S&P 500 rally continues

Thu 30 July 2009: I have been out of the country and not monitoring financial events much, but the S&P 500 rally that triggered a buy signal a few months ago continues in force (see "this rally has legs" below). Pullbacks are always possible after such a rally, but the breakout to new relative highs on good volume with what looks like a tight flag forming bodes well for the intermediate term. Again, we don't have to guess.

The SPY (97.65) has rallied over 20% since the buy signal issued at 80 in mid-March, when the trailing 20 day high was violated. Technically, the market should have been sold at 87.5 when the trailing 20 day low was violated to the downside, but that is the nice thing about being too busy to monitor these things too closely - it turned out to be a false sell signal (which is very bullish, by the way, and you could have reversed shortly thereafter or waited for the formal reentry signal and given up a few points. As Jesse Livermore once said, it's not the chasing of every tick that makes you money but "just sitting still" and riding the big moves up.

I don't know when this rally will end and either does anyone else, but even a market agnostic can make plenty of money by riding the tide in and out.

I don't know the fundamentals and don't care much. I know our country is in much better hands in every sense of the word - credibility, integrity, transparency, fiscal restraint, accountability, and ability to learn from mistakes - than we were under the last disastrous administration, whose debts from Enron to Worldcom to the invasion of Iraq to the systematic defunding of our infrastructure from schools to levees to bridges as wealth was shifted from the workers to the hedge fund managers. Eventually that will show up in the markets, as the price tag for cleaning up this mess is being absorbed by adults who don't believe in tooth fairies or the magic of tax cuts and deregulation to solve all our problems (and pay for themselves).

Expect some ugly headlines about the deficit, joblessness, the price of providing healthcare for all citizens (unless that effort stalls)), but it's all noise. Turn down the volume and watch the markets. They have an interesting story to tell and you don't have to guess the ending to profit!

S&P 500 Rally Continues

6/6/09 (SPY 94.55) The market continues to rally, up 40% off its March low.   The market, despite its whacky short-term ups and downs, remains one of the most reliable leading economic indicators.   Therefore, I am very encouraged.  

Again, using a simple trend-following system, you would have continued to do quite nicely, avoiding the meltdown last year and participating in much of the upside this year.  

The 20-day breakout system triggered a buy signal only 8 trading days after the market put it in its low.   Following this system, you would have entered the market at 80 (I must admit I fudged a little and entered at prices a bit lower, based on the strong technical action, the unremitting gloom in the headlines, and the fact that I felt I had seen this movie before and kind of knew where the plot ended).   Since then the technical action has been very strong:

• no pullbacks into the lower end of the 20 day high-low trading range;
• continued series of higher highs with a healthy base-building period in May;
• breakout from the base the last trading day of May;
• a tight trading range (possible flag) above the point of the breakout.

I am not a big fan of moving averages anymore, since their lag is so extreme that they are telling you more about what the market did than what it is doing.   They are like economists declaring a recession 6 months after the fact.   Useful for confirmation, not so good for action today.  Nevertheless:

• the 50 day simple has climbed above the 150 day simple indicating the long-term trend has changed for the first time in many months;
• the 50 day is above the 150 day;
• both averages are sloping up.

Usually when a chart looks this good there is a pullback to remind everybody that this nothing is simple or obvious for too long.    A pullback to the 50 day or the 20 day low (both at about 88) is highly possible, as the market consolidates its gains.   However, it's just as likely the market will surge much higher, surprising everyone (including me).  Again, we don't have to guess.  Anyone who entered the S&P 500 at 80 can set a sell stop at 88 and would have a nice 10% profit in the worst case.  Not bad for a 2 month trade.  

Longer term investors should be building up their equity positions again if they have not already. 

The world will not end after all.  

S&P 500 Triggers Buy Signal, but Pulls Back... Caution

Thursday March 19, 2009:  The S&P 500 (SPY 78.94) has surged dramatically from its low of 66 and change.  Note that the market did a few things on March 10 that a vigilant chart reader could have profited from for a nice swing trade:

  - exceeding and closing above the highest highs of the past 3 days following a very protracted decline; 

  - extreme gloom in the financial and mainstream media;

  - no end of fundamental reasons to sell; 

  - loss of faith in the ability of our leaders to get us out of this mess. 

The rally did not look back but the knocking out of the trailing 20 day high (lowered to just around 80) should make traders look for an entry point to go long.  A pull-back to at least the 75 range would not be surprising giving the speed of the rally; if it fails to rebound much or sags back to the lower end of the range, anticipate the next, hopefully final leg down.  

At 27.4x trailing earnings, the S&P 500 is far from cheap, even if those are depressed cyclical earnings.  Other significant market bottoms have occurred at single digit PEs, although interest rates were much higher at those bottoms.  The earnings yield is not horribly below the 10 year yield, but we will see what all this blowout government spending will do to the bond market and the dollar.   Transfering wealth to AIG derivatives traders away from taxpayers does nothing to solve the problem, but much to prop up business as usual on Wall Street.  

We shall see.  A continued rally from here would be surprising and more likely a bear market rally, but the market will tell us.  We don't have to guess.  

Gold continues to have a beautiful chart.  I was shaken out of a position but may reenter, unfortunately at higher prices: 

S&P 500 Continues to Violate Key Support Levels; Gold a buy?

Thursday March 5, 2009, 11:46 am (SPY @ 69.12).   

Since last post, 11/21/08 (S&P 500 Violates Key Support on Heavy Volume)

Thu 11/20/08 (SPY @ 75.45) I 

I warned about "catching a falling knife," stating the SPY had 

 plunged through the ice after bouncing off it 3 times.  It was a decisive, high volume penetration and the nearest support would take us back to the lows of 2002-3. 

As it turns out, the SPY rallied back above those lows for a time, generated a false, brief buy signal with no follow-through, and the falling knife has now fallen to the lows of 1996!   A snapback rally or two cannot be ruled out, but this ia very sick market with little nearterm support.  

To update, if you were using a trailing 20 day buy stop to reenter the market and a 20 day sell stop to exit it, you would have been SHORT THE SPY SINCE 125 with only 1 false buy signal on the way down!! That's a 65 point open profit! The current buy stop if you are using this system is 87.74 but will probably drop soon. 

Gold (GLD @ 90.05) is also looking very interesting.  Fundamentally, the case for gold could not be stronger with central banks around the world racing to print money, in effect diluting their currencies (in which their debts, conveniently enough) are denominated.  This is reminiscent of the late 60's, early 70's, when the Great Society Program, Vietnam War, and Apollo moon shot all conspired to swamp the federal budget.  Curiously, inflation and interest rates remain tame this cycle, apparently because future economic demand is so massively discounted.  

One of the silliest arguments against market timing is that you have to make 2 decisions - when to sell and when to buy back - and get both right.  Although I am an advocate of buying and holding and dollar cost averaging with the bulk of your longterm assets into a sensibly diversified portfolio, there are a few moments in time when side-stepping or lightening up during a major decline can really improve your long term returns.  This is probably one of those times.   

If you still need to lighten up to sell down to your sleeping point but are afraid of missing the next upsurge (and it will come, whether in 6 weeks or 6 years is anyone's guess), use the simplest of all technical signals to re-enter the market.  If you can't trust yourself to do it, immediately enter a buy stop order at the time you sell.  For example, let's say you owned 1,000 shares of SPY currently at 69 and change.   If you wanted to sell, go ahead and do so, then turn around (once filled!) and place a buy stop order at 87.75 (a bit above the 87.74 4 week trailing high).  You have to adjust the dollar amount for the higher price (assuming you want to keep the same dollar amount long stocks when the market turns, so would divide you $69,000 proceeds by 87.75 to come up with 786 shares (rounding down).  So your order would read: 

  Buy 768 shares of SPY stop at a stop price of 87.75 good til canceled. 

Done.  Now you can go on vacation, to your day job, golfing, whatever, and if the market really surges on you, you won't miss out on all the upside.   

What is the good of buying at such a high level relative to today's market? you might ask.  Several.  First, if the S&P 500 reaches this level, it has significance, because at that point many traders and market participants are showing a profit.  Those who were waiting until they had an opportunity to sell at around 87.74 have done so, eliminating or reducing immediate overhead supply.   The headlines of newspapers will no doubt trumpet the fact that the marked is marching higher, and Joe Public will call his broker and start to move some money in, driving the market higher, etc.    

Now 87.74 is 27% higher than the current SPY value of 69, but it is very unlikely you will be filled at that price.  

Why?  Because as time progresses, if the market continues to decline or move sideways, the trailing 20 day high will also decline.   You don't even have to count bars or calculate anything.  Simply follow this link and read the rightmost value of the "CHAN(20)" indicator.   That's it.   

If nothing much changes, the indicator should be at 80 in a couple weeks.  At that time (or earlier, as dictated), you would modify your open buy stop order to reflect this new reality, changing the buy price from 87.74 to 80.01, let's say.   Since you are buying the shares at a lower price, you can increase the number to keep the dollar value constant:

  $69,000 / 80.01 = 862.39. 

Round off and you must now modify your order to read:

  Buy stop 862 shares of SPY at 80.01 stop GTC.

I don't know about you, but this gives me a very satisfying feeling for several reasons:

1.  I am guaranteeing that the market will not run too badly away from me, making me regret having sold at the bottom.
   
2. I have now increased the number of shares I will purchase if filled from 768 to 862, a 12% greater position in share terms.  If the market eventually recovers to higher ground, all things being equal, my profit will be 12% greater from this point on. 
3. I am still sitting safely in cash, but am not at risk of second-guessing myself when or if the market turns.  I don't have to lie to myself that I will wait for a pullback when the inevitable occurs, because the market order will be executed automatically. 
4. I collect interest (not much, but it's something) on the money invested in a money market mutual fund.
5. I have the satisfaction of knowing that any future declines that do not trigger my buy stop will eventually lead to my buy stop being lowered, which in turn will mean I will enter at a much better price.   The market's decline is now turned to my advantage - rather than lamenting the daily lurches of the market downwards, I can even get a certain tactical and strategic satisfaction.

The best way to convince yourself is to do this.   What you must be prepared for is the inevitable false breakout (buying, then getting stopped out a few days or weeks later) as well as the regret of having to turn around and buy at a higher prices shares you sold at a lower price.   Most people cannot handle not being perfect, which is why I believe automating your system as much as possible is critical.   I tell myself that the difference in the buy price and liquidation price assuming the buy price is higher is the cost of insurance.  Avoiding one sickening market decline as occurred in 2008 and now and in 2001 or 1973-4 will make up for decades of getting nickled and dimed by being stopped into and out of the market. 

If you want to minimize your frustration even more, assuming you can be honest with yourself and follow through, you could modify the system as follows:   once a breakout occurs above the 20 day high, wait for a pullback.  There are several options including 3 lower highs in a row (put a buy stop above the high of the prior day) a pull back to the middle of the 20 day channel (halfway between the 20 day high and 20 day low) which you could do with a buy limit order at this price or using a moving average, such as the 50 day, assuming the price is above the 50 day when you buy.   These are all variations on a theme - I personally use combinations of these including Williams %R, but you have to find what suits you.   A combination of limit and stop orders, though, with a sensible, simple system that you have thought out ahead of time, will improve your sleep and your returns while allowing you to keep a day job and have a real life.  

And that, after all, should be the objective. 

The legendary Turtle Traders use a modified version of the above break-out system.  They also have a modification that if the last signal (whether taken or not) would have led to a loss, DOUBLE the amount on the next system.  You would be surprised how often this works.   False signals are often followed by true ones, and false signals are some of the most useful in technical analysis.