BGZ Trade Entry and Update

With this morning's large gap up in the stock indexes, BGZ gapped down below the suggested 63.00 limit order and opened at 62.26. That is the price I will use to track the trade on the blog from this point.

For people still looking to get in this, I would suggest placing limit orders to get in at 59.00 or better. I am not confident that that price will be reached, so the order may not get filled. I am pretty satisfied at this point with the 62ish price for entry.

To give a little background on big gap ups like this........

Frequently after a large gap up day like today, the price of SPY will close below today's opening within the next couple days. Check out the Quantifiable Edges blog linked on the right for more on this idea.

Also, today is the FOMC meeting on interest rates. Not much expected to change here on the interest rate front. However, when stocks gap up substantially on these days, there tends to be some follow through the rest of the day, and most often close higher than the open. However, for short-term traders, the 3 day returns are very bad if you buy at the open of the big gap. This means that there is a tendency for the "over reaction" to be swiftly corrected.

From my personal analysis of the price and time relations of the markets over the last several months, I think it is likely that this little rally will not last beyond next Tuesday. So I would definitely suggested taking a position in an inverse ETF before that date. I don't know how much further prices will run, but the 87ish level looks to be the most likely area for this rally to stop from my perspective. My advice is not to be fooled about the "stimulus plan" saving the day (at least for the stock indexes). When hopes and anticipation are very high, they can really only go down.

Pete

Limit Orders and Buy Stop Orders to Enter BGZ

Click on Chart to Enlarge

The chart above is a 90 minute chart of BGZ, meaning that each candlestick you see is 90 minutes of price action. From looking at this chart, it seems most likely that BGZ will fall a bit more before returning to an upward trend. However, the price move to come is one that I wouldn't want to miss, which means there needs to be a "Plan B." That is to buy BGZ if the market starts to collapse, which will result in BGZ prices rising because it is inversely correlated to the stock market averages.

So here are my recommendations for entering BGZ......

Have a "limit" order in place (GTC) to buy BGZ if prices comes down to 63.00 or lower.

Also, have a "stop" order to buy BGZ at 73.00 if BGZ starts to rise sharply.

I am not going to suggest a stop loss on this, because I know from experience that using a stop loss for this trading methodology will decrease the returns over time. That is typical of mean-reverting types of strategies. So consider this a speculative recommendation and think of devoting a certain percentage of funds toward this trade but without a set stop point.

Pete

Update on USO/Crude Oil and BGZ

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I showed this chart of USO (main ETF tracking oil prices) a few days back and suggested that the blue lines would be an approximate representation of the price pattern I expected to form. The updated chart is shown below. It appears that the "re-test" of the recent low has happened and prices are moving higher now.

Click on Chart to Enlarge

At this point, assuming the price pattern suggested is in force, price should move above the recent highs of 39.00. Based off the time of the first up leg off the Dec. lows, I would expect an upward move to last into late this week or early next week. At that point, an excellent shorting/put option buying opportunity should occur. The reason why is (assuming things play out as suggested here) that price should come all the way back down to the recent lows in just 1 or 2 weeks after the high. An ideal entry for the bearish trades would be on a move above 39.00 that forms a bearish candlestick after reaching one of the two pink lines on the chart above. Failure to breakout above those highs, would be classic topping patterns.

Tomorrow I will make a post suggesting placing 2 types of standing orders to potentially enter BGZ, as has been my focus over the last few weeks. Ideally, I would want to see a little more market upside to get hopes up and get in a bearish trade at a better price. But any break of last week's low in the market will likely lead to severe and persistent selling. Last week's low is the line in the sand and the edge of the cliff, so to speak. If a trade is not entered by that point, the opportunity for a relatively low risk entry (for bearish index trades) is likely to decrease quickly.

Pete

What Might Happen Today.....

The VIX rose by more than 20% yesterday. When this has happened it has consistently led to short-term market rallies with the peak gain coming around 4 days later.

In looking back at the past instances of these VIX spikes over the last year, I have seen a tendency for the markets to gap up the next day, which occurred today. However, it was far from smooth sailing after the open. In several instances the markets fell hard during the day to actually undercut the prior day's low significantly, and then stage a very large rebound before the close to end up in positive territory.

SPY is appoaching yesterday's low as I type, so we are halfway into that pattern again. I would be more inclined to try to pick a bottom reversal today than on most days. I would follow the 15, 30, and 60 min charts today to look for a hammer reversal type of candlestick occurring on heavy volume after the markets break yesterday's lows.

Also, I have mentioned several times on this blog that filling and reversal at key gaps is a key part of my methodology for selecting good trade entry points at short-term extremes. The large gap up at 79.50ish from the day after the Nov 21 bottom is not yet filled. I would be surprised at this juncture if buying interest does not come in when that gap is filled.

I may suggest re-entry to the recently stopped out BGU trade if things shape up well today.

Pete

Stock Market Learnings of History: for Make Benefit Glorious Long-Term Investment

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Today's post is an extremely important one for anyone who does not already know the information and historical precedents that are decribed here. The concept is also extremely simple and easily measured by the average investor with a stock chart and calculator. I will be explaining why it is not safe to be buying into the stock market now, and when it will be safe to buy back in the future.

This post is really for the benefit of the reader who fancies himself or herself as a long-term investor. They want to hold stocks for several years and make long-term capital gains, but would prefer not sit through horrendous bear markets or get suckered into buying stocks too early in a bear market and undergo enormous drawdowns on their investment, before (hopefully) realizing a profit several years down the road. Even with that long view in mind, since the markets are fractals, this concept applies to all degrees of trend, and can be used on short-term time frames as well. So are you ready.......?

Before you could be relatively certain that a bear market has bottomed, you need to see an advance that is greater in percentage terms than any advance/bear market rally during the bear market. Also the rate of this advance should typically exceed the rate of any other bear market rally in terms of (% advance) / (duration of advance). Also, in order to have a decent sample size, you need to have several rallies to compare to, say 4 or more failed rallies that make new bear market lows.

If you can grasp this concept, you will be ahead of the game by far. Certainly ahead of the talking heads on the TV.

The chart above is the Great Depression market crash of 1929-1932. It shows the percent advance from low to high of every major rally off of intermediate bear market lows. The red lines show the level at which price broke down to new lows. The green line shows the price level at which the % advance off the lows exceeded any prior advance in the bear market. The pink line shows the level at which the last major high before the bottom was exceeded. Now, say that there was an advance of 50% early in the bear market and now you see a 51% advance some time later. It is probably wise not to jump in right away because that rally could still fail. So typically you would take the largest advance of the bear market and require a rally 20% or 25% greater than that advance before entering the market again. That will give you an added degree of confirmation.

Click on Chart to Enlarge

For people who want a more recent example, this chart is of the Nasdaq bear market from 2000-2002. The same color scheme applies. Notice how the advance off the post Sept. 11 bottom slightly exceeded the largest prior advance in percentage terms only to fail several months later. That is why it is wise to require an advance that is 20% or so larger than the largest prior advance. Also, there were only 3 major rallies to compare to, when you really would want to see at least 4 intermediate rallies to get a better comparison. There are other more complex reasons (relating to complex wave patterns) for needing more than 3 rallies as well.

So how does this apply to the current market? There have been several failed rallies since the Oct. 2007 highs. The most recent advance from the Nov 21 low to the Jan 6 high was 27%. The prior largest rally was 24%. That is NOT enough greater than 24% to meet the 20% greater requirement. Also, the 24% advance took only 3 days, while it took 6 weeks for the recent 27% gain. That is not the explosive buying interest needed to confidently mark a bottom.

I could go on with further subtlties and detail about the time component, but careful study of the charts above should be enough for now to know to stay out, and what to look for to get back in the markets on a long-term basis.

Pete

Trade Modifications

Click on Chart to Enlarge

First, off I wanted to make a couple modifications to prior trade recommendations. First, keep the stop loss and limit order to sell the current SSO trade like stated previously. But cancel any standing orders to buy BGZ at 62.00. Nothing drastic has changed, but I think that later this week, I will have a better idea of where to get in. I suspect that we can get in lower than 62.00, so just wait until things clear up a bit to make any new trade entry.

The chart above is SPY which is the S&P 500 ETF. Recently I had made a post addressing the potential reverse head and shoulders pattern forming in the market. My conclusion was that the pattern had several weaknesses and should be viewed very skeptically by chart pattern traders. In another recent post I had noted a tendency for markets to make short term gains shortly after topping and breaking through support. At this stage I believe an advance toward the "neckline" of this pattern is probable. This purpose of this rally, if I may ascribe intentionality to the markets, will be to trick people into believing the market will "breakout" of this pattern. Those traders who have the Audacity to Hope this breakout is real are likely to be disappointed.
For reasons I won't detail here, I think this Friday is a likely day for the high of this reaction rally. Should the short-term model become overbought this week, I will recommend a new trade entry that should last several weeks.

As a side note, or plan B, if you will, any price move below 816 (last week's low in the S&P 500) will likely spark severe selling and would be justification to enter short positions or inverse ETF's at that point. If there is no substantial advance before that level is breached, I will still recommend an inverse ETF at that point so that we do not miss what history suggests will be one of the most dramatic price moves for years or decades to come.


As a secondary side note, I plan to purchase SPY Q1 (March 31st) 70 strike put options within the next few days or so, in anticipation of a move to 600 or below prior to expiration of those options. An added benefit to put option purchases at this time, will be what is likely to be another huge increase in implied volatility on the way down, which will inflate the value of the options in addition to the the anticipated price move "into the money" (below 70.00).

Pete

SSO Trade Update and New Trade Recommendation

Well the SSO trade was filled if using the buy limit stop order suggested earlier. Today washed out a bunch of stop orders and has reversed hard. Now the priority becomes protecting gains and setting a good exit limit.

For the time being place a stop loss at 22.00. If the market rises into tomorrow, then place a "sell limit" order of 24.50 to exit the trade.

Now for the next order of business is to enter a trade that correlates inversely with the market to take advantage of the likely large decline to come in the next couple months.

So, here is the next recommendation which should be a high probability trade but will have to allow some volatility for a few days.......


New Trade Recommendation:

Place a "buy limit" order to buy BGZ at 62.00; OR place a limit order to buy SDS at 72.00.

BGZ will fluctuate about 3 times the amount of the S&P 500 and will profit as the market falls. SDS will flucuate about 2 times the amount of the S&P. So BGZ is more volatile but will give a bigger absolute return if the trade goes in our favor.


Keep this order in place over the next few days to try and get into the trade if the market rises a few percent over the next few days.


Pete

POTENTIAL Trade for Short-Term Traders Only

I may make a few update post throughout the day today following a potentially explosive short-term bullish trade. If you read yesterday's posts, you will know that we are right in the bottoming area outlined yesterday. But with the market tanking hard, we need price confirmation of a reversal to make for a "safe" bullish trade. The way that price confirmation comes is from a price advance larger than any on the way down so far.

As of right now, with the S&P lows around 820, a move to around 837, especially if it happens as a reversal today, will be a larger advance than any since the high last week. With that info, here is a trade recommendation for short-term and disciplined traders only....

Trade Recommendation

Buy SSO with a "buy stop" order of 22.67 today only. Place a stop loss order at 21.75 after entry if the order gets triggered.

For anyone who does not understand a "buy stop" order, it is an order which will not be triggered unless the price rises to the specified level. So we DO NOT want in the trade unless price gets up to that level.

Post comments if anyone needs further info.

Pete

My Gap Indicator

Click on Chart to Enlarge

Today's chart is related to a recent post I made showing the ratio of the last 5 days cumulative gap percentage divided by the sum of the absoltue values of those gaps. That indicator ranged from -1 to +1 and was a way to help identify short-term exhasution points by excessive gapping in one direction over a period of one week.




The chart above takes that same data and multiplies it by a ratio of the average absolute gap size the last 5 days to the average absolute gap size for the last 21 days. The idea behind looking at the data this way is that this indicator will take the relative size of the recent gaps into consideration as well. So this chart will tend to oscillate between -1 and +1 but has no theoretical limit either up or down. The times to pay attention are when the indicator exceeds the -1 or +1 level.




As of yesterday, the indicator was -1.04 which is a relatively extreme reading. On a conceptual level, this shows that the gapping for the last 5 days has been largely to the downside, AND the gaps have relatively large compared to the gaps over the last month.




So what would I conclude from this data? From the past data I have looked at, it would indicate that the market is near a short-term bottom and may make a violent snap back rally soon. It DOES NOT indicate any major bottom. The highest or lowest readings in this indicator will tend to come at volatility breakouts, which is bearish in general. The indicator may be useful though for short-term traders to show short-term exhaustion points.




Pete

Still Waiting for a Good Entry for the Next Trade

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The chart above is the S&P 500 symbol $SPX. Today broke a major support level, and almost certainly is price confirmation that the market rally has topped. We will probably see the November lows broken in the next couple weeks.


The dark blue box on the chart above is the main support area on the S&P from which to expect a bounce that will provide a good short-selling opportunity, which on this blog translates into buying an ETF that is correlated inversely with the S&P 500. The light blue box is the area that I would expect typical reaction rallies to peak and is the area that I would be quick to recommend the next trade on this blog.


For interesetd technical analysts, the top horizontal pink line is the primary major support level that was broken today. In recent years and during this bear market, the market has tended to break support and then quickly advance several percent over a period of a few days giving the appearance of a false breakdown. That advance will typically move back to the middle of the recent leg down, only to fail and then see the market much more quickly accelerate to the downside.


With that in mind we should be looking for a reactionary buying thrust in coming days, though there is no obvious support until 819 on the S&P 500 and there is an unfilled gap up from the November bottom at 800ish. So I expect we either have another ridiculously bad day tomorrow that goes below 819, or we get a strong buying thrust. I would prefer the second scenario, but either way, an opportunity should present itself to make a trade soon.


For those who wish to sell short an index fund, I would place a limit order to sell short at a price corresponding to 870 on the S&P 500. If we get a buying burst the next day or two, then I would expect the market to have trouble going higher than that. If the market drops hard tomorrow, even if it reverses during the day, I think limit price would have to be lowered to the 850 area from that point.


Pete

Review of 2008 Trade Recommendations

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With the start of a new year and all, I thought now would be a good time to review last year's trade recommendations from the blog.

The table above shows all the trades entered in 2008 that I recommended using the "short-term model". Those are the trades that this blog was built around and intended for. Throughout the year I also gave ideas on some option trades and even made some recommendations on ETFs using other methodologies. None of those types of trades are included above.

Also, anyone who has followed this blog for a while will probably know that I don't typically recommend a stop loss for the trades I recommend. The primary reason for this is that I know from my personal experience that my results would be better strictly following the model for exiting the trade once I have entered. However, there have been a few trades where I suggested a stop placement after entry. The results above reflect those stop orders, and will give an accurate idea of results when managing the trades as I have suggested on the blog.

From the table above you can see that there were approximately 2 trades a month (I started the blog in April 2008). The average trade was about a week in duration. Also, the results were outstandingly positive despite one of the worst years in stock market history.

The symbols in green font are bullish ETF's which profit if the market rises. The symbols in red font are bearish ETF's which profit if the market falls. All of these trades are "long only" equity trades and could be made in an IRA brokerage account or any individual brokerage account. I believe that 2009 will be another outstanding year of trading using this methodology as I believe that volatility is likely to remain well above long term historical averages.

For more information about the funds/ETF's that I typically recommend for these trades checkout

proshares.com (QLD, QID, SSO, SDS, DDM, DXD)

direxionfunds.com (BGU, BGZ)

Pete

Some Projections for Oil/USO and Stocks/S&P 500

Click on Chart to Enlarge

I wanted to follow up on a few recent posts to give readers some more historical background on what is taking place right now and what it likely means for the future.

First off, in a recent post I had suggested that oil prices may have made an intermediate term bottom (lasting at least several weeks). Based off the price action since that post, I am going to slightly backpedal on that. Because of the amount of the recent 40%+ advance that has been given back, it indicates oil prices will not make a strong further rally. However, from a market logic standpoint, it still appears that the recent lows completed an important downward phase in this bear market. The slight change in my outlook is that I now expect more of a sideways to slightly downward trading range/channel (rather than a vertical type advance) which may go below the recent lows on occasion over the next several weeks.

In the chart above (which is the USO ETF, not crude oil prices) I have drawn a box that would indicate the expectation for prices based on comparable historical commodity bear markets. Also, I drew some lines on the chart indicating the approximate price formation that I would expect to form over the next few weeks. The target box indicates that prices may go higher, though so far I would say that I expect prices to peak in the low end of that range if they make it at all.

The next topic I wanted to follow up on is the most recent post indicating that stocks are likely in another leg down. I also mentioned that I sense that the "investment community" thinks that the worst is over...... especially since the S&P 500 has made an apparent double bottom with the 2002 lows. However, the best historical comparisons to the current market environment, in terms of the size and duration of the price moves so far in this bear market, indicate an approximate 40% decline in approximately 4 months from the highs of this rally at 945ish (assuming that the rally has topped). That would put the S&P in the mid to high 500's. The historical range would be approximately 33% to about 50% in less than 6 months.

So despite what we as investors or traders think will happen or want to happen, these numbers are what history tells us is likely to happen....if we are willing to study and learn from history.

On a different note, based on short-term price behavior and the historical tendency for extreme moves on Friday and Monday to be reversed into the middle of the week, I would aniticipate an opportunity to initiate the next recommended trade (SDS, QID, DXD, BGZ, index put options, etc) by Thursday.

Pete

Major Sell Signal from the VIX, but Short-term Oversold

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First off, I have been waiting to recommend an intermediate term bearish trade until the VIX was showing a sell signal from all the ways I look at basically. The blue line on the chart above is a 63 day Time Series Forecast study which has been a very good guide for timing the market via the VIX in this bear market. Intermediate time frame traders (several weeks to a few months) should definitely take a bearish bias from this point in my opinion. Long term investors should initiate appropriate hedges for their portfolio. In my opinion, put options with either March or June expiration should give a good time frame for downside protection.

Click on Chart to Enlarge

Unfortunately the market appears to be overly stretched to the downside to initiate any short-term bearish trades now. The chart above is the 3/5 day equity put/call ratio showing that as of yesterday, the 3 day average was 110% of the 5 day average which has conincided with short-tem bottoms in this bear market. Also, the short-term model I use to post trades for this blog is as about as oversold as I have seen it. So, I would anticipate at least some market advancein the coming days. I will likely let things play out a couple days, and then suggest a new intermediate term trade to enter with a limit order.

Pete

Follow Up on WMT and VZ and General Commentary

I wanted to follow up on a few stocks that I had given some detailed technical analysis on in prior posts. First I had mentioned that Wal*Mart (WMT) was forming a long-term top and should be on the short-seller's watchlist. This past week, the stock made a huge gap down on the highest volume in about 4 years. This gap took the stock from above the 50 day moving average to several percent below it and broke the uptrendline of the rising wedge pattern since October's low. In this instance it is unlikely the stock will make a significant retracement of the gap down and could/should be sold short immediately with a stop loss of no more than 7% from the entry price.

I had also given a detailed analysis of Verizon (VZ) as it was approaching major overhead supply and testing the 200 day moving average during this bear market rally. That stock has not clearly broken down yet, but all the signs of breaking down are there except major price confirmation and a high volume close below the 50 day moving average. Short-sellers could use 31.00 as a "sell stop" order to enter a short position this week with a stop no higher than 34.45.

On a general market note, I made put option purchases on NEM (gold stock) and QQQQ (Nasdaq ETF) this past week. A major sell recommendation could be made this week, with the VIX being the primary entry signal. This is my next planned trade for this blog, and will be of a longer term nature than previous trades.

From the many types of data I follow, and from a market logic standpoint, I feel the stage is set for a huge market decline in coming months. My general assessment of financial news and public opinion toward the stock market at this time is that, either the bear market is over, or the worst is behind us. If I had to pick one phrase to sum up the attitude I believe to be present, it is "Things have come down so much, why sell now?" Unfortunately, a thorough study of market history will tell you that this is not the attitude at major market bottoms. The attitude at bottoms tends to be shear panic, followed on a longer term basis by disillusionment and disinterest in stocks before major bull markets begin.

While I don't value market opinions without a basis in history and statistical analysis, I believe the above opinion is well supported by available data and study of market history. All I can say is that from my veiwpoint, extreme caution is warranted for investors holding stocks right now.
For investors that want to hold stocks long-term, please quickly look into intelligent hedging strategies through inverse ETFs or put option purchases with expiration 3 to 6 months from now.

Pete

SDS Trade Exit

The short-term model for the S&P 500 is oversold today, but not for the Nasdaq. I am recommending exiting the open SDS trade now for short-term traders, though it is certainly justifiable to hold the trade longer if money management allows a stop loss at 64.00. For longer term trader I would suggest holding the trade with a stop loss at 64.00.

The current price of SDS is 70.15 which is a loss of about 2% and is one of only a few losing trades since April using my selective timing of this model.

The next trade recommendation may be a strictly intermediate timeframe trade which will be different from the trades I typically post, which are very short-term in nature. The reason for the longer time frame is that many of the indicators I follow and have discussed on the blog are flashing longer term negative signs and I feel the best reward will come over a period of several weeks.

Pete

Buy Signal from Equity Put/Call Ratio?

Click on Chart to Enlarge

Today's chart is a look at the equity put/call ratio and what it is telling us right now. I have followed put call ratios closely for a couple years now, and I have several different ways I look at them. In a recent post I showed a chart of the 5 day versus 63 day ratio that was showing complacency recently relative to the last quarter. That is bearish in the intermediate term, though there has been no clear breakdown in prices yet.

Today I want to show a ratio that I have never seen looked at or discussed before, though the concepts are identical to those mentioned in the 5 vesus 63 ratio. In the chart above I plotted a chart showing the ratio of the (3 day average of the equity put/call ratio) divided by the (5 day average of the equity put/call ratio). I also plotted 1.5 standard deviation bands around the data which should contain about 80% of data. First, to get the basic concept here, the long term average of this ratio should approximate 1.00, or the 3 and 5 day averages being equal. However, the 3/5 ratio will tend to oscillate around 1.00 and rarely be 1.00. Whenever the reading gets much above 1.00 that means that there is a short-term increase in fear (as evidenced by put buying) and may be a good time to initiate short-term bullish trades.

I really use this ratio to fine tune the identification of market bottoms and tops. So when the 5 vs 63 day ratio is showing excessive put buying, and then we also see the 3 vs 5 ratio jump up and show excessive put buying, you can be fairly sure that you are nearing a climax (of fear) point.

The reason I am showing this chart today is that the equity put/call ratio jumped to a high level today (1.07) and caused the 3 vs 5 ratio to jump to 1.1 which has been an excellent short-term buy signal in the past. For those interested the last times this ratio reached 1.1 were 1/9/08, 1/17/08, 2/6/08, 2/7/08, 3/17/08, 3/18/08, and 10/24/08. Incidentally, the ratio reached 1.09 on the Nov 20 2008 closing low in the S&P 500.

Now let's step back and put this reading in context. First, we are only 1 day off a 2 month high, so we aren't at a market bottom by any stretch of the imagination. Also, the longer term ratio (5 vs 63) is not showing excessive fear, in fact, it is showing excessive complacency. The last time I saw a ratio of 1.1 at a multi-day high was June 1-2 of 2006. After that signal, the market tanked for about 7-8 straight sessions before forming a major low.

So, it is tempting to see this jump in the ratio as a short-term buy signal, but I am not inclined to trust the current signal because it is not even at a multi day low. Maybe in the future I will show this chart again when we are at a multi-day low, and talk a bit more about some ideas on trading after such a reading.

Pete

Update on Crude Oil - Intermediate Term Bottom is Likely In

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The chart above is of USO which is the main ETF used by equity investors to trade the oil market. The price of USO very closely follows the price of crude oil on a % basis though the actual price of USO and $/barrel crude are different.

The issue I wanted to raise today is a follow up to a post from last July that can be found at the link below.

http://stockmarketalchemy.blogspot.com/2008/07/update-on-oil-market-and-uso-chart.html

In that post I had stated that the % decline and rate of decline in oil had been greater than any correction in the bull market for the last couple years. These types of movements often reflect major trend shifts. This was at a time when most news and blogs, etc that I read were seeming to suggest that that decline was a good time to go long oil - good buying opportunity.

So now 6 months later, we are in the reverse position. The chart above shows USO with the % gain from low to high of every significant price advance so far since the top in oil. The advances are roughly 10%, 22%, 16%, 14%, 22%, and 40% for the most recent advance in the last week or so. Notice how the first 5 corrections, while not all the same %, were roughly in the 10-20% range with the average about 16%. Now suddenly, we see a 40% advance in the same amount of time that the other advances typcially took. As a rule of thumb, if you take the largest advance of several corrections (in this case 22%) and a new correction exceeds that amount by 25% then there is a good chance that a trend shift is occuring, especially if the rate of advance is more explosive than the others as is the case currently.

So a very aggressive trader could use the pullback today to buy USO or crude oil. Or you could wait for a break above the recent high and set a stop below the most recent swing low to that point.

I had posted about DBA the other day. The situation of the recent advance in the grains is similar to that of oil, though DBA is a little extended beyond a safe buy point right now from my perspective.

So just to think ahead, I don't really expect that this low in oil is a multi-year low, etc, but bear markets of these commodities typically have strong rallies of say 30-100% that can last several months before running out of steam.

Pete

General Update

I wanted to follow up on a few ideas from posts the last 1-2 weeks. First, I had mentioned that optimistic sentiment among sentiment surveys has yet to increase to extreme levels despite many other sentiment factors indicating excessive optimism. I had also suggested that a breakout of the 920 level on the S&P 500 may increase the bullish opinion of the AAII survey. Well despite a small move above 920 by last week's survey, the bullish % actually fell substantially. This could be interpreted that the individual investor group does not believe the breakout. That would actually favor a further market rally. Since last week we have continued to rally, though not a whole lot. It will be interesting to see this week's results later in the week.

Another thing I had mentioned was that I had seen several good looking reverse head and shoulders patterns that had not broken out yet. By today, several stocks have broken out of patterns, and the volume on those stocks has picked up substantially helping the bullish case.

Stocks that should be on swing traders watchlists are OSG, SNDK, ZEUS, KLAC, and KWK which all broke out of patterns and could be purchased on a lower volume pullback to the breakout price if the market gives up some gains in the coming weeks. Also VSEA has not broken out yet, but volume is picking up and the pattern looks good.

The simple fact that several top quality companies are breaking out of these patterns makes me take seriously the prospect of a further market rally in coming weeks, though the short term still looks ripe for a pullback.

Stocks on my watchlist for bearish short to intermediate term trades are T, SUN, ABX, PNRA, UPS, CL, ADM, and WMT. In particular, some of these stocks are not confirming the new highs in the markets over the last few days. Stocks that are lagging are likely to get beat up on a market decline.

On a technical note the %K on slow stochastics in now over 80 as of yesterday. The last 5 times it reached the 80 level the market made a short or intermediate term top within one day (which would be today). This again is another short-term bearish warning. Coupled with today's gap up opening and high volume stalling type behavior forming doji candles in SPY, DIA, and QQQQ, I believe the today was likely a short-term high.

Pete

Pete

Quick Trade Update

Today looks like a classic short term failed breakout in DIA this morning. The last trade recommended was SDS, which is currently at a loss, but has not signaled an exit yet. I would use this current opportunity to purchase SDS if not in the trade already. As an alternative trade one could purchase DXD which is similar to SDS but is inverse the Dow performance rather than SDS. The Dow appears to be lagging in this rally.

The short-term model is neutral right now, so an exit would not be anticipated until tomorrow at the earliest.

Pete

Reverse Head and Shoulders?

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I wanted to have a short discussion about the reverse head and shoulders bottoming pattern today because I have started to see various blogs, etc., suggesting that this pattern may be occurring in the stock indexes.

You can refer back to the post from a couple days ago about SNDK to get an example of a pretty healthy volume pattern for a reverse head and shoulders. The chart above today is $INDU which is the Dow 30 index. When analyzing a reverse head and shoulders the volume of the pattern is of paramount importance. First, the heaviest volume should be in the left shoulder, which is the case here, so that is OK. Next, a real good pattern should show substantially lighter volume at the head or lowest point. The volume is slightly lower at the head in the Dow, but not enough that you could be really confident in the pattern even at that point.

Probably the most important part of the pattern are the upward moves off the bottom and especially the breakout move. In this chart the volume is low coming off the bottom relative to the left shoulder and head, and that is not a good sign. Next, if you could construe this week as a breakout, then it is a pathetic breakout, because volume should be very heavy here, but in the case of the Dow shown above, the volume is very light.

Another thing bad about this pattern is that (assuming the formation is already complete) the neck line is rather steep for a good head and shoulders pattern. A steep downward neckline indicates weakness coming off the bottom/head.

Another more subtle point about the pattern that I have never heard mentioned before, but stands to reason, is that the move up off the head to the neckline should not take substantially more time than the move down from the neckline to the head/bottom. If it does, then that indicates that the rate at which the market is advancing now is weak relative to the rate at which it was falling. If the time of the moves was closer to equal, then that would be better.

Now I know that the holidays will decrease volume across the board, but it is not a good idea to make excuses for a pattern like this, and the holidays shouldn't really have hampered the volume of the first move off the bottom much anyway.

So my advice is to be very suspect of this "breakout" and the potential reverse head and shoulders pattern.

With that said, I have seen some individual stocks with decent looking patterns (take SNDK for example, which happened to break out strong the last 2 sessions), but most of them have not broken out yet. I personally would wait to see if the stock breaks out, then plan to buy on a pullback to the neckline in the days/first few weeks after the breakout if things look OK at that point. I don't think the market is strong enough right now to worry about missing a breakout and never getting a chance to get in on a pullback/retest of the neckline.

Pete

Some Charts on Put/Call Data and Gap Sizes

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This first graph is a 2008 chart where I plotted the 5 day average of the equity put/call ratio divided by the 63 day average of the same data. Why those numbers? The 5 day data shows the average put/call ratio for the last trading week. There are approxiamtely 21 trading days a month and 63 per quarter. So the 63 day average is the average ratio for the last quarter.

When the 5 and 63 day ratios are similar the overall reading on this chart will be close to 1.00. That is would be completely unremarkable. But when you see recent data readings that are far from the longer term average (1.00), then you need to pay attention as these data tend to revert to a mean of 1.00.

In the current situation, the ratio is below 0.80 or more than 20% from 1.00 (normal). The last time we saw a reading this stretched was in early May of 2008 a little less than 2 weeks before the top of that bear market rally. I didn't plot standard deviation bands on this chart but the current reading is pretty extreme in a statistical sense. This indicates recent complacency relative to the longer term trend in put call data. That would indicate high risk of further market declines in coming weeks or months.

Click on Chart to Enlarge

This next chart is a plot I made of the cumulative gap % in SPY over the last 5 days divided by the sum of the absolute value of those % gaps. The highest the ratio can go is 1.00, and the lowest is -1.00.

When the reading is near 1.00 that means that almost all of the gapping done by the market over the last week has been to the upside. By looking at this data I was hoping to gauge whether this ratio is indicative of short-term exhausion in the past. The rationale is that gaps are largely created by novice traders entering orders for the next day and by news events which create short-term overreactions in light of the longer term picture.

As Friday's close, the ratio was 1.00. The last times the ratio reached this level were typically at short term tops and some at more intermediate term tops like in mid May 2008. This is yet another sign of potential short-term exhaustion.

Taken together with all the other indications from volatility, put/call data, breadth, etc. I feel like a short-term top will occur in the next few days, and this may be also an intermediate term market top.

Pete

SNDK, T, Trading Ideas, and Random Info

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This first chart is of AT&T, ticker T. The reason I am posting this chart is because when the market is nearing a potential top, there are some things to help clue you in to which stocks to look to short. Today the general market is pushing higher and making highs beyond those of the last few weeks. So when you see a stock that is not doing this, meaning it is still well below recent highs, etc., then you should keep an eye on that stock.

At market tops, both short and long term, some stocks or sectors will diverge or not confirm the new highs of the general market. These stocks are often the ones that get sold off most heavily on the next decline. So we have T below the highs of last month, and the market very overbought short-term, with signs of intermediate term topping as well. If T holds below the 30.65 level and breaks and uptrendline on an hourly chart, I think it would be a good short swing trade with a stop no higher than the 30.65 level.

Click on Chart to Enlarge

This chart is of Sandisk, ticker SNDK. Today the stock broke out of a reverse head and shoulders pattern on strong volume. The volume pattern of the entire pattern looks pretty good. Heavy volume in the left shoulder.....light volume at the head.....rising volume off the bottom up to the neckline.

Many times after a breakout, especially of a bottoming pattern, there will be an eventual test or pullback to the breakout price level. In this case, a test of the neckline would be expected. The problem with buying now, is that the market is short-term overbought and the price is well above the breakout price. Traders interested in this stock could look to enter on a limit order of 10.00 to 10.45 to try to catch the stock as it drops back to the neckline. The stop loss would be about 8.65......under the lows just prior to the breakout.

On another technical note, the major stock averages touched their upper bollinger bands today for the first time since early August 2008. So in a statistical sense we are at the upper end of the price range for this rally. That doesn't mean the market will fall apart right away, but I would take this as yet another caution sign for intermediate term bulls.

Despite many short and intermediate warning signs, I have seen many reverse head and shoulders patterns forming in different sectors. Steel stocks, housing stocks, some semiconductor stocks, retail, and shipping stocks as well. Because of this I am willing to continue to take long trades on short-term weakness. Right now I just think things are too stretched to the upside, and most of these patterns have not broken out yet, so there is still a chance of failure.

As another piece of random technical info......Despite the stock averages powering up into the close, the VIX made a major upside reversal in the minutes prior to the close. This formed a hammer type candlestick in the VIX. The VIX made a 10th lower low since the Nov 20 highs. The VXN (Nasdaq volatility index) made a 13th lower low. I consider 12 or more to be very stretched, but give more weight to the VIX than the VXN. This data is sending another short-term and intermediate term caution sign in my mind.

Pete