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Monthly Archives: November 2011

A Rising Tide Lifts All Boats

Assessing the overall market via broad indexes like the S&P 500 ($SPX, SPY) is perhaps the most essential step of any traders daily routine.  Matter of fact, it should be the first step as it will undoubtedly shape how one spends the remainder of their day.  In performing such an analysis, traders can identify current market trends and overall market posture.  This revelation should influence how traders manage existing positions as well as how they go about finding additional trading opportunities.

An insightful aphorism to remember regarding the relationship between the broad market indexes and individual stocks is:

A rising tide lifts all boats

The majority of stocks are positively correlated with the S&P 500 Index (SPX).  That is to say, most stocks rise and fall with the SPX.  Consequently, your outlook on the SPX should have a large impact on your outlook on individual stocks.  It should also influence how you manage existing positions in your portfolio.

When the SPX is in a solid uptrend, consider it a green light for bullish trades.  When the SPX is in a downtrend, consider it a green light for bearish trades.

Take the current market for instance.  With the breakout from the symmetrical triangle last week we’ve seen multiple support levels give way.  We also now find ourselves beneath the 50 day moving average.  Suffice it to say the short-term trend has turned down.  As a result, traders should be very cautious in entering bullish plays and perhaps be more proactive in seeking out bearish opportunities.

Market Peek: November 20th

This week, I am looking forward to two things.  The first one is obvious, the number one holiday ever created.  In no other holiday can I sit around, watch football all day, feast until sleep and not have a worry in the world.  The other one is the continuation of the fantastic debt conversation that we have been having for over a year now.  It looks like US politicians were jealous of their European counterparts stealing all the debt thunder.  The obvious headlines pertaining to Greece, Italy, and Spain will dominate the headlines in what should be a very low volume shortened week.  We also have yet another deadline for Congress this week concerning 1.2 trillion in spending cuts a bi-partisan congressional committee needs to agree upon Wednesday.  Whether they come to a compromise or not is of little concern and it would be a little surprising if they did.  If they do not come to an agreement, then automatic spending cuts will start in 2013.  The cuts that have been made in the past few months and the others that could come with a compromise will have an impact on an economy that is starting to shows signs of life.

Over the past couple months, economic data such as manufacturing data, inflationary indicators, consumer confidence/spending and even to a certain extent, unemployment data has been better than expected.  The federal spending cuts won’t drive a stake into the heart of the national economy, but it will play a roll along with overall unemployment and the situation in Europe, in keeping the economy from getting better.  The US economy is resilient; however, as stated in previous articles, this is a long-term problem and will take time to heal.  I have a difficult time seeing a robust market anytime soon.  One of the problems is there is no real answer that does not include what could be labeled as “very difficult times ahead.”  This is what politicians and most of society refuses to acknowledge, the fact that there is not a fix that does not mean some degree of pain for the economy, politicians, corporations, the 1 percent that consumers love hating and everyone in between.  We refuse this because of what our society has become.

None of this means the market will tank.  The market has been going sideways for over a decade now and nothing suggest that we will not have another 5-10 years of similar behavior.  Markets go up and down for many reasons but sometimes we believe it should do something today based on our personal bias towards the economy.  This is not how the market works.  Unfortunately, the market is too massive to care what we think.  This is why learning many different strategies that work in multiple market conditions is desired.  It is also why we hedge, diversify, and protect money in every market.  If you are struggling in this area then feel normal.  Many are, but at the same time, realize you need to make some changes and adapt.

With a short week of trading, it is expected that volume will be light.  This is also true of the economic reports that need to be prepared for.  On Monday we will get existing home sales.  It is expected to be a slight decrease under October’s numbers.  The FOMC minutes will be released on Tuesday as will GDP numbers.  Santa still has not showed up for anxious investors wanting a gift in the form of QE 3.  It will be close to impossible for the FED and Bernanke to make a major dent in fixing an economy that may not need to be fixed.  GDP numbers should have minimal impact as most of the information is already known and priced in.  Unemployment claims and consumer sentiment report on Wednesday.

In analyzing technical analysis from a standard approach, one could argue that we broke down last week out of a short term bullish symmetrical and intermediate bearish symmetrical triangle.  The break down out of this pattern is a bearish indication that the S&P 500 should continue the decline it had last week, which was its largest in close to two months.  I am not certain this is the case.  Right now the identification of short and intermediate support and resistance is key. It  will be interesting if the level I identified last week in this same newsletter, will in fact hold.  If 1200 in the S&P does break, I would expect a rehash of August thru October and the market to test into the 1120 range.  If 1200 holds, a test of 1275 is probable.  Always remember what probability means.

Happy hunting,

Matt

Volatility Cycles

The study of the financial markets reveals a number of cycles that occur on a fairly regular basis.  Some adopt a calendar-centric view to the markets and look to seasonal cycles.  Some focus on  the differing stages of the economic cycle. And yet others look to presidential cycles.  In addition to analyzing cycles in the price of the stock market, we can also look to cycles that crop up in the volatility space.

The cycle of volatility is one alternating between expansion and compression.  That is, periods of relatively large movement followed by quiet periods of consolidation or digestion.  One typically begets the other.  It is therefore reasonable to expect a stock that has recently experienced a large run in price (volatility expansion) to shift to a period of consolidation (volatility compression) and vice versa.  We see this type of behavior play out in the market today.

A brief analysis of current conditions reveals the a market in the midst of a compression in volatility.  With the S&P 500 forming a symmetrical triangle it’s clear to see the market is trading in a tighter and tighter range.  With the apex of the triangle approaching, we are on the cusp of seeing some resolution and a shift back to another volatility expansion.  The $64K question is in which direction?  Either way, traders should wait for solid confirmation before throwing their lot in with the victor of the current stalemate.

Market Peek: November 14th

Market Overview:  Well the newsletter is back after my extended month-long break and amazingly, we are saddled with the exact same issues that we were in early October.  This is not surprising in the least and for those that have been around the block a time or two understand  that these issues do not simply go away or fade into the night.  Debt is a macro economic issues and these types of issues take time to heal.  As I have stated in the past these issues will hang over the market and our economic environment for years, not weeks as most people would prefer.  However, the market response to news and events coming out of the Euro Zone can and has changed.  I believe the market has become a little numb to the up and down, in and out, will they or won’t they news that comes out of multiple countries in Europe on a daily basis.  I know I have.  This does not mean I am suggesting that the volatility will fall back to levels earlier this year, not at all.  However, I do see it subsiding slightly.

Economic:  Looking at the market this week we will have some important economic report with retail sales and the PPI on Tuesday.  These are both very important reports as they give us an insight on consumer mindset going into the holiday season as well as inflationary measurements.  It is expected that the PPI report is to decrease after an unexpected jump in the prior months.  (Update:  I wrote the prior paragraph on Sunday and am swamped today to change.  Both economic indicators were very good today.  This eases a little of the recessionary discussions.  All retail sales numbers next month are vital.  I still think the inflationary numbers are slightly skewed and do not buy them.)  On Wednesday we will receive more inflationary numbers in the CPI report.  The market expects the CPI report to maintain the status quo and it would be a little surprise to get either a .2 increase or decrease from the norm.  This report has been fairly predictable recently.  Thursday is building and manufacturing data.  EuroZone news will also be in the headlines everyday as well.

Earning Season:  Another earning season in the books and, for the 11thconsecutive time, it has been better than expected.  Not to be a naysayer but this earning season just did not have the pop as some of the other ones in recent memory.  Unlike past earning seasons we had less than 70% report better than expected earnings.  In comparison, the 1st and 2nd earnings season of 2011 were in the low to mid 70’s.  This may not seem like a big deal and could be splitting hairs but a 5% change is billions in total dollars and a change of 25 companies not beating estimates in the S&P 500.  The second trend I am noticing is the downward revising on earning expectations.  This earning season, there was about a 30% reduction in overall expectations.  Based on these two trends in earning expectations and revising of expectations we should start to see earning seasons in the future that are not nearly as good in the past.  Yes, another reason to be cautious moving into 2012.

Technical Analysis:  I have recently seen many question the quality of technical analysis in markets that are volatile and very news driven.  This is a mistake.  The identification of support and resistance is vital and timing is equally important.  We have also seen a pattern in the market the past 6 months where the market will maintain a neutral stance between multiple numbers of support and resistance.  From April to August, the market went between 1350 and 1250.  August till October, the market traded between 1225 and 1120.  After the breakout in the middle of October of 1225, the market is now sideways again between 1125 and 1285, with a slight increase in support and decrease in resistance.  The pattern is becoming tighter with less range over time.  What this represents is the market could be getting close to breaking out of the  symmetrical pattern it is currently forming.  This could be either direction with a slightly higher probability to the upside for the short term.  Longer term is a different analysis.

I currently have no monkey and European politicians jokes at my disposal.  They will return next week.

Thanks,

Matt

Candles Lighting the Way

Among the different chart styles to choose from, candlesticks are undoubtedly the most popular.  Their superiority lies in part on their enhanced display of price action which aids in making quicker, more informed decisions.  A daily candle provides a brief summary of the day’s action between the bulls and bears. The four data points used to create a candlestick are the open, high, low, and close of the trading session.  The relationship between these price points determines the degree of bullishness or bearishness in the candle.

Ever since the beginning of October, there seems to be a perpetual bid beneath the market.  This underlying bid has been especially prevalent over the past four trading sessions.  In each session the market sold off during the morning trading hours only to be bought back up by the end of the day.  These intraday reversals are manifest on the candle chart as the long, thin wick or tail at the bottom of each candle.  These “bottoming tails” reflect the underlying bullish tone of the marketplace.

Consider these tails one more piece of evidence supporting a bullish viewpoint on stock prices for the time being.

This is just one example of how learning how to read candlestick charts can help you better analyze the markets and forecast future prices.

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