Monday, February 29, 2016

Trading Notes for the Week of February 29, 2016

Friday, March 4th

*  We continue to see buying interest in stocks, particularly among smaller and midcap names, but it's the absence of selling pressure that's particularly notable.  We have been getting few highly negative NYSE TICK readings and that is creating relatively modest pullbacks.  Meanwhile, breadth continues to expand, as the chart of stocks making fresh three-month highs versus lows illustrates:

*  I notice both equity and index put/call ratios have come down, if we look across all issues and all exchanges.  This by itself doesn't create a sell signal, but it's an early sign of the kind of bullishness that typically leads to a market peak.  Volume and volatility also continue to come down, with VIX closing below 17.  Note in the chart above how we took out lows from last year, only to now return into the year's range.  I would not be surprised to see an eventual test of the highs of that range, given the considerable momentum thrust off the recent lows.

Thursday, March 3rd

*  I've mentioned how viewing markets from a cycle perspective has been exceedingly useful in my own trading.  Below is an example of how I'm using short-term cycles built with event bars to identify potential points for entry and exit execution.  I find that the markets' cyclical structure becomes clearer when using event bars rather than bars denominated in time.  The chart below makes use of volume bars.

*  We continue to see buying interest in stocks, with some rotation among sectors and small/midcaps outperforming.  The number of stocks across all exchanges making fresh monthly highs expanded once again, from 1310 to 1465; new lows dipped from 146 to 112.  

*  Market volume and volatility appear to be on the wane as we move higher.  That has ramifications for price targets and stops.  My measure of pure volatility (volatility per unit of market volume) has been coming off the highs we saw at the market lows.  That means that, not only are we getting less volume, each unit of volume is moving the market less.  Adapting to such market changes is essential.

Wednesday, March 2nd

*  Yesterday was about as textbook as it gets when it comes to upside trend days.  We saw very positive breadth early in the session, the broad participation of market sectors, consistently positive NYSE TICK, and a healthy majority of shares trading above their day's VWAPs throughout the trading session.  Identifying such days relatively early in the session can yield very profitable day trades.  Pullbacks in NYSE TICK at successively higher price lows offer good entry points.  

*  The fact that we got an upside trend day and made fresh rally highs off yesterday's short-term oversold readings attests to the vigor of the present rally.  Breadth once again expanded, with 1310 stocks making fresh monthly highs against 146 lows.  VIX collapsed to below 18, a new low for this move.  This is a market getting stronger; we're not yet seeing evidence of upside breadth divergences typical during topping processes.  Note, however, that we're once again stretched in short-term breadth, with over 80% of SPX stocks trading above their 3, 5, 10, and 20-day moving averages.

*  The chart below of new highs versus new lows for SPX stocks (raw data from Index Indicators) shows how we continue to make fresh highs on strong breadth readings.  That is typical of the momentum phase of a market cycle.  The cycle concept is important, because it orients us as to when to expect momentum and when to expect mean reversion.  It is a massive mistake to assume that a market is "due for a correction" simply because we've had a large price move.  It all depends upon where we stand across market cycles.   

Tuesday, March 1st

*  I believe this is one of the most important posts I've written and helps explain how a great deal of the frustration traders experience comes from logical sources, not psychological ones.  This approach opens the door to an entirely different way of analyzing market opportunities.

*  Monday's market fell back and we registered short-term oversold readings, with about 26% of SPX stocks closing above their 3-day moving averages.  What we're looking for in bull phases of cycles is short-term oversold readings at successively higher price levels.  We've seen a bounce in overnight trading, consistent with that picture.  

*  That being said, on an intermediate-term basis, my cycle measures are quite extended to the upside, as illustrated below.  In strong market cycles, we work out this overbought condition with minimum price damage, as occurred in October, 2015 following the September bottom.  I'm quite open to that possibility in the current cycle, given recent price action.  A break of today's overnight lows would lead me to question that scenario.

*  Yet another indication of buying strength has been a recent peak in the ten-day moving average of the cumulative NYSE TICK.  Note how it's not uncommon for peaks in the TICK measure to precede cycle price highs, as the thrust of buying power shows short-term momentum.

Monday, February 29th

The previous post provided a chart for a useful short-term overbought/oversold measure.  We're coming off overbought levels with weakness on Friday and in overnight trade.  Note below that my intermediate-term measure of strength has also been stretched to the upside.  In a strong market, those overbought conditions are worked off with modest price damage (i.e., they correct as much in time as in price); in a weak market, bounces from selloffs are modest and facilitate price damage.  It is how the current cycle unfolds that lays the groundwork for the coming one.

*  Breadth has been strong lately.  Even after Friday's drop, we have over 70% of SPX stocks closing above their 3 and 5-day moving averages and over 80% above their 10 and 20-day averages.  (Data from Index Indicators).  At the February lows, we saw meaningful breadth divergence, with fewer shares making new lows than in January.  Since that time, we've had a meaningful breadth thrust to the upside.  That has become stretched and we're seeing corrective activity at present, but my base case is that the current cycle will bottom at a higher low relative to the February bottom and ultimately lead to further price gains. 

*  My latest work has been refining intraday cycle measures to aid shorter-term trading but also to aid entry and exit execution for longer-term positions.  These cycle measures are denominated in event bars, not time-based bars.  Below is a 50-bar rate of change measure that I have found useful.