Holding Short

Very little has changed in the short term charts since my last update. While I still don't have a confirmed signal to sell short, I'm out in front with a few inverse ETF holdings. I plan on adding to these positions once prices break below the 10 dma and the average line rolls over...

I will point out that I now have zero interest in being long anything in this market that's not inversely correlated. I'll remain short or on the sideline and will even venture to say that the high for 2010 has already been printed. That's 2326 on the Nasdaq for those keeping score...

Looks like the DOW is the laggard and if things play out as I expect, this index will be the first to break below the 10 dma...


While I'm not one to usually go out on a limb with big, bold predictions, I think there's a good chance we'll look back on the recent rally as the completion of a 50% retracement on the S&P before a more serious correction pushes prices much lower. Here's a monthly view...

I view the move in the Nasdaq similarly, only the retracement here is 62%...

It's also 50% for the DOW and note the volume fade that has accompanied the climb...

While this entire rally has been fueled by soft volume, the most recent action again highlights the lack of buying conviction behind the rallies and the stronger volume behind the selling. This is classic distribution...

Chart Courtesy of http://stockcharts.com/

We also continue to see large selling on strength numbers in the SPY and the dollar has been able to hold above the $80 mark, which may now act as support. I don't see anything I like here from the long side and as I stated earlier, I'll continue to pick my spots from the short side or sit it out completely until I see some increased buying conviction.

The Short Report

While there's little to point to currently in the short term charts that indicate an imminent market decline...

I'm giving more credit to the bigger picture here and I'm fully short going into tomorrow's session (currently only 25% invested, but looking to add aggressively on weakness). Volume patterns continue to suggest distribution on all indices and leadership remains questionable. Perhaps more than any other factor at this point, risk from the short side is very easy to manage from this level. If the market has other plans, I should be able to escape with minimal damage. For example, check out the /ES channel we were following and the spot prices were rejected...

Click Any Chart To Enlarge

Additionally, I pointed out in the prior post the need for caution from the long side and today's weak volume bounce did little to convince me that prices on the S&P are ready to overcome the 50 dma. Going forward, I can easily use a close above the flat 50 dma to exit short positions. I like the risk/reward here and I can't imagine a better spot to press/add to the short side on any weakness...

The Nasdaq was able to push back above the 50 dma today, but volume also receded here...

Here's a look at the DOW and I have very little faith in this market pushing above the 50 dma from here given the recent action. I don't see much buying conviction behind this recent rally as volume continues to diminish...

Charts Courtesy of http://Stockcharts.com

Consolidation Continues

The last couple of sessions appear to be a healthy consolidation of recent gains, but there's reason to be cautious in the short term. On the S&P, the level I'll be watching closely for support in today's session is 1103. A hard break below there could see prices test the 1085-1090 level and a test of the rising 10 dma. That's roughly 20 points lower than yesterday's close...

Looking at the Nasdaq, I'm watching for buyers to step in around 2225-2230. If that level fails to hold, the next level of support appears to be closer to 2200...

The DOW is consolidating in the middle of a prior price channel. I see about 40 points of downside here before moving average support, but a break below there could see a move back to the lower channel line around 10,250...


I'm still giving the benefit of the doubt to the buyers here and continue to view the recent price action as a healthy consolidation. If I had to point to a catalyst for the next leg higher, I'd look no further than the dollar. If Friday's action proves to be an intermediate swing high, higher prices in equities and commodities should soon follow...

If there's one negative for the bull's case, the recent rally has shown very little conviction as volume has faded on the way up. I'll note that volume action has not been a good indicator of future price action for nearly a year now, but still worth keeping an eye on...

Chart Courtesy of http://stockcharts.com

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When Trends Align...

I have yet to find a more powerful indicator than trend alignment when it comes to timing explosive moves in either direction. Just as it became increasingly difficult to profit from the long side after Jan. 20th, it has now become increasingly difficult to profit from the short side since mid-February. When the layers of short term moving averages become aligned in the same direction, powerful moves typically follow. With only a handful of opportunities each and every trading year to capture a large directional move, it pays to pay close attention to which part of the cycle the market is currently exhibiting. The pattern of distribution to consolidation to the current accumulation can be seen in this 60 minute chart of the S&P...

As you may notice, there's typically a test of each moving average during any given trend before it eventually consolidates and ultimately reverses...

The Nasdaq gave as clean of a signal as you'll see in both the correction and the reversal...

Click Any Chart To Enlarge

Unless you're trading the indexes themselves, stock selection and relative strength are still going to play a very important role in your performance. Being aligned with the market's short term direction won't guarantee profitable trades, but it will increase your odds and keep the wind at your back. Pick the right stocks, industry groups or sectors that lead a rally or fall harder during a decline and your portfolio performance will soar.

As far as my system as a whole, I try to keep it as simple as possible. If I had to rank the signals in order of importance, it would look something like this...

First and most important, trend alignment for short term market direction (now watching the $VIX to determine 5 dma vs 10 dma... see here). Next, the IBD method of follow-through, confirmation, and distribution days to help determine intermediate trend and to help find relative strength leaders in individual stocks and sectors. The IBD Top 100 is often a starting reference point and I often use pattern recognition and confirmations to time entries (buying breakouts, pullbacks to support or retracements back to manageable reference points such as the 20dma or 50dma, all while keeping a close eye on volume). One could make great money using nothing but what I just described and I often have, but I take it a step further. Next comes cycle analysis... for my money, nobody does that better than Gary Savage over at The Smart Money Tracker. When my trend alignment agrees with Gary's cycle analysis, magical things seem to happen. He saves me both time and money and does an excellent job. Lastly, I keep an eye on currencies and interest rates and I use a group of sentiment indicators including put/call ratios, AAII bull/bear surveys, short interest ratios, COT data, Schaeffer's research, etc. All are used as contrarian indicators.

There you have it. For me, a system that takes my emotions out of trading and when the majority of indicators point to the same direction, I simply try to hold on tight. A healthy dose of technical and fundamental data, mixed in with sentiment and market participant emotions can be a powerful combination. Sure, I still have to make decisions of when to cut a loss or take a profit and I get false signals and conflicting data, but I can choose to sit out those periods or get hedged or just tread lightly. After all, and remember this, using all of the above still guarantees you nothing in the way of profits, but I do think it will increase your odds. Trade well!

Brief Update

Looking at the short term chart of the S&P, I can see two distinct scenarios playing out over the next few sessions. With a push above 1103, I don't see much resistance up until 1115, followed by the 1130 level. Should the market decide to pull back and consolidate the recent gains, a right shoulder formation setting up an inverse head and shoulders pattern fits in well with a test of the 10 dma, which is beginning to turn up...

I can see the same scenario developing in the DOW. There's very little in the way of resistance here up to 10,500, but a right shoulder to complete the reversal seems a distinct possibility...

The Nasdaq is the relative strength leader and the 10 dma has already turned up. Looks like very little in the way of resistance here up to 1170 or so...


The dollar continues to dance around the $80 mark and will likely be the determining factor in how the near term action unfolds. I see the recent action here as toppy and will watch for a clear breakdown back below $80 as the "all clear" for the next leg of this cyclical bull to truly launch. Note the MACD has been a reliable indicator for the dollar trend and now looks poised to crossover...

Chart Courtesy of http://stockcharts.com/

It's Getting Interesting

Looking at the /ES channel, prices tagged the upper channel line today before fading late in the session. If we're going to see higher prices in the near future, a breakout from this channel would be a good start...

As you'll see in the chart below, the S&P was battling resistance from the falling 5 dma and was unable to close above that average line this afternoon. The series of higher lows and higher highs is an encouraging sign for the bulls and volume patterns are looking better this week as compared to last. However, the 5 dma is still declining and trendline resistance lies just overhead...

The DOW is sitting on the 5 dma and found resistance at the trendline. Either we see a breakout from here or this could be an easy to manage short opportunity...


While the DOW and S&P were finding resistance from the 5 dma and trendlines, the Nasdaq was using them as support into the close...

The dollar fell back below the $80 mark and put in a daily swing high. I've mentioned how that $80 level could act as resistance and we'll see if the break back below leads to continued weakness. Further downside here, perhaps to trendline support, would be bullish for equities...

Chart Courtesy of http://stockcharts.com

As I scanned through the charts tonight, set-ups on the long side are few and far between. Lots of technical damage has been done during this decline, but this cup and handle pattern on CTXS has potential. The volume pattern suggests accumulation. I already own a piece here and I'll be looking to add on a breakout...

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Quick Update / Backtest Results

We'll start tonight with the /ES channel and prices sitting basically in the middle at the 50% line...


There's really not much to update on the short term charts tonight. Prices didn't quite make it up to the resistance that would've provided a low risk short entry and all indices closed below their short term moving averages. The path of least resistance continues to be down. If there's any consolation for the bulls, volume did drop significantly today from the levels we saw late last week. Here's my view of the S&P and you'll see that prices fell short of my target, although I did put on a few hedges after the drop below the shortest term moving average (red) today...

The Nasdaq was the relative strength leader early in the session and popped into my "short" zone before rolling over late in the day...

Here's my view of the DOW, the laggard today...

Click Any Chart To Enlarge

I mentioned in the previous post that I was going to do some backtesting over the weekend and I want to share a couple of results to this point. This was significantly more time consuming than I thought and I plan on doing more down the road, but here's what I have so far...

First, a little background. I prefer to use the 5 day moving average on a 30 minute chart to capture as much of a trend as possible. As you'll see, there are usually several big moves through any given year that provide the opportunity to ride a trend and score big gains rather quickly. In fact, nearly all of the yearly gains for a trend trader will come from these big moves. Take a look at the current chart of the Nasdaq below. With an entry up around 2290 (highlighted green circle), a trend trader could still be short here with prices now trading at 2126. That's 164 consecutive points in one trade... and counting! While prices moved above the 5 dma in early February, the line never turned up and thus has yet to give the signal to cover...

On the other hand, the DOW and the S&P did give a sell signal over that same period and shook me out of my short positions. That's where this study comes into play. I noted that if I used the 10 dma on the 60 minute chart, I would still be in those short positions. I posted that chart and discussed my thoughts on volatility being a factor in the previous post here.

So I decided to test the 5 dma and the 10 dma in periods when the $VIX was high and match that against a period of lower volatility. For the purposes of this study, I used 24 as my over/under on the $VIX to determine high vs low volatility periods. That number simply worked as the dividing line in the periods I studied. I considered a signal "false" if it was reversed within 3 days and I used the S&P for prices. The goal here is to capture as much of a trend as possible without getting shaken out from a false signal. Here's what I found so far...

The first period is the low $VIX environment from May '06 to Feb '07. Using the 10 dma, I got 9 buy/sell signals with 3 being false. Using the 5 dma, I got 23 buy/sell signals with 8 being false. Not much difference there, as about 1/3 of the signals were shakeouts and obviously, the shorter term moving average gives more trade signals. Here's where it got interesting, the largest trend that the 10 dma captured was 96 consecutive points (1280-1376), while the largest trend the 5 dma captured was 60 points (1320-1380). I'd have to give the low volatility round to the 10 dma and if it wasn't for a "false" sell on 8/14/06, it would have captured 294 consecutive S&P points (1082-1376).

Next, we'll take a look at the high $VIX period from June '02 to April '03. Using the 10 dma, I got 10 buy/sell signals with only 1 being false. Using the 5 dma, we saw 22 buy/sell signals with 2 being false. Note how the number of false signals is comparatively less using either moving averages during a higher volatility environment vs the low volatility environment described above. The ratio went from about 1:3 to around 1:10 The largest trend captured for the 10 dma was on the short side for 174 consecutive points (1074-900). The largest trend the 5 dma captured was also on the short side for 184 consecutive points (1020-836) and if it wasn't for a "false" sell on 6/18/02, the 5 dma would have captured 254 consecutive S&P points (1090-836). I'd have to give the high volatility round to the 5 dma here.

I plan to run these same tests over many more periods to see if I get similar results. I wish I could chart these out for you guys or at least graph the results here and now, but like I said, just getting this data is very time consuming. Maybe I'll save that for another weekend... preferably when there's no Super Bowl!

In summary, the 10 dma captured more of the trend with the $VIX below 24, while the 5 dma captured more of the trend when the $VIX was above 24. While the 5 dma will always give more buy/sell signals, there's very little difference in the ratio of false signals to valid trades when comparing the two moving averages in either a high or low volatility environment. However, there's a significant increase in the number of valid trades vs false signals in a higher volatility environment. Obviously, I'd like to study more data to verify that these results are valid, but it's a start.

Super Bowl Weekend Update

I'm not certain whether we put in an intermediate term bottom on Friday or not, but several signs are pointing to that possibility. I'll share a couple of those with you a little further down in this post, but first we'll take a look at the short term charts of the indices. We have several levels to watch early next week, starting with the 1080 spot on the S&P...

We've got the possibility of about 100 more points of upside on the DOW before we'll have to pay close attention to price and volume action...

The path looks good for adding another 15-20 additional points on the Nasdaq before things become a bit more dicey...

The charts above represent levels that I'll be paying close attention to early in the week. I will base my decisions to buy, hold, sell, hedge, etc. depending on the price action if/when those spots are tested.

Arguably, the most important chart to focus on going into next week is the dollar. As you'll see in the chart below, the $USD broke out of a bull flag formation with a price target of about 4 points. I have this projected to about $81.50, but I've noted on several occasions in prior posts that I expected the dollar to struggle to overcome the $80 mark. On Friday, the dollar topped at $80.68 before giving back about half of its gain and closing at $80.36. I can't completely discount a weekly close on strong volume above $80, despite the market's late day heroics. If the dollar rolls back below $80 early in the week, then Friday's low will likely hold as the intermediate term bottom in this correction. If we see continued strength here, we may be in for more downside and possibly more than the 10% most are looking for...

I mentioned we'd be looking for a $CPC ratio above 1.2 to mark the bottom. We got that on Friday...

For those of you that may need a reminder of the last time we saw the $CPC reach these levels, I offer the following chart of the S&P...

Chart courtesy of http://stockcharts.com

I'll admit that I've been a bit discouraged lately by the shakeouts and false signals with the 5 dma on the 30 minute timeframe. This has been a solid tool for me over the past couple of years, but not as accurate over the past several months and the number of whipsaws are increasing. I realize no indicator is perfect, but I'm thinking the low volatility has been a contributing factor. I plan to do some backtesting over the weekend and see if I can find a correlation between its effectiveness and a low vs. high $VIX reading. Perhaps, and this is just a thought, in times of low volatility with the $VIX below 25, it's better to focus on the 60 minute timeframe and the 10 dma. I know this may seem counter intuitive at first, but during times of high volatility, the market is moving quicker and responds better to the shorter term moving averages. That would make the 5 dma a better choice when the $VIX is high.

The recent shakeout (highlighted blue circle below) would have been avoided and the signal would have been to stay short using the 10 dma method with the $VIX below 25. The other signals over the past couple of months were also profitable, as evidenced in the chart below...

Click Any Chart To Enlarge

I'm always striving to find ways to improve performance and one can never have too many indicators in his/her trading arsenal. I'll keep you posted on my findings. In the meantime, hope all the football fans enjoy the Super Bowl and with a little help from Peyton Manning, I plan on getting a nice little payday!

I may or may not be back with another update before Monday's opening bell. If I come across any price patterns worth watching, I'll mention them in the comments section, if not in a full post. Enjoy the weekend and the big game!

Brief Update

As difficult as it is, I'm trying to keep the bigger picture in mind. I'm still viewing this as an overdue correction in a bull market. I must admit that I'm drawing my lines in the sand as we speak and I'll highlight a couple of them below, but a 7-10% dip was what I was expecting until the strong start to this week. We're in that window now, but it appears the news headlines will trump any lines I can draw on a chart. Oh well, let's do it anyway...

The $USD in coming into resistance at the $80 level. A strong move back above this level would not be good for the indices and certainly not for commodities (of which I'm heavily invested). This will be an important level to watch moving forward...

The shorter term charts have all turned back negative and I find myself roughly 60% invested on the wrong side of the trade. The question now becomes whether or not we see a dead cat bounce, which could provide a great opportunity to get hedged, lighten up on longs, or get net short... depending on how it all unfolds. I don't believe we've seen the bottom yet. The other scenario would be a break down hard with an ugly open tomorrow and a strong flush to end this decline. I favor the latter, let's shake'm out and move on. Remember, 1035 on the S&P marks the 10% off the highs spot...

Prepare for the DOW below 10,000 headlines and a healthy dose of the "end of the world" scenarios on any weakness here tomorrow...

The Nasdaq simply looks to be in freefall...

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The $CPC is headed in the right direction and a move to 1.20 or better would correspond well with an intermediate term bottom...

Chart Courtesy of http://stockcharts.com

Looking For Confirmation

If you would have shown me this candle on the dollar and nothing else, I would've predicted the market down massively in monster volume again...


Showing some resilience to the dollar's spike, the market actually consolidated the recent gains on declining volume. That's a welcome change in the market's character of late and a healthy sign given the recent amount of distribution. For those of you familiar with the William O'Neil system of rally confirmation, tomorrow is day 4 of this rally attempt and a strong gain on increased volume between Thursday and next Tuesday could confirm the start of the next leg higher...

Chart Courtesy of http://stockcharts.com

The 30 minute chart of the S&P also shows signs of a healthy consolidation...

Same goes for the DOW and is that an inverse head and shoulders pattern shaping up to confirm the reversal?

The Nasdaq even showed some life today as the only index closing in the green...

If we do get a confirmed rally, it's usually the first group of stocks that push to new highs that will lead the next leg. I've already added a few potential leaders to the portfolio and here are a few more that may be ready to break to new highs...

ASPS is a newer issue, but has been consolidating and forming a base while most of the rest of the market was tanking. The level to watch is around $24...

ACF - Ascending Triangle

HSP has been reacting well off recent trendline support and looks like it wants to go higher. The catalyst here will likely be the earning's report...

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