Market Rewards us with a Trend Day Up

Feb 14, 2008: 12:02 AM CST

The intraday action in the major US indexes was a gift in the form of a ‘trend day up’ structure, which occurs rarely, but offers us significant opportunities for profits.

Let’s peek:

Notice how the market (DIA ETF – 5-minute chart) gapped up, representing an initial momentum imbalance. A gap can serve as the first clue that the day has greater than normal odds of being a trend day.

Second, notice how the market was unable to fill the initial gap (which is perhaps the intraday theme of February so far), and found support at the 50% mark of the gap, which corresponded with the rising 50 period moving average.

Third, price trended higher and continued to find support at the rising 20 period moving average. The structure of the moving averages (20 above the 50 above the 200) gave us another clue beyond the ‘gap failure’ that today would be a trend day in the making, and that we should go ahead an establish an initial position and then trade around pullbacks to the moving average for the rest of the day.

We see the pattern continuing, as the market came back frequently to ‘test’ the rising 20 period average, which set up low risk (stop beneath the 50 period average) and high reward (retest of the recent swing-high or beyond) trade opportunities.

The Dow Jones Index ended the day 178 points higher (up 1.45%).

Also, let’s look at the DIA’s 30-minute chart for a quick lesson on the divergence resolution pattern:

See if you can ‘feel’ the positive divergence building, which resulted in the change of trend (short term) back to up. Notice how price kept making narrower swings and lower lows, but the momentum oscillator, which is more sensitive to price swings themselves, continued to make higher lows.

Lengthy divergences such as these often serve as counterpoints or turning points in the market, depending on what time frame you’re viewing. In this case, the building positive momentum preceded the actual price reversal.

Notice how the February 12th gap took price cleanly above the moving averages which had previously served as support.

Price still has more to ‘prove’ to become declared as an uptrend on the daily chart, and I am classifying this recent move as a counter-swing up which could be setting up a more favorable price action in the future.

Time will tell, of course, but it pays to be one step ahead of the crowd if possible.

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Consumer Discretionary Spending Sector Analysis

Feb 13, 2008: 2:08 PM CST

The Consumer Discretionary Sector is important to study for the broader implications for the economy and stock market. When the consumers spend, it is generally good for the economy and when they don’t (or hold back purchases), it’s not. Let’s look at the chart for the XLY, Consumer Discretionary Sector SPDR ETF (weekly):

Notice the lengthy negative momentum divergence that occurred through most of 2007. It resolved strongly to the downside, forming both a new momentum low and a classic bear flag which actually far exceeded the ‘measured move’ or price objective inherent in the pattern.

2008 saw price make both a new price low and a new momentum low, indicating higher odds that a new price low is yet to come. Notice the current rally which was met by the falling 20 period moving average as resistance.

The rally was sharp and explosive, and sent interesting and murky signals to the sector rotation model, but it appears that this was simply a strong counter-trend move or a massive short-squeeze rally.

The daily chart shows more of the wave-like pattern I have been describing previously.

Notice how you can almost “feel” the price swings, as supply overtakes demand and vice-versa. I think it’s easiest to study the structure just from the waves themselves, and not complex indicators.

Notice how the price undulates toward and away from its key moving averages in a trend, and how they serve as both support and resistance as price moves from one price level to the next in the trend.

Notice also the massive reversal in late January and the fact that price is now trapped between the 20 and 50 moving average. An upward break would be a wonderful sign for the bulls, but should price break downward, it would be more of the same as th e bears would take over again and price would retest the $28 level or perhaps make new lows.

This sector and the Financials sector are tied closely together, in that they both benefit from reduced interest rates (cost of carry, or credit card interest rates, or the like). Consumers are more likely to spend if they have lower credit card rates than higher (though it’s not as simple as that of course).

Keep an eye on this critical sector, and if it shows signs of a bottom, then that would be wonderful news for the overall market itself.

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Gaps and Momentum Bursts

Feb 13, 2008: 10:07 AM CST

The last two days in the major market ETFs have shown gap opportunities, though the gaps have (yet) to close on both occasions. Also, interesting momentum impulses have developed which warrant an educational lesson. Let’s see:

DIA (Dow Jones ETF) 5-minute chart:

First, notice the purple ovals, which represent overnight gaps. While January was a month when 70% of gaps filled, February is looking to be just the opposite. I’ll run the numbers at the end of the month, but it wouldn’t surprise me one bit if 70% of gaps in February did NOT fill. It’s one of those instances where the market character changes, and strategies with edge (that become known to the masses) erode as everyone catches on to the ‘easy money.’

While the current action (as of 11:00am EST) could be headed for a fill, time will tell if this is the actual case.

Second, I wanted to highlight the three momentum ‘bursts’ or impulses which resulted in a reversal into the close yesterday. It formed an interesting pattern worth further study.

Notice the first impulse burst resulted from the overnight gap and major (temporary) demand imbalance. You can almost feel the imbalance (momentum) wane as price reached a peak and then reversed for a counter-swing against the momentum.

Imagine a ball being thrown into the air as you are traveling down the road in a car. If you plotted the trajectory of the ball as it was thrown, it would look similar to yesterday’s action. This sort of analogy helps explain a large portion of price swings and counter-swings in the market.

As the ball reaches the peak, it first slows down before stopping and then traveling back to earth. Each time it was caught at a higher level and then thrown with a bit less force until the ball eventually came back to earth as the child lost strength and ‘dropped the ball.’

We see another toss of the ball upwards this morning, but we’re currently experiencing a ’sell swing,’ which is analogous to the ball coming back to earth. At what level will it be caught and thrown back up?

Rather than overcomplicate your chart with excessive indicators, why not look at the pure price action and study the swing nature itself of the price, and envision the waves of supply and demand (of buyers and sellers) as they exert influence over prices in a rhythmic manner. Now, see if you can identify normal and natural trading opportunities within this structure.

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As the Financials Turn

Feb 12, 2008: 6:07 PM CST

The Financial Sector has experienced a bit of rampant volatility since 2008 began. Let’s look at two ten-day periods and see the absolute returns and how they differ for that period for the XLF sector ETF.

Everything was rosy as could be from January 17th until January 30th, 2008:

The Financial Sector (red bar on right) XLF increased 12% over this ten day period, and money was starting to flow into Consumer Discretionary Spending (blue bar, up 9.8%) as well. These were positive signs as the economy was responding to interest rate cuts.

But the great bullishness that appeared in this chart was not to be – it was only a mere deception… a temporary mirage.

January 29th to February 11th was not so kind for the Financial Sector:

The most recent ten day period has the Financials (XLF) down 7%, meaning the prior move was likely a perverse short-squeeze play.

Let’s look at the chart itself for some perspective:

Notice first the two divergences that resolved nicely back to the 20 period moving average for a profitable ’scalp’ style quick trade.

Price is still in a confirmed downtrend, and price is currently beneath all key moving averages and the averages themselves are in the most bearish orientation possible.

While the momentum oscillator recently made a new high, price failed to confirm this new momentum high.

I believe odds are high – for the meantime – that the most recent price strength represented a short-squeeze, rather than a massive influx of new buyers. The news has been so bad and newer (and experienced) traders were loading up short positions, and something had to give (at least from a contrarian’s perspective).

Will price make a higher swing low now? Time will tell, but due to the prevailing downtrend, odds favor lower prices. Notice how the momentum oscillator seems to be building buying pressure (with the three higher lows). This is a hint that should not be ignored, should there be hidden strength we are unaware of currently.

Do we even want to glimpse at the weekly chart? Sure, why not:

Price inflected off the falling 20 week moving average to the penny (green arrow). This is what we would expect in a down-trending market.

I do want to note one important fact. Notice the “flatline” momentum divergence, in that as price continues to make new lows, the momentum oscillator is only flat-lining (or forming a potential triple bottom) pattern. This is a non-confirmation for lower prices and may also be hinting at potential underlying bullishness which has yet to surface.

Let’s keep a close eye on this sector, because this sector has been known at times to lead the market both up and down.

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Market Reverses, Invalidating Bear Flag

Feb 12, 2008: 10:11 AM CST

As I mentioned in last night’s post, I saw some bullishness underlying the market from the fact that the sellers were unable to take prices lower than 12,500 three times in the last week. Also, the classic bear flag which formed wasn’t resolving with any satisfaction, meaning that the pressure was building behind the scenes for a bullish upswing, however temporary it may be.

Let’s look at a daily chart of the Dow Jones Index, where I have called out the most recent price action and placed a spotlight on the price rejection zone and the failed bear flag:

I noticed that the price rejection, in the form of lower shadows on the candlesticks, was a clue that sellers were losing the battle of supply and demand.

Today’s news reports that Warren Buffett offered assistance, which eased the credit concerns. “In an interview on CNBC, Buffett said his Berkshire Hathaway Inc. holding company has offered a second level of insurance on up to $800 billion in municipal bonds.”

The NASDAQ is showing a similar pattern, but looks a bit more bearish than the Dow Jones Index:

The NASDAQ chart is showing a potentially interesting pattern. Notice the miniature Bear Flag within the larger Bear Flag. That’s very interesting to me and I’m anxious to see how it resolves.

Notice the near perfect 45 degree angle as price makes a counter-trend move into key resistance from the falling 20 period moving average. I’d like to see price clear that hurdle and bust this mini-flag before getting bullish. In fact, this is a downright bearish position that the NASDAQ is in currently. It is perhaps another opportunity to ‘get short’ with a tight stop should price continue to rise.

Apply your own analysis and see where you think the potential profit zones are compared to the risk.

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