Monday, October 19, 2015

Trading Notes: Week of October 19th

Friday, October 23rd

*  The combination of prospects of further QE from the ECB and positive earnings news breathed fresh life into the market, as we rose on substantially increased volume.  The increased volume told us that fresh participants were coming into the market; the positive skew of the NYSE TICK told us that the participation was dominantly to the buy side.  Picking up those cues early in the trading day is an essential part of short-term trading.  Thursday's action was further confirmation of the base case outlined yesterday, though I'm certainly open to the possibility that, with the renewed buying, a momentum peak lies ahead of us.

*   Below is an interesting chart that tracks "relative volume":  how volume at each minute of the day compares with the average volume for that minute in SPY.  A value of 1.0 means that volume is average for that time of day.  A value of 2.0 is a full standard deviation above average; 3.0 is two standard deviations above average; etc.  Note in the chart how volume yesterday was well above average, particularly when the market was rising.  Great tell.

*  Interestingly, new highs *and* new lows expanded in yesterday's trade, and small caps continue to lag large caps.  I'm watching that relationship closely, as well as the new highs/lows.

Thursday, October 22nd

*  Weakness in small caps noted earlier contributed to a sell off in stocks through much of the day Wednesday.  My measure of buying vs. selling pressure, interestingly, did not show a great surplus of selling.  This continues to look to me like a correction of the recent strength, not bear market behavior.  With fewer than half of stocks now trading above their three and five-day moving averages, the risk/reward looks a bit better and I am open to buying weakness that holds above the overnight lows.  I do note, however, that the number of stocks making fresh monthly lows has expanded beyond the level seen last week.  Continued expansion of that number would make me more concerned regarding the market's downside.  

*  In short, my base case is that the August/September lows were significant ones; that we began a new market cycle off those September lows; and that the cycle has hit a potential momentum peak but has further to run on the upside.  Waning breadth, especially among small cap stocks, and waning relative strength among EM shares concerns me about this base case, however, so I'm cautious and updating views day by day.

*  A tell for market weakness prior to the August drop was that we were persistently seeing more shares trading below their lower Bollinger Bands than above their higher bands.  At present, we've been seeing the opposite: more stocks trading above their upper bands (see chart below).  I'm watching that balance closely as yet a different kind of breadth measure that captures the relative breadth of strength vs. weakness.


Wednesday, October 21st

*  Stocks showed continued resilience on Tuesday, with pullbacks limited, ultimately leading to higher daily lows and higher highs.  We also expanded the number of stocks making fresh monthly highs, rising to 812 from 698.  Interestingly, VIX rose, but realized volatility and volume continued low.  We're seeing strength in overnight trade, after late day weakness yesterday--that continues the grind higher.

*  We've seen a drop in one of my measures of breadth volatility, which tracks the variation in the number of stocks making new highs and lows.  Going back to 2010, when breadth volatility has been high, the next five days in SPX have averaged a gain of +.52%.  When breadth volatility has been low, as at present, the next five days in SPX have averaged a gain of only +.03%.  I continue to view the risk/reward in the market as not particularly appealing for multi-day positions and instead lean toward shorter-term tactical trading of intraday swings.

*  I am continuing to watch small cap and mid cap issues to see if we can expand breadth or whether relative weakness in those groups can expand to other segments of the market.  The Cumulative NYSE TICK has been rising in recent sessions; buying strength has been moderate, but selling strength has been low.  I don't expect a major market decline until we see a reemergence of sellers, and that's not occurring so far.

Tuesday, October 20th

*  The topping behavior referenced yesterday was evident in Monday's trade, as we ground higher in SPX.  I continue to note relative weakness among small caps, which is contributing to breadth divergences.  We saw 698 new monthly highs on Monday against 166 lows.  That is against over 1000 new highs on the 7th through the 9th.  That being said, breadth divergences in rising markets normally don't signal major reversals until we see expanding numbers of shares making fresh lows and overtaking new highs.  During topping processes, it's more of a rotation trade than a trending one, with volatility, volume, and momentum coming down.  That makes it an opportunistic trading environment, as the lower volatility means that moves extend far less than they had when VIX exceeded 20.

*  One of the big mistakes traders make in low volume/low volatility environments is looking for the next big move, rather than planning for the lack of movement.  To accomplish that planning, traders either need to trade short term swings opportunistically (intraday swings) or extend their holding periods to seek larger moves that ride out the shorter swings.  I find that pullbacks and bounces in NYSE TICK intraday help to identify those shorter-term swings.

*  Should we see small caps and midcaps catch up to the large caps in performance and move to fresh highs, that would be a worthwhile clue that the upside has further to go.  I'd want to see other market sectors underperform before taking a longer-term bearish stance.

Monday, October 19th

*  I'll be tweeting from Stocktoberfest the next couple of days.  My latest Forbes article highlights a topic I'll be addressing in my Stocktoberfest presentation:  how we can make the transition from being good traders to becoming great ones.  That means that repeated experience is not enough; we actually have to undertake directed training.  The Forbes piece describes how we can use psychology to sustain training efforts.

*  Here's a simple way you can know if you're truly engaged in a process of expertise development:  Are there *specific* things you're working on in today's trading; are you keeping score to see if you are truly making progress; and are you making ongoing corrective efforts with continued scorekeeping if you're not making progress?  If you're not intensively engaged in the above, you are not on a course of peak performance development.

*  Friday's trading continued the bounce from the short-term oversold situation noted last week.  We once again are at a juncture where I'm not enamored of the risk/reward situation here.  Intermediate-term measures are stretched to the upside; put/call ratios have come down; and we continue to see fewer stocks make fresh new highs despite new highs for this move in the broad indices.  My pure volatility measure is at levels associated with subnormal forward returns over a several day basis.  All this is consistent with my overall perspective that we've seen a momentum peak for this market cycle and are now involved in a topping process.  That process can extend for a while before we see an ultimate price peak and eventual bear phase. 

*  An uptrend is sustained when we are able to register higher price highs and higher price lows across multiple short-term cycles.  So far, that is what we've been doing.  Until that pattern changes, I'm reluctant to take short positions for anything more than short-term trades.