Keeping Us On Our Toes

Well, after writing a post entitled "Why I Think The Bears Are All Wet", they managed to dump a little cold water on me today.  Still, one day doesn't make a bear market and nothing that happened today changes what I said yesterday.  The first day of November is usually an up day, so we will see what happens.  I expect some choppy action for the next few days.  Only if we see a break of the August high of 1231 in the SP500 followed by a retracement and a break of the resulting swing low would I conclude that a more significant retracement or leg down is underway, and we are a long way from that happening at the moment.

It is also likely that the MF Global bankruptcy had some effect on trading activity.  MF Global acted as a clearing house for my futures broker, which was unable to process trades today.

Why I Think The Bears Are All Wet

There are many different ways to look at the market, and different conclusions will often be reached depending on one's perspective.  Since the 2009 low, most people who have been looking at the market action through the lens of elliott wave analysis have been overly and persistently bearish, as have those that view the market from a fundamental perspective, for the most part.  However, sometimes the problem with either of these viewpoints is that they impose an expectation about what will or should happen as opposed to what is actually happening which leads to rigid positions.  Being rigid and being profitable are pretty much exclusive.  Personally I'd rather be profitable.  I'll save being right for engineering and academic work.

When we look at a long term chart of the QQQ Nasdaq 100 ETF, it is very easy to see that there are two key levels going back to 2000.  The first level which was a resistance zone for some time was from about 50 to 54. The Qs were repelled from this level 4 separate time over the last 4_1/2 years.  In January of this year there was a clear break above the 2007 high of 55.07 in January followed by a return to the broken resistance level in August and October.  Had the August and October lows failed a more substantial decline would have probably occurred, but the fact is that October has seen one of the best rallies in the last 25 years, which is clearly evident on the monthly chart below.  The median line for the Qs going back to the 2002 low has held in conjunction with the May 2001 swing high.  At this point there is very little reason to believe that the Qs will not move in a sustained way up to the next resistance level at the May 2000 swing low which is conjoined by the upper channel line around 70 to 72.

Trying to get a handle on the market's moves over the last 2_1/2 years has been difficult for most everyone.  It hasn't been anything like 1994 to 2000 or 2000 to 2002 when the trends were persistent and clear.  Even so, the overwhelming evidence is that the market wants to go higher despite the abundant economic and elliott wave evidence to the contrary.  I think it would be in trader's best interest to continue with a generally long side approach until there is a clear break of the August/October 2011 lows or there is clear evidence of distribution at the next resistance level for the Qs.  Overall, in my opinion the market is in a 5 year pattern described by Gann as a 2-1-2 where the market goes up for 2 years, sideways to down for 1 year, and then up for 2 more years.  It is not exact and the transitions are not always easy to navigate, but this puts the top of this rally at sometime between 2013 and 2014.  If that is correct, there is a long way to go.

Besides trading the indexes, how can traders take advantage of this rally in individual stocks? It is easy to waste many hours trying to find stocks to trade, and much of the services available and sold are designed to help traders make stock selections.  In my experience, costly experience, most of this is a waste of time.  There are really only 3 categories of stocks that make good trading candidates:  1) fundamentally undervalued stocks with rising earnings and revenue forecasts, 2) high relative strength stocks that are outperforming the market, but that have not yet reached a climax stage, and 3) high beta stocks that have exaggerated swings relative to the market.

In the early years of my trading I spent countless hours trying to find the best stock screens.  It was total waste of time.  You can find great stocks to trade in literally about 30 minutes once every 3 months.  There are different ways to find fundamentally undervalued stocks, but the simplest and easiest I've found is presented in the book The Little Book That Beats The Market by Joel Greenblatt.  I developed screens in TC2000 and in online stock screeners that come close to matching his methods, but the simplest way is to just go to his free site http://www.magicformulainvesting.com/welcome.html.  I run his screen with 2 or 3 different levels of market cap about once a quarter and come up with a list of about 20 to 30 stocks I like.  I don't just accept his list.  I want to see expected earnings growth above 15% and a nice looking chart.

High relative strength stocks are easy to find.  Just setup up your stock screener to sort by relative strength.  I troll through the first 100 or so stocks and pick the ones that have strong persistent trends, then I see if they have decent ROE and earnings growth.  I usually end up with 20 to 50 stocks on this list.  This is how I found QCOR back in 2008, which I have successfully traded several times including the recent advance off of the September low.  I also use IBD, but you have to be careful as a lot of their stock lists have stocks that are in or are approaching distribution stages.  It's interesting that QCOR was not mentioned much in IBD until it exceeded $20.  I first bought it around $6.

Finally, I sort the Nasdaq 100 stocks by beta and pick the top 10 to 12 stocks.  When I see a nice setup like I did with WYNN recently, I trade it.

I just run these screens once a quarter.  There is little reason to waste time doing it more often.  It won't improve your results much and may hurt them.  There's no reason to pay for expensive stock picking services.  I just use Worden Brothers Stockfinder and TC2000 to do my charting and screening, and I subscribe to IBD.

Using these methods and employing the trading techniques I have described on this blog, I have reduced the total amount of time that I spend analyzing the market and picking stocks to around 15 minutes a day.  I spend more time writing this blog than I do trading.  Currently, my annual returns are running around 40% over the last 4 years.  It's possible to do better occasionally, but realistically few traders are going to do better than 20% to 40% on average, although some do consistently achieve 60% to 100% returns.  These are the stars.  It would nice to be a star, but consistency is the most important thing, and if you have enough capital, you can do just fine on 20% to 40% a year.

I hope this helps.  Have a great week trading!

% Stocks Above 50 MA Says Rally Has Legs

The % of stocks above the 50ma has broken out above a downsloping trendline after a rally initiation move above the lower swing high.  This fact suggests that the current rally has greater potential than it may have seemed earlier.  Notice how the indicator declined in a series of lower highs after the last two moves up from a major low.  It doesn't mean it will be pretty, but I think the bears are going to be disappointed.

On the other hand the # of new 52 week highs has not been very impressive compared to prior rallies.  This may reflect an underlying weakness, or it just may mean that the market more oversold than before previous rallies.

I am now fully allocated to the long and plan to remain that way into at least early December.  Positions that hit profit targets or get stopped out will be replaced with new positions until momentum begins to wane.

I will discuss my methods for finding stocks to trade this weekend.

So Much For Analogies

It is still very possible that the current pullback will extend for 2 or 3 more days, but the strength of the reversal today suggests that the pullback is probably over.  I took positions in the Qs and the IWM near the mid-day low.  We'll see how that works out.

Wednesdays are peculiar days.  They tend to be very neutral.  If they start out going down in the morning, they tend to finish up in the afternoon, and vice versa.  One clue that today might be a day that could complete the pullback was the very fact that it started out going down instead of up.  Had today been an up day as I thought it might, we probably would be looking at a continuation of the pullback.

2007/8 Analogy Continues To Hold

The analogy with the decline from the 2007 high into 2008 continues with the October 11, 2007 high aligned with the 5/2/2011 high and the March 17, 2008 low aligned with the October 4, 2011 low within +/- 1 day.  So far the rally has matched the 2008 rally with 14 trading days up, although the current rally is stronger.  I was expecting more of a pullback in the middle of the 14 day rally as occurred in 2008, but we did not get it.  However, I suspect we will see the 5-6 day pullback that followed that began today.  If the pattern continues the pullback should bottom by Monday or Tuesday at the latest.  Given the strength of the rally, the pullback may be shorter.  Afterward we should see a 30 TD rally into the first of December at a minimum.

I don't know why this analogy would work except for the current approximately 3.5 year +/- cycle that has been in force for some time.  However, until it breaks down I will presume that the analogy is correct.  The main point to understand about the analogy is that is to the turning dates and not necessarily the form, although so far the form is similar as well.

I am looking to buy this pullback with the view of holding into the December top.

Loud and Clear

The market spoke loud and clear today with a solid move above the recent pullback.  The current move up should be wave (C) of [W] or C of (W), which should last into the end of November or early December.  The next pullback to support should be a buying opportunity.  When it will begin is anyone's guess, but probably soon.  The October 20 low should not be broken.

Pullback May Not Be Complete

The most notable feature of the market's action this week was that the Qs did not make a new high for the recent rally while the SP500 did.  This negative divergence suggests that the pullback is not yet complete.  I propose that the Qs completed wave b of the pullback or nearly so on Friday.  Wave c down should begin sometime early this week.

It follows that the SP500 and other similar markets are probably trading out an expanded flat or running triangle pattern.  The main point is that, barring a breakdown, the pullback should be complete by the end of this week with a target at the 50ma.

The equity only put call ratio shows that sentiment has not yet reached an extreme and the rally has further to go.  If history is any guide, the rally should continue into early December.