Category Archives: Patterns

May 2nd, 2012

“Trading Around a Core Market Direction View”

Jim Cramer did one of his “I’m going to teach you ‘homegamers’ how to trade the same as I did when I was in my multi-million dollar hedge fund years ago” shows.  The point at which I was surfing through the show was when he was answering a viewer’s question about when to sell a winning position?  His answer was that if the viewer didn’t want to act like a novice trader, he needed to “trade around your core positions”.  But what does that mean?

According to the show’s transcript, the concept involves:

  • start by picking a stock about which investor has an opinion. They should believe the stock could go higher over the long term. It should be a great underlying company with a stock that could get tossed around by market volatility, but nevertheless has potential to push higher in the long haul.
  • Each time the stock jumps 3 percent, the investor sells 16% to make some profits and continue selling shares as the stock advanced until the position was reduced by 50%.
  • At that point, the investor would wait for the stock to be knocked down, so they can buy more shares.  When the stock declines 6%, the investor would buy back 16% and continue buying in increments until the original position was repurchased.

According to Cramer, “A lot of people think that trading is incredibly exciting and it can be, but if you’re good at trading around a core position, you should be pretty bored because all you’re doing is watching the stock move and trimming or adding to your position accordingly.”  It sounds simple enough but, I’m sorry, the market isn’t that accommodating and unless your portfolio has less than a handful of stocks to follow it sounds like just to much trading.

Rather than watching the daily trading patterns of individual stocks, I like to “trade around a core position” where the core position is my total portfolio and the trading is making essential a single investment decision: “How much should be invested and how much cash should remain at the present time.”  What I’ve found is that investing is essentially a risk and cash management strategy.  There are times when you should be fully invested (or more so when using margin) and other times when you need to be 100% in cash.

I arrived at that conclusion by watching the action of individual stocks and my total portfolio as compared with the S&P 500 Index.  What I’ve found is that the odds are that stocks tend to follow the market’s general direction; they may vary in degree but the direction of the movement is usually in the same direction.  Regular readers are familiar with a saying that I’ve quoted here often: “50% of a stock’s price movement can be attributed to the overall movement in the market, 30% to the movement in its sector and only 20% on its own.”  Here are several examples from today’s trading.  The blue line is the S&P and the black is the stock on a on minute chart:

  • TKR
  • EOG
  • CE
  • ALGN
  • LLTC

I could go on and on but you get the picture.  When the market goes up, most  stocks will go up; when the market goes down, individual stocks will likely go down.

Bottom line, it’s probably more important having a good sense of what the market will be downing this minute, this morning, this week, this month or the next six months than it is trying to predict what individual stocks will be doing.  Rather than timing sales of individual stocks by the price action of that stock,  it’s probably more worthwhile tying that transaction to what the market will be doing.  Rather than selling a stock because it’s gone up 10%, 20% or even 50%, you should time the sale to the health of the market or industry group.  Conversely, time purchases according to whether the market will be firm or if it’s on the verge of correcting or reversing.

“Trading around a core position” can lead to either major opportunity costs in lost profit or real losses from buying into a deteriorating stocks or market.  Figuring out market direction is probably time better spent then finding stocks with the most ideal stock charts.  When the market is rising it’s more important to throw money at a diversified portfolio (or even into index ETFs) than trying to find “the best” stocks to buy; when the market is falling, getting out of the way is more important than trying to decide which stocks will survive the downdraft and which won’t.

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April 23rd, 2012

The Lower Boundary is Becoming Clearer

Less than two weeks ago I wrote ““Identifying the Boundaries of Stock Chart Congestion Areas” in which I talked about three potential bottom boundaries of the congestion area that was developing and might eventually turn into a recognizable chart pattern.  With time, the emerging chart pattern is becoming clearer and, I must add, a bit more worrisome.

 

The discussion of “boundaries” is actually at the core difference between fundamental and technical analysis.  In fundamental analysis, analysts look at the slowing Chinese manufacturing index, Spanish debt refunding, elections in France and the upcoming U.S. elections, this quarter’s corporate earnings reports and the guidance for the year, upcoming Fed meetings, jobs reports, etc., etc.  Those analysts would then attempt to distill and prioritize the voluminous and disparate data facts into a consistent picture.  Finally, they will translate that picture into not what it means today, where it all might be headed in the future and what the impact might be on the stock market and individual stocks.

Needless to say, there are about as many divergent opinions about each of these data points as there are analysts willing to speak about them.  Some of those opinions are meaningful and reliable while most are guess that are about as useful as yours or mine.

Technical analysts, on the other hand, focus more on the actual decisions continuously being made by millions of investors, whether rightly or wrongly, rather than the reasons for their having made them.  They look at the continually changing balance (or imbalance) between supply (sellers) and demand (buyers) as reflected in transaction prices and volumes.  The primary focus begins with whether that balance is shifting on a continuous basis in one direction or another because when that imbalance starts it tends to be self-perpetuating, reinforcing and continues for some time (i.e., momentum).

The market, after having risen nearly 30% since October, is currently almost perfectly balanced between buyers’ demand and sellers’ supply.  Based on investors’ various interpretations of those fundamental facts, nearly an equal number see the facts portending a bearish future as those who see the facts leaning in a more bullish direction.  In other words, about as many see the market glass as half-full as see it half-empty.

Our search for boundaries is an attempt to learn when that equilibrium balance starts tilting in one direction or another.  Sometimes the balance continues for a few weeks and sometimes it takes months.  In the last post, I inserted three possible bottom boundaries.  As a result of today’s severe open, one of those supporting trendlines was penetrated; if there isn’t a quick strong bounce before the close and into tomorrow, then more downside can be expected.  If the demand is insufficient to absorb the supply of those investors who see a pessimistic outlook then the market will break below both of the remaining support levels and will continue lower until a new equilibrium balance forms at lower levels.

April 12th, 2012

Identifying the Boundaries of Stock Chart Congestion Areas

I was traveling this week so, fortunately, I wasn’t able to react to the ups and downs of the market this week.  If I had, I would have been closing some really good positions on Monday and Tuesday and then kicking myself as I scrambled to put them back on Wednesday and Thursday.  The lesson to be learned that was reinforced yet again is to turn off the CNBC, tune out the noise of all those explanations (read “rationalizations”) for why the market had done what it had done and to focus intently on the longer term for true trend reversals.

For the past several weeks I’ve been writing to members in my Weekly Recap Report that

“This narrowing, trading range can’t continue indefinitely and, I believe, will in all probability be resolved with the market falling below the bottom trendline as contrasted with a highly unlikely blow-out cross above the upper boundary.  I’m guessing the cross (the “collision”) will take place as the market approaches the horizontal resistance trendline extrapolated to occur sometime towards the end of April.  Coincidentally, that also coincides with everyone launching into their seasonal ‘Sell in May and go away’ discussions.  Taking that course of action would have been the right move to take in 2010 and 2011 and could again be true this year.”

But even that wasn’t sufficient to call this week’s action as a reversal.  There are millions of investors around the world making a huge number of trading decisions every day.  It takes more than a few hours, days and even weeks of trading to have this ship, the market, list to the other side as the majority of them run from one side (the bull side) to the other (the bear side).

One of the most difficult challenges in charting is distilling from the daily action the true boundaries of emerging chart pattern that are emerging from the congestion of what will, with the clarity of perfect hindsight will be either an obvious reversal or consolidation pattern.  Boundaries require pivot points, the short-term reversals made be either the market or individual stocks.  I’ve inserted three possible bottom boundaries based on the market’s recent behavior:

The important take-aways from this exercise are:

  1. Don’t get wedded to one point of view or another too early as to the market’s future course (and that’s what we’re most interested in since it determines 50% of each stock’s performance).  Congestions, those times when sellers and buyers, bulls and bears, supply and demand are fairly much in balance struggling to take control of the future trend.
  2. Regardless of how astute or knowledgeable you may think you are, it’s nearly impossible to predict the outcome and nothing you do can change what the ultimate outcome will be.  The best course is to wait for the trend.
  3. Don’t get wedded to what you think will be the pattern likely to emerge.  Supply and demand is dynamic and constantly in flux.  It’s difficult making money during these congestion periods but profits are relatively easy to come by when either a bullish or bearish trend emerges.

It’s only after several pivot points are made over an extended period of time (weeks or months) that solidify the trendlines will you be able to determine whether the congestion will in all likelihood be a consolidation, a top reversal or a bottom reversal ….. and then the market will confound you further by either doing the opposite or continuing adding further clarity to the congestion area.

March 26th, 2012

“Sell-in-May” in 2012, too?

In my weekly recap report to members yesterday, I wrote that “having a ‘game plan’, some expectation of the market’s near-term direction, helps put context to individual security trading decisions.  That game plan may turn out to be precisely correct or widely off the mark.  In any event, your game plan should give you more confidence in the decisions you ultimately make.”

My “game plan” foresees a “collision”, or convergence, between two significant chart patterns, or paths:

  1. the trendline extending through several key pivot points that occurred during the 2007-09 Financial Crisis Crash.  I described that trendline on March 19 at the area of 1435-1440 because “that’s approximately the level of the higher of two alternative necklines of the 2007-2008 reversal top of the 2007-2009 Financial Crisis Crash.
  2. a narrowing ascending “spiked” channel boundaries of the market’s move since the end of last November.  “This narrowing, trading range can’t continue indefinitely and I believe will be, in all probability, resolved with the market falling below the bottom trendline as contrasted with a highly unlikely blow-out cross above the upper boundary ….. sometime towards the end of April.”

The chart I included in the report depicting that “collision” follows:
Coincidentally, that projected “collision” coincides with what likely will be the launch of the seasonal “Sell in May and go away” mantra.  Taking that course of action in 2010 and 2011 would have been the right move; doing so this year may again prove to be best decision.

Supporting that view but from another direction based on Elliott Wave counts [a technical approach which, in full disclosure, I don't follow or believe in], Bloomberg BusinessWeek reprinted a report this morning from the technical analysts at UBS AG in an article entitled “S&P 500 Index May Begin Correction: Technical Analysis“.

““The S&P 500 (SPX) is trading in a wave 5, which suggests the market is on its way to a first important tactical top,” Michael Riesner and Marc Mueller wrote in a note yesterday. “The current rally is driven by fewer and fewer stocks and this is usually something we see at the end of rallies or bull moves….a setback could last as long as 10 days, dragging the benchmark gauge for U.S. equities to retest the 1,340 level.”

Where did they come up with 1340?  A 5% decline to 1340 would bring the market to a level where it last pivoted and, thereby, create a trendline that soon will be identified as the neckline of an emerging head-and-shoulder pattern with the decline completing the formation’s head portion.

So if you feel that the market has been running away from you, if you are looking to take some money out of fixed income investments that are currently generating a nominal yield and putting it to work in equities then I would recommend that you wait.  If you have some nice gains from having been adventuresome and put bought stocks last fall when everyone was scared to death by the European sovereign debt crisis then taking some profits could also be prudent.

There’s no need for predictions because the market will tell us within the next several of weeks its future direction.  A move above the 1425-35 area will indicate further advances.  A move below 1380 indicates that “sell-in-May” returns for a third year and purchases can be deferred to September-October.

March 21st, 2012

1912 = 2012; so many things change yet stay the same

These posts aren’t usually on subjects unrelated to stocks and the market but I just couldn’t resist this one.  I’m working my way through the last of Edmund Morris’ monumental biographical trilogy of Theodore Roosevelt called Colonel Roosevelt.  If you haven’t read much about our 36th president then you can’t possibly understand much about what made the world we live in today.  In many ways the two periods are nothing alike but when it came to the political, economic and international scene there are interesting similarities.

There probably aren’t many history professors and teachers assigning the following project to their pupils: “Compare the similarities and differences between 1912 and 2012″ but, if I taught such a course, I certainly would.

This morning’s NYTimes business section included and article entitled “Inequality Undermines Democracy” which stated:

The gap between the rich and the rest has been much wider in the United States than in other developed nationsfor decades….. Our tolerance for a widening income gap may be ebbing, however. Since Occupy Wall Street and kindred movements highlighted the issue, the chasm between the rich and ordinary workers has become a crucial talking point in the Democratic Party’s arsenal. In a speech in Osawatomie, Kan., last December, President Obama underscored how “the rungs of the ladder of opportunity had grown farther and farther apart, and the middle class has shrunk.”

…..a growing share of Americans have lost faith in their ability to get ahead. We have accepted income inequality in the past partly because of the belief that capitalism can’t work without it. If entrepreneurs invest and workers improve their skills to improve their lot in life, a government that heavily taxed the rich to give to the poor could destroy that incentive and stymie economic growth that benefits everybody…..Evidence is mounting, however, that inequality itself is obstructing Americans’ shot at a better life.

That was written today but it could just as easily have been written 100 years ago, in 1912, when the country was going through a similar argument about social and economic equality.  At the time, it was Theodore Roosevelt who, like the Tea Party of today, was disenchanted with the way the Republican Party led by his successor, Howard Taft, was pulling the country back from his Progressive programs.  During his eight years in office he had promised more progressive (read “liberal”) reforms to come.  A battle for the nomination of the Republican Party to run against the Democrat Woodrow Wilson ensued between Taft and the “progressive” Roosevelt.

Predating Obama’s trip this year, Roosevelt traveled to Osawatomie, KS in the summer of 1910 to set the stage for that nomination battle by delivering a historic speech.  He argued that one of the central issues of the government was protection of human welfare and property rights.  That 1910 Osawatomie speech later became the basis for his 1912 break from the Republican Party and formation of his Bull Moose Progressive Party.  In it he said that human welfare was more important than property rights and that only a powerful federal government could regulate the economy and guarantee social justice.  A President can only succeed in making his economic agenda successful, he believed, if he makes the protection of human welfare his highest priority.“

[Interestingly, Osawatomie might also lay claim to being the "birthplace" of the Civil War since it was where John Brown led his first anti-slavery massacre in 1856 followed by his raid at Harper's Ferry in 1859 and the start of the Civil War in 1860.  Immediately before the Civil War, Kansas was the battleground of the effort to prevent the expansion of slavery and, in that battle, a main terminus of the underground railway for fugative slaves from the South.]

Key elements of Roosevelt’s New Democracy speech were (from Wikipedia).  It’s amazing how many of those issues are the ones still we debate today in one form or another:

  • A National Health Service to include all existing government medical agencies.
  • Social insurance to provide for the elderly, the unemployed, and the disabled.
  • Limited injunctions in strikes.
  • A minimum wage law for women.
  • An eight hour workday.
  • A federal securities commission.
  • Farm relief.
  • Workers’ compensation for work-related injuries.
  • An inheritance tax.
  • A Constitutional amendment to allow a Federal income tax.
  • Women’s suffrage.
  • Direct election of Senators.
  • Primary elections for state and federal nominations.
  • Strict limits and disclosure requirements on political campaign contributions.
  • Registration of lobbyists.
  • Recording and publication of Congressional committee proceedings.

We often incorrectly believe that the issues facing us are new and, at times, appear insurmountable.  But all we need do is, like in stock charting, to look at history and see that what is happening today follow from and follow patterns like events in the past.  If we understand that history and those patterns we are likely to make better decisions today.

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February 16th, 2012

Parallel trendlines for positioning targets

There are those who follow Bob Prechter, one of the strong proponents of the Elliott Wave principles have their ways of identifying price level targets.  And then there’s the crowd who hide out at Slope of Hope, the place where perma-bears can always find a reason for an impending correction or “much welcomed” bear market crash through targets derived by their overly precise application of arcane Fibonacci mathematics.  But I’ve always found a rather simple approach to projecting out potential targets by applying a resistance trendline parallel to the corresponding supporting trendline and thereby creating a channel.

Take for example XHB, the homebuilders ETF.First, you should note how reversal and consolidation patterns easily morph from one form to another without a general market tailwind.  Until last summer’s meltdown due to the domestic budget and European sovereign debt crises, it looked as if XHB would break out the upside of a symmetrical triangle.  Since last summer’s 30% decline, it now appears that pattern has morphed into an ascending triangle and, with cooperation of a more constructive general market backdrop and expectations for finally an improved housing market, that upside breakout might now be at hand.

If break out does materialize, the next question is what might be a reasonable target for the move higher?  Consider a parallel line as on benchmark:

Parallel lines are simplistic and anything but elegant but they usually work.  They definite position a target for one’s expectations.  They won’t let your dreams run wildly out of control and add a time dimension to a price expectations.

Reality never really works so perfectly but, if the market and XHB dramatically diverges from this trajectory then we can make mid-course adjustments when and to the degree necessary.

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January 25th, 2012

“The Great Convergence”

In last week’s Recap Report recently sent to subscribers, I wrote and included the following chart:

“….. at the risk of being labelled melodramatic …. I see “The Great Convergence” coming to a head and finally getting resolved with the 18-month struggle between bulls and bears with (I hope it’s not just wishful thinking but an actuality) the bulls finally gaining the upper hand and finally being able to break into new higher ground.”

After today’s close and after closing higher for 20 of the last 23 trading days, the market is now up 10.01% since December 19.  Even more important is to note that today’s close was at 1326.06, almost exactly the level many chartists have touted as the breakout point that confirms an exit from this summer’s bear market and the continuation of last year’s bull market run off the lows.

It should also be noted that it’s almost exactly where the descending trendline connecting the 2007 and 2011 peaks is today.  However, rather than thinking in terms of points (e.g., 1325 or 1326) we need to think of a zone.  Every single trader doesn’t simultaneously decide to buy or sell which in turn causes a reversal at a single point.  Furthermore, the Index is composed of 500 different stocks in every economic sector and each of these stocks will have their own underlying market dynamics.  Market psychology does change when the market hits various levels but a change of psychology happens over time.

What the above chart indicates is a change in market psychology that’s been on-going since the bottom of the Financial Crisis Crash (see “Revisiting Housing and Banking With a New Ending” of a few days ago).  The ascending trendline since the bottom (higher lows) and the descending trendline from the pre-crash peak (lower highs) results in this “Great Convergence”.  The best momentum indicator (in my book) of moving averages across multiple time horizons are turning constructive adding to the conviction that a clear-cut signal to put, as they say in Wall Street, “risk back on”.

I believe there needs to be a 4-6% consolidation of this 10%, 23-day run and we’re going to look at it as a buying opportunity.  But if the market continues to zoom ahead another 2-3% without that correction, then it’s “damn the torpedoes, full speed ahead.”

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January 24th, 2012

The Outlook for FXI and Chinese Stocks

From the EconomicTimes of India:

“China’s economy is showing signs of slowing, with foreign investment falling for the second straight month in December and home prices dropping in most cities, the government said Wednesday.

The latest indicators came a day after data showed the economy expanded 9.2 per cent last year, narrowing from 10.4 per cent in 2010, as global turbulence and efforts to tame high inflation put the brakes on growth.”

From USAToday:

“China’s gross domestic product grew at its slowest pace in more than two years in the fourth quarter, and the worst may be yet to come, as weak exports and government tightening ripple through the world’s second-largest economy.

In the final three months of 2011, China’s GDP — the total value of goods and services — increased 8.9% from a year earlier. That was a fourth-consecutive quarter of slowing growth and the slowest expansion since the second quarter of 2009, when the economy grew 8.2%, the Chinese government said Tuesday.

For all of 2011, China’s economy expanded 9.2%, compared with 10.4% the year before.”

And finally, from The Guardian in the U.K.

“China’s economy is also “unstable, unco-ordinated and ultimately unsustainable”, a verdict delivered not by some capitalist running dog on a Canary Wharf trading floor, but by none other than premier Wen Jiabao. Nevertheless, any appraisal of China’s prospects must begin by admitting that the Middle Kingdom is the most astonishing development success story in the world today, and that its three decades of 9%-plus growth have been achieved in the face of widespread scepticism from foreign observers.”<

When we look at a chart of FXI, the ETF of Chinese stocks, we see a classic inverted head-and-shoulder or ascending triangle or any of a number of bottom reversals:

From the above chart it appears that the Chinese market would rebound in sync with the US market ….  should that come to pass.  The extent of that rebound, however, is bound by different constraints than the US market when viewed from a longer-term term perspective:

This short-term inverted head-and-shoulder may signal the beginning of a Chinese market recovery but a complete reversal of its long-term downtrend would also require a cross above a long-term descending trendline stretching back to the heydays of 2007 followed by a cross above the top boundary of what now looks potentially like a multi-year ascending triangle at 46-47.

The near-term inverted head-and-shoulders supports a move to 47 but moves above that need more umph and momentum to overcome their local economic and international trade challenges.

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January 6th, 2012

Is the Secular Bear Market Close to Ending?

A recurring theme among some reporters and bloggers is the possible breakout of the mega-caps.  I believe one cause for this line of reasoning is the persistent dream of an end to what is now the 12th year of the secular bear market.  A name that continues to come up as emblematic of this breakout thesis is WMT (Walmart).  Any stock chart aficionado salivates over the potential of a stock like WMT.  When stuck in a horizontal trading range for over 10 years there’s the potential of a huge move should a breakout above that huge wall of resistance is ever successful:

But WMT isn’t the only large-cap stuck in the secular bear market trap.  As a matter of fact, half of the 30 Dow Industrial stocks are below where they were on December 30, 1999 (WMT is down 12.8%). There are a number of large-cap stocks not part of the DOW that also have charts that have attractive potential should they break above their own multi-year resistance levels:

  • MSFT (Microsoft)
  • AMGN (Amgen)
  • QCOM (Qualcomm)
  • DIS (Disney)

What we’re all waiting for are stocks to breakout like IBM because when more do, we’ll be certain that the 12-year secular bear market will have ended:

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December 28th, 2011

Big Pharma: Industry Group with Upside Potential

While market direction and momentum trumps everything else, the Industry Group in which a stock belongs ranks second in importance.  A subscriber to Instant Alerts last week brought to my attention a stock that, on further research is in an Industry Group that is worthy of taking a nibble into if the market will be able to sustain some sort of upward bias as we enter the New Year.

“Big Pharma” stocks, or the larger stocks in the Ethical Drug Industry Group, all seem to be forming nice size, well formed (so far) bases which could, with a good tailwind, be among the leaders in next year’s market.  The Group has consistently ranked among highest among IBD’s 197 Industry Groups: Among the largest firms in the group whose charts show the early makings of nice bottom reversal patterns (a few have already broken above the top boundaries) include (click on images to enlarge):

  • BMY (Bristol Myers): crossed above a nearly 10-year long resistance trendline
  • LLY (Eli Lilly): crossed above upper boundary of an ascending triangle but is now facing a nearly 10-year descending resistance trendline which it failed to cross over in 2007 and may fail again next year.
  • GSK (GlaxoSmithKline): Let’s not split hairs. Was it an ascending or symmetrical triangle or was it an ascending wedge? It doesn’t really matter that much since stock is clearly trudging higher.
  • PFE (Pfizer): Same as GSK, ascending triangle or wedge? Same as LLY, facing a long descending resistance trendline.
  • NVS (Novartis): An nice inverted head-and-shoulders which, since it’s not at the bottom of a trend but at the top might be called, in IBD parlance, a cup-and-handle.

Others with patterns that are not as fully developed and still in progress include:

  • SNY (Sanofi-Aventis): an ascending triangle
  • AZN (AstraZenica): a 10-year horizontal trendline that needs to be crossed.

A lot to digest but, with a more cooperative market, some potentially good fruit to pick from.  Note: all of these stocks pay dividend with yields currently 3.6% up to 4.8% for GSK.  They are about the only stocks among the 45+ in the group that do pay dividends.

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