and vagaries. It is the colloquial merge of science and art as well as herd mentality. We're often told that if something is too good to be true it probably is, and also that the market exhibits maximum pain upon the most participants, so when the market reaches and extreme reading on one breadth indicator is a bounce due, is a bounce due to self-fulfilling prophecy, or is the bounce a set-up to exert max pain upon shorts who covered too early and longs who bought too soon?

Additionally what happens if there is conflict in breadth indicators? Sometimes an order or preference has to be decided as to which is more significant. Bar Charts has the $MTMW which is the number of stocks above their 20 period moving average. WORDEN has their T2108 which is the number of stocks above the 40. StockCharts has the $NAA50R which is the number of stocks above 50. How does one determine conflict resolution in this scenario? Which data is more important and more influential in the current decision making process? Which data set will get one on the correct side of the market on their time fame with the least amount of lag?  

For this post my main focus will be on breadth comparison of the current market conditions to those of April-June.

Index	Apr-June	09/04-Current
NYSE	-10.29	-5.99
Russell	-10.11	-9.69
NASDAQ	-9.45	-9.79
SP-500	-7.99	-7.16

The first thing that becomes apparent is that the major indexes I pay attention to have corrected as deeply with the exception of the NYSE.  So while overall there are similarities between three of the indexes, one of these things is not like the other which highlights that tab A is not going to be a clean fit to slot B.

Next, looking at the Primary Indicator that I use, it's clear that from an underlying breadth perspective this correction has not seen similar selling. So even though the indexes have pulled back to a similar percentage at the deepest point of the correction, the underlying selling has not. What this informs me is that while their may be a playable bounce here due to a number of indicators flashing oversold signals, the merits of a bounce will have to be characterized by the subsequent buying interest. Lacking aggressive buying to support a floor here a bounce will merely set up more stocks for shorting opportunities. Again, Tab A, slot B.

Primary

It's rare for markets to establish a V shaped bottom. More often there is a retest establishing a W bottom pattern. Looking again at the previous correction, this W bottom retest and undercut of the low is clearly evident. This is the pattern formation that I'll be paying attention to here and should it unfold the next logical step would be confirmation of a new up trend with a series of higher highs and higher lows. What's also worth noting in these two charts is that from the perspective of the $BPSPX and $BPCOMPQ, the later is much closer to the level of it's previous bottom than the the prior. Thus far what I deduce from this is that the NASDAQ has seen much more selling than the SPX and this is a divergence worth paying attention to. Secondly, if a W pattern is to form, then these two readings should follow suit on the retest which is a positive for a more sustainable move to the up side.  And again, tab A is not a clean fit to slot B.

SPX

COMPQ

If this is the beginning state of a market turn, my expectation going forward is to see an increase in volatility and large swings of buying and selling would verify this this for me. The following graph showing the number of stocks up/down 4% daily will be the model for this price volatility. I'll specifically be looking for the number of 4%+ days to be above 400-600 or more for confirmation of aggressive buying. Currently it's clear that selling has been dominant.

4% Advance/Decline

This buying/selling pressure can be smoothed out using a 10 Day period. In addition to increased buying I'm looking for this to graph to move into positive territory. Staying positive indicates to me periods when it is more conducive for me to trade on my time frame. There will be some lag in the initial stage of the move but I'm looking for confirmation of large buyers coming to fatten up on the bread crumbs and who can't unwind positions on a whim which will allow me to ride on the coattails and let me capture the marbled meat of the move.

10 Day Differential

Right now the only thing I know for certain is that the market is in a confirmed downtrend. Friday's action established a new lower low on the indexes but closed near the high and this type of action can establish a logical pivot for not only a bounce, but a potential bottom as well. It's too early to tell so I'll be looking for evidence that this is so. Nicholas Darvas had a simple technique that he applied to markets that can be condensed as: buy when his candidate list has break outs and step aside when his stocks are breaking down one by one and stopping him out. He noted repeatedly that when he went against this simple premise and pressed during inopportune times his results and account suffered.

What's important to take from his perspective is that regardless of how one goes about analyzing the current condition of the market, what ultimately matters most is paying attention to the stocks themselves which will shed clues much earlier than breadth will indicate. Ultimately set-ups and a focus upon stocks that meet one's criteria as actionable is what matters at turns. It's easy to get swayed and begin to take marginal trades because the level of noise heightens and optimism increases as hope of a bottom takes hold of the herd.  For myself I wish to avoid getting too eager too soon and getting trapped here.  If there is a move to the upside the heavy lifting will be done for me and all I need to do is wait until there are too many set-ups to take.