Research Lab Blog

Mar

Research Lab Blog for Week of March 5th, 2012

Heed this warning:

The environment is about to get a lot tougher – in the near-term.

Based on my research this weekend, I think we have reached the inflection point, where this market “actually” has a pullback. The S&P 500 could be heading for the 20-day moving average, gasp!.

I will be surprised, but not shocked if “they” can muster one last “leg up” in this market.

Remember this – in my opinion at some point in the next two weeks there will come a time when most long positions should and will get stopped out. that is, if you are using proper stops…

As I pointed out last week, the Russell 2000 (IWM) was not confirming the highs in the other indexes.

Last week, it broke down…it lost the 20-day moving average and the bottom of the horizontal channel we were watching.

…yea I know that’s all Pisani and the talking heads on CNBC talked about Friday, but remember last week when I raised the caution flag.

Here’s what I said:

“The key to continued market strength in my opinion lies with the IWM breaking out to new highs. If it fades down to the lower part of the channel, or even breaks down through that, it will likely coincide with the S&P breaking below the “get out” red line I had on the chart up top.”

It is very close to that right now…

IWM 60-minute chart:

Now, here’s the thing. Just because the IWM looks like it’s starting to break down does not mean it won’t “revert” a bit, and perhaps move back into the channel.

But, at this juncture I think it is highly unlikely the IWM is going to “thrust up” and take out the recent highs at the top of the channel above.

So, any “retracement” back up into the channel will be met with overhead resistance. Within a couple weeks I think it will be lower than it is now. I think it is a good possibility this is just the “warning shot across the bow”. The S&P is right down at the lower trendline of the tight channel and is likely to “confirm” the weakness this week.

However it almost seems “too easy” for the entire market to just “roll over immediately” here. So I am thinking the next little “run-up” into the 17/43 moving average area would be a good place to consider taking a short position. This “thrust down” may retrace a little bit.

Based on the chart above, I would not be afraid to be short the IWM with a stop at the green rectangle as long as my position size and leverage were acceptable.

Sure I have been “cautious” and skeptical and calling for a “potential pullback starting any time” for probably a month now, but as I said earlier:

Heed this warning:

The environment is about to get a lot tougher.

With that said, guess what? There is a silver lining…

When I said “in the near-term” I meant perhaps a few weeks, maybe a couple extra. Then, I think we will reach a point where there will be TONS of buying opportunities (barring any outright collapse).

I arrived at the conclusions mentioned above by looking through several thousand stock charts this weekend. What I see is not pretty. “Most stocks” are starting to roll over – go down – reverse. The majority of charts are simply “not bullish” going into this week. That’s just where they are in the cycle.

We need a pullback. We need a correction. We need a shake-out. Or should I say “the market” needs them.

Then, we want to see a period of consolidation….I want to see some “rounding bottoms”. The only ones I see right now are in the “inverse ETF’s”.

As I ran dozens of my typical scans over the weekend, the “who’s who” of inverse ETF’s kept coming up over and over on all sorts of scans and screens…

To me, that’s a warning, perhaps a sign.

Therefore, I am on “full alert” for “conditions to deteriorate significantly”. I shall “Beware the Ides of March” as they say.

If I am wrong here is what will happen.

Two weeks from now, the IWM will be trading at 83.38 or higher. It will have moved back into the sideways channel, broken up through the top of that channel, into the green rectangle and perhaps beyond.

You will be able to knock me over with a feather if that occurs…

To sum it up:

I am bearish in the short-term – for the next 2-3 weeks. I think we touch and lose the 20-day moving average on the S&P and it will feel like a Bear Market

The medium-term, I am still bullish as long as the market stays above the 50 and 200 MA’s on the daily.

The long-term market timing signal is on a “BUY” as long as the market stays above the 10-month moving average on a monthly chart.

The key will be patience for us traders that like to “swing long” individual stocks.

It’s been a very long time since we have seen the inverse ETF’s show up on the Grid, especially on a day to day basis. That is likely to change soon. Keep an eye out.

In the mean time I will still do my best to find “isolated cases” , where certain stocks have patterns I like.

We can still trade individual stocks selectively, but have to be careful.

Here are some with potential for moves up, if everything I said above turns out to be nonsense…

This weeks “setups to watch” are on daily charts:

So there’s a few I’m watching…

Some look pretty good to buy on a little more pullback, some will only look good if they break-out.

I’m really thinking the approach this week is to be very cautious on the overall market but at the same time, taking select trades.

If we start to get “everything is going down at the same time” periods, it might be wise to get on the sidelines.

Regardless, I will be using very tight stops going forward and not worrying at all about taking small losses.

To be successful trading, you have get used to taking lots of small losses and never worry about being right or wrong on a trade.

My thinking is starting to turn toward “buying the pullbacks” in some cases and catching the bounce rather than just expecting our normal “trendline break” pattern to carry on the first break.

The “buy on the first trendline break” strategy won’t work if the market turns down, so be careful.

We’ll dig into this more on the shows this week. I’ll show you some good examples.

Remember, when the character of the market changes, the patterns that work change too. I’m always looking to adapt to what’s working now and there’s nothing certain in the market except change.

I think the market behavior is beginning to change before our very eyes…

Join us at the market open M-W-F this week on the live show.

You will be glad you did.

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Feb

Investing Systems Research Lab Blog for Week of February 27th, 2012

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My passion for the stock market and trading stocks is directly related to my fascination with geometry.

I actually just realized that last year when I was writing on this very blog one evening.

I was marking up a bunch of stock charts, creating “an artists rendering” of potential areas of support and resistance.

It occurred to me that I was simply overlaying geometric patterns on the chart that could be interpreted in a number of ways, but the lines clearly represented “exact numbers”.

From a completely objective point of view, the market and stocks themselves are simply studies in geometry represented by Time on the X axis and Price on the Y axis.

We all know that interpreting stock charts is part art and part science, but it seems there’s also an “intuition” component built-in somewhere.

The funny thing about intuition is that it’s not really “ever present”, but seems to come along every now and then. For instance in the past I have been so bold as to draw an “expected trading range for next week” on the chart. I have drawn “boxes” that I expected the market to trade in at a point in time and things like that.

Right now I “see” something very interesting on the chart, but I have no “intuitive” read on what’s going to transpire this week.

Let’s take a look at the 60-minute chart of the S&P 500 with the next 5 days as our “blank canvas”.

Here’s where the “geometry” part comes in…

I can say with absolute certainty one of three things will happen this week.

1) the market will trade into the green box and “probably” hit the 10-month old 2011 high at 1370 represented by the horizontal green line.

2) It will touch the bottom upward-sloping trendline that represents the lower boundary of the “inner-channel” we have been discussing for weeks.

3) It will trade completely sideways is an ever-narrowing range and end the week right smack in the apex between those 2 lines, very unlikely.

Now of course it is possible that 2 or more of these conditions occur, but here’s the way I see it.

If the market trades down to the lower trendline, I expect there will be some dip buyers anticipating a bounce where I have the green arrows pointing up.

If the market breaks below that parallel upward sloping red trendline where the red arrows are, the near-term likely area of support will be the horizontal red line. That would be a significant event because it would mean the narrow-channel going all the way back to Dec 20th of last year would be broken. If that happens I will turn very cautious very quickly.

Going back to the first possible scenario, if the market somehow maintains it’s current trajectory, perhaps due to “inertia”, it will almost assuredly trade into the green box I drew and perhaps plow through the May 2011 high. That, in my mind would be a big event and more impressive than DOW 13000.

One week from today when I review this chart, I would be shocked to see the market wedged smack in the apex of this “ascending triangle”.

In other words, we’re about to break the high or break below the long-standing rising channel one day this week. Unfortunately my intuition seems to be out doing something else while I am writing this. My guess is as good as yours how this plays out, but the good news is this – I can “react” based on what transpires, so I don’t have to try to predict it.

One thing I am watching closely is the Russell 2000. The chart looks quite a a bit different than the SPX and the other indexes.

Here’s a 60-minute chart that shows it’s been trading sideways in a narrow range for 15-days now.

The key to continued market strength in my opinion lies with the IWM breaking out to new highs. If it fades down to the lower part of the channel, or even breaks down through that, it will likely coincide with the S&P breaking below the “get out” red line I had on the chart up top.

So we want to watch the IWM closely this week as I think it will be “the tell” for which direction the market is likely to take in the near-term.

The market goes both up and down. Stocks go up and down. I have no control over the zigs and zags, direction or inflection points. I am simply a market observer that constantly monitors the situation to use as a read on the current environment. In other words, I really have no bias, but just want to know when it’s a good time to be in stocks and when it’s a good time to be on the sidelines. Or perhaps even short…

Speaking of shorting…

I think there are too many people that want(ed) to short too soon. They aren’t willing to wait for “clear evidence” that the bias has changed. They are ignoring the “inertia”, trying to time the exact inflection point that marks the high of this cycle.

Personally, I take a much more “laid-back” approach. In my mind, when the trend changes it will become readily apparent, self-evident and offer plenty of opportunity to play the downside. Until I see some “distribution days” and the volatility and trading range pick up, I am not going to bet against the inertia we spoke of last week. I think patience is the best approach when it comes to the idea betting on the downside.

With that said, I’m still as cautious as ever…

I’m watching the VIX very closely these days. The various VIX ETF’s have my interest and might be good trading vehicles when “something bad happens”.

There will definitely be a price to pay in the future based on the recent move in oil prices.

There are also plenty of other “market torpedoes” lurking out there, the Eurozone debt situation, tensions in the Middle East and of course the seemingly inevitable looming start of WWIII. The “magic carpet” could get pulled out from under this market at any time, so whatever you do, don’t be complacent.

While we are waiting for the first “distribution day” in the market, we can still whistle past the graveyard and play the game of musical chairs by trading individual stocks long. On a day to day basis, the market is still a popularity contest of stocks and every day we see plenty of stocks that make significant moves up. Until we start to see “selling across the board”, we might as well stay in the game.

All this “macro stuff” aside, I see some stocks that have patterns I like.

Speaking of patterns, here’s one of my favorites. Don’t focus on the stock, focus on the concept of the pattern – you see a lot of these on the charts I post here.

That’s a 60-minute chart but the pattern is actually useful across multiple timeframes.

Essentially what you have is a stock that just had a pullback. Breaking above the downward-sloping trendline and above the 17/43 moving averages is the clue of a possible change in trend. The next thing I look for is a confirmation that it wants to start moving back up and that confirmation comes when it breaks above the “horizontal resistance”, indicated by the line at the “prior high”.

One thing I know for certain. IF this stock is going back into the 13’s or even 14’s, it HAS to break above that line on it’s way there.

IF the stock is destined to “break down” and go lower, it WILL trade below the support line I drew and break below the red “stop” line.

Pretty much a “mathematical certainty”…

That’s why I like this pattern so much. The “tricky part” lies in the horizontal channel. There are plenty of times a stock will break above the prior high, then fall right back into the channel. There are times an intraday low or one of those “crazy spikes” will put the low below the stop line, then the stock bounces right back into the channel. But all we can do is “take our chances” and play the setups as we see them.

While the example above is perhaps not perfect, one of the keys to the pattern is being able to place the stop below the “prior low” and having that be within an “acceptable stop” range. In other words, sometimes when I see this pattern, it looks great, but the prior low is too far away from the breakout to set a reasonable stop-loss.

Here’s an example on the 60-minute chart of FTK.

Last week I attempted to set FTK up in a Trade Plan as it was breaking above the horizontal resistance just over 11. But my plan was quickly thwarted by the fact that the “logical stop-loss” would have been at the prior low of 10.10. That would be almost a 10% risk and way beyond the limit of risk we can take in the Trade Plans.

Now that doesn’t mean that we can’t trade these patterns “on the side” when we see them, but the inherent mathematic constraints of the Trade Plan software preclude taking a trade like the one above. Mainly because Target 3 is set in stone at 7% in this case and one would never risk 10% with a 7% target in mind. It really goes without saying…

Many stocks are too volatile in the short run to make for good trade plans, even when the pattern looks great. That is part of the reason I like to post them here on the blog, because in many cases the larger picture looks good and the setup might make for a great trade.

In some cases, what would be target 3 in the Trade plans would just be a “resting place” on a move to much higher prices, so a wide stop would not be totally unreasonable. Each case is a little different and it’s important to take the “daily range and typical volatility” of any given stock into consideration when you find a pattern you like.

Here’s another pattern I like with a similar twist – trendline breaks and horizontal resistance.

Notice the stock is in a clear uptrend, just had a pullback and broke the trendline. In this case the main horizontal resistance I see is above the recent high. Again, based on simple math, if this stock is going into the 6’s or 7’s, it has to break above the prior high at 6.

The trendline break that occurred Friday on THC does not mean it’s smooth sailing back to the high. In many cases you will see a “throwback” to the break-out. Sometimes it will even fall back into the triangle or drift down along the top of the trendline for a bit.

THC is another case of a stock that trades in a “wide range”, percentage-wise. There’s a few ways I see that one could play this pattern but I will save that discussion for another post.

So next week should prove to be very interesting based on the S&P pattern I discussed at the beginning. It’s getting squeezed into a triangle and it has to break one way or another soon.

Place your bets…place your bets…

Here are some stocks that look interesting to me right now.

Just like last week, these are all 60-minute charts so be sure to take a look at the daily chart to see the larger context. One thing you wouldn’t know about THC unless you looked at the daily chart was that the stock just broke over the 20-day moving average at the same time the trendline was broken and the stock is well above the 50- and 200 day moving averages.

On the daily chart of FTK, another previous example, the stock literally just broke above the 20-day and 50-day moving averages, which were sandwiched together. That helps confirm the stock looking good “technically”.

For these same reasons, it’s imperative to look at the daily charts to get a "birds eye view”.

Some stocks for your radar:

There’s a few to add to your watchlist. I actually have a lot more we can look at this week on the show…

Of course as always, in order for breakouts to “carry”, it will require the market to act well. When the market starts it’s “inevitable pullback”, the patterns will break and most stocks will roll over with it.

I am starting to see more and more of these pattern breakouts that don’t have good follow-through so we have to be careful. The best way to do that is to use good stop-losses.

When a pattern “fails”, and they frequently do, you have to be willing to cut and run and move on to the next one.

IF the market cooperates this week, I expect to have some good Trade Plans on deck.

Be sure to check the Waiting Trade Plans page each morning before the market open.

We will see you Monday morning at the opening bell in the Research Lab.

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