Market breadth continues to be
stretched and the chorus of “Top” and “Impending correction”
is beginning to ring louder. It's easy to be swayed emotionally when
the crowd begins to chant in unison and I've experienced this
personally so I know how easily convinced I can become and crumble
under the perceived threats by acting upon those and not my plan of
action. I've found it of the utmost important during these times to
take a step back, sequester the noise, and focus upon the trading
rules written down.
It's said that from a swing trading
perspective the markets are robust and healthy between 2 to 3 times
a year. I've found from experience that I miss a portion of each
move because I am typically late in entry and miss the beginning of
the move as well as early to exit in part due to fear of
participating in the later stages. On occasion I've traded through
the topping process and deeper through the decline in part due to a
lack of acceptance of what the breadth data actually indicates and
how I wish to interpret it, and in part due to not having a plan that
I truly believed in unconditionally. My lust of wanting to make
profits is often stronger than the prudence of preserving capital.
This year I've made it more of a point
to focus upon limiting draw downs and focus more upon compounding.
What this means to me is that I want to be more attuned with where on
a breadth cycle I am and act in accordance. It's my goal to become
more aware of when moves begin and positioning myself accordingly as
well as adjusting my risk profile in the later stages. I acknowledge
I will not know at the time when the market tops but there is plenty
of evidence available for me to at least be prepared and adjust.
For my preparation going into next week
I wanted to do a longer term breadth analysis of the Primary breadth
reading that I follow. I started to fiddle around with the Google
spreadsheets and noticed they've extended their data cap which
allowed me to increase the scale of my breadth charts. The Primary
reading is based upon the breadth analysis of
Pradeep Bonde of StockBee and uses the Worden stock universe to tally the number of
stocks up and down 25% over a 3 month time frame. When the number of
stocks down 25% over this time frame is below 200 it indicates a
breadth extreme. This breadth extreme was reached on January 11.
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| Primary at Extreme Level |
Simply because this number is under 200
does not indicate that there will be an immediate market turn. In
comparing the current number to other periods over the past few years
it is clear that when this extreme occurs the market can continue to
run. The following couple of charts exhibit this.
Currently the number of stocks up 25%
is at 1200, as represented by the green shaded area. This puts us in range of the last market turn but the
following graph which breaks down the number up and down 25% shows
that this number can continue upward to 1800 and even then there are
prolonged period before a deep correction occurs, represented by the red shaded area where the number of stocks down 25% begin to increase.
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| # of Stocks up 25% |
I've also broken down this as a
percentage of the entire Worden universe. Currently 20% of stocks
meet this criteria but there are periods where 30% or more stocks
will be up 25%.
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| % of Stocks up 25% |
In conjunction with this breadth
extreme, sentiment has also reached exuberance over the past few
weeks with both the AAII and II surveys above 50%
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| AAII |
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| Investor Intelligence |
Even exuberant and stretched markets
can melt up higher so while it is wise to be cautious it would be
unwise to be fearful of a looming correction until there is evidence.
What I'll be keying in on this week is whether or not the breadth
thrust the market is currently under begins to wane. Thus far there
has been 18 consecutive sessions where the number of liquid stocks up
4% on a daily basis has been greater than the number down. This is
the longest period I have documented. What I'll be looking for is
whether or not readings begin to come in where both are under 100
and/or in close proximity to each other which I define as a stall
day. Additionally I'll be looking for outright selling where there
are a large number of stocks down 4% for the session.
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| 4% Advance/Decline |
Next I'll be looking for dwindling
set-ups. If I begin to suffer eye strain trying to find set-ups they
aren't there. Also I'll be more focused upon quality of set-ups and
the avoidance of extended stocks or stocks that have been showing
momentum for some time and look for fresher trends that are in their
beginning stages. Lastly, if positions I'm currently in begin to get
stopped out one after another I'll know conclusively that something
is not working out on my time frame and go into my shell.
I plan on acting more gingerly this
week and placing emphasis on controlling what I can control. There
are steps of mitigating risk and still taking advantage of the
potential remaining in the market. This can be achieved by avoiding
margin, limiting the number of positions taken, taking smaller
position sizes or trading less in general. As long as the market offers me an edge here I'll be in it, but I'll be adjusting my risk tolerance according to what the market is willing to offer me
