Monday, January 25, 2016

Trading Notes; Week of January 25, 2016

Friday, January 29th

Easy to get burned out sitting in front of screens all day and trying to stay disciplined.  Here is an important antidote to burnout.

*  I've been offline for a couple of days, swamped with coaching work with traders.  Whenever that happens, it's a sure sign that markets are tricky and people are having trouble making money.  We had a real risk off start to the year, with oil, stocks, and emerging markets lower and firmness in the U.S. dollar.  Late last week we saw a sharp rebound and these posts talked about having put in a momentum low for this market cycle.  Evidence was also suggesting that this cycle was not like ones we had seen in 2014 and 2015, with far more persistence of weakness in stocks.  This week we have generally continued the bounce, but in a highly choppy fashion, making it difficult to make money from either the bull or bear side.  Hence the recent frustration of traders.

*  A momentum low implies the possibility that further price lows could remain ahead, albeit with breadth divergences.  That is what we saw in the trade following May, 2010; August, 2011; and certainly January, 2008.  Thus far, this has been a low Sharpe ratio bounce; not the kind of resumption of uptrend that we saw following, say, the October, 2014 low.  That uneven bounce increases the likelihood in my estimation of those retests of lows.

*  Which brings us to today's trade.  With the move to negative rates in Japan, we saw a sharp rally in stocks, followed by a sharp dip, followed by more rangy behavior in the ES futures.  Oil has rallied significantly from its lows; VIX has remained above 20.  I'm concerned that we're having trouble making fresh highs in ES in pre-market trade even with the Japan easing and oil strength.  That has me looking to sell strength as long as we can remain below the post BOJ highs.

*  Note that there is a difference between a retest of lows and the start of a fresh bear market leg.  When we had extended bottoming processes in May, 2010; August, 2011; and even that January, 2008 period, there was a two-way trade and rallies interspersing the declines.  My leaning will be to take profits opportunistically on short trades and not necessarily assume a resumption of a high Sharpe downtrend.

Tuesday, January 26th

*  After failing several times to stay above the 1900 level, we saw a selloff in the ES contract that featured numerous very negative NYSE TICK readings.  The inability of buyers to get the upticks much above +500 for any sustained period was a clear indication that we had put in a top and that sellers were in control.  Prices continued to weaken during Asian hours and now have rebounded in premarket, with a bounce in oil.  All of this is consistent with a market that has made a momentum low and is early in a bottoming process.  Note that such a process took months in early 2008, mid-year 2010, and fall 2011, with multiple rallies and pullbacks.  This two-way action can be frustrating for bulls and bears alike and highlights the importance of not assuming that moves will extend.

*  Note the significant weakness in KRE, the ETF for regional banks.  Some of those banks have exposure to energy-related loans, which could be in jeopardy if oil prices continue weak.  That's a dynamic I am watching closely.  I'm also watching the big banks (XLF) to see how global economic weakness, particularly among emerging market countries, might affect loans and market exposures.

*  Note that we continue to be significantly oversold on most breadth measures.  I expect further working off of this oversold level in the next couple of weeks.  My cycle measure has turned up, but is not at levels that have corresponded to intermediate-term highs.  As noted before, we've made a lower low in that cycle measure, which opens my thinking that what we're seeing is more than the kinds of corrections that we experienced in 2014 and 2015.

Monday, January 25th

*  Friday saw a continuation of the rebound from momentum lows, with breadth finally touching short-term overbought levels.  Over 80% of SPX shares closed above their 3 and 5-day moving averages; that's the first time we've seen that since December 24th.  (Data from Index Indicators).  The rally took the great majority of stocks off their lows.  Across all exchanges, we had 139 monthly highs against 208 lows.  Compare that with 44 monthly highs and 3250 lows just two days previous.  (Data from Barchart).

*  One sign of continued strength on Friday was that significant negative readings in the uptick/downtick measure (NYSE TICK) could not stop us from making higher price lows and higher price highs.  I will be watching for that dynamic in early trading today.  A drop below the Friday afternoon and overnight lows would likely break that pattern and signal fresh selling interest.

*  I will also be watching this week to see if the bearish market themes (weak oil; weak emerging market shares; strong dollar versus EM and commodity currencies) reassert themselves.  I'm also watching to see if we can print fresh price highs for this rebound with continued strong breadth.

*  A nice view of the market's cyclical behavior is provided by the number of NYSE shares giving buy vs. sell signals for the Parabolic-SAR measure.  That cumulative total has tracked market cycles well over the past two years.  (Data from Stock Charts).  As you can see from the chart below, we've bounced, but are not yet near levels that have corresponded to intermediate-term cycle tops.