Thursday, December 31, 2009

A Review Of The Modified Donchian Channel System

(I accidentally posted this before it was edited and complete, so check out the finished post.)

The Donchian Channel trading method was popularized by Richard Dennis as part of his Turtle Trading system. It could not be simpler. Just go long an N period high and then sell or sell short an N period low. Clearly the success of the Turtle traders proves the validity of this method. doesn't seem to work too well with stocks and stock indexes. In the book, Way of the Turtle by Curtis Faith, the system tests results are based on commodities, currencies and treasuries, but not stocks or stock indexes. (This is a great book for understanding the philosophy behind trend following systems.) I think there is a good reason for that. While I haven't run any tests myself on the original system, anyone who tries to trade it on stocks will quickly get frustrated with the long strings of losses and small profits with just enough big wins on occasion to make you think it's going to work. The obvious problem using the method with stocks led to the Turtle Soup method, which is essentially the same system in reverse, and has led many to claim that it doesn't work at all.

Of course, this is nothing new. I've heard it all before: moving averages don't work, the macd doesn't work, elliot wave doesn't work, trend following doesn't work, and on and on and on. An analogy might be helpful. Imagine someone who has no experience with golf, who has never seen a professional or successful golfer play, but perhaps has heard about the joys of playing golf from friends and family and wants to learn how to play. This person goes out and buys an expensive set of golf clubs and a couple of books, and then heads off to the driving range. How hard could it be? Just hit the little ball with the club. We all now how it's going to turn out - slices, blocks, hooks, shanks, poor distance and frustration. Even after expensive lessons there is likely to be little improvement. The novice soon concludes that it is impossible to consistently hit a long straight shot with a golf club. Whoever invented the golf club surely didn't know what they were doing. Except we know that isn't true. We have many great examples from professional golf that prove that one can hit great golf shots with a golf club. The problem is there are very few people who know how to teach other people how to use one even if they can use it well themselves. The same holds true with trading.

Using the Donchian Channels for stocks and stocks indexes requires some minor tweaking and a little discretion to make it work. I call this the Modified Donchian Channel System. The changes from the original system are based on a couple of observations. First, stocks don't trend as well as commodities and currencies. Second, stocks have an underlying bullish bias. And third, stocks tend to have more false breakouts. So the first modification is that we require CONFIRMATION on all sell and sell/short signals, and long signals that fail to CLOSE at new 20 day high. The second modification is that we do not go short on all sell signals, but only go SHORT when the stock or index is BELOW THE 200DEMA. Third, we use FAILURE SWINGS to help indentify turning points and avoid false signals. And finally, 20 day lows are often a great time to buy stocks.

Let's look at the Qs during 2008 with two channels on the chart. The channels are 20 days and 10 days with 1 day forward offet. The 20 day channels are for buy and sell signals, and the 10 day channels are to help identify failure swings. They should be used for exits only.

The first short signal occurs on 1/4/08. This is a valid sell signal because the previous 20 day low occurred on 11/12/07, there was no intervening 20 day high (closing basis) and the Qs were below the 200dema. On 1/4/08 the Qs closed below the 11/12/07 low CONFIRMING the short signal.

On 3/18/08 there was a failure swing. On 1/23/08 the Qs made a new 20 day low, and then 6 weeks (a long time) later on 3/10/08 there is a new 20 day closing low. There was another attempt with a new intraday 20 day low on 3/17/08, but on 3/18/08 the Qs closed above the highest close of the previous 12 days. So we exit short, but do not go long. This one is somewhat discretionary.

On 3/24/08, the Qs close at a new 20 day high. This is a long signal. After a downtrend with a long period of sideways consolidation and a failure swing, CONFIRMATION is not required.

The double top on 6/5/08 followed by a new 20 day closing low on 6/11/08 confirms a swing failure, and we exit long. This is not a short signal. On 6/24/08, the Qs make a new 20 day closing low below the 200dema CONFIRMING the sell signal and we go short.

On 8/6/08 the Qs make a new 20 day closing high and we exit short and go long. On 9/4/08 the Qs make a new 20 day closing low. On 9/5/08 there is another new closing low CONFIRMING the sell signal so we exit long and go short since the Qs are below the 200dema.

On 1/2/09 the Qs make a new 20 day closing high, so we exit short and go long.

Below is the same chart of the Qs for 2009.

On 1/24/09, there is a new 20 day closing low. We exit long and go short. I should've waited for another new closing low to CONFIRM the signal, but hey, I'm not perfect. On 2/6/09 there is a 20 day closing high, but it fails to close above the 1/6/09 high so we need to wait for CONFIRMATION, which does not come as the Qs do not close above the 2/6/09 high on 2/9/09 and then head down to the 3/9/09 low, which is not a new bear market low, but a retest of the 11/21/09 low.

On 3/17/09, there is a new 10 day closing high, which would have been the best place to exit short due to a failure swing. I missed it.

On 3/18/09, the Qs make a new 20 day high, but close poorly making it a good idea to wait for CONFIRMATION. CONFIRMATION comes on 3/23/09 and we have been long ever since.

I realize these rules do not permit a completely mechanical approach, at least not easily. However, they can be implemented successfully with a little experience. You only need to use common sense, wait for CONFIRMATION when prudent, and learn to identify swing failures.

The above examples show that one can be successful even with a few mistakes. Let's get real folks. We are going to make mistakes. To pretend that we aren't is to deceive ourselves. I hope this helps.

Wednesday, December 23, 2009


This week's low volume breakout may end up being something, but I doubt it. I am just waiting for the next valid signal.

I promised a chart this week, but it'll have to wait until next week. Holiday preparations have taken my time this week.

Happy holidays!

Monday, December 21, 2009

Transports Closing In On A High

The Dow Transports appear to be closing in on a 5th wave high. The above count is a clean 5 wave impulse that really did not become entirely apparent to me until December 4th. This count does throw a kink in my view that the 10 month cycle low is coming in January as we would expect a correction that lasts at least 1/3 the length in time as the impulse. However, there is at least one solution that would satisfy both constraints, and it is one that I am beginning to think may be true for the other major markets, and that is a triangle. But, that is pure speculation on my part.

Regardless of the new highs today, low volume, momentum divergences, and weak breadth all point to an impending correction. It doesn't have to be a severe correction, but a typical correction would be at least 33% to 38% of the preceding move. The new highs in the Qs also allow for a 5 wave count although it is not as appealing as the count in the Transports. Thus, we could expect a move back down to the June highs, which was the original projection with the zig zag count back in September and October. This is probably deeper that most are anticipating, but we should be on guard for it nonetheless.

I need to make one additional point from this exercise. If the above count is correct, then this bear market rally is not over, as there must be at least one more 5 wave sequence to finish the rally. This contradicts the many primary wave 3 scenarios that have become so ubiquitous lately.

To JK: I will post a Donchian Channel chart this week.

Friday, December 18, 2009

The Party Just Keeps On Going

Trying to figure out what this market is going to do can make you crazy. Today's action in the Qs looks very much like an upward double zigzag that could resolve to the downside, but the extent of the rally means that selling must resume fairly quickly Monday. The problem with that is the Wilshire and the Dow look like they have another upmove to go before completing their respective upward corrections, which means there is a strong likelihood the Qs will make a new rally high on Monday. This doesn't destroy the bearish case as the Qs often are the last to top, but it certainly puts a kink in it.

All that said, unless and until we see multiple indexes closing at new rally highs on higher volume we should assume that a correction will occur. I wouldn't put too much "stock" in next week's action as I suspect few professionals will be trading, but the week after Christmas should be telling.

Have good weekend and enjoy the snow if you can.

Thursday, December 17, 2009

Correction Underway - Again

On Monday I said, "If am feeling this emotion, I am sure there are many others. I have felt this before, and usually it means there is a top at hand." Yesterday the Wilshire 5000 Index made a new rally high right at mid-day and has since fallen in a very clear 5 wave impulse move. At this point, we can expect a retracement rally. If it is a simple move, it could end tomorrow or early Monday. If it is a complex move, it could last most of next week. However, I expect that the selling will accelerate the week after Christmas.

Afterhours, RIMM and ORCL both beat earnings expectations, and RIMM is up substantially, but that will probably not be enough to keep this correction from gaining steam. Time is an issue though as I am projecting at least some type of low around January 4. Whether or not that is the low of the correction cannot be determined yet, but I am expecting that we will at least see a retest of the November lows in the Qs and a move to 9700 to 10000 in the Dow before this correction is over.

What I have been pretty clear about is that I do not believe that yesterday's high was the top of primary wave 2 and that this is the start of the dreaded wave 3 armageddon in stocks. A low should be seen in January that will be the last best buying opportunity for some time, in my opinion.

Wednesday, December 16, 2009

Tuesday, December 15, 2009

No Breakout Yet

It looked like there might be a breakout attempt early this morning, but it fizzled out. Now we are only 1 to 3 days away from a cycle high, and 4 days away from the winter solstice on December 21. The longer we go with no breakout, the greater the probability of a breakdown.

The above chart shows that both the MACD and the RSI of the Qs have not broken out above their trendlines. This is a must, in my opinion, to validate any breakout.

Monday, December 14, 2009

A Thought Or Two On Discipline

Discipline means more than just following your rules. First and foremost it means not being swayed by one's everchanging emotions to deviate from the chosen course of action. If there is a valid reason to change course, then there is certainly nothing wrong with that, and often it becomes clear that one should change course. However, when the impetus to change is due to a feeling of regret, disappointment or greed, then the change is likely destructive.

The market is a great barometer of the public mood, and it is not likely that we can avoid the emotions that it is communicating to us. Time and again I have found myself imagining the incredible profits that might be realized if a position achieves some extraordinary target. When that happens I know that I have fallen under the spell of the market, and if I, a usually disciplined trader, have fallen under its spell, then perhaps the majority has, and it's probably time to exit the position. It is rare that this emotional cue, when recognized, has failed to save me from a sudden swoon.

Yesterday and today, I have been battling a different demon. All of my reasoning aside, it feels like the market wants to blast off. The temptation is to just dump my short positions and reverse and go long. I can easily calculate potential targets that would make such a move justifiable. However, I also know that the market is communicating something, that the desire for higher prices has become so palpable that it is beckoning me with its siren call to buy, buy, buy. As much as I might want to do that, it makes no sense to do so. Even if it was profitable this time, next time it might not be. I must be willing to lose, unless there is truly a justifiable reason to change course. If I am feeling this emotion, I am sure there are many others. I have felt this before, and usually it means there is a top at hand.

Maybe the market's siren call to buy will be right and I will feel regret, but better regret than to be a puppet.

NYSE A/D Line Breaks Out To New High

The NYSE A/D line broke out to a new rally high today, while the Absolute Breadth Index turned up from its low on Friday. It would not be at all surprising to see new highs in the indexes tomorrow, but the question is whether or not these new highs will hold. At the moment, I will be content to be stopped out of index short positions with stops that are above the recent highs and wait for a retest of the break out levels before going long if the retest holds.

On the daily chart the pattern in the Qs looks like a running triangle, but on the 30 min chart, it is not so clear. If it is a triangle, that would point to a high in the near future as triangles always precede the final wave in a movement.

I still suspect that any new highs this week will be a fake-out until proven otherwise.

Sunday, December 13, 2009

2010 Trading Plan

If you haven't already done so, it's time to start working on your 2010 trading plan. I have been working on mine over the last week. I was quite happy with my 2009 plan, but changes in margin requirements for the double leveraged ETFs have forced me to change that approach, which is probably a good thing because although the plan has worked well overall, it has suffered due to too much concentration which has lead to excessive portfolio volatility. My goal in 2010 is to increase return and reduce volatility. I am measuring volatility using month to month returns. The goal here is to get the standard deviation of monthly returns to be less than 4% to 6%. Studies have shown that the expected maximum drawdown can be estimated by multiplying the standard deviation of monthly returns by 5. So the above target would produce a theoretical maximum drawdown of 20% to 30%. If I can do better, then great.

I have found that although some advisors, like Investor's Business Daily, recommend trading only a few positions, that trading more positions using multiple systems reduces volatility. And I like the challenge of managing more positions, so it is a win/win.

I am going to divide my portfolio into 6 groups: Core, Majors I, Majors II, Stocks I, Stocks II and Commodities. The Core group will consist of 6 SPDR sector ETFs. I will trade these using the Swenlin Trend Model found at Decisionpoint. The method is explained under the Learning section. I expect that trading will be infrequent and occasionally go into a neutral stance, which should reduce risk exposure. The Majors I group will consist of 2 major index ETFs. I will trade one using the MACD as demontrated in the System Tracker, and the other using IBD's market calls. Again the trading in this group will be relatively infrequent although there has been alot of action with IBD this year. The Majors II group will consist of 2 major index ETFs. I will trade this group using short term methods including fading the trend when appropriate. The Stocks I group will consist of 4 stocks that I will trade using intermediate and long term methods. The Stocks II group will consist of 4 stocks that I will trade using short term methods. The Commodities group will consist of 3 positions in gold, oil, and one other commodity or commodity index. I will trade gold using the fractal trading method as described in the book Trading Chaos by Bill Williams. I will trade oil using Monthly trade triangles as used by Market Club.

The total maximum number of positions is 21. This may seem like of lot to keep up with, but only 3 of the groups and 8 positions will require short term management. This plan gives me diversity of markets, diversity of methods, and diversity of time frames. We will see how it works out.

Saturday, December 12, 2009

Dollar Breakout

The US Dollar Index continued its breakout from last Friday this week. With multiple buy signals including a positive divergence MACD buy signal, trendline breakout, and a clear 5 wave impulse move from the 11/25 low, there is little doubt that higher prices will be seen. However, some sort of pullback lasting 3 to 5 days could occur beginning next week. This could very well be the impetus for a false breakout in the stock indexes, which would be followed by a reversal once the Dollar rally continues. The effect of the Dollar rally on the stock indexes may be muted if the recent action is any indication as the indexes have been flat, not down, during the first leg of the rally. That could change though.

Friday, December 11, 2009

The Squeeze Continues

There is little to add tonight. The tightest squeeze in the indexes that I have seen in years is still in progress. This setup occurs more frequently in individual stocks. The bands usually only stay this flat for 6 days, rarely longer, which puts the end of the setup at Monday and the start of the breakout on Tuesday. This is only a guess, of course.

A similar setup in the SP500 occured in December 2005. The index first fell to the lower 1.50 Keltner band, but reversed and broke out to the upside. The current setup is widely known, whether in the above format or not, as almost everyone recognizes the tight trading range of 30 to 35 SP points over the last 4 weeks. We all know what happened after the most widely recognized head and shoulders top formed in June this year. It faked a breakdown and then reversed to the upside. I think the same type of thing will happen here. The first breakout attempt will be the false one, after which it will likely reverse and show us the real move.

I have updated my turning point and cycle calculations. The next turning point occurs next week on December 16 followed by the 10 month cycle low projection on January 3-4. At this point a sharp move down to the 200dema may be all that we see with such a short window of time.

The Absolute Breadth Index fell to its lowest point since May 2007 today. Another indication that a turning point is at hand.

Thursday, December 10, 2009

Absolute Breadth Revisited

The Absolute Breadth Index measures the absolute difference between the number of advancing and declining issues. The original theory was that a high reading would be expected at bottoms and a low reading at tops. At bottoms there are typically a large number of declining issues compared with advancing issues. At tops the number of advancing issues tends to fall first making the absolute difference between advancers and decliners low.

I have labelled the extreme readings in the Absolute Breadth Index above from March 07 to the present. Out of 12 high readings 8 are bottoms and 4 are tops. Out of 7 low readings 5 are tops, 1 was an acceleration point, and the current low reading is to be determined. I could have labelled one more low reading as a top from Feb 07. So, the theory seems to be supported by the market action over the last 3 years. However, one could say more generally that extreme readings are associated with market turning points.

Market volatility continues to contract and low volatility is generally followed by high volatility. Something big is going to happen soon. The only question is what. While the current action could very well be setting up to be another acceleration point, until resistance is overcome with force, there is little reason to believe that will the case. The probability lies with topping action as the SP500, in particular, remains under strong resistance.

It is encouraging to know that we should soon see a resolution to the current tight action. If it doesn't turn out to be a top, then I'll have to do what I did with gold, ie go with it. That turned out great, and this should too.

Wednesday, December 9, 2009

Dull and Duller

Never short a dull market is an old adage, and perhaps it is fitting for the current environment. That said, I remain 1/2 short against the rally highs after re-entering short positions last Friday. The NYSE Advance/Decline line is not giving us any indication which way this market is going to go, but the MACD of the A/D line is starting to roll over which may point to a downside breakout.

A second clue is that the Dollar index broke out above its downtrend line on Friday and is holding above it. It is only normal to see a retest of that line, which is in progress. More upside in the Dollar is expected and that should correlate to lower stock prices.

Oil is near the limit of its downward correction from the October high, stopping right at its 200dema. It must hold above the September lows to prevent a retracement to the $50 to $55 level. Also, oil is coming in on a 55 day cycle low, a pattern that has been in place since the April low. The overall character of the decline from the October high is corrective, not impulsive, and one possibility is that all of the action from the June high is part of a much larger running triangle. In that case, the current downmove is wave C of the triangle. Even so, oil should not move below the 61.8% RT of wave (B) (7/13 low to 10/23 high) which is 67.53. This level is still above the September low. Therefore, any sustained move below that level must be considered as a larger correction to the 50 to 55 zone.

Tuesday, December 8, 2009

Another Distribution Day

The distribution days keep piling up, but the downside action has been muted. The longer the market can levitate as we move toward the anticipated 10 month cycle low date in early January, the greater the likelihood this will remain a sideways consolidation that will lead to continuation breakout in the new year.

However, today the NYSE advance/decline broke down below its trendline for the rally from the March low signalling that all is not well. The breakout in utilities, the decline in financials, the rally in the Dollar and selloff in gold all point to a change in sentiment that begs for a correction. Clearly there is a desire to maintain the extraordinary gains from the March low into the end of the year, but success in this regard could lead to a more vicious downdraft after the new year. That event should it occur would be the next great buying opportunity in my opinion.

A 40 trading day cycle has developed since the March low which projects a high mid-week next week. This will probably be a lower high as it was on July 1. Momentum as measured by the MACD moved lower today suggesting that we will see lower prices this week. I suspect that with TXN selling off after hours we will see lower prices this week followed by a rally into the cycle high next week and then a more pronounced selloff.

Monday, December 7, 2009

QQQQ Squeeze Setup

The 20 period 2 SD Bollinger Bands have moved inside of the 20 period 1.5 ATR Keltner Channels setting up a volatility squeeze for the Qs. Typically one would expect the breakout from such a setup to lead to a sizeable move in the direction of the prevailing momentum which is currently negative. The previous squeeze setup was followed by an upside breakout after the momentum turned positive. It remains to be seen which way this one will go, but you probably know by now that I am leaning to the downside.

Saturday, December 5, 2009

Two Charts Point To A Top

The chart above of the Dow Jones Whilshire 5000 index is probably the best representation of where the overall market is at the present time. The index closed below the 50% retracement level of the 2007 to 2009 bear market yesterday after moving briefly above it intraday. It is also trading below both the median line and the lower trendline of the rally from the March low. We thus have a confluence of 3 points of resistance that must be overcome for the rally to move higher. At the open yesterday, it appeared that was exactly what was going to happen. The failure to do so on such positive news was a clear failure at resistance and points the way to lower prices. No doubt, another attempt to get through these levels may be seen in the coming week, but until there is a solid close above resistance we should assume the next move of significance will be to the downside or that a longer period of consolidation is coming.

The above chart of the FXY which tracks the Japanese Yen shows a clear breakdown below trendline support on a likely move to below the April 08 low. When I first presented this chart on November 18, the upward correction in the FXY appeared to be complete, which is why I felt confident that a market high was imminent. The Dollar has since moved lower and the YEN higher, but now that the FXY has broken down below the 2008 high, we should expect a retest of the April 2008 low, which should correspond to a correction in the US stock indexes.

The pattern in the FXY appears to be a very large flat correction, which means that the decline should occur in 5 waves. The impulsive decline should occur with some speed as well implying that a bottom is not that far away in time. There is no way to know how severe the decline will be in the stock indexes but until we get a solid breakout from current levels, all the facts point to the 10 month cycle low still ahead.

For those of you who read Carl Swenlin's weekly posts at I want to point out that my work does not agree with Mr. Swenlin's view that the "9" month cycle low occured in November. Mr. Swenlin's market views are some of the most sound and rational that I have seen, but on this point I must disagree. If we do get a breakout, then I'll have to reconsider.

Friday, December 4, 2009

What A Day!

Today's action was about as exciting as it gets with stock indexes closing well off the highs and failing to close above breakout levels, but managing to hold above critical support. The action off of the lows appears to be an upward correction that may have a little more to go on Monday before more selling follows.

It has been my intent since I started this blog to share with you my insights and views on the markets as well as my market positions within reason. I make no claim of trading omniscience. I just call it like I see it within the framework of my trend following and pattern methodologies. If anyone got whipsawed because of my commentary, I apologize, but I must remind readers that the decision to take a position or exit one is your responsibility and yours alone. Please do your own homework and make your own decisions. I hope that my comments will aid you in that process.

In case you are wondering whether I am just blowing a lot of hot air, my total return since I started this blog in January 2008 is approximately 272% using an average of 50% margin. I am disappointed with my results for this year as I have fallen a little short of my goal relative to the market swings that have occurred. Most of this has been caused by attempting to take short positions at potential tops so this is an area I have to work on.

The action for the last few months has been particularly difficult, and I don't think I am alone in that view. However, just as has occurred with the gold market since late August, I expect the stock indexes will begin to trend strongly one way or the other before long. This change of character between strongly trending and choppy markets is just the nature of market behavior. While I have heard many claims of those who are able to alter their strategies to suit the market behavior I have yet to see any evidence of that ability in practice. For the most part traders would do well to stick with one or two approaches.

That said, my intent for the coming year is to better integrate intermediate term strategies with short term strategies to increase return and reduce volatility. As I work on my trading plan for the coming year, I will do my best to share this work with you. Unfortunately, I have a great many things to accomplish by December 31 with my other businesses, and it will be a challenge.

Today I suffered my largest drawdown in the last 3 months, but not because of the index short positions, but because of gold. I had a position in the DGP as well as two mining stock positions. It was evident by 10:30am as gold moved strongly below its 12dema and the dollar was rallying that a substantial selloff was in the making. I exited all of the gold positions with a nice profit but with some drawdown. This is the nature of trading. We can only exit before or after the top (take your pick), but rarely at the top. I don't think I could have traded it any differently so I am satisfied with the result. I don't believe the rally in gold is over, but the runup had gotten to an extreme and a correction is in order.

While oil may retest the November low I still think we will see new highs with a move to around 100. Please see Adam Hewison's Marketclub video on oil which closely matches my own view: Crude Oil.

Tomorrow I will revisit a chart I posted recently on the FXY and look at the potential ramifications of a falling YEN.

May Go Long TWM Again

As I said last night, I would not hesitate to re-enter the index short positions if the action warranted. I am amazed at the lack of follow-through this morning after the blow-away jobs report. I have an order to go long the TWM at 27.25 with a stop at 26.75 as markets appear to be rolling back over. A close below yesterday's low would be a severe blow to the bulls.


The TRIN has collapsed to very bullish levels, < 0.60, and the SP500 has broken out to new highs. I have exited all index short positions. I am looking to add to positions that are working OIL, e.g.


I was afraid of that. That little slip-up by the White House yesterday appears to have done its job as futures are on the rise after a much better than expected jobs report. Is this a sell on the news event? I don't know. I will give the market a few minutes to see what it's going to do, but I will only hold my index short positions if the indexes hold below the rally highs. I will not be reversing and going long the indexes. I will wait for another opportunity.

It has been a while since I have been so wrong footed with an index position. So many factors have pointed to a top that has simply not materialized even though the pattern, price levels, and timing have supported that point of view. In general, I am a trend follower, and it usually pays to wait until the trend has developed, but sometimes one can build a case for taking a position at a top or bottom. See my post on how I traded JPM, Oct 31. But also, take a look at my post of Oct 28 entitled "Is there any doubt?" where I mention how oversold the market was based on the McClellan Oscillator. That little piece of information has proved to be very accurate. If this move fails, I will have not any qualms about going short again.

As I had mentioned in an earlier post, this could turn out to be an acceleration point, and that may be the case now, but it will take a breakout and pullback to prove it. There will be a pullback at some point. We will evaluate the situation when it happens.

Thursday, December 3, 2009

Banks Vs Utilities

The top chart shows the BKX bank index rolling over out of a bear flag after breaking down below its rally trendline in October. The second chart shows the XLU utilities index breaking out of a textbook expanding wedge formation and looks solidly higher.

Banks down - utilities up doesn't sound like bull market behavior to me. Note that the BKX was one of the first indexes to break down in 2006 well before the rest of the market while the XLU was one of the last to break down, holding up until December 2007.

Failed Breakout Attempt

The SP500 attempted a breakout this morning which has so far failed. Closing under yesterday's low would warn us that a near term top may be developing, and closing under last week's low at 1083.74 would confirm a top. On the other hand, a reversal of this morning's selloff with a solid close above this morning's high would put the bulls firmly in control.

The ISM nonmanufacturing index came in well under the expected level this morning and also under 50, which indicates contraction. Shortly afterward, the White House put out a press release indicating we may see a rise in the unemployment rate tomorrow morning. This smacks of an attempt to manipulate the markets by either trying to minimize the impact of a worsening unemployment rate or sandbagging the bears who may be wrongly positioned if the rate comes in better than expected tomorrow morning. Either way, this type of behavior is not conducive to a bull market, no matter what our leaders believe. It only adds to uncertainty and skepticism.

Regardless of the market reaction to the unemployment data tomorrow morning, traders would do well to wait for an hour or so to let the market settle down before entering new positions or exiting existing ones.

Wednesday, December 2, 2009


Markets have made little progress over the last 3 weeks, but watching the financial channels you might think they are considerably higher than they are. On Friday 11/13 the Qs closed at 44.01. Today they closed at 44.07. While the action has been frustrating, I haven't yet relinquished my half short index positions. The signs of an imminent top are everywhere. The chart above shows the absolute breadth index in Telechart. It has been a reliable indicator of turning points at extreme levels and is rapidly approaching levels that have marked turning points during 2009. Nevertheless, a solid breakout above today's high will force me to exit.

Meanwhile, the DGP, selected gold stocks, OIL, and a few other miscellaneous long positions have more than offset the index short positions in my account. Gold may be approaching some near term resistance at 1246, but I have a revised target at 1297. Oil is still holding well above the critical level of 68.32, and appears to be setting up for its next move higher even if oil inventories are rising.

As Kevin Haggerty is fond of calling them, the generals, the big money players, seem to be doing everything possible to hold this market up until the end of the year, which makes it more likely that any selling will take place after the new year. With Investors Intelligence Bears now down at 17.6%, traders should be on guard for downside risk rather than chasing year end gains.

Tuesday, December 1, 2009

Lonely Dow

The markets moved higher on lighter volume again today with the Dow making a new rally high all by itself. This fact alone should give traders pause. The chart above shows that the Qs are still below the primay trendline from the March low and in the process of developing a broadening top formation. Markets can breakout either way from such a formation but it is typical to see 3 touches of both the upper and lower trendlines.

I have relabeled the wave count with a new count that eliminates the ending diagonal triangle pattern. Thus, the likelihood that we will see a retest of the July low is significantly diminished, which fits with the fact that there is little time left to complete the 10 month cycle low. The number of new highs continues to fall relative to prior peaks - another sign that the rally is narrowing and another sharp downdraft is likely.


The pre-market futures are up this morning, but I would urge caution. While the large caps may continue higher into year end, the small caps, financials and semi-conductors, among others, are still lagging badly. Oftentimes, the large caps will play catch up to the downside in this situation. It's fine to swing trade the move, but just be aware of the risk.

I have only added to two long stock positions in the last two weeks. Most of the stocks I have been following have yet to trigger swing trading buy signals, which I find intriguing in and of itself as I watch the Dow levitate near it's highs.

I realize that it is difficult to watch this market grind higher, but this is exactly the type of market that seems to carry the greatest short term risk. Only a sizeable up move in above average volume would alter that view, and we haven't seen it yet.