Constructive week, yet...

I trade a market that is uniquely my own. Whereas the methodology I use is in keeping with the spirit of great predecessors and is in no way especially unique, the manner in which I approach and study and interpret market conditions will be greatly influenced by the nuances of my experience and belief. In addition, as my knowledge base grows and compounds with each passing day, what I thought I saw, believed or knew yesterday may be completely different from what I see, believe or know today.

Over this past year I've often envisioned myself as a tree of knowledge, and when approaching concepts that challenge my beliefs I ask myself if in this instance I should remain firm like the trunk, bow like the branches under a heavy wind, or release the idea like an Autumn leaf. Another vision I've had consistently over this year is an accordion which when expanded sucks in information to be processed and when compressed expels the concepts that aren't in keeping with my current understanding like air, while retaining just enough that on the next expansion the remaining ideas can create continuity and narrative with the newer information to process.

In keeping with this spirit, each weekend I sit down and exhale the previous weeks prognostication and approach the upcoming one in this frame of mind. What important changes in character occurred over the past week and how may they carry forth through the upcoming 5 days? One process in which I accomplish this is through a composite of the market, which much like the rudimentary stick-figure animation scribbled into the corner of a grammar school primer unfolds motion over time. In order to achieve some continuity and form from the abstract a consistent skeletal structure is helpful, and my choice of late has been using the $USHL5 and sector rotation.

Last week I held two expectations coming in:

The first was to see the higher low established on the $USHL5 hold and although this indicator fell further establishing a lower higher low pivot from last week, it still has yet to undercut -1015. 

$USHL5 09/15

The second was to see the beginning of more aggressive “riskier” asset classes rotate into the sector mix.

Morningstar Industry Groups 09/15

Both of these events have occurred, so now what? Reviewing this past week, there has been constructive action validating the long point of view with the NASDAQ and SP closing up 5 days in a row and up 6.25% and 5.35% respectively. This past Friday established 67 new highs which is another positive. However, I'm still dancing to the Waltz while the market is dancing Salsa. These moves have been swift and volatility high with index moves of 6% up followed by 8% down followed by 10% etc... and still the range continues. Regardless of how constructive the action has been, I'm still out of cadence and maintaining form and discipline during this stage is the only concern I have.

Granted, I don't trade indexes I trade the underlying stocks themselves, however they as of late having been moving lock step as well with the result of wide and loose price movement. The current underlying pattern structure I look to trade and the time frame for my holding period are not quite in sync with the current environment and I've come to accept that I am not experienced enough to trade this structure and continue to choose patience as my trading vehicle of choice.

Take Me To Your Leaders

Looking at the $USHL5, there was a brief pop positive setting a higher high before dunking again and finishing up the week -640. I'll be looking to see if this firms and establishes a higher low which would indicate that selling is beginning to abate. Considering the state of the market with the major indexes down between 15 to 20 percent, there are two scenarios I am anticipating: one being a bottoming formation, and the second being the precipice of a full blown bear market should all major indexes drop through 20% or more. Regardless of which unfolds, I can begin to prepare for the next cycle by looking at stocks that are holding their own under the weight of this market.

$USHL5

 

There are two freely available tools through FinViz that I looked at this weekend, the first being their list of new 52 week highs:

MFN ARCO STMP VRUS RGLD RIC BAA WPRT NGD NEM EXK AZO AUY CALP TVLT

The second is a screen I use to look at pockets of recent strength. This list is composed of the following:

MITK DY PMC MAKO WPRT EXK ACTG HOTT NXG UAN PAET MLI FCFS EDR DLLR MFN JAZZ OCN CLP EXR AKR CSR JCOM AEC EDU ORI MRGE EBIX UIL DPZ AVA MNRO AKRX EE CNU VGR

Additionally keeping an eye on the changes occurring on a monthly basis in the Morning Star Groups with a focus when more risk oriented sectors emerge should divulge further clues about risk appetite and where the next leadership may emerge.

Sectors by Price % Change 1 Month

 

Arranging this list by price as percent of 52 week high continues to show defensive sectors at the top.

Sectors by Price % 52 Week High

 

Two areas I'll be focusing in on through the remainder of this month is keeping a list of strong relative strength stocks and stalking for when a plethora of bases and set ups emerge As of now, with price jumping around like a flea circus finding low risk high probability swing trades is like shooting guppies in a barrel. Yeah I might hit one or two, but is it worth it?

One Bad Trade

A trade that violates the trading plan can make money, but it can never be classified as successful.

I find the first hour of the open a grind. I have little problem staying up until 5 AM and functioning well enough, but awaking at 5 AM after 7 hours of sleep feels like walking through a George Romero flick. Try as I might, I've yet to create a recipe for alertness during that first hour and in order to mitigate mistakes I am prone to do during those foggy moments I attempt to keep disciplined and avoid trading. Sometimes I do and sometimes I don't.

Yesterday (09/07 in this context) was one of those moments I didn't and it's a shame because yesterday was one of my better thought out trade ideas and one I was fully prepared to take with the belief that I had a high probability, low risk trade. It was a trade I had spent an entire weekend dreaming about after having a crystallizing experience a few days earlier after a member of Stock Bee shared his methodology. Something about it resonated and I couldn't quite put my finger on it. Turns out, I didn't have to as a glance at my book shelf began to kick in a series of until then random incidents that suddenly joined together with the power of Voltron.

One look at my book shelf and Trade Like an O'Neil Disciple all but called out to me. Picking it up and leafing through the pages and index card was tucked away in Chapter 7. The note was simple: “Look to add a short idea of the Qs when MM turns bearish.” A clue in a book I hadn't picked up in 6 months led me down a train of thought where a few sentences from a video I watched months back echoed across my cranium and a tweet from Stock Twits flashed in front of my eyes as I recalled what I thought at that moment and how suddenly the trade referenced in this context began to make perfect sense. I couldn't sleep and continued to read this chapter 4 times and jot down some ideas to begin to work on over the weekend in preparation.

Going into the week I began to plan out this trade and how it would be executed and managed. I wrote down my notes in preparation:

 Looking to take a position in the QID permitting- looking for a day of increased selling. Not looking to trade an opening gap to the downside as that is the intended direction of this trade- an opening gap to the upside and fade on volume would be the ideal situation as it would offer a better price entry and risk reward situation- looking to trade on the path of least resistance and finding a solid entry is advisable.

Having what I thought was clear cut instructions for an entry signal it simply became a matter of stalking and it was during this stage that things began to unravel. The market did gap up on the morning which was the preferred direction for the trade. I watched the action during the first half hour and was anticipating a fade and simple watched how the action would unfold. Two events would have been a trigger for entry, the QID breaking the opening high, or the Nasdaq fading and breaking its opening low, but neither happened and yet I entered the trade anyways.

QID Order Flow

COMP with journal notes

This is where everything goes south. A successful trade begins first with following the plan devised during the off hours, taking the signal, determining if I am on the correct side of the order flow for my intended time frame and managing the trade accordingly. The main problem is that if the plan is not adhered to from the beginning then nothing else matters. If the entry signal is not taken correctly nothing else matters because it should have never gotten to the point where decisions are made on the fly. I should be fully prepared for the outcome and the follow up is simply the execution of this step. Once I entered this trade, what does having a stop matter anymore because I'm now in the land of improv and this is not a situation I am comfortable with and will likely listen to the cacophony inside my head telling me anything- “get out now and save your risk” or “ahh stay in, you have a stop loss in place as risk management.” While these are true in the context of the plan, they are no longer true once I break the second rule of immediately getting out if I have taken a wrong signal. So not only did I not take the signal, I compounded the error by not rectifying it immediately.

The following day I stopped myself out of the position as I no longer held conviction in the trade and decided it was in my best interest to simply cut out the cancer. I could let the market action after my exiting near the low of the day only to watch price rebound effect me and I could make excuses like, “I knew all along.” However, none of that matters when the trade starts off incorrectly, nothing can go well and nearly everything can be manipulated. Adding salt to the wound, not breaking down the position that night and making key decisions in the off hours about how to handle it and instead waiting until I'm involved during market hours before deciding is unconscionable.

Although the trade was was less than stellar, it s completely up to me to learn from this experience and avoid the repetition. A few keys I've taken from this:

• Trade execution that is flawed from the get go is flawed through and through-
• Learn to accept responsibility much quicker for a inadvertent trade-
• Defined risk does not justify keeping a trade that never triggered the signal.
• Once a trade is entered mistakenly, protecting risk is no longer about capital, but emotions
• The plan is to protect myself of the preparation phase from myself during market hours
• I am capable of convincing myself of anything at any given time in a trade
• The earlier a mistake is admitted, the easier it is to rectify and diffuse the negative charge building with each moment. 

One aspect of my character is internalization of dialogs.  Keeping my mind quiet is difficult.  This is somewhat detrimental when it comes to my trading, for as an internal discipline my mind makes little distinction between a trade being an occurring event and the numerous fantasy dialogs that bandy about my inner eardrums.  This post therefor is cathartic in that it is concrete and outside of myself and being read by others.  In this context it is easier for me to understand the reality and significance of this event and make improvements in my trading.  Now if I can just quiet down Heckle and Jeckle for a few moments.  

Exit Stage 4, Right Even

In Stan Weinstein's Secrets for Profiting in Bull and Bear Markets the 30 week moving average is a key determinant of which stage the market is currently in.  Based upon his methodology, a declining 30 week moving average is Stage 4, and regarding stage 4 he states on page 39, "Don't get caught up in the macho game of riding out a decline.  Hanging tough in Stage 4 is a masochistic and costly game."

The weekly chart of the SP clearly shows that the market is in Stage 4.  In order for the market to transition into a new up trend- Stage 2- it must first go through Stage 1, a basing area. As of yet the volatility remains exceptionally high indicating the unlikelihood of a transition in the near future.

Weinstein's Stage 4

  Sometimes deducing a markets character really can be this simple. 

Speechless

I'm finding it hard to string together enough words into a cogent thought as the sun shines outside my window.  However, my commitment to get out at least a post a week for consistency calls.  In keeping with this task I'm simply going to post a few images sans commentary and follow up at the end of the week.

Weekly SP 09/02

Market Monitor 09/02

Morning Star Price Percent Change 30 days

$USHL5 09/02

Dan Zanger, Male Model

In a recent post I discussed using the Adoption/Diffusion model in conjunction with the Wyckoff model of market stages. At the time, the indexes moved through a stage of distribution into mark down according the Wyckoff model, signifying the Innovators unloading inventory to the Laggards according to the Adoption/Diffusion model. During this period the possibility of further redistribution and mark down as First Adopters began to support Innovators came into question.

Since then however, the landscape looks much different and it is becoming clear that First Adopters did not show up in support of the move. I do not know for a fact that they won't show up, but they've neither signed the registrar nor have been seen at the party. Further, recent evidence shows that the Innovators are moving to the long side. Through the process of the Adoption/Diffusion study, the modeling of Innovators, who they are and whether or not their actions can be identified and modeled seemed like a logical follow up- but where to begin wasn't quite clear.

It wasn't until I saw a couple of tweets on StockTwits that I realized I had my model of study- Dan Zanger.

Dan Zanger Tweet August 26

What suddenly stood out was the swiftness with which he changed his mood. Until recently many of the charts he posted indicated further downside and his tweets cautioned getting chopped up in this tape and keeping one's powder dry.  Within a few hours after posting another cautious tweet he switched on a dime and opened a long position.  I thought, if there is someone who has an understanding of their risk tolerance along with knowing when leadership begins to emerge before the indexes make up the lag time, and would be considered an Innovator it would be Dan Zanger. So if he is suddenly becoming opportunistic I would consider this a change of market sentiment by an acknowledged market technician and worth paying attention to.

Harvesting the Fields and Rotating the Crops

The fields tilled by the traders of yore yield much wisdom.  One theme that keeps cropping up in the five books that I am currently reading and/or rereading is sectors.  From Livermore and Wyckoff to Weinstein and O'Neil, the understanding of sectors and cyclical cycles is repeated through their works, which is to be expected after all since in many regards they are branches from the same root limb.

In order to get a composite of sector rotation to better my understanding I set up some simple metrics and ran 5 scans through TeleChart and screen captured the results.  Using Morningstar Industry Groups as the universe I decided to scan the current list using a simple formula of C/C20 and C/C165 which gives the change over a shorter term 20 day cycle and medium term 165 day cycle and ranked these from high to low, taking the top 20.  I then modified the formula to scan for the same cycle 100, 200, 400, and 600 days ago (the last being approximately 1 month into the bull run since March 2009).

04/21/2009 Sector List (600 Days)

11/20/09 Sector List (400 Days)

01/26/2010 Sector List (200 Days)

03/30/2011 Sector List (100 Days)

Now that the composite of days 600, 400, 200, and 100 has been completed, questions can be framed around this information.  What did Resorts and Casinos jumping to the top of the 20 day list in April 2009 say about the prevalent attitude at the time vs. the market's attitude?  How are people getting to the resorts? Cruises?  Air planes?  Will these sectors come into play?  Looking at the image from November 2009 shows not only did Resorts and Casinos have duration and were clearly one of the leading sectors of the bull move, but also Airlines did enter the mix as well.  Additionally, in noticing the persistence of Resorts and Casinos over a period of time, are laggards beginning to reap the sector strength benefits as well?

08/19/2011 Sector List

Using this composite during the bull move as a reference to the current list, it can clearly be seen that this list is composed primarily of defensive stocks and there is a story being told here as well.  A defensive stock is described by Investopedia as:

The utility industry is an example of defensive stocks because during all phases of the business cycle, people need gas and electricity. Many active investors will invest in defensive stocks if a market downturn is expected. However, if the market is expected to prosper, active investors will often choose stocks with higher betas in an attempt to maximize return.

source: http://www.investopedia.com/terms/d/defensivestock.asp#axzz1Vmmetw7v

This list is unadulterated information and simply states that over a 20 day and 165 day period these sectors have shown greater price appreciation.  Regardless of what is being said on television, radio, the internet, semaphore, or smoke signals, the simple fact is this: the price flow is speaking quite clearly and it is chanting: "Defense! Defense! Defense!"


Using this context of defensive positioning and returning to the first image from April 2009, what can be seen during the initial stages of the bull market is a mixture of cyclical and higher beta sectors.  Using this as a model, paying attention to which sectors begin to rotate into this list may lead to clues about investor sentiment and money flow and when first adopters begin to get more aggressive as well as lead to clues about where the next leadership may be found.  Additionally, learning to ask questions about the data may lead to further insight and undiscovered sectors or germinate some ideas to harvest later.