Saturday, January 03, 2015

Making Sense of a Weak Start to a New Year

I thought I would update a few of the measures that I follow to help us make sense of the relative weakness that we've seen ushering in 2015.  In the grand scheme of things, the weakness is not extreme; indeed, my Cumulative NYSE TICK measure has made new highs and advance-decline breadth has not been lopsided at all.  Still, the weakness has exceeded my expectations; the charts above capture a worthwhile perspective.

First, however, a trading psychology comment.  When I'm stopped out in a trade--as happened recently with my long position in ES--I stop.  My stops are placed far enough away that, if they're hit, I'm wrong.  And before I resume trading I need to figure out what the hell I got wrong.  One of the most destructive patterns I've observed among traders is a tendency to continue--or even accelerate--trading after stop outs.  Insanity, the saying goes, is redoubling one's efforts after having lost sight of one's aim.  A more sane strategy is to use losing trades as learning experiences.  The charts above are part of my review and reflection process after a trade that I thought was good turned out to be a losing one.

The top chart is a measure of breadth for SPX stocks.  It represents the percentage of shares trading above their 3, 5, and 10-day moving averages.  (Data from Index Indicators).  You can see how this breadth measure reliably tops out ahead of price during market cycles; it's also done a reasonable job of bottoming ahead of price at cycle troughs.  We've come off quite sharply in this measure; more so than is typical in a market cycle.  This invites the hypothesis that we've already seen a momentum peak for the current cycle.

The middle chart tracks all NYSE stocks closing above their upper Bollinger Bands vs. closing below their lower bands.  (Data from Stock Charts).  It too has shown an admirable tendency to top ahead of price at cycle peaks and ahead of cycle lows at troughs.  That has not come off as sharply as the breadth measure, but also has moved steadily lower since a rapid peak off the mid-December bottom.

Finally, the bottom chart tracks a basket of stocks that are institutional favorites and the upticking versus downticking in those stocks.  When the majority of stocks in the basket uptick simultaneously, that is deemed to be evidence of the presence of institutional buying programs; when they downtick simultaneously, that is counted as the presence of selling programs.  We can see that buying programs dominate early in a market's cycle history and give way to selling programs as markets make cyclical peaks.  Note how we showed very strong buying program activity off the December lows and now have moved to a dominance of sell programs.

These measures leave me open to the idea that we've hit a momentum peak for the current cycle, which will have me looking closely at any bounces from here to see if we see waning or strengthening breadth.  This could have longer-term ramifications, as it invites the hypothesis that the end of year strength was not a fresh leg in a bull market but rather part of a much larger topping process that began in 2014.

Further Reading:  Losing Your Money Begins With Losing Your Focus