A Tale of 4 Indices

For some the S&P is the only index that matters.  Others take the mantle for the Q.   Occasionally the NYSE gets thrown into the mix.  When assessing risk tolerance the Russell tends to take the spotlight.  Some will say it's not about the indices, it's all about stocks, then bring up support and resistance levels on the indices and map out price points with little to no sense of irony.  There are times when I vacillate between viewing the indices as useful, actionable information, and times when I think they are not at all useful.


Recently there were two interesting tidbits I came across which I thought were useful and actionable information.  One is from @ukarlewitz on the Twits who posted the following. 

Analysis from @ukarlewitz

Another useful piece of information regarding breaking down market sell offs.  Market Sell Off Analysis from Alpha Architect.

When markets begin to sell off one of the first things I do is put up on a percentage basis where key levels are from the highs.  Knowing the frequencies of sell offs and the probability of them dragging an index down between 5 to 20 percent can help as a guidepost for zones where settling may occur and potential reversals begin to take root.  Upon looking at four heavily followed indices, what I noted is that on two of them, the NYSE and IWM, I have not had to adjust these levels since early 2018 for the NYSE and mid 2018 for the IWM.  Whether this in and of itself is useful or actionable is in the eye of the beholder.

SPY

COMPQ

NYSE

IWM

Extreme Momentum on the Indices

It is uncommon for the major market indices to show up in my momentum scans.  It's rarer still when they all do.  The tendency thereafter has been a sharp pullback. 

IWM Momentum Phase

NYSE Momentum Phase

QQQ Momentum Phase

SPY Momentum Phase

After spending a lengthy period of time elevated at extended levels, the % of stocks above their 20 period moving average dipped below 70.

% Stocks > 20 Period MA

 
On a higher time frame and also after an extended period of time at elevated levels, the % of stocks above their 40 period moving average has also declined, but not significantly enough to drop under the 70 zone.

T2108

These are the periods when a prudent speculator may want to consider transitioning from trader to risk manager.  The lock out rally has been forgiving, maximum adversity may not be so.

A Tail of Two Extremes

% of Trading Universe <> 25% in a Quarter

For nearly two years the percentage of stocks above/below 25% over a three month period remained fairly consistent with a ceiling of approximately 20%.  Beginning October through December 24th the percentage of stocks down 25% clipped 50%.  Two months later this has almost completely inverted with the percentage up currently at 45%.

Avoiding Extended Stocks

PYX

One of the crucial fundamentals of swing trading is avoiding extended stocks.  But what qualifies as extended and how can one quantify that?  In some cases it is transparent.  PYX is one such example which is up over 100% within a 30 day frame.  When things aren't so clear what is an extended stock may be answered with, it depends.

Frequently attempting to quantify relationships in trading is a chicken/egg scenario that may end up quaking like a duck.  Attempting to find a hard and fast rule to define extended stocks may lead to a dogmatic assessment of the information provided by a stocks price action.  As with many trading questions, it is better to look inward than outward for solutions to this problem.

Suppose one’s metrics show an average holding period of 5 days and an average position gain of 8% over that time horizon.  Within these parameters a stock up 10% over the past 5 days already exceeds one’s avg. gain over holding period.  Under differing parameters this may not be extended at all, but within the prism of one’s actual results this may qualify.  Taking this trade would be under the expectation that price appreciates 20% within a 10 day time period.    At the time of this writhing there are 107 stocks above $5 with daily volume of 100K that are up 20% over 10 days.  Not only would the hypothetical trade exceed what one’s metrics show, under current market conditions it may also be a low probability.

Knowing this, scanning for stocks that have not had a significant move over one's average holding period will lead to stocks that are not extended.

CHRS

Another technique is to remove price entirely and look for flattening price zones using a MA that makes sense for one's holding period.

CHRS 10-Period MA

Metrics based analysis helps take the guess workout of what is or is not extended.  Using one's data and stats as the floor from which to build one's trading foundation will lead to actionable information.  Coupled with analysis of how the market is structured and behaves will help build out the frame.

December Monthly

The general market indices have completed three months of correcting through price with a decent bounce from the December lows.   With this much damage done to price it is now more likely a question of time.  While the December lows may yet again be tested, the extreme extension of breadth to the down side across a number of indicators suggest that a bottom in price has been established.  The length and duration of price oscillation before buyers step in resuming an uptrend remains to be determined but the first five trading days of the year may offer clues.

IWM Monthly

COMPQ Monthly

NYSE Monthly

SPY Monthly

Wide and Loose Range

General market indices have been trading in a wide and loose range for the past 6 weeks.  The S&P is currently on week 5 without establishing a new closing low and has had a weekly close in the 10% pullback zone multiple times without breaking lower.

SPY

IWM has been hovering in the range of a 15% pullback and undercut it's previous low pivot point.  20% correction in small caps may be on the horizon.  

IWM

The COMPQ was the first to undercut a key pivot low 2 weeks back and continues to hover in the range of 15%.  This is a key pivot to observe as an undercut puts the index in 20% correction territory.

COMPQ

NYSE continues to hover between 10-15% but is close to undercutting a pivot low from 6 weeks back.

NYSE

One thing I've been keeping in mind is the oft repeated quip, "When the cops raid the brothel, everyone gets arrested, even the piano player."  Additionally there is the belief passed through the O'Neil books and practitioners that when the markets correct, leading stocks for the next up leg decouple.  There are a number of stocks that have bucked the general market direction and continue to hold well through the volatility suggesting to me that until these break down I'll continue to be optimistic of upside continuation when things settle.

TTD

SEND

#STUDY: Improve Market Timing and Risk Management

When the underlying market structure is no longer in agreement with periods of peak effectiveness and profitability, my focus turns to assessing information that suggest a realignment between how I trade and how stocks are behaving.  In order to quantify this I defer to the facts of my trading results, the expansion or contraction of my trading universe, the effectiveness of my signals, and the quantity of stocks that match gains over my holding period.

My process is as follows:

Breadth of my trading universe.  How many stocks are in my trading universe and is it contracting or expanding?

How are stocks behaving over my time frame?  How many meet my average gain over this time frame?

How are my signals behaving over my time frame?  

My trading universe is dynamic and based upon a simple calculation of momentum over a 3 and 6 month time frame.  Being dynamic this will contract or expand depending upon the underlying market structure.  There are currently 5700 stocks and ADRs in Telechart and of those only 357 meet my 3 month requirements and 161 my 6 month requirements.  This is clearly a period of contraction and indicates that the market I trade on my time frame is not conducive.  What would indicate to me that there is an improvement on my time frame would be seeing this universe expand to 10-20% or more. 

Universe

How many new highs are there over a 3 and 6 month period?  Currently they are inverted.  1 month highs have moved above 1 month lows which is positive for my holding period of 5 to 10 days, however stocks that meet my momentum requirements are currently inverted with new lows eclipsing new highs. 

New Highs-Lows

In addition I have a scan based upon weekly price action.  One of the benefits of dynamic scans that have consistent properties is they expand or contract based upon the underlying market structure.  This particular scan is based upon a decrease in price volatility.  For this week there are only 346 of 5700 stocks that meet the requirements which is on the lower side.  Clearly there has been an increase in volatility which is reflected in the return numbers of this scan.  Periods where I have traded better have lower volatility, so as volatility decreases this scan will reflect that and indicate the structure of the market is realigning to my strengths.

Weekly Watchlist

Weekly Watchlist

Moving from trading universe to trading signals, I asses how many stocks that met my entry trigger have had a follow through on day two and are higher by my time stop —day 5.  As the numbers currently show, by day 5 only 48 of the stocks that flashed a signal ended higher than signal day.  This indicates that even with a decent bounce in the general market as represented by the major indices, price from my signals on my time horizon is not well reflected.

Price/Time Horizon

My weekly signal gives a wealth of information.  From this universe I assess whether or not there are there stocks that meet my technical requirements to trade.  How many there are and how they behave over my time horizon gives me information about current structure.   Are they triggering?  Are they reaching my exit signals or stopping out due to a loss or time stop?  How are they behaving over the entire ten days?  A time comparison of these metrics is a useful template for when the market is realigning or diverging.

Period of Alignment

Period of Divergence

During times when the underlying market structure is congruent there will be a number of candidates, they will trigger, and expectations will generally be met over time as targets are hit.  When there is divergence the candidates decline and fail to trigger, or trigger and targets aren't hit but stops are.

Another piece of information from my trading results is what is my typical gain and how many stocks have met that over my holding period.  If on average my exit is in the range of a 12% gain and my average dollar is $2, then knowing how many stocks are up 12% or $2 over my time frame is useful information that marries my expectation with what the market is offering.  Conversely, knowing how many stocks retreat the value of expectation highlights periods where I may be out of alignment with market structure.

Leadership

Through using one’s trading stats along with periods of peak profits as a template, the current market backdrop can be more clearly assessed.  Risk reduces when the market structure aligns with one's trading metrics.  Market analysis through the lens of one's metrics gives quantifiable information to filter the current structure and behavior that can be repeated.  This is an inherent part of risk management, trading aggressively during conducive periods while tampering down during divergences, and a repeatable process helps ensure consistency. 

Additionally, filtering the market through metrics assist in timing during corrective periods.  Instead of falling into the trap of guessing a top, allow the contraction of one's trading universe and a divergence of expectations to be the awareness that structure may be changing.  Instead of falling into the trap of picking the bottom, allow metrics to be the guide when stocks realign with expectations, one's universe increases, and behavior over one's time horizon improves.