Small Caps Encroaching on Bear Territory

This week the S&P, IWM, and NYSE established new pivot lows.  IWM has now corrected ~18% closing in on the 20% bearish threshold.  

SPY Weekly

IWM

NYSE

NASDAQ Composite low from 4 weeks ago has held thus far but has broken below 15% again.  Time heals all markets, and with earnings season 4 weeks away the market may continue to drag until stock specific catalyst renew participation.

COMPQ

Red Flags raise the White Flag

Conventional wisdom suggest that: bullish oriented markets shake off bad news and in bearish oriented markets there is no good news, bullish markets open weak and close strong while bearish markets open strong and close weak, and bullish markets grind up while bearish show increased volatility with some of the largest intraday index gains recoded during these periods and tendencies to viciously flush down.  The later is what I look to protect myself from by avoiding to trade the long side when the preponderance of evidence no longer suggest being bullish on stocks.

Currently I see little evidence to suggest that there is an edge to trading stocks from the long side on my time frame.  The preponderance of evidence suggest that breadth continues to deteriorate and has yet to firm enough to lead me to believe buyers have returned to the market.  Two of my standard go to indicators, the percentage of NYSE stocks above their 20 period and 40 period moving average are currently at extended readings.  However, there’s a subtle nuance about breadth extremes, particularly to the downside.  The further breadth gets extended across multiple time frames the more bullish I become, but in addition the further the weakness the more cautious I become that there may be a crack and cascading water fall effect upon stocks.  

$MTMW

T2018

Additionally the Market Monitor is  red across all time frames, but there is some evidence to suggest that this correction might be contained at these levels.  The last column is shaded green indicating that in my trading universe less that 5% of stocks are up 25% or greater over the past quarter.  Coupled with extreme downside breadth on my time frame of 5 to 10 days, the market has been correcting across longer time frames as well while the major indexes have modestly pulled back.  This is one of the few positives I've noted.

Market Monitor

From a different perspective, using BarCharts Daily New Highs/Lows we can see that across multiple time frames more stocks are down than up over a multitude of time horizons.

BarCharts New Highs/New Lows

Using Stockcharts Elder New High/Low to gauge stocks over a 5 day rolling period shows the largest negative reading in two years.

$USHL5

Of particular note and perhaps most disconcerting is the bearish stage 4 price action of the Russell 2000 which is below a declining 30-Week moving average.  This is something I am paying attention to as there appears to be a bear market in small caps if not potentially topping out action.  The Russell is a good clue to risk on/risk off mentality and has been struggling for much of this current year.

RUT 30-WK MA

Scaling out on a monthly time frame and using a 6 period moving average there has historically been a period of consolidation following a close below this average with the occasional deep correction on the Russell.  In comparison it’s evident that the SPX has not had a close on a monthly basis below this for over two years and has climbed steadily above the entire time; however take note that it is currently positioned to do so suggesting a change of character.

RUT Monthly

SPX Monthly

Looking at the COMPQ and number of stocks above their 50 and 200 period moving averages it is becoming increasingly evident that the index is beginning to catch up to this weakness.

$COMPQ

And a last perspective I bring up is the Guppy Multiple Moving Averages of the COMP and SPX.

COMP

SPX

A difficult challenge in trading is trying not to extrapolate further than necessary when creating a cohesive plan of action.  There is a fine line between allowing price action to confirm one's expectation or using confirmation bias to affirm price action.  The market as of today and for the past few weeks has been one I’ve chosen to side line.  In order for this perspective to change I’d have to note an increasing number of quality set ups on my time frame, as well as stocks breaking out and following through.  Stocks making new lows should stabilize and decrease while stocks making new highs should increase.  Additionally I'd pay attention to an increase of stocks up compared to down across  shorter term time frames carrying over into larger time frames and a number of stocks above moving averages of varied time horizons.   If this becomes more than a modest correction of 8-10% across all indexes then I'll focus on signs of panic selling and capitulation leading to exhaustion followed by a lengthy repairing of charts and a breadth flip. 

Salmon Run

The 200 MA is considered to be the den of the bear and the major indexes I follow, the Russell, SPX and COMPQ are swimming in these waters. At times like this the general chorus of the market being oversold and due for a bounce begin to ring loudly. Additionally there's discussion about the market's fear index, the $VIX, being very low considering the extent of the correction thus far. It's worth keeping in mind that fear is not a logical process that can necessarily be modeled exactly, but more of an event. There are two situations where fear can often arise: an event after prolonged anxiety, or suddenly like encountering a bear around a blind bend.

Thus far there hasn't been a singular black swan type event to trigger panic, but there has been plenty of signs of anxiousness. Most traders have a long side bias which makes sense since the market has historically had a long side bias as well and there is more profitability to the long side than short. Through observation of myself I've noted that as markets drop I become more optimistic and begin to look for information to confirm this bias. Through observation of other traders I've noted that trend lines of support tend to drop along with the market, as do the moving averages used to gauge where the next level of market support is.

In anxious markets it's crucial to keep an honest assessment of probable outcomes. It's well documented what occurs to markets after the election of an incumbent president so this drop was not out of the ordinary based upon historical data. In addition we know that breadth has been waning, earnings decelerating, and uncertainty about taxation and policy decisions are effecting mindset and decision making. Healthy markets tend to shrug off bad news, but sickly markets are vulnerable to a sneeze upon a return key that fat fingers a cascade.

One of the benefits of trading in this era is the accessibility to Market Wizards and Turtle Traders who are willing to share their experience. After the market closes I like to go through some of their tweets and see if my analysis is in line with theirs or if they are offering insight from their decades of experience in various market conditions. Today I came across two noteworthy tweets from Mark Minervini worth documenting.

Encyclopedia Brown and the Case of SPXU

After the close and before checking the election results I quickly jotted a couple of notes on the SPX and COMPQ.  The general market has been in a down trend since 09/14 with the NASDAQ taking the brunt of it. I've noted a number of times that the SPX has shown relative strength in comparison and that should heavy selling begin to hit the tape this may offer the best risk/reward scenario. The recent bounce and small range offered a lower risk entry by establishing a lower low pivot to trigger entry.

$COMPQ

$SPX

There's three reasons why I looked specifically at shorting the SPX rather than the NASDAQ.

$COMPQ

1) Generally, markets will correct in tandem and since the NASDAQ has lead this down trend my hypothesis is that the SPX will catch up so there is greater reward/risk

2) The $BPSPX is  at 69 while the $BPCOMPQ is at 53 confirming the SPX has held up much better during this correction.

3) The $RHSPX is at 94 in comparison to the $RHCOMPQ which is at 16, so I consider the NASDAQ slightly extended here and more likely to have a counter-trend bounce.

$SPX

At the close of today there were 5 ETFs which put in year high volume giving a clue to current market psychology, the SPXU, SDS, UVXY, VIXY, and VXX. When volatility spikes the corresponding ETFs can break sharply, and during capitulation phases can offer low risk/reward opportunities of 30% to 50% or more.

SPXU

SDS

UVXY

VIXY

VXX

Bottoming Process Continued

On June 11^th I published a post “Bottoming Process” and noted a few of the common technical chart patterns along with a few of the poorer performing Russell 2000 stocks up to that date to be compared to. The primary point of the post was to be aware what components the indexes are comprised of and be aware of whether or not they were suggesting bottoming patterns in accordance to the model. Since the indexes are lagging, burrowing under to the individual stock will get one closer to the actual price action and behavior under the surface.

What I wanted to start this post with is comparing 6 of these charts then and now as a follow up. The premise at the time was that unless these charts began to put in floors and stabilize then the likelihood the market was putting in a bottom was the less probable scenario. Worth keeping in mind as well is that simply because these have floored is not enough, stocks behaving well should be monitored in addition to note topping behavior and a next wave of potential selling.

  

On occasion a market will sell off and put in a sharp V-Shaped bottom, but the more probable scenario is going to be action like that which has been occurring since the June 04 pivot low. Action reminiscent of trying to find one's footing on a sheet of ice as limbs flail akimbo until there is traction and stability. Something that stood out to me when analyzing the NASDAQ chart today is time and factors of it, particular mine. Through observation and empirical evidence I've decided upon a time frame of 5 days in which a stock has to prove itself to me or else I will stop myself out. In keeping with this theme I wondered why in turn I was not analyzing market action based upon this same time frame.

Eventually a market will reach a low that will be “the low” and when that is we can not determine with 100% precision, especially at that moment. But what we can use is time. The longer a low holds, the more probable that becomes the low of the move. So I broke down chunks of 5, 10 and 20 days price action from that low and a key higher low that followed thereafter. The underlying hypothesis for me and one I intend to use from this point forward is that: if it is a low it should be not be breached for a five to ten day period and thereafter any key higher low pivot should follow to confirm. This is just one piece of information however, the second is the pure statistics of market action.

Over the past 84 years there have been 294 pullbacks of 5% or more which averages out to 3.5 per year and of these at least one will be in the magnitude of 10%. A move of 15% occurs 14% of the time and 8.5% of the time a move of over 20% will occur. If a move is going to 15% it obviously has to punch clearly through 10 and this information helps formulate a belief about current market structure and time. Once a market hits 10%, a not uncommon pullback, the chance that it goes much further decreases, therefor the probability there may be a bottom forming increases. So by combining the magnitude of the move in addition to the the length of time a key pivot low goes unbroken can assist in getting on the correct side of the market move much earlier.

Another aspect of time to be aware of is the horizon. A move of 4-6% is a modest pullback and the horizon for the return to uptrend will be shorter than if there is a much more corrosive move of 10-15%. A move of this size will not bounce back swiftly so expectations of markets breaking to new highs rapidly should be muted. These types of moves need a longer span to unwind before commencing the next uptrend.   

Fledgling Rally Gets Wings Clipped

I made it a point this week to focus upon two metrics to filter out what was expected to be a news driven 5 days of trading. Two days back the ducks were aligning and I noted a window of opportunity open as the Russell closed strongly above a key pivot point. I also mentioned how I was maintaining a stance of caution until the primary breadth trend indicator I follow flipped bullish. Fast forward to today and the results of Fednesday are in and is there much more to say than the market hemorrhaged like an Ebola victim.

The window of opportunity has been slammed shut and any lack of nimbleness the past two days resulted in fingers pinned to the sill. Obviously volatility has kicked up, the indexes have closed below the lower high pivot of 05/29, and the secondary breadth trend I follow has flipped bearish again. I started off the week optimistic of a short term rally having some legs and looks like I'll be ending the week on the sidelines, which is fine.  Now that the window is closed it's time to wait patiently for a knock at the door.

Bottoming Process

One thing a study of the historical market bottoms in conjunction with chart patterns can assist in is awareness of what bottoms look like and act like. With this in mind, I collected a few charts from StockCharts.com which show a some of the more common bottoming formations.

Using these as a template we can put into perspective where the market currently is in relation to typical formations which can assist in clarifying where the market is. Does the following resemble any of these patterns thus far?

RUSSEL 2000

Taking the Russell 2000 and sorting by stocks that have underperformed the market during this correction and sorting those by dollar volume we can determine whether or not these patterns are forming in the underlying stocks and from this infer whether or not the indexes may follow.  If there is continued selling in these broken down stocks then it follows that it will be difficult for the indexes to put in that pivot low that distinguishes the bottom from the entire process.