Have We Put in a Stock Market Bottom?

Above is a daily chart of the S&P 500 Index (SPY) with the number of NYSE, ASE, and NASDAQ stocks making new 65-day lows printed below the relevant bars and the number making fresh 65-day highs printed above. You can see the pattern of dwindling new lows and, recently, expanding new highs. After pulling back and holding support, the market is in rally mode today. An expansion of new 65-day highs above the 480 level registered on 4/7 would confirm that we have, indeed, put in an intermediate-term bottom in stocks. A return to the trading range of the past several days would obviously invalidate today's breakout move.
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Volume in the Stock Index Futures Market - Part One

My recent post offered a simple tool for active traders who were having difficulty getting a handle on the character of the evolving trading day. This two-part series will outline a different set of tools for the same purpose, based on market volume. The core idea is that how the market will trade is a function of who is participating in the marketplace. If large, institutional traders are active, we will tend to see greater price volatility and larger market moves per unit of time. If those institutional traders are not active, the market is more likely to be quiet, with low volatility and smaller moves per time unit.

Those large traders are trading directionally, many times keying off fundamental dynamics (news, earnings reports, economic reports) and intermarket dynamics (shifts in interest rates, currencies, commodities). It's when these related markets are moving actively that we're more likely to revaluations of stocks, and hence greater institutional participation (volume). When news is relatively absent and those related markets are not undergoing shifts in their value areas (to use a Market Profile term), it is less likely that stocks will be revalued. That keeps volume in shares low and price action quiet.

A large part of understanding the character of the market day, then, is seeing what is happening in those related markets and seeing how stocks are trading relative to expectations regarding economic news, earnings reports, and the like.

Another way of capturing the character of the market day is to directly measure volume and compare it to the median volume for that particular time period over a lookback period. My research has found that, when this relative volume is elevated (i.e., when we're trading higher volume than normal in a particular time frame), the added volume almost exclusively comes from transactions of 50 contracts or larger in the S&P e-mini futures (ES contract). Clearly, those trades are not coming from small retail traders. Rather, it is the professional trader who is more active in the market when volume is elevated. The increased volume is the footprint that tells you *who* is in the market at the time.

For purposes of illustration, I went back to March 13th (when the June ES contract became active) and broke down each trading day into nine 45-minute segments. The correlation between the volume of the 45-minute period and the high-low price range for that period was a considerable .83. To give but one example, when the volume of the 45-minute period was above 170,000 contracts (N = 105), the price range for the period averaged .78%. When the volume was below that level (N = 102), the price ranged averaged only .42%. On average, price movement was nearly twice as high during busy periods as during slow ones.

Interestingly, 14 of the 20 highest volume periods occurred during the first or last 45-minute trading segment of the day. Conversely, 17 of the 20 lowest volume periods occurred during the midday periods from 11:45 AM ET to 2 PM ET. That tells us that *who* is in the marketplace changes significantly over the course of the market day. An active trader needs to have different anticipations of price movement early and late in the day compared with midday.

Finally, on a daily basis over the March 13th-present period, daily price range correlates a whopping .86% with daily ES contract volume. When the ES volume has been over 1,800,000 contracts (N = 12), the daily price range has averaged 3.16%. When the volume has been below that level (N = 11), the daily price range has averaged only 1.43%.

Clearly this has important implications for how traders manage trades. In a busier, more volatile market, it makes sense to place stops wider and to let profits run further (i.e., to place profit targets further from good entry points). In slow markets, it makes sense to keep stops tight and take profits aggressively, as these are less likely to run.

Who is in the market dictates how you should trade that market. That varies from one day to the next, and it varies from one time of day to another. I cannot think of a more important lesson for developing active traders.

RELATED POST:

Intraday Volume Patterns and Volatility
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Sector Correlations as a Decision Support Tool for Active Traders

I've spoken with a number of intraday traders who have difficulty judging the daily market environment in which they're operating. Is this a busy, volatile day, or a slow, non-volatile one? Is this a range day, or a trending one? Of course, none of us can know the future with certainty and, at any point in the day, markets can shift gears. Still, making as accurate an assessment of market conditions as possible is extremely helpful in knowing where to place profit targets (nearer in slow, range markets) and stops (wider in volatile markets). Understanding the character of a market day is also very helpful in the decision of whether to let profits run vs. book them in a more opportunistic fashion.

Above is one of my analytical tools that helps me identify market conditions as they're evolving. The blue line is the S&P 500 Index (SPY) at 15-minute intervals. As we can see, over the two day period charted, we have been quite rangebound.

The pink line represents the correlation among four key S&P 500 sectors: financials (XLF), energy (XLE), consumer discretionaries (XLY) and consumer staples (XLP). I calculate the correlation of each sector with every other sector over a moving one-day period (26 15-minute periods) and then plot the average of those correlations. Historically, this average correlation among sectors is .53. When we see the correlation significantly higher than .53, it suggests that the different sectors are moving very much in tandem intraday. When we see the correlation significantly lower than .53, it suggests that the different sectors are not moving in unison.

Why is this important? In a trending market, the sectors tend to move in harmony. Strong uptrends or downtrends tend to move all sectors. Conversely, as markets become transitional and rangebound, sectors tend to move their separate ways, with stronger ones showing relative strength and weaker ones lagging. So, as a rule, when I see a correlation among sectors that is high and rising, I view the current environment as trending. When I see a correlation among sectors that is low and falling, I view the trading environment as rangebound. When the correlation is low and rising, I entertain the possibility that a trending move is in the making. When the correlation is high and falling, I consider the possibility that a trending market may turn transitional and rangebound.

As you can see from the chart above, the low, falling correlation has been an excellent tell over the past two days for the market's range behavior. This was very helpful in terms of avoiding bad trades (not buying range highs or selling lows) and considering some good ones (fading moves to range extremes). The low correlation has also been useful in suggesting that market moves are unlikely to extend, making it particularly important to book profits when they're available.

The above chart was created in a matter of minutes in Excel using data from a real-time data feed. No special software or programming expertise was needed. I have found such decision support tools invaluable in my own trading. They do not take the trader away from the screen for lengthy periods of time and very much help in preparing the trader for the coming day.

RELATED POST:

Anticipating Market Volatility (see also the links at the end of that post)
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Overnight and Daytime Market Regimes

The charts above decompose the S&P 500 Index (SPY) and 10-year Treasury rates ($TNX) into two components: changes that occur from close to open (overnight) and those that occur from open to close (day). For purposes of comparison, the charts are set to an arbitrary index value of 100 on 12/31/04. It doesn't take much analysis to see that the overnight and day markets behave quite differently. In fact, the correlation between overnight price changes and subsequent day changes is -.05 for SPY and .03 for $TNX. These, in essence, are separate markets.

The top chart illustrates how much of the stock market's bullish trend since 2005 has been a function of overnight price change. Indeed, a pure daytrader experienced none of the benefits of this bull run. To be sure, overnight exposure brings its risks, but closing positions at day's end also has greatly dampened reward.

Notice how, for the most part, interest rate changes have been much more pronounced during the day session compared with overnight: swings up and down tend to be larger. A good part of the trending behavior in rates has occurred during the day--at least until recently.

Which gets us to one of the most interesting aspects of this exercise. Until January of this year, much of the drop in stock prices since mid-2007 occurred during the day session. Similarly, much of the fall in interest rates (flight to quality) also occurred during the day. Since January, however, the day behavior of stocks has been relatively muted--as has been the day behavior of rates. Instead, we've seen pronounced overnight weakness in both stocks and rates since January.

This shift in regimes may be quite meaningful, reflecting a thematic shift in the markets. Much of the drop in shares and rates from mid-2007 through the January lows was a function of credit fears, whose epicenter has been in the U.S. Since January, however, U.S. stocks and rates have been responding increasingly to global recession fears, weakness in global share prices (across Asia most notably), and preopening economic and earnings reports related to recession.

It's interesting that the number of common stocks on the NYSE making fresh 52-week lows hit their highest level in January at exactly the time this overnight/day regime shifted. I believe that January low represents a pivotal point at which markets shifted their focus, such that overnight events--and the global economic picture--are now weighing more heavily on stocks.
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RELEVANT POSTS:

Are Technical Indicators Relevant for Daytraders?

How to Lose Money Buying in an Uptrend

The Multiple Personality of the Stock Market
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Perspectives to Start the Market Week

* Yet Another Longer-Term Perspective - I recently offered a long-term perspective based on the percentage of NYSE stocks trading above their 200-day moving averages. Here's a different take on the issue. In January and March of this year, as markets hit their lows, the S&P 500 Index ($SPX) moved more than 10% below its 200-day simple moving average. I went back all the way to 1960 (N = 11962 trading days) and found 667 occasions in which $SPX was more than 10% below its 200-day MA. When we look 200 days later, $SPX was up 525 times, down 142 times, for an average gain of 13.51%. That compares very favorably with the average 200-day gain of 6.05% (8017 up, 3268 down) for the remainder of the sample. Of course, that's not to say that a weak market can't get weaker: in 1974, 1987, and 2002, $SPX went more than 20% below its 200-day MA before righting itself. Interestingly, there have only been 78 days in the entire period from 1960-present in which $SPX has been more than 20% below its 200-day moving average. The market finished stronger 200-days later on 76 of those 78 occasions.

* Interesting Fed Perspectives - The Big Picture takes a look at Greenspan, Bernanke, and Friedman and the use of the printing press to work our way out of deflation. For more on Fed perspective, check out the updated links at Trader Mike's site and several excellent links at Abnormal Returns.

* Profile of a Stock Picker - Charles Kirk interviews a winning stock picker and takes a look at what makes him tick. While we're on the topic of stock picking, check out the fruits of Chris Perruna's recent research.

* Declines in a Consolidating Market - Quantifiable Edges examines what tends to happen when markets drop during a non-trending period.
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Indicator Review for April 14th

Last week's indicator review noted significant buying pressure among stocks as we approached important resistance near 1400 in the S&P 500 futures contract. That post further observed some potential negatives on the horizon--weak advance-decline lines, an overbought market condition, and worrisome credit spreads--but anticipated a breach of the overhead resistance, given the market's apparent double bottom. "What would change my mind from this scenario," I explained, "would be reversals of the dynamics we're currently seeing in NYSE TICK, money flows, and the expansion of stocks making new highs. Particularly worrisome would be an expansion in the number of stocks making fresh 20-day lows."

Well, guess what? As we see from the bottom chart, the cumulative NYSE TICK did indeed roll over, as we failed to sustain the test of the important resistance area. Stocks fell back last week, ending Friday on a particularly weak note. New 20-day lows expanded through the week, with a Friday reading of 450 new highs and 545 new lows. My five-day indicator of money flows into the Dow Industrials stocks turned positive with the market's rally, but fell to a modest negative level by the end of the week. Those weak advance-decline lines weakened even further, making new bear lows across several sectors and, for the broad market (NYSE common stocks), is now near bear lows. Moreover, my measure of technical strength stalled out early in the week and intermarket themes associated with stock market weakness reasserted themselves.

So where does that leave us? My cumulative Demand/Supply indicator, which has done a terrific job of identifying recent short-term market tops and bottoms, is back in neutral territory. Given the recent expansion of stocks making new lows, the declining NYSE TICK line, and the weak advance-decline performance, the best we can say is that we are trapped in a trading range between that resistance near 1400 in the ES contract and the March price lows. A retest of those lows is not at all out of the question, particularly if we continue to see further weakening among these indicators. I'll be updating the indicators daily in my Twitter posts to keep readers up to speed.

It is not at all clear to me that the current weakness will bring a new bear market leg. The number of stocks registering fresh 52-week lows has been drying up since January. For example, among NYSE common stocks, we had over 700 new lows in January, but only a little more than 300 new lows at the March price lows. This past Friday, we had 19 annual new highs among NYSE common issues and only 42 lows. That cumulative NYSE TICK line shown above has indeed turned down, but is very well off its March lows. In the past, that has set us up for divergences and reversals of tests of trading ranges. Should we fail to sustain a move below the March lows, I believe we could see some real opportunity to the upside, given the market's historic oversold condition.

As long as the indicators continue to weaken, I remain defensive. I think it's fair to say that I'm cautiously bearish on a day-to-day basis and cautiously bullish on a longer-term basis. How we resolve the aforementioned trading range will have significant implications for stocks and the broader economy.
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Is Market Weakness Offering Opportunity? A Long-Term Perspective on Stocks

With a major shout-out to Decision Point, here's a long-term perspective on the NYSE Composite Index ($NYA), which is a pretty good reflection of the broad stock market. The top panel shows price movement in $NYA, and the bottom panel shows the percentage of NYSE issues trading above their 200-day moving averages. I labeled the points at which we moved below 20% in the indicator. As you can see, those points captured major market bottoms in December, 1987; October, 1990; December, 1994; October, 1998; October, 2002; and most recently in January, 2008.

The percentage of stocks trading above their long-term moving averages is not a bad indicator of "overbought" and "oversold". If you think about it, we can define a bull market as one in which we see successive overbought and oversold levels at higher prices. A bear market is one in which we see successive overbought and oversold levels at lower prices.

I'm well aware of the market's short-term weakness, and I'll be commenting upon it in tomorrow morning's indicator update. But I wanted to pull up this longer-term perspective because, unless my eyesight is failing me, $NYA remains in one helluva bullish configuration. For all the sky-is-falling worries about housing, weak dollar, national debt, and toxic credit, we remain far above our 2002 lows and less than 15% off all-time highs.

Now maybe this time is different, and maybe the sky will fall. If so, my shorter-term indicators will pick up the expanding number of stocks making new lows; the sustained weakness in cumulative TICK, money flows; etc. But we've seen dwindling new lows since January, and the percentage of NYSE issues above their 200-day moving averages has been on the rise since then--even as we made price lows in March. If we cannot sustain the recent weakness and decisively take out the March lows, I will approach the long-term the way I approach short-term trading, entering an established trend on a pullback.

RELATED POST:

Getting Close to a Bottom?

Cracks in the Bear Foundation
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Two Stock Market Sector Ratios I'm Watching Closely

The above charts represent price ratios between pairs of sector ETFs within the S&P 500 universe. Each represents a theme that I consider to be a driver of the recent bear market. Accordingly, I am watching these ratios (and themes) for indications of a continuation vs. reversal of bear market dynamics.

The first theme (top chart) represents the price ratio between the Materials ETF (XLB) and the Financials ETF (XLF). It depicts the relative valuation of physical assets--raw materials--to financial assets. In a weak dollar environment, as well as an environment of low confidence in the banking sector, raw materials should be more attractive than financials. A reversal of this ratio would suggest that the dynamics underpinning the weak dollar (expectations of further interest rate cuts by the Fed; lack of G-7 action toward a stronger dollar; recessionary expectations; fear of bank failures) were shifting.

The second theme (bottom chart) represents the price ratio between the Consumer Staples ETF (XLP) and the Consumer Discretionary ETF (XLY). It depicts the relative valuation of defensive stocks--those traditionally deemed relatively recession-proof--vs. those that are more vulnerable to contractions in consumer spending. In a recessionary environment, Staples should outperform Discretionaries as investors flee to sectors representing relative safety. A reversal of this ratio would suggest that the dynamics underpinning the recession (weak housing market; weak consumer confidence; weak employment market) were shifting.

What we see clearly in both charts is that, since mid-2007 (the period recently highlighted as one of changing intermarket dynamics), these ratios accelerated significantly as the stock market sold off. The XLB:XLF ratio topped out in mid-March (when the stock market made its price lows), pulled back sharply, and has since been clawing its way back toward its highs as stocks have fallen back. The XLP:XLY ratio topped out in early January (when the number of stocks making new 52-week lows maxxed out), dropped back sharply, and has bounced back in a choppy manner since then.

Both of these ratios capture something of the psychology of the current stock market. A move to new highs would suggest that the psychological drivers of the recent bear market are intact. A failure to advance to new highs, even as the number of stocks registering fresh 52-week lows is dwindling, would have me questioning the bear's longevity.
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Five Lessons Traders Can Learn From American Idol

* It's a Marathon, Not a Sprint: You don't have to finish #1 to have a very successful career, and some top finishers have short-lived careers. Check out Chris Daughtry.

* Many Are Called, Few Are Chosen: For every Idol, there are many deluded wannabees. Know your strengths, and go with them.

* Be Yourself: Much of success comes from picking the right song (market, trading style) and making it your own, rather than mimicking others. Check out David Cook.

* It Takes More Than Dreams: Some of the worst tryouts are contestants with the loftiest dreams. Without talent and skill, dreams are mere fantasies.

* Listen to Feedback: The verdicts of the markets may sound more like Simon than Paula, but they provide important information for the next performance.

RELATED POST:

Ten Lessons I've Learned From Traders
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How Markets and Intermarket Relationships Have Changed Since Mid-2007

One of the great dividing points between experienced, successful market participants and amateurs is that the former realize that markets are continuously changing. They make active attempts to identify and adapt to these changes. Amateurs look for fixed patterns across all markets and all periods of time. For them, financial markets are relatively static entities.

This post illustrates how markets do, indeed, change over time. The chart above tracks volatility--the median price movement--for equities (S&P 500 Index, SPY) and interest rates (10-year Treasury rates, $TNX) both during the overnight period (close to open) and during the day period (open to close). Note that we're looking at the absolute size of movements--pure volatility--not the directionality of those moves.

What you can see is that the volatility of those movements has expanded significantly since mid-2007. In each case, the red bar is quite a bit higher than the blue bar, meaning that volatility since July, 2007 has increased for both stock price movements and the movement of interest rates. Indeed, for the most part, the movements lately have been twice as large since July, 2007 as they were from 2006 through June, 2007.

But it's not only the *size* of these movements that has changed dramatically. The relationship between stock price movements and the movements of interest rates has also shifted meaningfully. Below, here are the correlations between equity and rate movements:

Overnight, 2006 - Mid 2007: .16
Overnight, Mid 2007 - Present: .45

Day Session, 2006 - Mid 2007: .09
Day Session, Mid 2007 - Present: .40

In other words, the size of movements in equities are rates were relatively uncorrelated from 2006 through mid-2007. Since mid-2007, however, the size of those movements has been significantly more correlated: when we see big moves in one, we tend to see large moves in the other.

And, of course, when we look at the directionality of those movements, we see greater correlation during the recent period as well. In past periods, falling interest rates (rising Treasury prices) have been associated with bullish movements in stocks, as reduced rates have spurred lending and economic activity. Since mid-2007, however, Treasuries have acted as a safe haven when there has been uncertainty about stocks and the economy. As a result, we've seen a tight correlation between falling yields and falling stock prices.

Specifically, the correlation between end-of-day changes in SPY and $TNX was -.03 from 2006 through mid-2007. Since mid-2007, that correlation has soared to .56.

Volatility has changed, intermarket relationships have changed. We've also seen dramatic changes in trending over these time periods, across bonds, commodities, currencies, and stocks. Identifying and understanding these shifts is essential to successful investment and portfolio management. I would also argue that, on a day-to-day basis, it's also invaluable for intraday and swing traders.

RELATED POST:

Intermarket Relations
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Tracking the Impact of Recession Fears on the Stock Market

* Advance-Decline Weakness - The above three charts from the excellent Decision Point site show how we are testing bear market lows in the advance-decline lines specific to S&P 500 stocks (top chart), NASDAQ 100 stocks (middle chart), and Dow 30 Industrials (bottom chart). The themes of weakness noted recently continued through week's end.

* Sector Deterioration - My recent review of sector strength and weakness found strength confined to a very limited portion of the S&P 500 universe. In the last two weeks, the percentage of Consumer Discretionary stocks trading above their 50-day moving averages has plunged from over 70% to 30%. The corresponding percentage for Financial stocks has dropped from 65% to 28%. Meanwhile, we're still seeing 59% of Consumer Staples stocks trading above their 50-day averages, as money flows continue to reflect defensiveness and fears of recession.

* New Flight to Safety? - I've been watching the tax-free bond funds of late, largely because I committed a chunk of long-term portfolio money toward those. Interestingly, when we had stock market selloffs in August and March, there were selloffs among tax-free bonds, reflecting fears of default. During the recent stock market weakness, however, a number of tax-free funds have been making six-week price highs. We're also seeing some strength carry through to investment-grade corporates. Even as we price in recession, we may be discounting the probability of Armageddon.
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An Effective Technique for Preventing Frustration and Its Effects on Trading

The first post in this series dealt with stilling the negative thoughts that are triggered by trading-related frustrations. The second post outlined three steps for breaking patterns of frustration as they're occurring. In this final post in the series, I will describe my personal favorite among the strategies for dealing with frustration, one that I use extensively myself as well as with traders I coach. The appeal of this methodology is that it is preventive: it is designed to head off frustration before it occurs.

To understand the method, let's take a simple, practical example. Suppose you find traffic jams to be especially frustrating. You often lose your cool during periods of traffic delay, ruining your mood for the remaining morning or afternoon. How could you prevent this from occurring?

Telling yourself to not overreact doesn't work: emotions are amazingly refractory to such willpower efforts. Interestingly, the best approach is to actively *plan* for the very frustration you hate. If, say, you *knew* you were going to be delayed in your commute due to a snowstorm, you could prepare in advance. You might bring extra music, snacks for the car, or an audiobook for listening. You might plan out conference calls you can make from the road while you're stuck in traffic. Once you are actually sitting in the traffic, you find that it's not so frustrating: you are prepared--and that takes the emotion out of the event.

Let's take a step back and examine the causes of frustration. We become frustrated when we have a goal or purpose in mind and when this objective is hindered by forces beyond our control. Thus, we might be frustrated by an airline delay when we're in a hurry to a business meeting, or we might be frustrated when we're looking forward to a good night's sleep, but are kept awake by noise outside our window.

Frustration hits us when we experience these impediments as *threats*. The airline delay might be a mere annoyance if we're not in a rush to an important event. If, say, that event were a crucial job interview, we could be frustrated indeed.

When a trader emotionally accepts losing as part of the business, loss is not so threatening. With proper money management, it can be contained and need not pose more than an annoyance. But if a trader *needs* to make money--perhaps because of perfectionism, or perhaps because of dire financial circumstance--then normal loss might be experienced as unusual frustration. It's the overriding *need* to make money that sets the trader up for acute frustration.

As in the above example of anticipating the traffic delay, we can anticipate losses and prepare accordingly. For example, let's say I'm preparing myself for a potential reversion to a mean trading price as we're trading near the bottom of a multi-day range. I know that, as we approach the lower end of that range, that we'll either get the anticipated reversion, or we'll see a downside breakout. Either way, there will be a good trade in the offing.

Before the market opens, I seat myself comfortably and breathe deeply, slowly, and rhythmically, focusing my attention on relaxing music playing through headphones. Once I'm calm and focused, I walk myself through the anticipated trade, imagining in detail how the market trades near the bottom of its range and bounces higher, how I wait for the first pullback from that bounce, and then how I enter with my long position to capitalize on the return to the average trading price within that range. It's as if I'm watching a movie, visualizing vividly myself executing the trade idea.

Then, however, I include the frustrating event in the visualization: I vividly image the market reversing and trading weaker, with volume now hitting the market bid. I imagine myself feeling frustrated that my trade hasn't followed through, and I visualize myself stopping the trade out once we trade below the point at which the above-mentioned bounce began. Then, I further visualize waiting for a fresh downthrust (confirming the weakness) and immediately entering the market on the short side on the first bounce, flipping my position to capitalize on the downside breakout. That is my preparation for the frustration, just like the preparation of the driver who knows he'll be stuck in traffic in a snowstorm. Instead of viewing it as threat, I'm mentally rehearsing it as opportunity. The stopped out "reversion" trade tells me that we're not going to stay rangebound. Instead of focusing on the loss, I stress the information gathered from the loss and prepare in advance to flip my position.

As with the earlier exercises, this exercise requires repetition and the willingness to take time each morning to prepare for frustrations with vivid scenarios. Readers of my book on trader performance will recognize this approach as a variation of the exposure methods I described in the chapter on behavioral techniques for change. My experience is that traders can learn these methods for themselves as part of becoming their own trading coaches. My upcoming book will describe this in considerable detail. The key is embracing frustration by anticipating it and turning it into opportunity. That removes the threat from emotional triggers, enhancing a trader's self-control.

RELATED POSTS:

Overcoming Anxiety

Consumer's Guide to Coaching Traders
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A Few Thursday Thoughts

* Tracking Adverse Excursions - This is an excellent post worth thinking about. Henry Carstens has tracked the average amount a position taken at the market close will move against you by the close of the next day. You'll see why the current market has been challenging for traders and investors alike.

* Imminent? - A number of observers are predicting Middle East war. See also this perspective from Stratfor.

* Economic Realignment? - Given the new oil and gas boom in such places as the Dakotas and Western Pennsylvania, as well as a farming boom worldwide, the commodity bull market is creating a new set of economic winners and losers, as well as a new set of winners in the stock market.

* Commodities in a Weak Economy - One analyst sees weakness among industrial commodities, but strength among those linked to the US dollar.

* Thanks - To those who have passed along congratulations regarding the recent Business Week accolades.
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Currencies, Interest Rates, and Stocks: It's All One Market

* Intermarket Relationships - The ES futures (top) and Yen (middle) charts look like mirror images. As the yen has strengthened vs. the US dollar, stocks have weakened. This relationship is carrying forward this morning as I write and provided some nice intraday tells regarding market direction on Wednesday. Similar tells have been evident in 10-year Treasury yields (bottom chart), which have paralleled stock moves of late. When there is a flight from stocks, we see a flight to quality in Treasuries (rising prices, falling yields). Not shown is the euro vs. the dollar, which is moving to new highs this morning. The falling U.S. dollar has not been helping stocks, as interest rate gaps among countries continue to weigh on the currency. By way of comparison, two-year rates are down to 1.73% in the U.S., but are 3.93% in the U.K.; 3.44% in Germany; and 6.18% in Australia--even as the Fed is expected to ease rates further. The charts show different asset classes but, in times of fear, these trade as one market--which suggests that intermarket correlations are not a bad measure of investor psychology.

* One of My Better Posts - This one came in handy on Wednesday and very much supports the above intermarket observations.

* A Word of Thanks - I've received a number of positive emails about the Twitter posts, which link daily themes in markets and summarize market indicators. My goal has been to create a blog within a blog via Twitter, and the rising number of people subscribing suggests that this has been useful. For those new to the blog, the last five Twitter "tweets" appear on the blog; the entire list appears on my Twitter page.
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Quick Market Update

* Broken Support - The NQ futures were the first to break below multi-day support on Wednesday, as consistent selling sentiment (NYSE TICK) and weakness in the financial sector eventually led the entire market lower. The shrinkage in stocks registering new highs as we approached the 1400 area of resistance in the ES futures and the loss of upside momentum among stocks--both noted in the Tuesday post--anticipated this breakdown. Now we're seeing an expansion of stocks making fresh 20-day lows amidst continued negative momentum. A rundown of Wednesday's indicators will be posted to tomorrow's Twitter comments.

* Deterioration of Technical Strength - Among the stocks in my basket of S&P 500 issues evenly selected from eight sectors, we're now seeing only 16 in uptrends, 9 neutral, and 15 in downtrends. Energy issues continue to shine, given strong oil prices. If you take those shares out of the mix, however, you see that strength is difficult to find among the sectors.

* Tale of Three Markets - We're seeing bull market highs for the Advance-Decline line specific to the S&P 500 energy stocks that comprise XLE. We're also seeing fresh bear market lows for the Advance-Decline line specific to the S&P 500 financial stocks that make up XLF. It's not a good sign that the AD Line specific to the S&P 500 consumer discretionary stocks that comprise XLY has also made a bear market low as of Wednesday. If we were on the verge of an economic turnaround thanks to central bank and government intervention, one would think that the lines would be moving higher in unison, in anticipation.
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Market Review and Resources for Wednesday

* Banks Continue to Lag - Here we see a chart of the S&P 500 Index ($SPX; top chart) since the mid-March bottom. Beneath it is the equivalent chart for the banking sector ($BKX). Whereas the large cap market overall has vaulted above its 3/24 highs, the banks have not. Moreover, the large caps have only retraced a modest portion of their early April rally, but the banks have retraced about 50%. As my recent post indicated, the strongest sectors of late have been energy and materials--a reflection of weak dollar and strong commodities. That's not a theme that is a good foundation for a sustained bull move in stocks. The 1400 area remains important resistance for the ES futures; I don't think we'll sustain an upside breakout unless something ignites these banks.

* More on Mind and Body - An interesting research report links depression as a causal factor in Alzheimer's Disease. As some of the links I posted recently indicate, depression is also implicated in heart disease--and negative patterns of thinking are implicated in the genesis of depression. It's not too difficult to connect the dots and see fascinating patterns between how we think, how we feel, and how healthy we are. The exercises from my recent post (and the one from my upcoming post) might be helpful for more than trading alone.

* Establishing a Track Record - I see Rob Hanna's trade ideas from his tested historical patterns have performed nicely. Rob generously shares many of his patterns in his blog. If you didn't catch my Twitter link to his pattern post, it's worthy of study. And, while we're on the topic, Rennie Yang maintains a continuous track record for his "trend catcher" system and provides intraday alerts of signals. That system recent moved to new equity curve highs, amidst an increasing incidence of trend days. Excellent resources; you have to admire newsletter writers that test their ideas in advance and then track their performance in real time.

* Gaming Stocks Ahead of Earnings Reports - Kirk takes a look at issues that make his stock screening cut and then examines their earnings report patterns and expectations prior to announcements. This could be a nice way to play behavioral finance biases associated with underreactions to surprise news events. While you're at it, check out The Kirk Report's interview with economist and contrarian Irwin Yamamoto. His outlook on housing, consumer debt, and the Dow is sobering.

* Not Shorting a Dull Market - Trader Mike notes a short-term sell signal, but he's holding off until he sees volume confirming the intentions of sellers. So far, we've seen dwindling new 20-day highs among stocks in recent days, but no expansion of 20-day lows. It's the latter that would turn me bearish on this market.

* Going for the Yield - Anyone looking to park money relatively safely and achieve any kind of real returns has to be disappointed with the yields available for Treasury instruments and bank certificates of deposit. With baby boomers fearful of returns from stocks and real estate, it's only a matter of time before they swarm to AAA-rated tax-free yields that continue to exceed the aforementioned taxable rates. The Vanguard funds (intermediate-term: VWITX; long-term: VILPX) are ones I've been nibbling at, given low management fees and good diversification among AA and AAA-rated issues. Also on the radar are investment-grade corporate bonds, with long-term instruments pushing a 6% yield (VWESX). Not all safe bond funds are safe, however; check out the links at Abnormal Returns.
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A Quick Look at Technical Strength

The stock market's rally has stalled out as we've approached the resistance area emphasized in the most recent indicator update. Short-term momentum has turned negative, with Demand (an index of stocks closing above the volatility envelopes surrounding their moving averages) finishing Tuesday at 21 and Supply (an index of those closing below their envelopes) at 81. Stocks making fresh 20-day highs dropped to 706; new lows were 236. By contrast, we were seeing over 1900 fresh 20-day highs at the middle of last week.

So which sectors are strong and weak in technical strength? My measure of short-term trending across 40 stocks (five from eight S&P 500 sectors) looks like this:

Materials: +240
Industrials: +60
Consumer Discretionary: +140
Consumer Staples: +200
Energy: +360
Health Care: +40
Financial: +40
Technology: -80

Once again, those commodities/weak dollar themes of Materials and Energy continue to lead the stock market, whereas growth themes (Technology, Discretionary) somewhat underperform defensive themes (Staples). I find the lack of follow-through in relative strength among the Financials particularly concerning and strongly suspect that, if we're going to sustain a break above the 1400 SPX resistance, the strength will need to come from confidence among those Financial shares.
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Three Steps for Breaking Patterns of Frustration in Trading

In my recent post, I recounted the example of Rick and the frustrated thoughts that were interfering with his trading decisions. A major idea from that post was that Rick's thought and behavior patterns were not really overreactions (as he thought they were); nor were they signs that he was "crazy" or "immature" (also things he called himself). Rather, Rick's patterns represented conflicts from his past that were triggered by events in the present, setting off old (and out of date) ways of thinking and behaving.

Research that I recently cited finds that "willpower" is much like physical energy: it can be depleted with effort. When we expend effort on following markets and containing emotions, our reserves of self-control dwindle. This, in turn, leaves us ever more vulnerable to those situations in which present events trigger automatic thoughts and actions from the past.

It is for this reason that "controlling" or fighting emotions is not helpful for the trader. Even if we succeed in keeping a lid on feelings, we take ourselves out of that performance "zone" in which we'll make our best decisions. Only by removing ourselves from the trigger situation and putting ourselves in a different physical and emotional state can we short-circuit the negative patterns (make them less automatic) and enable ourselves to re-enter that decision-making "zone".

So let's break this down: the first steps in changing negative, automatic patterns are threefold:

1) Recognizing the triggers for our patterns - Typically, there are a limited number of situations that set us off. For Rick, for example, a trigger situation was one in which the market moved suddenly against him. This set off feelings of frustration, which then triggered self-talk about markets were "rigged" by the "big guys". Those thoughts, in turn, triggered efforts to fight the big guys, leading Rick to double down on his now-losing trades. This sequence can occur relatively quickly, but notice how there are many points at which Rick could interrupt the cycle. One technique I've found consistently useful is having traders keep a journal in which they look back on periods of frustration and identify the triggers. Reviewing this journal helps us become more aware of--and sensitive to--our triggers. This brings us to our second step.

2) Recognizing that the patterns are occurring - This means monitoring your state of mind and your physical state at regular intervals during the trading day. One tool I've used with traders is a simple picture of a thermometer, in which traders can fill in the time of day and their "stress temperature". The idea is to recognize frustration *before* it triggers ongoing, negative, automatic patterns of thought and behavior. (One trader I worked with stayed hooked up to a biofeedback unit while trading for this very purpose. He stopped trading temporarily when he exited the "zone" to a significant degree). The idea is to generate a mental red flag when we recognize that frustration has been triggered. A journal can be helpful here, as well. In this case, the entries would be in real time: How am I feeling right now? What am I thinking? What is the state of my body? Such a journal strengthens our ability to act as an observer of our patterns, reducing the likelihood that we will become lost in them. This, in turn, brings us to our third step.

3) Taking the break from trading and entering a new state - Once you exit the situation that is triggering frustration, you can engage in an activity that greatly shifts your physical state. The odds are good that this will also move you to a different cognitive and emotional state. A quick round of active exercise (such as jogging on a treadmill, calisthenics, or push-ups and sit-ups) can work very well. Conversely, you may find it more effective to listen to very quieting music and then perform a meditation exercise: vividly imagining yourself in a peaceful location while you rhythmically breathe very deeply and slowly for a few minutes. If you use biofeedback, this would be the time to engage in one of the biofeedback routines. One unit I use, for example, (em-Wave) includes on-screen "games" in which you keep a balloon aloft by staying "in the zone". The idea would be to only return to the trading station once you've kept the balloon aloft for a few minutes. That completely short-circuits the negative behavior pattern. It will take some creative experimentation to find the specific activities that work best for you in shifting your state. In many cases, just taking a break, putting on some music, getting a bite to eat, and walking around are enough for me to clear my head and start fresh.

Notice that the most important step in the above is the decision that a trader makes to not buy into the frustration and the resulting negative self-talk. The market is not the problem. Other traders are not the problem. "My terrible luck" is not the problem. The problem is buying into negative thinking and letting it control trading decisions. That is why the most important step of change of all is the decision to actively fight these automatic patterns. They--not you, not trading--are the problem. Once they're triggered, your sole priority is to interrupt them and prevent them from controlling your behavior. With each interruption, you distance yourself from the patterns and make it easier the next time to extricate yourself from them.

If you find that you cannot identify the triggers and recognize them as they're occurring, you may want to try some of the techniques highlighted in the two chapters in the Enhancing Trader Performance book devoted to cognitive and behavioral methods. I wrote these chapters specifically as self-help mini-manuals for traders. If you find that even self-help methods are not working for you, that's the time to consider professional assistance. Here's a reputable website that offers referrals of licensed professionals in various geographic areas.

That having been said, my experience is that the most common reason that self-help methods don't work is that traders don't stick to them. Patterns that have been acquired over a period of years and reinforced by years of repetition will not go away simply by talking with a coach or trying an exercise a few times. If traders faithfully carried out the three steps above every day for a month, I'd expect to see significant progress in the vast majority of situations. What happens, however, is that traders don't see progress after a few days and give up. It's not the time with a coach or counselor that generates change--it's the consistency of hands-on efforts day in and day out to interrupt and change our patterns.

For my last post in this series, I will outline a specific routine that I use to work on myself. It will illustrate a different aspect of working on changing our automatic patterns: preventing them from occurring in the first place.

RELATED POSTS:

Brief Therapy Techniques for Traders

A Framework for Rapid Behavior Change

Solution-Focused Change
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Markets and Minds for a Monday

* Sector Strength - The above chart shows how stock sector ETFs have fared since the January and March market bottoms. Interestingly, Materials (XLB) and Energy (XLE) are strong performers since the January lows, but have not been so dominant since the March lows. Conversely, Financials (XLF) have moved only modestly since the January lows, but are leaders in the recent period since the March bottom. Homebuilders (XHB) show up strong since both bottom periods. The most recent rally has been led by beaten down sectors, as investors are showing less fear and more optimism regarding housing and banks. Health Care (XLV) has been something of a laggard, perhaps anticipating challenges following the upcoming election.

* Building Willpower - Thanks to a reader for passing along this research perspective on how to build self-control and willpower. That is exactly what biofeedback and meditation are all about. An interesting implication, supported by research, is that efforts to contain our emotions deplete our reserves of self-control. This could be one way that emotional arousal is connected to poor trading performance, as our efforts as self-containment leave us less capable of making disciplined efforts.

* Health and Emotions - Research conducted at Duke University suggests that, individually, depression, anxiety, and anger are positively correlated as traits with the risk for heart disease. When those exist in combination, however, the risk of heart disease rises dramatically. This suggests that the overarching trait of "neuroticism"--the tendency to experience negative emotion--may bring more than just psychological consequences. Indeed, hostility may be more predictive of heart disease than such risk factors as smoking and cholesterol. It appears that the combination of hostility and depression elevates inflammatory proteins in the blood. Moreover, hostility and negative patterns of thinking are directly associated with the risk of depression. How we think thus can affect how we feel, but also how healthy we'll ultimately be.

RELATED POST:

Negative Thoughts and Trading
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Tracking a Flight From Safety

Clawing Back? - After a harrowing decline from 40 down to 16 during 2007, the Homebuilders ETF (XHB) failed to make new lows when the major averages hit new lows in March. Since their lows, the group has risen 50% and is making new year-to-date highs.

Buying Surge - If today holds up, it will represent the 16th day out of the last 19 in which the Adjusted NYSE TICK has been positive on the day. What that means is that, across the broad universe of NYSE stocks, large traders are dominantly lifting offers rather than hitting bids. A similar pattern holds true for the Dow TICK (TIKI) as well. The chart from my recent indicator review clearly shows the consistent pattern of buying.

Flight From Safety - Two-year Treasury notes, which captured well investors' flight to safety, dropped to a yield below 1.3% in March and now, with quite a drop today in bonds, are pushing a 2% yield. It's not difficult to surmise that the money that had found safe haven in Treasuries are being put to work in stocks, given the dynamics of the TICK noted above. Financial issues, so far today, have once again led the upside.
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