Monday, November 16, 2015

Trading Notes: Week of November 16th

Friday, November 20th

*  We moved higher during the morning trade on Thursday, staying above the overnight lows, but then something interesting happened.  Volume fizzled and we wound up with a slow range day.  This highlights the importance of tracking volume in real time.  My favorite way of doing that is with "relative volume":  a measure of current volume versus the normal volume for that particular time of day.  Below is a chart for yesterday's relative volume.  Values below 1.0 represent subnormal volume.  You can see how volume became subnormal as the day progressed.  That means directional participants are taking the sidelines.  And that leads, more often than not, to range days.

*  The possible good news is that we're getting low volume, flattish corrections following moves higher off the recent oversold levels.  That is consistent with the scenario of testing the recent highs and has me continuing to buy weakness that stays above prior day and overnight lows.  I'm currently working on a suite of innovative cycle indicators; as you can see below, we're coming off an intermediate-term cycle low and are nowhere near levels associated with cycle peaks.

 Thursday, November 19th

*  The strategy of buying weakness that stayed above the overnight lows--and then buying weakness that stayed above morning lows--worked well on Wednesday, as stocks rallied strongly with the release of Fed minutes.  We've bounced off oversold levels (see chart below of short-term breadth in SPX shares) and now are beginning to see short-term overbought levels.  I continue to expect a test of recent highs and look to implement by buying weakness that stays above key levels.

*  The release of the Fed minutes led to fresh volume entering the market, with well-above levels of volume for that time of day.  Such expansion of volume indicates that new participants have entered the marketplace and it's key to see which way they're leaning, as these are generally directional traders running large size. By tracking NYSE TICK, we can see the degree to which the new volume is leaning to the buy or sell side.  When there is a distinct buying or selling bias among these participants, it can turn what started as a fairly normal day into a robust trend day. 

Wednesday, November 18th

*  We held overnight lows in early trade and moved nicely higher, taking out Monday's highs, but then fell back into the range and have stayed there in overnight trading so far today.  The inability to sustain the strength has me treating this as a potential bottoming process, which is clearest when you look at the Russell 2000 Index and retail stocks (XRT).  We are oversold on an intermediate-term basis; I'm looking to buy weakness that stays above the overnight lows.

*  The aligning of shorter and longer-term perspectives that I like is using overnight and previous day's highs and lows as reference points and buying weakness that stays above overnight and prior day's highs and lows and selling strength that stays below highs for the overnight and prior day's sessions.  When keying off levels in this way, it's relatively easy to identify stop levels.  Those levels also help me differentiate price action based on U.S. flows from price action based on flows from Asia and Europe.

*  I'm also keeping a close eye on commodities.  Hard to believe we can sustain a broad rally if there continues to be deflationary dynamics in markets.

Tuesday, November 17th

*  Once again we saw a good example of how flows in stocks are entirely different during adjacent time zones.  Weakness in the index futures when they opened for the weekend was followed by buying interest in Asian and European hours and then an explosion of buying at the NY open.  The buying occurred on strong NYSE TICK, volume, and volatility, confirming a rejection of the opening lows and setting up an upside trend day.  Here are four things I look for in an upside trend day.

*  What has worked well for me is viewing each of the major time periods (Asian trade, European trade, US trade) as separate days and not necessarily expecting continuity from one time period to another.  In a sense, each day offers three daytrading periods, with the lion's share of movement in U.S. indices occurring during London and NY hours.

*  Buying interest has followed through in the overnight market; my leaning is to buy weakness that holds above the overnight lows.  As mentioned yesterday, my intermediate term measures had not yet reached typical oversold levels; still, given the thrust of the recent move higher, my leaning is to use any further weakness as an opportunity to buy.

Monday, November 16th

This is one of the more important posts I've written of late and helps explain why trying to eliminate our trading mistakes and bad trading practices is often the wrong way to develop ourselves as traders.  It also helps explain why the harder we try to become disciplined, the less disciplined we can become. 

*  Stocks fell in late trade and overnight in response to the Paris attacks, but have bounced well off lows as I write.  As long as we put in lower price highs, I think it's premature to assume we'll rally simply because we've been oversold.  As the posts last week indicated, we have not yet been at oversold levels that have recently corresponded with intermediate-term market lows, per the chart below that tracks new highs versus new lows among the SPX shares.

*  My measure of pure volatility shows relatively little spike during this decline compared with the elevated volatility per unit of volume we saw during the August and September drops.  This would be consistent with a market making an intermediate term correction rather than an actual fresh bear leg down.  My base case continues to be a test of the recent market highs, but it would not surprise me to see quite a few divergences on any such test.