Today's action helps but does not yet confirm the bearish case. We will likely know if the high is in by 8:30am tomorrow after the GDP report. I seriously doubt if AMZN's positive earnings will be enough to pull the market back up tomorrow. And even if the GDP report is not as bad as expected, any pop is likely to fizzle, so caution is still advised. However, a weak close tomorrow on higher volume will go a long way to confirming that 1/28/09 was the swing and wave E high. For confirmation I will be looking for either a continuation of today's decline followed by a minimum two day pullback to setup a sell pivot or a break of the 1/20 to 1/23 lows to get 100% short.
Gold, the metal, continued its rally today and I am looking for the rally to continue as long as the US Dollar continues to correct the advance from the December low with a target around 930. However, based on the cycles I do not expect gold's rally to last much more than another week. I will be looking to exit my long gold position at the target or the day after a positive large range day.
Thursday, January 29, 2009
A Simple Method To Improve IBDs Market Calls
I was tooling around in free stuff at http://www.decisionpoint.com/ last night studying the thrust/trend model (TTM) that Carl Swenlin uses, and it occured to me that IBDs follow-through method is quite similar in concept to the thrust component of the TTM model.
What would the results be if we added a trend filter and a confirmation to IBDs market calls? I looked at a couple of different ideas, but the simplest seems to be the following:
Trend Filters
1. The macd of the SP500 or Wilshire 5000 (choose 1) must be greater than its signal line.
2. The macd of the market or stock being traded must be greater than its signal line.
Confirmation
1. The SP500 or Wilshire 5000 (choose 1) must continue higher the day(s) after a confirmed rally call and before a market in correction call.
2. The market or stock being traded must continue higher the day(s) after a confirmed rally call and before a market in correction call.
By adding the trend filter and confirmation to the Qs for 2008 using IBD market calls, the performance went from a CAGR of 29.30% to a CAGR of 45.85% - a substantial improvement. This brings IBDs performance in line with the other higher performing trend following systems.
Using the above, we would not be a buyer today because the macd is below the signal line for the SP500, Wilshire 5000 and for the Qs. Also, the markets do not appear to be continuing higher after yesterday's confirmed rally call. Should the trend filters turn positive and we have the markets moving higher before a market in correction call, then and only then, would we consider buying using this modified method.
I hope this helps those who have been whipsawed as many times over the years as I have using IBDs market calls.
What would the results be if we added a trend filter and a confirmation to IBDs market calls? I looked at a couple of different ideas, but the simplest seems to be the following:
Trend Filters
1. The macd of the SP500 or Wilshire 5000 (choose 1) must be greater than its signal line.
2. The macd of the market or stock being traded must be greater than its signal line.
Confirmation
1. The SP500 or Wilshire 5000 (choose 1) must continue higher the day(s) after a confirmed rally call and before a market in correction call.
2. The market or stock being traded must continue higher the day(s) after a confirmed rally call and before a market in correction call.
By adding the trend filter and confirmation to the Qs for 2008 using IBD market calls, the performance went from a CAGR of 29.30% to a CAGR of 45.85% - a substantial improvement. This brings IBDs performance in line with the other higher performing trend following systems.
Using the above, we would not be a buyer today because the macd is below the signal line for the SP500, Wilshire 5000 and for the Qs. Also, the markets do not appear to be continuing higher after yesterday's confirmed rally call. Should the trend filters turn positive and we have the markets moving higher before a market in correction call, then and only then, would we consider buying using this modified method.
I hope this helps those who have been whipsawed as many times over the years as I have using IBDs market calls.
Wednesday, January 28, 2009
Limited Upside
First, a couple of comments: 1) the advance GDP report comes out Friday, not tomorrow, and 2) I missed the news on the "Bad Bank" plan until this morning. I was out running my wife around on some errands. Currently, she can't drive much since she is suffering from severe neck pain due to a car accident and is waiting on approval for surgery. All of us will encounter stress in our lives and it can, most likely, will affect our trading. I have had my share of stress over the last few years, and I can tell you that having a sound trading plan helps me keep from making stupid mistakes, although I certainly make mistakes from time to time.
I do not trade off of news events, except when such news events are concurrent with and supportive of a valid system trading signal. The news from last night and today really does not clarify anything with respect to the trend, but it does fit the profile for an E wave, or perhaps a 2nd wave. At this point the market is behaving as expected. The Qs should not push much above 30.84 to 31.00. The move following that level should be a hard selloff that quickly retraces back to the 1/20 low or we will have to reconsider the current viewpoint.
IBD has scored this as follow-through day, but I would still remain cautious. So far, markets are following the script of the post-election year cycle as can be seen on http://www.seasonalcharts.com/. The typical pattern shows an initial upmove in January followed by a low in the 3rd week and another strong advance to finish the month. However, February is hard down. Whether or not, the Qs make a minor new high, a selloff is the expected outcome at this point. Last year the election year cycle inverted which gave excellent guidance for the hard down move in the fall, although it was a little early. Now, the cycle has inverted back to its typical pattern, and regardless or whether we see new lows are not, February is expected to be down, so I would not get too caught up in the current bullishness without a pullback and confirming breakout.
I keep wondering what creative new scheme our government will come up with next. I wish I could move my mortgage under an unrelated entity. The improvement in net worth would be nice. Really, this stuff is not that complex. The fact is that if it won't work for an individual or small business, then it probably won't work. This is all just smoke and mirrors. If our government used basic personal finance, we would not be in this mess.
I do not trade off of news events, except when such news events are concurrent with and supportive of a valid system trading signal. The news from last night and today really does not clarify anything with respect to the trend, but it does fit the profile for an E wave, or perhaps a 2nd wave. At this point the market is behaving as expected. The Qs should not push much above 30.84 to 31.00. The move following that level should be a hard selloff that quickly retraces back to the 1/20 low or we will have to reconsider the current viewpoint.
IBD has scored this as follow-through day, but I would still remain cautious. So far, markets are following the script of the post-election year cycle as can be seen on http://www.seasonalcharts.com/. The typical pattern shows an initial upmove in January followed by a low in the 3rd week and another strong advance to finish the month. However, February is hard down. Whether or not, the Qs make a minor new high, a selloff is the expected outcome at this point. Last year the election year cycle inverted which gave excellent guidance for the hard down move in the fall, although it was a little early. Now, the cycle has inverted back to its typical pattern, and regardless or whether we see new lows are not, February is expected to be down, so I would not get too caught up in the current bullishness without a pullback and confirming breakout.
I keep wondering what creative new scheme our government will come up with next. I wish I could move my mortgage under an unrelated entity. The improvement in net worth would be nice. Really, this stuff is not that complex. The fact is that if it won't work for an individual or small business, then it probably won't work. This is all just smoke and mirrors. If our government used basic personal finance, we would not be in this mess.
Qs Heading To 30.72
The Qs are breaking out to the upside this morning from a small b wave triangle that completed yesterday afternoon. The most likely scenario is that this is wave E of the larger wave(4) triangle. E waves tend to suck everyone end based on some perceived good news event. So far, while the earnings news has been bad with lowered outlooks, etc, the perception has been that they could have been worse. Also, the 4th Qtr GDP report comes out tomorrow. As long as it is not worse than expected this is likely to be viewed in a positive light. However, caution is advised as this is typical market behavior in wave E.
The possibility of this outcome is why I only went 50% short with my index allocation last week. Once, and if, the markets roll back over and reconfirm the downtrend will I increase my index short position.
The Qs could run all the way back up to the January 6 high, but as long as they remain below it by even one tick, then we should conclude that it is still wave E. The other evidence supporting this view is that the Dow, SP500 and the Transports all declined much further relative to the Qs and will likely not approach the January 6 high on this rally. So, I think the key here is the Qs. If they exceed the January 6 high, then something else is going on and the bias will shift to the long side.
Traders should also not become extremely bullish if there is a lack of downside follow-through. As I will discuss in future posts, such an outcome would actually be more bearish for the 2009 outlook than if we get a nearterm retest of the 2008 lows.
The possibility of this outcome is why I only went 50% short with my index allocation last week. Once, and if, the markets roll back over and reconfirm the downtrend will I increase my index short position.
The Qs could run all the way back up to the January 6 high, but as long as they remain below it by even one tick, then we should conclude that it is still wave E. The other evidence supporting this view is that the Dow, SP500 and the Transports all declined much further relative to the Qs and will likely not approach the January 6 high on this rally. So, I think the key here is the Qs. If they exceed the January 6 high, then something else is going on and the bias will shift to the long side.
Traders should also not become extremely bullish if there is a lack of downside follow-through. As I will discuss in future posts, such an outcome would actually be more bearish for the 2009 outlook than if we get a nearterm retest of the 2008 lows.
Tuesday, January 27, 2009
Market Becoming Overbought
A rare condition is developing with the 5 period RSI over 70 while the 14 period RSI is below 30. Given the lack of upward progress since last week, this is a strong indication that a sharp selloff is just around the corner. At this point, I expect that the broader market will continue to rally into Friday and possibly next Monday, although it need not do so. Only a sharp explosive rally that closes above the 50dema will alter the situation in my opinion.
Today was an NR7 day (narrowest range in the last 7 days) for the Qs and the SP-500. This may mean a sharp move in either direction is imminent. If it is to the upside, expect a fakeout.
RIMM moved up nicely today and CHKP made a 3 month high. There are signs that some sectors and stocks have bottomed even though the broader indexes may move to new lows. The next four weeks would be an ideal time to be filtering for strong relative strength stocks to buy after the market bottoms.
Today was an NR7 day (narrowest range in the last 7 days) for the Qs and the SP-500. This may mean a sharp move in either direction is imminent. If it is to the upside, expect a fakeout.
RIMM moved up nicely today and CHKP made a 3 month high. There are signs that some sectors and stocks have bottomed even though the broader indexes may move to new lows. The next four weeks would be an ideal time to be filtering for strong relative strength stocks to buy after the market bottoms.
Monday, January 26, 2009
Waiting For Resolution
There's little to add after today's action. We are still awaiting confirmation of wave c of D down in the triangle or wave 3 of (5) down. However, if it is going to go down into the January 31(30) turn date, then it must begin tomorrow. Otherwise, we can expect a continuation of the muted rally until this Friday and then a selloff into Feb 6. So far the Dow has moved perfectly with my projected Gann turn dates with a top on January 6, a bottom on January 23 and so a possible top January 30 or February 2 would fit the pattern well.
One thing about trend following systems that traders must understand is that conditions like we have experienced since November 21 can do significant damage to your account, and this may be perfectly within the expected performance of the system. It is not enough to have a trading system with a trend filter, and entry and exit signals. You must know the system's expectancy, payoff ratio, optimal heat(portfolio risk) and the expected maximum drawdown.
The psychology of trading has become a popular field of interest in the last few years, but I think that perhaps there is too much emphasis put on psychological solutions to perceived trading problems. As long as you have a plan, you are trading the plan, and you do not hesitate to take the trade that comes in accordance with your plan, then any problems you might be experiencing have nothing to do with your state of mind. Rather, if you perceive a problem, you need to do more analysis and testing of your system with the objective of understanding the performance of the system under all conditions and what the optimal heat level should be.
One system that I tested this weekend had an expectancy of 31.46%, a payoff ratio of 3.49 and produced a CAGR of 62% with 40% heat and 3 x margin. The maximum drawdown was 50%. The same system with 10% heat and no margin produced a CAGR of 18% with a maximum drawdown of 17%. Notice how the maximum drawdown seems to be correlated to the CAGR. This is what one should expect, which means that annualized returns in excess of 100% may eventually lead to a total account meltdown.
However, there is one other factor that significantly affects the expected maximum drawdown and that is the stability of monthly (or specific) period returns. The more stable the returns are the lower the expected maximum drawdown will be. One way to estimate the maximum drawdown in your account is to multiply the standard deviation of your last N months returns (N>=12) by 5.
Suppose your average (not CAGR) monthly return over the last 12 months is 10% with a standard deviation of 6%, then you can expect a 30% drawdown at some point. On the other hand, if the standard deviation was 2%, you could expect a drawdown of 10%. Clearly, stability of returns is the most important factor in determining your ability to sustain high annualized returns without a significant drawdown.
This will be one area that I will be diligently working on this year and I look forward to sharing the results with you.
One thing about trend following systems that traders must understand is that conditions like we have experienced since November 21 can do significant damage to your account, and this may be perfectly within the expected performance of the system. It is not enough to have a trading system with a trend filter, and entry and exit signals. You must know the system's expectancy, payoff ratio, optimal heat(portfolio risk) and the expected maximum drawdown.
The psychology of trading has become a popular field of interest in the last few years, but I think that perhaps there is too much emphasis put on psychological solutions to perceived trading problems. As long as you have a plan, you are trading the plan, and you do not hesitate to take the trade that comes in accordance with your plan, then any problems you might be experiencing have nothing to do with your state of mind. Rather, if you perceive a problem, you need to do more analysis and testing of your system with the objective of understanding the performance of the system under all conditions and what the optimal heat level should be.
One system that I tested this weekend had an expectancy of 31.46%, a payoff ratio of 3.49 and produced a CAGR of 62% with 40% heat and 3 x margin. The maximum drawdown was 50%. The same system with 10% heat and no margin produced a CAGR of 18% with a maximum drawdown of 17%. Notice how the maximum drawdown seems to be correlated to the CAGR. This is what one should expect, which means that annualized returns in excess of 100% may eventually lead to a total account meltdown.
However, there is one other factor that significantly affects the expected maximum drawdown and that is the stability of monthly (or specific) period returns. The more stable the returns are the lower the expected maximum drawdown will be. One way to estimate the maximum drawdown in your account is to multiply the standard deviation of your last N months returns (N>=12) by 5.
Suppose your average (not CAGR) monthly return over the last 12 months is 10% with a standard deviation of 6%, then you can expect a 30% drawdown at some point. On the other hand, if the standard deviation was 2%, you could expect a drawdown of 10%. Clearly, stability of returns is the most important factor in determining your ability to sustain high annualized returns without a significant drawdown.
This will be one area that I will be diligently working on this year and I look forward to sharing the results with you.
Thursday, January 22, 2009
Clarification - Finally
As we approach the end of intermediate wave (4) of primary wave 1 down, the picture is becoming increasingly clear. The action of the last 4 days has completed a small symmetrical triangle that is clearly evident on the intraday charts. For starters this means that the trend is clearly down, which agrees with our trend following systems. The reason is that a triangle always precedes the last wave of a movement. If the market goes up tomorrow, then the small triangle is part of an upward abc correction to be followed by another decline. If it goes down tomorrow, then the small triangle is wave b of D of the wave (4) triangle or wave b of C of an ending diagonal triangle. At this point, the most probable outcome is a bearish descending triangle is nearing completion with wave c of D down to come over the next few days. Once complete, we will see wave E up, which may last as long as 5 days. The current Gann turn dates that appear to be in play are January 31 and February 6. January 31+- should mark the end of wave D and February 6+- should mark the end of wave E.
If the November lows are taken out on the next decline, then we are in wave c of 3 of an ending diagonal triangle with waves 4 up and 5 down to go.
The least likely, yet possible scenario, if the market goes up tomorrow is that we will be going down in wave 3 of (5).
Interestingly, back in November and December I commented on the lack of equality in time between waves (2) and (4). The triangle pattern makes waves almost equal with wave (2) at 57 days and wave (4) around 70 days (by 2/6/09) for the Qs.
Traders should continue to look for the short side until there is resolution. While I continued to look for a breakout in January that never came, the trend models are short now and should stay that way for some time.
The above elliott wave analysis helps give a context for the market action and what we might expect, but the important point is to realize that the trend models brought us to a confirming conclusion without knowledge of the pattern. There are many different elliott wave patterns, and sometimes, the patterns are clear enough to trade, but knowledge of the pattern is not necessary for successful trading.
I am now and will remain 50% short during the completion of wave D down. I will exit short on approach to the November lows, and look for a new entry point on the next rally with an initial position of 50% short. As (and if) price rolls over after wave E up, I will be 100% short.
The triangle pattern projects a low in late February or early March with the Qs retesting the 2002 lows at or below 19.72. Wave E should retrace back up to today's highs or slightly higher offering traders with a chance for another 30% gain in wave 5 down.
If the November lows are taken out on the next decline, then we are in wave c of 3 of an ending diagonal triangle with waves 4 up and 5 down to go.
The least likely, yet possible scenario, if the market goes up tomorrow is that we will be going down in wave 3 of (5).
Interestingly, back in November and December I commented on the lack of equality in time between waves (2) and (4). The triangle pattern makes waves almost equal with wave (2) at 57 days and wave (4) around 70 days (by 2/6/09) for the Qs.
Traders should continue to look for the short side until there is resolution. While I continued to look for a breakout in January that never came, the trend models are short now and should stay that way for some time.
The above elliott wave analysis helps give a context for the market action and what we might expect, but the important point is to realize that the trend models brought us to a confirming conclusion without knowledge of the pattern. There are many different elliott wave patterns, and sometimes, the patterns are clear enough to trade, but knowledge of the pattern is not necessary for successful trading.
I am now and will remain 50% short during the completion of wave D down. I will exit short on approach to the November lows, and look for a new entry point on the next rally with an initial position of 50% short. As (and if) price rolls over after wave E up, I will be 100% short.
The triangle pattern projects a low in late February or early March with the Qs retesting the 2002 lows at or below 19.72. Wave E should retrace back up to today's highs or slightly higher offering traders with a chance for another 30% gain in wave 5 down.
Wednesday, January 21, 2009
Final Rally
The current upswing from the 1/20/09 low will be the final one of the rally from the November 21 low whether new rally highs are seen or not. The Gann turn date was 1/22/09 so it can a couple of days early. The next Gann date is 1/31/09. Originally I had envisioned the 1/22 date being a swing high followed by a pullback to the 1/31 date and a final high on 2/6. It now appears that the 2/6 date will not be the high, but a stopping point on the way to new lows in February. This dull and choppy rally has been wearing to say the least, but we are now getting to a point where the trend may get moving again. As I said I would yesterday I dipped my toe into with a 25% index short position. I will add to it once the current move is over.
There are now quite a few stock short setups that are showing up, and this rally will provide the entry pivot to get short on a break of the 1/20/09 lows. Some stocks will breakdown early, so you may want to look at some new short positions next week, and add to on a breakdown. I will be looking to exit what few long positions I have left as the rally fades. While I have been stopped out of most, RIMM has worked very well and should hit my target of 64.
As an observation, it is quite common to see a shakeout reversal the day after a sell signal, therefore today's rally does not in itself mean anything.
There are now quite a few stock short setups that are showing up, and this rally will provide the entry pivot to get short on a break of the 1/20/09 lows. Some stocks will breakdown early, so you may want to look at some new short positions next week, and add to on a breakdown. I will be looking to exit what few long positions I have left as the rally fades. While I have been stopped out of most, RIMM has worked very well and should hit my target of 64.
As an observation, it is quite common to see a shakeout reversal the day after a sell signal, therefore today's rally does not in itself mean anything.
Tuesday, January 20, 2009
All Trend Models Are Now Short
Today provided all that was needed to swing most of the remaining trend models into short status. However, today's volume was light which is inconsistent with wave 3 of (5), or iii of 1, as postulated by others. The 62% retracement from the November 21 lows lies just below most indexes, which leaves many interpretations on the table. We are quickly approaching a swing turn date of January 22/23 and the post election annual cycle shows a typical end of month rally in the indexes. I think the best approach here is to begin to look for suitable short trades in anticipation of a retest of the November lows in February, but with perhaps a 25% to 50% allocation to the short side. If the expected upcoming rally fails, add to the short allocation. On the other hand if we get a follow-through day, then look for potential new rally highs. I will wade in with a 25% short index allocation on any pullback in case the down trend accelerates, and add to it on a rally failure.
Interestly, the current behavior is beginning to look a lot like our originally postulated triangle. If that is the case, then the down side targets will be easy to project. Presently, the Dow projection is around 6422.
While we now have trend system confirmation of the downtrend, it may still be prudent to wait for a rally to position to the short side. As Dave has pointed out in the comments on the previous post, this current decline could be an X wave or failed 5th wave, either of which will punish the shorts, so caution is still advised.
Interestly, the current behavior is beginning to look a lot like our originally postulated triangle. If that is the case, then the down side targets will be easy to project. Presently, the Dow projection is around 6422.
While we now have trend system confirmation of the downtrend, it may still be prudent to wait for a rally to position to the short side. As Dave has pointed out in the comments on the previous post, this current decline could be an X wave or failed 5th wave, either of which will punish the shorts, so caution is still advised.
Monday, January 19, 2009
Introducing The Breadth Momentum System
It has been a while since I have added a new market trend system to the current list of trend following systems in the System Tracker. (As a side note, the System Tracker and trend following systems that I present are for educational purposes only.) This week I am introducing a proprietary system that I am calling the Breadth Momentum System. This system incorporates three components: market breadth, market momentum, and market trend. When all three components are in agreement with positive breadth, positive momentum and positive trend, the market is in a confirmed uptrend. When all three components are in agreement with negative breadth, negative momentum, and negative trend, the market is in a confirmed downtrend. The system goes to neutral when the momentum reverses from positive to negative or from negative to positive depending on the initial trend.
On January 7, 2009 the system signalled a confirmed uptrend and went neutral on January 15, 2009. At present, we are just one down day away from a confirmed downtrend. I expect that there will be some whipsaws with this system, however, my backtesting shows that they generally occur in clusters and once the system gets going, it keeps you in the trend for a long time.
On January 7, 2009 the system signalled a confirmed uptrend and went neutral on January 15, 2009. At present, we are just one down day away from a confirmed downtrend. I expect that there will be some whipsaws with this system, however, my backtesting shows that they generally occur in clusters and once the system gets going, it keeps you in the trend for a long time.
Saturday, January 17, 2009
Rally's Last Chance
The decline this week has surely seemed to bolster the bearish case, but there is still an outside chance that a significant rally may ensue next week until the end of January. The key level is thursday's (1/15/09) swing low of 28.07 in the Qs and 7995 in the Dow. As I stated in the previous post, this decline has the feel of a B wave, probably wave c of a flat correction. After reviewing 500 stock charts this morning, I found a significant number sporting 5 waves up from the November 21 lows followed by 3 waves down or sideways. What I did not find was a significant number of bearish looking charts. Yes, many stocks are down, but the patterns do not look bearish on the intermediate term.
A good example is GE which has 3 up and 3 down from November 21. GE could possibly hit 20 in the next two weeks. At the same time some markets are already testing the November lows, e.g. the DJ-20 transports and the financials, BKX and XLF. Finally, the Qs are now showing rising relative strength which has coincided with rallies for the past few years. Expect upside next week. If volume increases and the rally approaches the January highs, then new rally highs are probable. On the other hand if volume is weak and the rally stalls at the 50dema, I will looking to go 50% short for a retest of the November lows. I do not expect much downside below the November lows so profits will be taken there if seen.
Over the next few weeks I will begin showing trades I have taken for better or for worse on a weekly basis. I will do my best not to cherry pick. Constructive criticism is appreciated and I hope that the examples will be beneficial to readers.
Good trading next week.
A good example is GE which has 3 up and 3 down from November 21. GE could possibly hit 20 in the next two weeks. At the same time some markets are already testing the November lows, e.g. the DJ-20 transports and the financials, BKX and XLF. Finally, the Qs are now showing rising relative strength which has coincided with rallies for the past few years. Expect upside next week. If volume increases and the rally approaches the January highs, then new rally highs are probable. On the other hand if volume is weak and the rally stalls at the 50dema, I will looking to go 50% short for a retest of the November lows. I do not expect much downside below the November lows so profits will be taken there if seen.
Over the next few weeks I will begin showing trades I have taken for better or for worse on a weekly basis. I will do my best not to cherry pick. Constructive criticism is appreciated and I hope that the examples will be beneficial to readers.
Good trading next week.
Thursday, January 15, 2009
Wave 5 Follow-up
After perusing a number of sites this morning, I appear to be alone in my view that there is still upside potential in this rally. Of course, price has made new 3 week lows and the macd has given a sell signal. The Cabot Tides system gave a sell signal yesterday as well. In the current environment, we should not expect a move straight down to new lows, if that should be the course. My comments over the past week have been intended to temper the obvious bearish sentiment of traders. Consider, is it likely that a serious decline will be underway when so many see it? Everywhere I read from large public sites like CNBC and CBS Marketwatch to trading blogs I see sell, sell, sell. This, to me, is not a recipe for a continued short trade. If you are short and have not taken profits from the recent decline, you need an exit plan. Then stick to the plan. The fact is that if you were short, you were probably not trading a trend following system, but a swing system or the hourly charts. Just make sure you don't try to turn a swing trade into a trend trade and end up with a loss. If I am wrong about the bullish potential, I am confident that there will an opportunity to get short in the near future.
Wednesday, January 14, 2009
Are We In Wave 5 Yet?
I am sure the shorts were happy today, and rightly so. Anyone who has been short since the end of the year is mopping up right now, but it would not be prudent to gloat too much. This decline does not feel like a 5th wave, an impulse wave, to me at all. This is an intuitive thing and not something that I can easily communicate, but more often than not I have regretted trading against my intuition that has come from watching the markets daily for 10 years. However, perhaps a few observations can provide some perspective.
First, the intensity of the decline is missing, Although it is possible that this is just wave 1 of (5). Secondly, the cycles don't match up right. One thing that has been very reliable for the last 4 years is my understanding of the 10 month cycle, and we are in the early up stages of the 10 month cycle. It is true that the larger 4 year cycle is down, and other larger cycles as well, but the first part of the 10 month cycle rarely has a significant decline, rather something like we had from 2/1/08 to 3/17/08. Thirdly, a large number of stocks have come off the November bottom in 5 waves, which means another 5 wave impulse will follow in the near future. Fourth, today was the first day of this decline with more than 40 new NYSE lows, rather late in the decline to breach such a low threshold. Fifth, the McClellan Summation index has soared almost 5400 points from November 21 to January 8, the most explosive surge in my data set which goes back to 1986. And lastly, there are at least 6 realistic elliott wave counts for the current market action, and only one of those is an immediate decline in a 5th wave.
But foremost, the price action itself does not warrant taking a strong stance in either direction yet. While some indexes breached the December 29 lows today, others did not, and except for the Dow, volume has been relatively light. My conclusion is that this is most likely a B wave of some type. It either ends tomorrow or Friday with a strong rally into the end of January or we go down to test the October lows early next week followed by a strong rally. The question is how to trade this market action.
First, if the markets trade immediately down to the October lows, it will most likely be an excellent buying opportunity on any strong reversal. We should not expect a breakdown to the Dow 6000 right away. Second, any rally from current or slightly lower levels on weak volume that fails to trade above the January highs is an excellent shorting opportunity. Finally, any rally from current levels on strong volume is a buying opportunity with an expectation of new rally highs. While several trend short signals were generated today, I believe that it would be best to wait for another opportunity.
In September 2008, all aspects of the markets were synchronized to the downside: price, momentum, breadth and cycles supported by bullish sentiment that swung from bullish to panic by early October. Now, weekly momentum is up, price action is neutral, breadth is positive and the cycle is positive. This is not conducive to a great short opportunity. More time is needed for market forces to align for a strong move. So the best thing to do is to be patient and wait.
First, the intensity of the decline is missing, Although it is possible that this is just wave 1 of (5). Secondly, the cycles don't match up right. One thing that has been very reliable for the last 4 years is my understanding of the 10 month cycle, and we are in the early up stages of the 10 month cycle. It is true that the larger 4 year cycle is down, and other larger cycles as well, but the first part of the 10 month cycle rarely has a significant decline, rather something like we had from 2/1/08 to 3/17/08. Thirdly, a large number of stocks have come off the November bottom in 5 waves, which means another 5 wave impulse will follow in the near future. Fourth, today was the first day of this decline with more than 40 new NYSE lows, rather late in the decline to breach such a low threshold. Fifth, the McClellan Summation index has soared almost 5400 points from November 21 to January 8, the most explosive surge in my data set which goes back to 1986. And lastly, there are at least 6 realistic elliott wave counts for the current market action, and only one of those is an immediate decline in a 5th wave.
But foremost, the price action itself does not warrant taking a strong stance in either direction yet. While some indexes breached the December 29 lows today, others did not, and except for the Dow, volume has been relatively light. My conclusion is that this is most likely a B wave of some type. It either ends tomorrow or Friday with a strong rally into the end of January or we go down to test the October lows early next week followed by a strong rally. The question is how to trade this market action.
First, if the markets trade immediately down to the October lows, it will most likely be an excellent buying opportunity on any strong reversal. We should not expect a breakdown to the Dow 6000 right away. Second, any rally from current or slightly lower levels on weak volume that fails to trade above the January highs is an excellent shorting opportunity. Finally, any rally from current levels on strong volume is a buying opportunity with an expectation of new rally highs. While several trend short signals were generated today, I believe that it would be best to wait for another opportunity.
In September 2008, all aspects of the markets were synchronized to the downside: price, momentum, breadth and cycles supported by bullish sentiment that swung from bullish to panic by early October. Now, weekly momentum is up, price action is neutral, breadth is positive and the cycle is positive. This is not conducive to a great short opportunity. More time is needed for market forces to align for a strong move. So the best thing to do is to be patient and wait.
Tuesday, January 13, 2009
The Qs have pulled back to the neckline of the head and shoulders bottom pattern shown in the above chart. The HS Bottom target is 34.89. The next move of consequence should be a rally of at least 5 days and possibly 10 days with an ideal cycle top date at the end on January and a near term swing turn date of January 22. The ideal cycle top date is the top of the 11 week cycle which 1/4 of the 10 month cycle. The swing turn date is a Gann based on 144 calendar days. The previous Gann turn date by this method was January 6, the exact day of the recent top, so January 21/22 may hold some significance.Currently, the upper channel line (not shown) of the rally from November 21 projects a high in 5 days around 34.10. The Dow projects a high in 5 days around at 9789, which seems unlikely, but certainly possible. Only a break below the December 29 lows will alter this probable outcome.
Monday, January 12, 2009
Before You Decide To Get Short
(Click To Enlarge Chart)The above chart of the XLF has been intriguing me for a couple of weeks now, and I think the pattern has become exceptionally clear. The XLF moved up in 3 waves off of the November 21 low, which has been followed by a long B wave. The reason it is so clear that it is a B wave is that we can see that waves a and c of B are separated by a triangle. This pattern is even more clear in JPM. If this analysis is correct then the current decline is nearly over and a two week rally should follow. Wave c of B should complete in the next 1 to 3 days. Wave A lasted 10 days and by symmetry, wave C should last approximately 10 days. I find it hard to imagine a scenario in which the major indexes continue to fall while the financials are rallying, so I am going to go out on a limb and say that I expect new rally highs by the end of January in all major indexes. I suspect this rally will surprise many traders who are now looking for new bear market lows. For those of you who have positioned yourselves short, I recommend keeping a tight leash on those positions and be prepared to get long for a swing trade above today's high.
I have repeatedly cautioned against being heavily positioned one way or the other since early December, and so far I think that recommendation has been a good one. I know that many have made profits trading the beaten down stocks for quick gains, and that has been a good trade to be sure. However, don't get attached to either direction.
Note that there were only 12 NYSE new lows today. Hardly indicative of an impulsive decline.
Friday, January 9, 2009
Close But No Cigar
The attempted breakout has failed, but a resumption of the downtrend has not yet been signaled. All indexes but the Dow are at or above the lower trendline from the November 21 lows. It is not at all uncommon to see whipsaws like this in January. Look at the Qs in January of 2000, 2006 and 2007. I realize that sentiment is or has reached extreme levels, but after the kind of decline we had last fall, this can sometimes signal the initiation of an uptrend. I am hearing too many comments about this rally failing from public domains to want to get fully short again. NYSE new lows were 7 on Wed, 8 on Thu and 7 today. That does not support the idea of distribution. At this point I am cautiously bullish on this rally until proven otherwise. I think the best opportunity for getting short again will come in February. Regardless of what I think, I will go with what price dictates.
Today I exited short positions in FCN(+28%), FAST(+32%), GPC(-4%), STRA(+9%). I was stopped out of AFAM(-15%) today, but am currently up in MEA(+22%). I am still short in MCO(+39%) and JPM(+12%). Note, I mentioned AFAM and MEA earlier this week.
Next week, I will be looking to add index long positions if the rally resumes, or index short positions if the decline continues. However, there is support at Dow 8350 and QQQQ 28.50. I would not be at all surprised to see the indexes take off Monday morning with the employment report behind us, but upside targets are diminished with the depth of this week's decline.
My recommendation is to be cautious in the current environment with smaller position sizes and fewer positions.
Today I exited short positions in FCN(+28%), FAST(+32%), GPC(-4%), STRA(+9%). I was stopped out of AFAM(-15%) today, but am currently up in MEA(+22%). I am still short in MCO(+39%) and JPM(+12%). Note, I mentioned AFAM and MEA earlier this week.
Next week, I will be looking to add index long positions if the rally resumes, or index short positions if the decline continues. However, there is support at Dow 8350 and QQQQ 28.50. I would not be at all surprised to see the indexes take off Monday morning with the employment report behind us, but upside targets are diminished with the depth of this week's decline.
My recommendation is to be cautious in the current environment with smaller position sizes and fewer positions.
Thursday, January 8, 2009
What Matters Is Profit
Prior to reading the little book titled The Adam Theory of Markets or What Matters is Profit by Welles Wilder I had been consistently losing money trading. Most of my efforts had been expended in trying to find the perfect method for predicting market movements. I had spent a considerable sum on subscription services to a variety of well known trading gurus that claimed to have solved the riddle of the markets only to be disappointed time and again. While I do not use the method described in the book, a story in the book helped changed my perspective on the markets.
In the beginning of the book, Mr. Wilder tells a tale about an aspiring trader who is attempting to explain to his young daughter what he is doing. As he shows her his trading screen he tells her that he is buying because the market is going to go up. He is certain of this because special numbers called the Azerhoff numbers are signalling that the market is going to go up. After listening to his explanation, the young daughter replies, “but daddy, it looks like it’s going down to me”. Frustrated, the aspiring trader tries to reassure his daughter that the Azerhoff numbers mean that the market will go up. Again she responds, “it still looks like it’s going down to me”. Eventually, the frustrated trader exits the trade for a loss.
The point of the story, of course, is that all market indicators and theories are secondary to price and even a young child can look at the chart and see which way the price is going. If we are long a market, we profit when we sell at a higher price that we bought, regardless of what the indicators or prognosticators say. Ultimately, it is always price that determines our actions in one way or another. Certainly, we can use indicators to help us anticipate, i.e. be prepared for, changes in trend, but the movement of price alone determines the trend. By learning to see and follow the trend in price, we can come to accept what the market gives us without being overcome by the emotions of fear and greed. Trading can then become an enjoyable and profitable experience.
The question arises as to what trend to trade. The trend can be different on different time frames. The approach that I have found that works the best is to look at three different time frames. Two examples are Monthly, Weekly, Daily and Weekly, Daily, Hourly. The smallest time frame is the trading time frame. When the higher two time frames are in agreement, we enter trades in the same direction on the smallest time frame.
Marketclub’s Triangle Technology is a good example of a method that employs the above approach. The Monthly trend is up when the market makes a 3 month high. The Weekly trend is up when the market makes a 3 week high. We enter long on the Daily time frame, i.e. on a specific day, when today’s price exceeds the high of the prior 3 weeks.
This same approach can be generalized to any number of trend following methods. For example, moving averages, macd, swing points and volatility breakouts can all be used to identify the trend. On Friday January 2, 2009 the major indexes closed above their 20 day 2.0 SD Bollinger bands giving an exit signal for short positions using a volatility system.
Currently, there is a great deal of speculation about the current elliott wave count for the markets. Many traders are increasing short positions in expectation of a final fifth wave down to new lows, but that may be a dangerous and costly position to take. The Monthly trend is still down, but the Weekly and the Daily trends are up. At the same time many market commentators have already declared an end to the bear market. This, too, may be a dangerous and costly position to take given the direction of the Monthly trend.
Even though the market stance is neutral using the Monthly, Weekly, Daily time frames, we can still profit from a potential rally in January. Since the Weekly and Daily time frames are now up as long as the market does not make a 3 week low and trades above the prior week’s low, the hourly time frame can now be used for entries and exits with a long bias. Ideally, we should wait for a pullback that does not break the prior week’s low, and then enter long on the hourly chart on a breakout above the prior day’s high. Trail a stop using a 3 hour low or a break of the prior day’s low with a view to exit at predetermined targets. Remember to adjust your risk on the trade accordingly, and do not trade this method if you cannot watch the markets intraday.
In conclusion, speculation about potential market movements can help us realize possible outcomes and manage expectations, but we should only trade the price for profit and not opinions and expectations. Short opportunities may come again soon if the Weekly trend turns down, but don’t bet on it just yet.
In the beginning of the book, Mr. Wilder tells a tale about an aspiring trader who is attempting to explain to his young daughter what he is doing. As he shows her his trading screen he tells her that he is buying because the market is going to go up. He is certain of this because special numbers called the Azerhoff numbers are signalling that the market is going to go up. After listening to his explanation, the young daughter replies, “but daddy, it looks like it’s going down to me”. Frustrated, the aspiring trader tries to reassure his daughter that the Azerhoff numbers mean that the market will go up. Again she responds, “it still looks like it’s going down to me”. Eventually, the frustrated trader exits the trade for a loss.
The point of the story, of course, is that all market indicators and theories are secondary to price and even a young child can look at the chart and see which way the price is going. If we are long a market, we profit when we sell at a higher price that we bought, regardless of what the indicators or prognosticators say. Ultimately, it is always price that determines our actions in one way or another. Certainly, we can use indicators to help us anticipate, i.e. be prepared for, changes in trend, but the movement of price alone determines the trend. By learning to see and follow the trend in price, we can come to accept what the market gives us without being overcome by the emotions of fear and greed. Trading can then become an enjoyable and profitable experience.
The question arises as to what trend to trade. The trend can be different on different time frames. The approach that I have found that works the best is to look at three different time frames. Two examples are Monthly, Weekly, Daily and Weekly, Daily, Hourly. The smallest time frame is the trading time frame. When the higher two time frames are in agreement, we enter trades in the same direction on the smallest time frame.
Marketclub’s Triangle Technology is a good example of a method that employs the above approach. The Monthly trend is up when the market makes a 3 month high. The Weekly trend is up when the market makes a 3 week high. We enter long on the Daily time frame, i.e. on a specific day, when today’s price exceeds the high of the prior 3 weeks.
This same approach can be generalized to any number of trend following methods. For example, moving averages, macd, swing points and volatility breakouts can all be used to identify the trend. On Friday January 2, 2009 the major indexes closed above their 20 day 2.0 SD Bollinger bands giving an exit signal for short positions using a volatility system.
Currently, there is a great deal of speculation about the current elliott wave count for the markets. Many traders are increasing short positions in expectation of a final fifth wave down to new lows, but that may be a dangerous and costly position to take. The Monthly trend is still down, but the Weekly and the Daily trends are up. At the same time many market commentators have already declared an end to the bear market. This, too, may be a dangerous and costly position to take given the direction of the Monthly trend.
Even though the market stance is neutral using the Monthly, Weekly, Daily time frames, we can still profit from a potential rally in January. Since the Weekly and Daily time frames are now up as long as the market does not make a 3 week low and trades above the prior week’s low, the hourly time frame can now be used for entries and exits with a long bias. Ideally, we should wait for a pullback that does not break the prior week’s low, and then enter long on the hourly chart on a breakout above the prior day’s high. Trail a stop using a 3 hour low or a break of the prior day’s low with a view to exit at predetermined targets. Remember to adjust your risk on the trade accordingly, and do not trade this method if you cannot watch the markets intraday.
In conclusion, speculation about potential market movements can help us realize possible outcomes and manage expectations, but we should only trade the price for profit and not opinions and expectations. Short opportunities may come again soon if the Weekly trend turns down, but don’t bet on it just yet.
Wednesday, January 7, 2009
A Day For The Bears
There are many who are now declaring that the rally from the November 21 lows is over, and they may be right. However, although today's decline may have seemed severe on the surface, it is too soon to call an end to the rally so soon after last Friday's breakout.
The lower trendline from the November 21 lows is still intact, the head and shoulders breakout is still intact, today's NYSE new lows was less than 10, and volume declined on most indexes from the day before. I did buy yesterday's breakout above the January 5 high and was stopped out today. I will be looking to go long again on a move above 30.87 in the Qs and 8885 in the Dow.
As I discussed in an earlier post, from a cycles point of view, we should have seen the decline continue from the mid-December high for a continuation into a late January low. Since that didn't happen, the most likely outcome would be for the rally to continue into late January with a decline in February.
At this point, a lot more damage will need to be done into to switch back the bear camp. In particular a break of the lower trendline and a break of the December 29 low. Until then we should expect higher prices. If Friday's employment report should come in anywhere under today's ADP report, that will be all the fuel the bulls need to push the rally higher.
The lower trendline from the November 21 lows is still intact, the head and shoulders breakout is still intact, today's NYSE new lows was less than 10, and volume declined on most indexes from the day before. I did buy yesterday's breakout above the January 5 high and was stopped out today. I will be looking to go long again on a move above 30.87 in the Qs and 8885 in the Dow.
As I discussed in an earlier post, from a cycles point of view, we should have seen the decline continue from the mid-December high for a continuation into a late January low. Since that didn't happen, the most likely outcome would be for the rally to continue into late January with a decline in February.
At this point, a lot more damage will need to be done into to switch back the bear camp. In particular a break of the lower trendline and a break of the December 29 low. Until then we should expect higher prices. If Friday's employment report should come in anywhere under today's ADP report, that will be all the fuel the bulls need to push the rally higher.
Monday, January 5, 2009
Pullback May Be Over
Today's decline appears clearly as 3 wave pullback, which implies strongly that higher prices are coming. Of course, any pullback can extend, however, the indexes held solidly above the 50dema. Swing traders can trade a breakout above the January 2/5 highs with a target around the November high. Most intermediate term trend following systems are neutral, so intermediate terms traders may want to sit this one out. It has been a difficult rally to trade. Some quality breakouts in individual stocks are beginning to show up, but the pickings are slim. The biggest gainers are the beaten down stocks such MEA which was up 36.87% today. As far as breakouts are concerned, CSKI and MYGN had nice moves today.
Saturday, January 3, 2009
Buy Signals Abound
I have been discussing now for several weeks that it appeared we were in wave C up of a triangle. While there is a remote chance that we are still in wave C, the lack of year-end selling coupled with a breakout to new highs for the rally reduces that probability considerably. Elliott Wave International has now introduced an alternate count that puts us in the early stages of wave C of a double zigzag upward correction and I think that view together with the positive 10 month cycle is the most probable case. There are many possible targets at this point, but the most likely target is the 200dema, which for the Dow is now around 10,470 and the for the Qs is around 38.45 so we could see Dow 10,000 and QQQQ 37.50 by the time the 200dema is hit.
The TC2000 McClellan Oscillator hit a new all time high this Friday at 328.28. This is near term bearish and intermediate term bullish. Therefore, we may see a 1 to 4 day pullback next week followed by more rally. The continuation of the rally into the first day of the year reduces the likelihood that the 11 week cycle turn date will be a significant low. It will most likely be a high or a minor swing low, so we should expect the rally to continue into the 3rd or 4th week of January.
The only thing that will negate this view is a break of last week's low on higher volume.
Let's look at the positive signals that have occured as of Friday 1/2/09:
Head and Shoulders Bottom Breakout
20 Day Donchian Channel Breakout
Positive Divergence MACD Buy signal still in force
Daily Bollinger Band Squeeze setup on the daily charts
3 Week Buy signal still in force
Weekly MACD Buy signal close call (needs one more week)
10-15demas Crossing Up the 20-30demas
Cabot Tides are neutral
Cabot Two Second Indicator is bullish
IBD Confirmed Rally
McClellan Summation Index is soaring
On the negative side, we have:
McClellan Oscillator extremely overbought
Declining volume every week of the rally
Friday's breakout was on significantly lower volume than previous December high
% Stocks Above 40ma is at a two year high of 82.86%
Sentiment by many measures is now very bullish
Overall, the weight of the evidence supports the continuation of this rally. However, it may be prudent to wait for a pullback to enter new long positions. Many trend following systems are not on buy signals yet, so depending on the system or systems you are using it may also be prudent to reduce position size regardless of how confident you are in the rally.
This is not a time to double up short positions. This is a time to be exiting short positions that are not working and looking for viable long positions. This is not the time to chase after stocks that are extended, e.g. RMBS and RGLD, but look for stocks that are setting up such as AFAM, MYGN, and HOMB. Lastly, if you have not been already entering long positions, this is not the time to go all in either. Look to enter no more than two or three new positions in a week. If the rally fails, your losses will be reduced.
I have invested a lot of time in this blog looking at the bearish case, but regardless of elliott wave or sentimemt, price is saying higher and the profits will be in the direction of price.
The TC2000 McClellan Oscillator hit a new all time high this Friday at 328.28. This is near term bearish and intermediate term bullish. Therefore, we may see a 1 to 4 day pullback next week followed by more rally. The continuation of the rally into the first day of the year reduces the likelihood that the 11 week cycle turn date will be a significant low. It will most likely be a high or a minor swing low, so we should expect the rally to continue into the 3rd or 4th week of January.
The only thing that will negate this view is a break of last week's low on higher volume.
Let's look at the positive signals that have occured as of Friday 1/2/09:
Head and Shoulders Bottom Breakout
20 Day Donchian Channel Breakout
Positive Divergence MACD Buy signal still in force
Daily Bollinger Band Squeeze setup on the daily charts
3 Week Buy signal still in force
Weekly MACD Buy signal close call (needs one more week)
10-15demas Crossing Up the 20-30demas
Cabot Tides are neutral
Cabot Two Second Indicator is bullish
IBD Confirmed Rally
McClellan Summation Index is soaring
On the negative side, we have:
McClellan Oscillator extremely overbought
Declining volume every week of the rally
Friday's breakout was on significantly lower volume than previous December high
% Stocks Above 40ma is at a two year high of 82.86%
Sentiment by many measures is now very bullish
Overall, the weight of the evidence supports the continuation of this rally. However, it may be prudent to wait for a pullback to enter new long positions. Many trend following systems are not on buy signals yet, so depending on the system or systems you are using it may also be prudent to reduce position size regardless of how confident you are in the rally.
This is not a time to double up short positions. This is a time to be exiting short positions that are not working and looking for viable long positions. This is not the time to chase after stocks that are extended, e.g. RMBS and RGLD, but look for stocks that are setting up such as AFAM, MYGN, and HOMB. Lastly, if you have not been already entering long positions, this is not the time to go all in either. Look to enter no more than two or three new positions in a week. If the rally fails, your losses will be reduced.
I have invested a lot of time in this blog looking at the bearish case, but regardless of elliott wave or sentimemt, price is saying higher and the profits will be in the direction of price.
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