Watch This Indicator

So, the big question on every investor’s mind is “What Comes Next?”  Since this is not an advisory service (and given the fact that I am not too good at predicting the future anyway) I have avoided commenting on “the state of the markets” lately.  That being said, I do have a few “thoughts”:

 

*The major averages (as of this exact moment) are still mostly above their longer-term moving averages (200-day, 10-month, 40-week, and so on and so forth).  So, on a trend-following basis the trend is still “up”.

 

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Figure 1 – The Major Index (Courtesy WinWayCharts TradingExpert)

 

*We are in the most favorable 15 months of the 48-month election cycle (though off to a pretty awful start obviously) which beings Oct.1 of the mid-term year and ends Dec. 31st of the pre-election year.

 

*Investors should be prepared for some volatility as bottoms following sharp drops usually take at least a little while to form and typically are choppy affairs.  One day the market is up big and everyone breathes a sigh of relief and then the next day the market tanks.  And so on and so forth.

 

An Indicator to Watch

 

At the outset let me state that there are no “magical” indicators.  Still, there are some that typically are pretty useful.  One that I follow I refer to as Nasdaq HiLoMA.  It works as follows:

 

A = Nasdaq daily new highs

B = Nasdaq daily new lows

C = (A / (A+B)) * 100

D = 10-day moving average of C

C can range from 0% to 100%.  D is simply a 10-day average of C.

 

Nasdaq HiLoMA = D

 

Interpretation: When Nasdaq HiLoMA drops below 20 the market is “oversold”.

 

Note that the sentence above says “the market is oversold” and NOT “BUY NOW AGGRESSIVELY WITH EVERY PENNY YOU HAVE.”  This is an important distinction because – like most indicators – while this one may often give useful signals, it will occasionally give a completely false signal (i.e., the market will continue to decline significantly).

 

A couple of “finer points”:

 

*Look for the indicator to bottom out before considering it to be “bullish”.

 

*A rise back above 20 is often a sign that the decline is over (but, importantly, not always).  Sometimes there may be another retest of recent lows and sometimes a bear market just re-exerts itself)

 

*If the 200-day moving average for the Dow or S&P 500 is currently trending lower be careful about using these signals.  Signals are typically more useful if the 200-day moving average for these indexes is rising or at least drifting sideways rather than clearly trending lower (ala 2008).

 

Figures 2 through 8 displays the S&P 500 Index with the Nasdaq HiLoMA indicator.  Click to enlarge any chart.

 

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Figure 2 – SPX with Jay’s Nasdaq HiLoMA ending 2006 (Courtesy WinWayCharts TradingExpert)

 

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Figure 3 – SPX with Jay’s Nasdaq HiLoMA ending 2008 (Courtesy WinWayCharts TradingExpert)

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Figure 4 – SPX with Jay’s Nasdaq HiLoMA ending 2010 (Courtesy WinWayCharts TradingExpert)

 

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Figure 5 – SPX with Jay’s Nasdaq HiLoMA ending 2012 (Courtesy WinWayCharts TradingExpert)

 

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Figure 6 – SPX with Jay’s Nasdaq HiLoMA ending 2014 (Courtesy WinWayCharts TradingExpert)

 

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Figure 7 – SPX with Jay’s Nasdaq HiLoMA ending 2016 (Courtesy WinWayCharts TradingExpert)

 

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Figure 8 – SPX with Jay’s Nasdaq HiLoMA ending 2018 (Courtesy WinWayCharts TradingExpert)

 

Summary

 

The stock market is in a favorable seasonal period and is oversold.  As long as the former remains true, react accordingly (with proper risk controls in place of course).

 

Jay Kaeppel

 

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

NASDAQ dive

Working on some slides for a seminar last week, it was apparent that breadth indicators on the NASDAQ signaled a divergence from the price action of the market.
Looking specifically at AD Ind and HI/LO, although other breadth measures told the same tale.

The AD indicator explained

 

The Advance/Decline Indicator is an exponentially weighted average of the net advancing versus declining issues. With this indicator, the direction of the trend is of importance and not the actual value of the indicator. When the indicator is increasing, advances are outweighing declines, and when it is decreasing, there are more declining is­sues than advancing.
The  Advance/Decline Indicator is a breadth indicator very similar to the Advance/Decline Line.  However, this indicator tends to be more sensitive and at times will signal a move earlier than the Advance/Decline Line.
The breadth was telling us something was amiss from last week. Take a look at this chart of the NASDAQ clearly a divergence was in place before the downturn.
Today’s (10-10-18) 316 point drop in the NASDAQ a 4% drop and nearly 9% drop from the high is close to the 10% corrective point and some buyers may come in over the next few days and keep the decline in check or not.
The markets are down between 6 and 10% in 5 days. Keeping good stops is a must in your portfolio to protect you from the worst of this. Using trailing stops between 7 and 10 % on stocks that are moving and protective stops 5 to 7 % below initial investment for example can easily reduce your losses in these volatile markets.

Bellwethers Looking a Bit Weathered

One of the benefits of being an avowed trend-follower is that it can allow you to avoid a lot of the “angst” that many investors suffer with each new twist and turn in the economic/financial/political/price of tea in China arena.  Let’s face it, if you scan the internet, watch cable news or read the financial press you will always have at least – roughly – 10,000 “things” that you could be worried about that will kick the legs out from whatever bullish thing might be happening at the moment.

 

I have a friend (no, seriously) and his comment recently was “The next person that mentions the Hindenburg Omen gets punched in the face”.  The bottom line: someone is always crying “Wolf”, and living in perpetual fear is – let’s be honest – kind of a crappy way to go through life.  Which is why I typically advocate focusing on the major trends and not sweating all the small stuff along the way.

 

Yes, things can go wrong and yes it would be nice to have at least some sort of a heads up in advance.  So, in an effort to not be completely ignorant of the goings on around me I do have a few “things” I follow in hopes of getting some “early warning” if trouble is brewing.  I call them my 4 bellwethers.

 

The main thing I look for is “divergence” between the action for the major stock market indexes and the action of these bellwethers.  Even the existence of divergences does NOT guarantee trouble.  But more often than not, major market tops are presaged by some “signs of trouble”.  So, let’s take a look.

 

The Major Indexes

 

Figure 1 displays the Dow, Nasdaq 100, S&P 500 and Russell 2000 indexes.  As you can see, they are all in up trends, well above their respective 200-day moving averages and 3 of the 4 are at or near all-time highs.  In other words, from a solely trend-following perspective, “Thing are swell, things are great.”

 

(click to enlarge)

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Figure 1 – Four major indexes all in bullish trends (Courtesy WinWayCharts TradingExpert)

 

The Bellwethers

 

Figure 2 displays my 4 bellwethers – they are:

 

Ticker SMH: an ETF that tracks the semiconductor sector. The world runs on technology and technology runs on semiconductors.

 

Dow Transportation Index: Whether the Transports confirm or diverge from the Dow Industrials has long been used as a gauge of market health by investors.

 

Ticker ZIV: An ETF that is designed to track the inverse of the VIX Index.  Long story, but bottom line, it should go up when the market goes up and vice versa.  Any deviation from that standard can be a warning sign.

 

Ticker BID: Sotheby’s Holdings which run high-end auctions.  Bottom line, if rich people are comfortable buying expensive stuff that is a good sign for the economy (and should be reflected in a rising trend in BID) and if rich people are NOT comfortable buying expensive stuff, well, vice versa.

 

(click to enlarge)

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Figure 2 – Jay’s Market Bellwether (Courtesy WinWayCharts TradingExpert)

 

As you can see, the Bellwethers are mostly not confirming the major average at the moment.  This is not a reason to panic or fell angst.  It is simply something to keep an eye on.  The longer these divergences continue the more troublesome, so let’s focus on a couple of key things to watch to decide if maybe you should go ahead and start feeling angst.

 

Dow Transports

 

As you can see in Figure 3, double-tops in the Dow Transports have in the past signaled trouble for the overall stock market.

 

(click to enlarge)

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Figure 3 – Dow Transport double tops often a sign of impending trouble (Courtesy WinWayCharts TradingExpert)

 

The Good News and Bad News for the Transport Index is reflected in the daily chart shown in Figure 4.  The Good News is that the Transports recently made a new all-time high.  The Bad News is that price has subsequently fallen back below the important support/resistance level marked in Figure 4.

 

(click to enlarge)

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Figure 4 – Daily Dow Transports – up or down? (Courtesy WinWayCharts TradingExpert)

 

Interpretation going forward is relatively simple:

 

Good = Dow Transports above 11,424

 

Bad = Dow Transports below 11,424

 

Ticker BID

 

As you can see in Figure 5, weakness in the overall market averages is often presaged well in advance by a major breakdown in the price of BID.

 

(click to enlarge)

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Figure 5 – Breakdowns in BID often an early warning sign (Courtesy WinWayCharts TradingExpert)

 

As you can see in Figure 6, BID recently tanked 25% before rebounding slightly.  Is this a “Look Out Below” warning sign for the stock market?  Dunno, but gonna keep a close eye on BID to see if it rebounds…or falls further.

 

(click to enlarge)

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Figure 6 – Ticker BID – which way from here? (Courtesy WinWayCharts TradingExpert)

 

Summary

 

The major market averages are (mostly) rallying to new highs while Jay’s 4 Market Bellwethers are, well, it’s too soon to say exactly what they are.  But for the moment at least they are mostly not confirming the new highs in the major averages.  Please try to remain calm.  The proper response is Not fell angst and doubt, but rather to simply keep an eye on how things progress from here.  If the Bellwethers start to move higher then “the crisis will have passed.”  If not, then it will be very important to keep an eye open for – and to take seriously – signs of weakness in the major averages.

 

Jay Kaeppel

 

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

New Highs, Check…Now What?

Let’s open with Jay’s Trading Maxim #7.

 

Jay’s Trading Maxim #7: Being able to identify the trend today is worth more than 1,000 predictions of what the trend will be in the future.

 

Yes trend-following is boring.  And no, trend-following never does get you in near the bottom nor out at the top.  But the reality is that if you remain long when the trend appears to be up (for our purposes here let’s define this roughly as the majority of major market averages holding above their long-term moving averages) and play defense (i.e., raise cash, hedge, etc.) when the trend appears to be down (i.e., the majority of major market averages are below their long-term moving averages), chances are you will do pretty well for yourself.  And you may find yourself sleeping pretty well at night as well along the way.

 

To put it more succinctly:

 

*THE FOREST = Long-term trend

 

*THE TREES = All the crap that everyone tells you “may” affect the long-term trend at some point in the future

 

Human nature is a tricky thing.  While we should clearly be focused on THE FOREST the reality is that most investors focus that majority of their attention on all those pesky trees.  Part of the reason for this is that some trees can offer clues.  It’s a question of identifying a few “key trees” and then ignoring the rest of the noise.

 

A New High

 

With the Dow Industrials rallying to a new high virtually all the major averages have now reached a new high at least within the last month.  And as you can see in Figure 1 all are well above their respective 200-day moving average.  Long story short the trend is “UP”.

 

(click to enlarge)

 

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Figure 1 – U.S. Major Market Indexes in Uptrends (Courtesy WinWayCharts TradingExpert)

 

Now What? The Good News

 

As strong as the market has been of late it should be noted that we are about to enter the most favorable seasonal portion of the 48-month election cycle.  This period begins at the close of September 2018 and extends through the end of December 2019.

 

Figure 2 displays the growth of $1,000 invested in the Dow Industrials only during this 15-month period every 4 years.  Figure 3 displays the actual % +(-) for each of these periods.  Note that since 1934-35, the Dow has showed a gain 20 out of 21 times during this period.

 

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Figure 2 – Growth of $1,000 invested in Dow Industrials ONLY during 15 bullish months (mid-term through pre-election year) within 48-month election cycle.

 

Start Date End Date Dow % +(-)
9/30/1934 12/31/1935 +55.6%
9/30/1938 12/31/1939 +6.2%
9/30/1942 12/31/1943 +24.5%
9/30/1946 12/31/1947 +5.1%
9/30/1950 12/31/1951 +18.9%
9/30/1954 12/31/1955 +35.5%
9/30/1958 12/31/1959 +27.7%
9/30/1962 12/31/1963 +31.8%
9/30/1966 12/31/1967 +16.9%
9/30/1970 12/31/1971 +17.0%
9/30/1974 12/31/1975 +40.2%
9/30/1978 12/31/1979 (-3.1%)
9/30/1982 12/31/1983 +40.4%
9/30/1986 12/31/1987 +9.7%
9/30/1990 12/31/1991 +29.2%
9/30/1994 12/31/1995 +33.1%
9/30/1998 12/31/1999 +46.6%
9/30/2002 12/31/2003 +37.7%
9/30/2006 12/31/2007 +13.6%
9/30/2010 12/31/2011 +13.0%
9/30/2014 12/31/2015 +2.2%

Figure 3 – 15 bullish months (mid-term through pre-election year) within 48-month election cycle

 

Now What? The Worrisome Trees

 

While the major averages are setting records a lot of other “things” are not.  My own cluster of “market bellwethers” appear in Figure 4.  Among them the Dow Transportation Index is the only one remotely close to a new high, having broken out to the upside last week.  In the meantime, the semiconductors (ticker SMH), the inverse VIX index ETF (ticker ZIV) and Sotheby’s (ticker BID) continue to meander/flounder. This is by no means a “run for the hills” signal.  But the point is that at some point I would like to see some confirmation from these tickers that often (though obviously not always) presage trouble in the stock market when they fail to confirm bullish action in the major averages.

 

(click to enlarge)

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Figure 4 – Jay’s 4 Bellwethers (SMH/TRAN/ZIV/BID) (Courtesy WinWayCharts TradingExpert)

 

Another source of potential concern is the action of, well, the rest of the darn World.  Figure 5 displays my own regional indexes – Americas, Europe, Asia/Pacific and Middle East.  They all look awful.

 

(click to enlarge)

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Figure 5 – 4 World Regional Indexes (Courtesy WinWayCharts TradingExpert)

 

Now the big question is “will the rest of the world’s stock markets start acting better, or will the U.S. market start acting worse?”  Sadly, I can’t answer that question.  The key point I do want to make though is that this dichotomy of performance – i.e., U.S market soaring, rest of the world sinking – is unlikely to be sustainable for very long.

 

Summary

 

It is hard to envision the market relentlessly higher with no serious corrections over the next 15 months.  And “yes”, those bellwether and world region indexes trees are “troublesome”.

 

Still the trend at the moment is inarguably “Up” and we about to enter one of the most seasonally favorable periods for the stock market.

 

So, my advice is simple:

 

1) Decide now what defensive actions you will take if the market does start to breakdown

 

2) Resolve to actually take those actions if the need arises

 

3) Enjoy the ride as long as it lasts.

 

Jay Kaeppel

 

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Attention Wild-Eyed Speculators

Most people are familiar with ADHD, manic-depressive disorder, depression and schizophrenia.  But one common affliction within our trading community that gets almost no attention is WESS.  That stands for “Wild-Eyed Speculation Syndrome”.  And it’s more common than you think (“Hi, my name is Jay”).

The exact symptoms vary, but generally speaking they go something like this:

*A person gets up in the morning with a hankering to make a trade

*Said person then finds “some reason” to make some trade in something

*If the person happens to make money on that trade then the affliction is reinforced by virtue of IGTS (“I’ve Got the Touch Syndrome”, which is one of the occasional side effects of WESS)

*If the person loses money on the trade the side effects can vary but may include: angry outbursts, kicking oneself in the head (typically figuratively), vows to either stop the behavior or at least do it better, and so on.

*The most common side effect of WESS is a declining trading account balance (which not coincidentally is how this disorder is most commonly diagnosed).

For those suffering from WESS – with the caveat/disclosure that I am not a medical professional (although I have found that ibuprofen really clears up a lot of stuff, but I digress) – I am here to help.

If you find yourself suffering from Symptom #1 above:

The most effective step is to go back to bed until the urge passes.  If this doesn’t work or is not possible (for instance, if you have one of those pesky “jobs” – you know, that 8-hour a day activity that gets in the way of your trading), repeat these two mantras as many times as necessary:

Mantra 1: “I must employ some reasonably objective, repeatable criteria to find a trade with some actual potential”

Mantra 2: “I will risk no more than 2% of my trading capital” on any WESS induced trade (and just as importantly, you must fend off the voice on the other shoulder shouting “But this is the BIG ONE!!”)

Repeat these mantras as many times as necessary to avoid betting the ranch on some random idea that you “read about on the internet, so it must be true.”

Regarding Mantra 1

There are a million and one ways to find a trade.  There is no one best way.  But just to give you the idea I will mention one way and highlight a current setup. IMPORTANT: That being said, and as always, I DO NOT make recommendations on this blog.  The particular setup I will highlight may work out beautifully, or it may be a complete bust.  So DO NOT rush out and make a trade based on this just because you read it – you know – on the internet.

The Divergence

Lots of trades get made based on “divergence”.  In this case we are talking about the divergence between price and a given indicator – or even better, series of indicators.  There is nothing magic about divergence, and like a lot of things, sometimes it works and sometimes it doesn’t.  But the reason it is a viable consideration is that when an indicator flashes a bullish divergence versus price it alerts us to a potential – nothing more, nothing less – shift in momentum.

Let’s look at ticker GDX – an ETF that tracks an index of gold mining stocks.  In Figure1 1 through 4 below we see:

*GDX price making a lower low

*A given indicator NOT confirming that new low (i.e., a positive divergence)

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Figure 1 – GDX and MACD (Courtesy WinWayCharts TradingExpert)

 

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Figure 2 – GDX and 3-day RSI (Courtesy WinWayCharts TradingExpert)

 

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Figure 3 – GDX and TRIX (Courtesy WinWayCharts TradingExpert)

 

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Figure 4 – GDX and William’s Ultimate Oscillator (Courtesy WinWayCharts TradingExpert)

So, do the divergences that appear in Figures 1 through 4 justify a trade?  Well, here is where the aforementioned affliction comes into play.

Average Trader: “Maybe, maybe not.  In either case I am not entirely sure that trying to pick a bottom in gold stocks based solely on indicator divergences is a good idea”

WESS Sufferer: “Absofreakinglutely!!  Let’s do this!!”

You see the problem.

So, let’s assume that a WESS Sufferer likes what he or she sees in Figures 1 through 4.  The good news is that we have met the minimum criteria for Mantra #1 above – we have employed some reasonably objective, repeatable criteria (i.e., a bullish divergence between price and a number of variable indicators) to spot a potential opportunity.

Now we must follow Mantra #2 of risking no more than 2% of my trading capital.  Let’s assume our WESS Sufferer has a $25,000 trading account.  So he or she can risk a maximum of $500 ($25,000 x 2%).

In Figure 5 we see a potential support area for GDX at around $16.40 a share.

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Figure 5 – Ticker GDX with support at $16.40 (Courtesy WinWayCharts TradingExpert)

So, one possibility would be to buy 300 shares of GDX at $17.84 and place a stop loss order below the “line in the sand” at say $16.34 a share.  So if the stop is hit, the trade would lose -$450, or -1.8% of our trading capital (17.84 – 16.34 = -1.50 x 300 shares = -$450).

Summary

Does any of the above fit in the category of “A Good Idea”.  That’s the thing about trading – and most things in life for that matter – it’s all in the eye of the beholder.  Remember, the above is NOT a “recommendation”, only an “example.”

The real key thing to note is that we went from being just a random WESS Sufferer to a WESS Sufferer with a Plan – one that has something other than just an “urge” to find a trade, AND (most importantly) a mechanism for limiting any damage that might be done if things don’t pan out.

And if that doesn’t work, well, there’s always ibuprofen.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.