Monday, November 23, 2015

Trading Notes: Week of November 23rd

Friday, November 27th

*  Not much changed from yesterday with respect to U.S. stocks, as we continue to hold important support in the lower 2080s in the front month ES contract.  I continue to be in the mode of buying weakness that holds above overnight lows, but expect trade to be slow today given the long holiday weekend that many U.S. traders will be taking.

*  So far, the number of stocks displaying unusual strength in the recent move higher has been modest.  Below is a chart of the number of NYSE issues closing above their upper Bollinger Bands minus the number closing below their lower bands.  (Data from the excellent site).  To this point, that measure of strength has been waning.

*  Another resource that I have found quite useful is the Stock Spotter site.  They provide buy and sell signals for individual stocks based upon their cycle models.  They also have price forecasts for each stock and ETF.  I've found those forecasts for SPY to have value and have backtested them for the better part of two years.  At present, their forecast is bullish for stocks over a next two-week horizon.

Thursday, November 26th

*  Happy Thanksgiving and many thanks to TraderFeed readers!  I look forward to a great 2016.  This latest article describes a structured process for dealing positively with setbacks and failure.  So much of the difference between the successful trader and the unsuccessful one is how they deal with the inevitable losses dealt by markets (and by our faulty processing of market-generated information).

*  We've continued modestly higher in overnight trade, as the basic strategy of buying weakness that holds above key prior day and overnight levels has been a good one.  The relative outperformance of small caps is something I'm watching.  Utility stocks, faced with the prospect of rising rates in the U.S., have been relatively weak.  Below, the graphic from the excellent FinViz site shows mixed performance among U.S. sectors.  It continues to be a rotational environment.

*  On a more global scale, I'm watching the relative performance of China, emerging markets, Japan, and European stocks, given the prospect of further easing from overseas central banks and a rate hike from the Fed.  Note the relative strength of the U.S. dollar of late; that is also a theme that is impacting U.S. shares.  I know too many traders who are so busy looking for short-term setups that they completely miss larger themes that are driving stocks on the longer time frame. 

Wednesday, November 25th

*  We tested the overnight lows in early trade yesterday and found strong buying off the lows, bringing us back toward the upper end of the recent range.  The inability to sustain weakness is consistent with a market in a rising cycle, though I do notice tepid breadth thus far in the move higher.  For example, the past couple of days, we've seen more stocks register fresh 52-week lows than highs.  While I do think we have a good opportunity to test recent highs, I am far from convinced that we're launching to a fresh bull leg from here.  

*  December promises to be an eventful month, with ECB and Fed meetings that could lead to monetary easing and an interest rate hike, respectively.  I think it's possible that, with a dovish Fed hike and monetary ease in Japan and Europe, we could see a renewed "QE" trade in stocks.

*  The chart of cumulative upticks vs. downticks among all listed stocks (red line below) has been heading to new highs.  That reflects relative strength recently among smaller cap issues.  Interestingly, the cumulative upticks vs. downticks for Dow stocks only is in a recent downtrend.  This rotational trade could well continue through this holiday period.

Tuesday, November 24th

*  Yesterday's trade was interesting in that we saw considerable buying interest in early trade, as tracked by NYSE TICK, but much of the strength centered on smaller cap issues and not the NASDAQ and SPX large caps.  What turns a bull, rising phase of a market cycle into a topping phase is that buying interest fails to take prices meaningfully higher, as some segments of the market display weakness as others hold up.  In yesterday's trade, it was the NASDAQ index--and AAPL specifically--displaying weakness.  As buying failed to push indexes higher, sellers came in during the afternoon and took us lower.  Yesterday's trade was a nice illustration of how markets turn on a short time frame.  It was also a nice illustration of how it's important to track multiple market sectors, not just the index you're trading.

*  Painful experience has taught me to not be long stocks with pure volatility (volatility per unit of trading volume) is low.  Forward returns just aren't positive on average.  As you can see below, pure vol had gotten quite low recently, a yellow caution light.  With the downing of the Russian jet overnight in Turkey, stocks have fallen back and taken out stops in the 2070s in the ES futures.  Pure vol has expanded meaningfully.  Adjusting volatility expectations and risk/reward is key here.  On one hand, corrections that elevate pure vol offer good entry points on the long side.  On the other hand, we now have a situation where idiosyncratic (geopolitical) factors are moving markets.  It is difficult to successfully trade historical patterns when idiosyncratic risk factors dominate.  I'm open to buying weakness that cannot take out the overnight lows, but in no rush to get involved.  

Monday, November 23rd

*  How much time do we waste and how much mental clutter do we create by staring at screens, opening superfluous email, and reading material irrelevant to our decision making?  How does that clutter clog creative processes and interfere with generating new and better ideas and trades?  This post on media consumption tackles a very important topic: we can't assemble good ideas if we're not collecting the right puzzle pieces.

*  We're trading in a relatively sideways range in the ES futures, correcting more in time than in price.  That is generally what markets do when they're trading in a good uptrend, and that's how I'm treating this market until proven otherwise.  The only flies in the ointment are low levels of implied correlation and pure volatility, both of which are associated with subnormal near-term returns.  My basic strategy, as has been the case recently, is to buy weakness that holds above overnight and prior day's lows.

*  I generally like to buy oversold levels in rising markets and sell overbought levels in falling ones.  A large portion of profitability comes from good entry execution.  The same applies to exit execution.  When positions go our way but are stretched to the upside or downside, it generally pays to take at least some of our position off in markets that display short-term mean reversion.  I look at a medium term rate of change measure on bars created every 500 price changes to provide perspective on overbought and oversold.  It's not something I trade off of directly, but use to generally guide good and bad trade location.