Monday, March 14, 2016

Trading Notes For The Week Of March 14, 2016

Friday, March 18th

Steve Spencer of SMB emphasizes that price action following a catalytic event provides us with important information.  This is especially true when we see a change in the distribution of transactions following a news event or other catalyst.  Increased volume and a new skew of volume lifting offers versus hitting bids, for example, tells us that fresh buying flows have come into the market.  This calls for an updating of our views of the stock or index.

*  This lesson has been especially relevant in the wake of the Fed announcement.  My cumulative measure of upticks vs. downticks has hit new highs for this move and breadth, which had been waning, vaulted to new highs.  Below we can see the chart of stocks across all changes making fresh 3-month new highs vs. lows.  The vigor of buying following the Fed announcement suggests that this, indeed, was a game changer.  Central banks globally are opting for accommodation and, historically, that has been favorable toward stocks.

*  The China/deflation thesis, which dominated discussion during recent market weakness, is far less discussed I find, given oil strength and USD weakness.  For stocks, in a negative interest rate world, anything safe with yield continues to find interest.

Thursday, March 17th

Interesting commentary on the fear of missing market moves from Victor Niederhoffer.  Many a bad trade is made because of the ego, not because of the objective market opportunity.

*  We saw a rise to new highs on the heels of the Fed announcement, with solid buying interest.  Recent posts have commented on weak breadth and, for the market overall, the breadth picture did not improve despite the Fed-related strength.  Across all exchanges, we saw 753 new monthly highs against 254 lows.  The latter is again an uptick in new lows and the new highs are half of what we saw two weeks ago.  Among SPX shares only, stocks making fresh 100-day new highs versus lows did expand to a marginal new peak.  Much of the weakness is among small cap shares, though financial and health care stocks within SPX are also lagging.  With the mixed breadth picture, I'm not surprised to see some retracement of yesterday's gains in premarket trade today.

*  Breadth issues notwithstanding, it's clear that this has been a vigorous bull move from the February lows.  Note below how we've stayed "overbought" on my multiperiod strength measure (daily tracking of SPX stocks making 5, 20, and 100-day new highs versus lows) for a number of days.  This only occurs in trending markets.  While the breadth issues often precede correction, my base case is to view such a correction as a buying opportunity.  


*  I'm working on creating a cycle-based measure of short-term momentum and value effects in the ES market.  The idea is to identify when markets are most likely to continue versus reverse their most recent directional movement.  Interestingly, the market's rise yesterday occurred on a low value of the momentum measure.  More to come on this research.

Wednesday, March 16th

*  Jim Dalton, who has pioneered trading via Market Profile, is offering his final mentorship program before his retirement.  I also see Terry Liberman will be doing a webinar with Jim later today.  When I taught an internship program in Chicago many years ago, Jim's work was the only mandated reading.  I continue to find Market Profile helpful as a conceptual framework for thinking about market behavior.

*  After some early weakness, we saw buying in stocks, but small caps continue to notably underperform large caps.  As a result, we see continuing deterioration among the breadth measures.  New monthly lows ticked up to 192, the highest level since February 24th and monthly highs dipped to 451.  Relatively weak sectors recently include energy shares (XLE) and healthcare (XLV).  Today's trading will be dominated by the afternoon's Fed announcement.  

*  We continue quite stretched on my intermediate strength measure, which looks at the number of SPX shares making fresh 5, 20, and 100-day highs versus lows.  (Data from Index Indicators).  If the Fed-related trade can't break us from the breadth deterioration, I expect an intermediate-term correction.  That would not necessarily be an end to the bull move from February's lows, but could suggest a new, topping phase to the current market cycle.  During a topping phase we can see higher overall prices for the index, but with deterioration in some sectors contributing to lagging breadth.  

*  Here is a unique intraday indicator that looks at buying pressure among all U.S. listed shares.  It tracks upticks among all shares (data from e-Signal) and expresses the result in standard deviation units.  This shows us when significant buying is coming into the market.  It also shows us when there is a meaningful absence of buying.  (A corresponding measure tracks significant selling and absence of selling pressure).  It helps longer-term positions when those are going with the flows.  The chart below shows yesterday's market.

Tuesday, March 15th

*  I'll be making an addition to these market notes and including each day links to readings that I find particularly informative and useful.  To kick this off, check out the Paststat blog for daily trading ideas based upon historical patterns, including this one based upon seasonality.  From my perspective, such patterns are the starting point for analysis, not an end point.  Once we see a pattern, the hard work remains of deciding: 1) is the current market regime typical of the period covered by the historical test; 2) is there a sound reason for the existence of the pattern, or might the pattern be a random occurrence; and 3) what is the variability around the pattern (could you survive the exceptional instances)?  Factoring market history into trading decisions is no guarantee of success--it's easy to look in so many places that some "significant" pattern appears--but ignorance of market history is not exactly a promising alternative.

*  The relative absence of selling pressure in Monday's session was noteworthy and helped lead to higher prices for much of the session before a late selling burst.  Selling has continued overnight with no new shot in the arm from the Bank of Japan.  Trading was unusually slow on Monday and we could get more of the same ahead of tomorrow's Fed announcement.  Note how short-term breadth has been strong for a number of days; the measure below tracks the percentage of SPX stocks closing above their 3, 5, and 10-day moving averages.  (Data from Index Indicators).

 *  The market looks tired to me--for the first time since the liftoff from the February lows.  Specifically, we're getting fewer shares registering new highs during market rallies.  Much of that relative weakness is coming from small cap shares.  Yesterday we saw 921 stocks across all exchanges make fresh monthly highs against over 2000 last week.  (Data from the Barchart site).  No individual sector within the SPX looks distinctively weak and I'm not at all convinced that we're going into bear mode.  Rather, I expect a normal correction within a bull move.  With the absence of selling having trouble bringing us higher, I'm leaning toward selling bounces that cannot keep us above the overnight highs.  Of course, the upcoming Fed announcement will provide a major catalyst for stocks tomorrow.

Monday, March 14th

*  Those who know me well know that I do not subscribe to the idea that successful trading is mostly a function of psychology.  Without an objective trading edge, one's frame of mind will simply dictate the rate at which we part with our capital.  Still, psychology is necessary, if not sufficient, for success and yesterday's post was perhaps my clearest explanation why.

*  We closed near the highs on Friday, continuing the upswing following the post-ECB selloff.  The rise left us quite stretched short-term, with over 90% of SPX stocks trading above their 3, 5, 10, and 20-day moving averages.  This in itself is not a common occurrence.  Going back to 2006, I could only find 12 instances of this happening when VIX has been below 20.  Interestingly, 3 were up, 9 down the next day for a net loss, but 10 were up, 2 down after 3 days.  We're trading a bit lower premarket as I write; the depth of a next pullback will tell us a lot about possible upside momentum over the next few days.

*  One concern starting to enter my head is that Friday's highs were the first in which we saw sizable breadth divergences.  If we look at all stocks across all exchanges, we can see that 1087 made fresh monthly highs on Friday against 2082 the prior Friday.  Much of this is a function of relative weakness among small caps.  We only had 92 new monthly lows on Friday, so nothing is standing out as weak and I'm not expecting any grand reversal.  I am concerned, however, that we could see a decent pullback from these levels as part of the start of a topping process.  Bottom line is that I was happy to take profits late Friday and I'm happy to stay on the sidelines and see what the bears can bring.  Ideally, I'd like to be a buyer of weakness early in the week for at least a retest of highs thereafter.  But I'm not seeing favorably skewed risk/reward right here, right now.