S&P 500 Breakout Confirmed (SPY @ 128.60)

29 Oct 2011: There are few things as satisfying as watching patterns worked out over the years play out in real time.  After spending the week in Venice, I returned to find that re-entering the market in scale prior to our departure paid for our trip several times over:


SPY (128.60) is following through nicely on its breakout below 122.5 2 weeks ago.  Volume is heavier on up days than down days - an encouraging sign - and it is making a pattern of generally higher highs and lower lows.   The lows of the last 6 days are all above the breakout point.  
I have reached the point in life where I generally ignore fundamental news, not because it is not important but because it is so unknowable.  Markets discount the future, not the present, and most market bottoms occur when the news is bleakest and all hope seems lost.  What is commonly misunderstood as callousness on Wall Street (the capital markets rallying while unemployment remains high) is simply the smart money recognizing that the market is improving and taking positions ahead of confirmation through improvement in, among other things, a drop in unemployment.   In fact, the stock market remains one of the best leading economic indicators for that reason.
Focusing on the movement of prices and volume (technical analysis) almost exclusively is simply a recognition of some brutal market realities:
1.) most people, most of the time, are wrong;  following the crowd is
2.) financial news, especially of the breathless variety, is beyond useless - it's distracting because its objective is not to inform but to entertain; if anyone really knew what was going on, they would not be standing with a microphone on the floor of the NYSE telling you what happened at 4:00 pm, but would have acted on that information before the market opened, quietly from a yacht in the Mediterranean (and it's unlikely they would be all that interested in sharing that information with you);
3.) when the minority of players who know what is going on act, they leave telltale signs on the markets in the form of volume and price action; these signs are of greatest use when they contradict the prevailing "wisdom" propagated by financial news;
4.) most financial letter writers, active mutual funds, and other so-called experts are better salesmen than investors; they make their money from selling subscriptions or charging fees for management; few outperform a passive index.

That being said, it does not mean all market action is random or that it is impossible to beat the market averages or consistently make money in all market cycles, only that it is emotionally very hard because it requires taking positions that are unpopular, even at times insane.  Using a trend-following approach requires buying prices at relative highs after they have usually enjoyed a good rally (but often when they remain far below more distant highs), being wrong about as often as you are right (in terms of percentage of times a trade closes profitable), but making most of your money from a few trades, perhaps as few as 1 in 10.   If your losses are much smaller on your losing trades than your gains on your winning ones, you will make a very comfortable living trading and enjoy the intellectual satisfaction that good fishermen and hunters have always known (which is why I think our brains evolved to be drawn to trading).

Enough philosophy.  On to other markets:


Homebuilders also followed through on their rally on very strong up volume with much lower down volume.  A very nice chart with a 15-20% pop from the breakout a few weeks ago.  If high volatility like this makes you nervous, you can move your stop up to break-even (after commissions) or follow the 3-day low, which is often the first thing to be violated when a move is showing signs of exhaustion.  If homebuilders double from here and you are stopped out at 15-20% you may deeply regret it, but that is the tradeoff.  I would prefer to let the homebuilders run.  My sense is the economy is much, much stronger than anyone anticipates and these things have a way of turning around much quicker than anyone realizes.  Homebuilders have sold off so brutally (conventional wisdom says "everyone knows no Americans want to buy new homes and besides there is a huge backlog of foreclosed properties" but conventional wisdom and then some has long been priced into these stocks).  


The Euro is another position I took recently I consider a no-brainer.  With all the action near the top of the 20-day range and all the news about Greece and Italy so gloomy, something had to give.  The markets said buy and I did.  In the world of currencies where fortunes can be made with a 2 or 3% move, this 2% gap move up is huge (although I used the far less levered ETF here rather than futures for which I feel I am getting too old).


Switzerland mirrored Wall Street's action, performing a bit better actually over the past couple weeks.  As a side note, if you want to take a position in a country, always choose a passively-traded, liquid iShares country web rather than an actively traded closed end fund whose share prices rise and fall not just on the underlying but on anticipations about the future direction of the underlying (as well as the wisdom of the active investors).  Contrast the 10-15% pop since breakout here with the sell-off and then recover to breakeven of EWZ, for example.

As with any economic recovery, you would expect industrials to be roaring ahead and they are:

The fact that consumer staples is not doing quite as spectacularly is an indication smart money is shifting away from relatively safe plays into more economically-sensitive ones:


Technology continues to be choppy but moving in the right direction:


There is an old adage that no true bull market can exist unless led by financials.  The performance of XLF, as much as I politically detest the behavior of the Marie Antoinettes in charge of these publicly-bailed-out companies, should be encouraging then:


I missed this when on vacation, but Gold has triggered a buy signal at 165 at almost the exact price you would have exited in September to close out a profitable trade from 152:


As always, stay tuned.

Market rally continues: SPY (123.97) gaps up across resistance

Friday 10/21/11 after market close.


This chart shows SPY breaking above both its 20-day trailing high and clearing the last two relative highs in the 122.5 area.   After a choppy week in which most of the action was in the upper quartile of the 20-day range, the market gapped higher and closed at its highs for the day, all bullish.  The only caveat was that volume was only average.


I feel particularly proud of this chart.  After banging the table a couple days ago about all of the bullish features of the homebuilders (XHB), I took a position and there was very nice follow-through today, again on above-average volume.  A 4% surge with no resistance in sight is a very good sign, especially after the failed bear trap in October (a breakdown below the 20-day low without any follow-through and a quick rally off the lows.  


The Euro is doing what it is supposed to do - rallying after its breakout then consolidation after falling back into its range.  It would be nice to see it close decisively above the breakout point, however.


Switzerland also had a nice day, rising 2.76% in dollar terms (versus a 1.90% for the SPY).  Switzerland sold off quite a bit more than the United States from peak to trough (June to September - about a 30% loss), so I would expect a more spirited rise.  Switzerland is in much better fiscal shape (the government is running a surplus) and its economy is by many measures much stronger than the United States.

S&P 500 (@ 120.75) Issues Buy Signal - Proceed Cautiously

Tue 13 Oct 2011 before market open:

The S&P 500 has done something it hasn't since July - triggered a buy signal as measured by an intraday violation of the trailing 20-day high (yesterday at 121.99).  
Technically, this is all we should need, mechanically following this signal, buying at a slightly lower price if we simply entered a market order today (assuming it doesn't gap at the open above the buy level, which is unlikely but possible).  
As always with the market, however, there is a on-the-one-hand, on-the-other-hand quality to this buy signal.  
Positives:
Volume on up days has been improving over the past 8 trading sessions;

Volume on the first trading day of October surged higher, at which time

SPY made a low of 107.5 then closed 5% higher just below 112.5 AND

Gave a failed sell signal, making a

new relative low, then reversing and closing higher;

7 days of higher lows and higher highs in a row;
3 closes above the 50 day moving average;
5 closes in the upper half of the 20-day trading range;
Last trading signal in this direction led to a (small) loss (bullish):  although the last trading signal was a profitable short sell from 129 to 122, the last long signal generated a loss (from about 131 to 129).  Believe it or not, this is bullish, and one Turtle Trading System insists that signals only be taken if the last signal generated (taken or not) would have led to a loss.  

Negatives:
SPY was turned back at almost exactly the point where it met resistance twice before (in late September and mid-October);
Volume, although improving recently, is below average; for a true breakout, you would like to see a strong surge in volume accompanied by at or near the intraday high;
Short-term over-extended:  the market has retraced half of the distance from the 110 closing low to the 135 high set in July; markets tend to find resistance after covering 1/3, 1/2, and 2/3 of the prior move (although this is a weak factor and certainly not always true).

The most likely scenario at this point is a pullback either to the 50-day (117.5) or the middle of the range (115) if not a test of the recent lows, but markets exist (or so it seems) to confound the most people most of the time, so a slog upwards from here with the market finding itself 20, 30, or 40% higher a few months from now is certainly possible.  When markets bottom, it is not pretty, and the fundamental news usually remains awful (the reasons for the buying only become evident long afterwards which is why following the money by studying the charts works so much better than following the talking heads on CNBC).  
At this point, an investor or trader true to the 20-day signal would go long at the market.  A less aggressive trader would place a high above the high of this move (122.14) which would only be triggered if the market confirmed its buy signal and moved higher.  Another way to enter the market would be to place a buy stop at the trailing 1- or 3-day high (take your pick), adjusting it every day as necessary.  That way, if the market pulls back then turns around, you will likely get in at a lower price and not have to waste time (and lose sleep) fearing that you bought at the very top of a move (a risk with any trend-following system).   Speaking of risk, there's quite a bit, over 12% if you use the 20-day low as your sell stop, 10% if you use the 20-day 110 closing low as your sell signal.

Other charts:
The dollar is pulling back with 2 unfilled down gaps after an initially impressive rally; this tends to be bearish for the stock market in the short-intermediate term:  



Of course, part of this is simply a mirror index of the Euro, which is rallying apparently in relief to the Greece bailout plan:


Anything that helps Europe will ultimately be bullish for the United States also, since the Eurozone taken as a whole is about the same size as the United States economy and one of our greatest trading partners.  

Gold has been hammered recently, gapping across its 20-day sell signal line at 165 in late September, and unable to rally up even to the bottom of the gap, much less filling it.  That buy signal, however, gave a nice run from 151 in July to 165 in September or 9% in a little over 2.5 months.


Germany is breaking out nicely with follow-through:


You would like to see better volume, however, but you had some very strong up days in September and the first trading day of October, indicating net accumulation.

If you missed the Germany Web buy signal, you could always trade the Germany Fund (more of an active ETF rather than an attempt to mirror an index) which gave a buy signal on heavy volume:  


Contrarians might keep an eye on solar energy (TAN @ 3.42) since the news out of this sector has been unrelentingly negative, distorted by a toxic political atmosphere (an attempt to highlight a failed $500 million investment in a much larger sector, an exception that does not prove the rule).   Because this ETF is so low-priced, it is not marginable and many pension and mutual funds maybe prohibited from buying it (meaning that the usual drivers of an explosive upside rally may have to stay on the sidelines), but for the individual retail investor or trader, this ETF maybe starting to get ready to rally.   I wouldn't bite here, but the fact it found support at 3 after such a brutal sell-off from 9, and on heavy volume no less, warrants close watching:


Of the sectors making up the S&P 500, only a few have triggered buy signals, notably excluding financials and energy.
Technology is a stand-out but up volume remains anemic and following the breakout yesterday, it closed at the lows of the day:


One bullish thing about technology is that it gave a recent false buy signal leading to about a 10% loss, which again is bullish, but the trading range is wide and sloppy.  

The Swiss Franc, after getting hammered, gapping down a staggering (in currency terms) 10 points from 125 to 115 in early September, has not even been able to approach the lower part of this gap and volume on down days remains much higher than on up days:


The Swiss stock market has issued a buy signal, however:  


Not for the faint of hart, the ETF that attempts to mirror the VIX (volatility index) looks as though it is approaching a sell signal after a fantastic trade was triggered at 25; if it does not gap below 41.35, then this would be a 65% profit in a little over 2 months.   The fact that volatility is settling down is settling down, or at least approaching lower end of its elevated trading range, maybe a sign that things are returning to normal, or at least that the panic levels of volatility recently seen are backing off.