Monday, February 22, 2016

Trading Notes for the Week of February 22, 2016

Friday, February 26th

*  I found yesterday to be an important day in stocks.  In early trade, we were unable to break the recent highs and my short position went into the money rather quickly.  Then we saw meaningful buying come into the market, with subsequent selling unable to take the market to new lows on the day.  I covered for a small profit and said to myself at that point, "sellers can't take this market lower."  It was one of those cases where a "failed" trade provided meaningful information.  We broke to new highs on the day and rather quickly took out the recent highs.  That strength has continued in overnight trade and so far looks to be a meaningful upside break out.  Of course, we need to hold yesterday's lows to validate that perspective.

*  Here is a chart of short-term breadth among SPX shares.  Note that we're staying overbought and making higher highs during that time.  That's what bull phases of cycles do: they follow strength with strength.  We had 237 stocks across all exchanges register fresh three-month highs against 114 lows.  That's a breadth expansion.

*  As the chart shows, of course, we *are* stretched in breadth.  Over 80% of SPX stocks are trading above their 3, 5, 10, and 20-day moving averages.  I would not be surprised to see some corrective activity in the near future, and I would not be surprised to see that activity base in the 1930s/1940s area for ES that had been prior resistance.  Failure to hold that area would give me greater pause regarding the vigor of the rise from recent bear lows.

Thursday, February 25th

*  After early weakness yesterday, we launched a significant rally, with strong buying readings from the NYSE TICK measure.  Now the issue becomes how we trade around the recent highs and whether that buying interest can be sustained.  This is particularly relevant, as many of my cycle measures are maturing:

*  As you can see from the chart above, my bigger picture concern for this market is that we're seeing cycle peaks at progressively lower price highs, which is precisely what you'd expect in a bear market.  That view suggests that, for longer-term traders, selling cycle highs that cannot make fresh price highs would be a promising strategy.

*  A concerning aspect of this bigger picture is that financial shares are now the laggards in this market, year to date--not the commodity stocks.  Here's a picture of sector performance from  When banking stocks are unusually weak, one has to be concerned about vulnerabilities within the broader financial systems.  In this case the concerns are global, including China and Europe, not just U.S. financial institutions holding risky high yield/energy debt. 

Wednesday, February 24th

*  Yesterday saw a significant pullback in stocks--a trend day to the downside--with weakness continuing in overnight trade.  The fall in oil prices, with hopes of production cuts dimming, continues to weigh on stocks as part of a general deflationary theme, with notably weak equity performance coming out of Europe.  I continue to track these macro themes closely.

*  Many of my cycle measures are maturing.  Should forward market strength prove unable to decisively break above the 1940s area resistance for ES, I would look for a fresh leg down in stocks.  The current market action, with the larger than normal drop yesterday and early today, reminds me of the cycle that occurred early in 2008, when a January low led to a choppy, but ultimately weak, cycle higher prior to the significant drops later in that year.

*  Here's how we stand on one of my favorite measures, an intermediate-term gauge of new highs versus lows specific to the SPX stocks.  Despite yesterday's weakness, we're closer to overbought status than oversold.

Tuesday, February 23rd

*  We saw a solid rally on Monday, supportive of the breadth and money flow pictures noted in yesterday's post.  I also note that yesterday saw the first close below 20 in VIX in a while.  We're also seeing moderating volume in stocks.  This should lead to more moderate volatility/daily ranges for the major market averages, which has implications for the placement of stops, targets, etc.

*  Breadth continues to expand with the market rally.  I generally become most skeptical of market rallies when a meaningful proportion of shares stop participating in the strength.  Those are often the sectors that lead the subsequent downside.  A good example from the most recent cycle was energy shares: they weakened far earlier than the broad market.  Right now, we're seeing solid, expanding breadth, which is typical of a relatively young phase of an upward market cycle.  That doesn't mean we can't have corrections, but those are contained in earlier cycle phases and are meant to be bought.  Yesterday we had 934 stocks across all exchanges register fresh monthly highs against 109 new lows.  The last time we had so many stocks making monthly highs was early November, 2015.

*  I do note that, short-term, we're pretty stretched on those breadth measures.  Below is a useful overbought/oversold measure, which is a five-day moving average of 5, 20, and100-day new highs versus new lows for all SPX shares.  (Raw data from Index Indicators).  It's not unusual for this to top out ahead of price during strong market cycles, but it's also not unusual to see some corrective activity prior to any upside continuation.  As cycles mature, I'm much keener on buying pullbacks than counting on upside momentum following price highs.  In a strong cycle, any such pullbacks are relatively contained and occur at successively higher price lows.  Despite the recent strength, I am very open to the possibility that the current cycle will not be a strong one and will terminate below the level of the prior cycle as part of a longer-term market correction.

Monday, February 22nd

*  Can we systematically make ourselves more successful in our work, our relationships, and in markets?  Here are four key strategies for building on success, drawing from several excellent recent books.

*  As I write, we're testing highs from the recent bounce; that fits with the breadth and money flow picture noted yesterday.

*  I continue to find it useful to track the number of NYSE issues that give buy versus sell signals across a variety of market indicators.  Here's a composite measure of indicators with relatively low correlations that adjusts the indicators for differences in volatility, so that each contributes more or less equally. We've moved above the zero line, but are not yet at levels normally associated with an overbought market.