Today’s Market Decline and Implications

Jun 7, 2007: 6:06 PM CST

Normally, I like to post charts of the general indexes and do minimal annotations and speak from the perspective of my own swing charts and momentum readings, but I wanted to showcase a few excellent brief commentaries on today’s action.

TraderMike writes a very concise yet informative post with an excerpt from the Worden Report in his “Stock Market Recap”. TraderMike posts some of the best snap charts of the daily action of the major indexes and is always worth a study.

The Trading Goddess, another popular blog, offers a quick S&P chart in the article “The Overall Market Tone has Changed… For Now“.

I wanted also to highlight a newer blog – Active Trader Blog – who recently posted a quick chart and post about the action and I had to reference his concluding question: “The ball has fallen off the building…will it crash or bounce?”. The author uses similar techniques as I and similar chart set-ups and I wanted to highlight the remainder of his posts and blogs. The blog is also frequently updated.

I actually almost referenced his site last night when I read his post Markets Doing as Expected where I wanted to reference his index chart and note the clear momentum divergence in the MACD bottom pane indicator.

The market was experiencing a prolonged momentum divergence and extremely overbought (overextended) conditions and a snap-back like this (400 Dow points suddenly in 3 days) is absolutely an expected result of such conditions. It was not a question of ‘if’ but ‘when’ and as Active Trader says, we must wait and see if it is over.

From StockCharts, we see a rare picture – it’s a day where almost everything has turned red on the market summary page.

First, ALL major US Indexes were down over 1% each. Notice the 3% daily damage to the Utilities (sensitive to rate increases).

sc-indexes.jpg

All S&P Sector SPDRs were down as well. All 9 market sectors suffered.

sc-spdrs.jpg

As if that wasn’t enough bad news, every major market industry suffered today.
Only disk drives, hardware, and hospitals escaped a full 1% or more decline.

sc-industries.jpg

As if the whole of the US market declining wasn’t enough, every single MSCI iShares (via StockCharts) international fund was down.

sc-international.jpg

And now it’s time to see green. What was green today? Hint: Most were green by greater than 2%

sc-bonds.jpg

That’s right – the Treasury Bonds Yields. Bond prices fell, stock prices fell as a result of bond yields increasing extremely rapidly.

What’s likely to be worse is that traders could set off a panic selling wave for any reason whatsoever, especially those who ‘fear’ losing large gains they have recently made in this rising market that defied seasonal patterns (‘sell in May’) and overbought conditions, as well as a wave of relatively negative economic news for so long.

Please be careful and don’t panic out of positions because of a day’s action. Also, don’t jump in short just because every thing’s red for the same reason. Have a plan for what you do and how you trade and do so within contained risk parameters. The traders with whom I spoke with today said they survived because of risk controls. Others made a large profit short. Do what you understand and know why you do it – and know how to objectively quantify your actions and results so that you can make corrections as necessary when you were wrong or the market moved unexpectedly against you.

Remember, if you feel frozen, take any action at all. Put a stop-order in or a bracket order (a bracket order is a simultaneous entry of an upside stop-market exit and a downside stop market exit so that you’re guaranteed to exit the stop either at a price better than the current price or a bit worse than the current price. Either way, you will be taken out of your position). See my post on “Deer in Headlights” if you linked directly to this page.

It goes without saying: Be safe and learn from what’s happening.

3 Comments

How to Avoid “Deer in the Headlights” Syndrome

Jun 6, 2007: 8:35 PM CST

If this scenario has not happened to you, you haven’t been trading enough:

You’re excited. You see your set-up or read a great news report on a company and can’t wait to execute the trade. You do, buying a bit larger position than you’re used to, but this is the ‘sure fire’ trade they say that will make your year right in front of your eyes. Excitedly, you watch as you start to make money!

Suddenly, without warning, something goes wrong. “Why has the stock retraced to my buy point?!” you ask. “They must be shaking out the weak hands. I have to be strong!” you exclaim.

Before long, you’re underwater, but that’s ok. You didn’t bother to place a hard stop yet because, well, this was a great trade. Or maybe you did place a stop and you pulled it out when the market approached, sure that the market would reverse right when ‘they’ took your stock away by wicked stop-running tactics.

So now the stock has blown through your original stop and you’re still in the trade… losing money as a flood of (in this case) sellers are entering the market and driving the price lower against you.

YOU FREEZE.

You don’t know what to do. Your palms are sweating, your heart is racing and your head is pounding. “How could this be happening to me [again]?!” you exclaim.

You have just experienced “Deer in the Headlights” Trading Syndrome. You’re in a situation you never anticipated and you’re losing money faster than expected. You know you should exit (or get out of the road or oncoming traffic) but you can’t.

I can point to at least three occasions in my personal day-trading where this has happened and they stand out in my memory because they cost me so much money and I felt horrible for days after experiencing such unexpected and deep losses. Events like this force you to the crossroads – either you quit and walk away disgusted or you get back up and learn your lesson and vow never to let that happen again.

How can you prevent this from happening?

This is a little harsh, but really the only way to ‘overcome’ this is to have it happen to you personally – and I don’t mean superficially. I mean, you have to have an experience where it hurts your account, your pride, everything. But for those of you to whom this has not happened (and you are actively trading… especially day-trading), it will and the best thing to do is be prepared.

First, include this (or a similar) sentence into your trading plan:

“I will honor my stops” and “I will only take positions that are within my position sizing limits” or alternately “I will not take positions larger than normal” (define what this means for you personally.

But IF you violate these rules (that’s ok – don’t beat yourself up too much yet), then there’s one thing left to prevent a catastrophic loss that erodes days or weeks of profits:

When you are psychologically frozen, TAKE ANY ACTION AT ALL to unfreeze yourself.

What do I mean? Place a physical stop. Place a bracket order. Hit the “sell now” button. DO SOMETHING.

When you take action, you physically release the ‘block’ on your brain functioning. It might be the wrong action at the time, but it is an ACTION. Perhaps the stock will reverse but you can’t take this chance. Don’t lower your stop to the next technical decision node, be it a trendline or a moving average or a Fibonacci projection. Your mind is clearest when you evaluate risk/reward and support/resistance when you don’t have a position on. Negative psychological effects are at their lowest when our trading account is clear of positions and we can evaluate a bit clearer.

Technical analysis deals strictly in probabilities, not certainties. You cannot AFFORD to play in probabilities when you are rapidly losing money. It is best to kill the trade immediately, or alternatively, place a hard exit stop just below the current price (market order, that is, not a limit order. When you want out, you want out. Don’t play games for a few cents). If the market takes you out, at least the ‘pain’ stops. Odds usually favor the stock continuing its rapid descent rather than reversing. In the rare cases the stock does reverse after your exit, that’s fine. It’s just probabilities. You cannot AFFORD one trade to continue to go against you and negate weeks of profits. It is NOT an option and you must prevent large losses literally at any cost.

In summary, when you are gripped by fear and frozen by a rapidly losing position, TAKE ANY ACTION in your account – exit immediately or place a market stop-out order slightly away from price but do NOT play games, do not perform sophisticated technical analysis, and do not remain motionless.

When a car hits a deer, not only is the deer ‘damaged,’ (or killed) but so is the car (and sometimes the people in it).

When the market hits you like a car, the market is never the one injured – you are. Sudden catastrophic losses may destroy something more valuable than your trading capital: Your will to trade and your hopes and dreams in one fell-swoop. Prevent this above all else.

(deer in headlights guy picture credit: www.emotioneric.com/emotionfill/deerinheadlights.html)

7 Comments

How to find Strong Stocks using Prophet.net Scans

Jun 5, 2007: 8:47 AM CST

Although there are various websites and programs used to find strong and weak industries and sectors in the market, I use Prophet.net and compare results with Investortools. I do deep analytical scans the first weekend of the month and then cursory updates as needed (or desired) on the weekends if I’m not satisfied with potential candidates.

Here is a step-by-step guide to using Prophet.net’s Industry Strength Scan toolbar.

You do need an account to do this effectively, and signing up is free (I have no affiliation with Prophet.net). A membership fee page is here. Basic service is $20 a month.

  1. Click on the EXPLORE tab (top of the page – reddish orange)
  2. On the little orange menu bar, click on INDUSTRY RANKINGS <—-link is here
  3. A table appears which describes broad trends in numerical form – default is 6 months and can be changed as desired
  4. Click on SEE HISTORICAL TRENDS for the graphical (color) chart — the default now is 1 year. Alter this as needed
  5. I generally change the period to 3 and 6 month trends depending on my purpose for scanning
  6. On the left side of the page is an explanation of how to read the chart properly

That covers how to view the trend charts and institutional money flow charts I post at times.

Now, that’s great and all, but how about using the table to find strong and weak stocks right now?!

Here is the procedure for scanning many charts quickly to find a strong watchlist of stocks:

  1. Click on any of the NAMES of the Industry Groups on the left. Generally scan the top 5 and bottom 5 and any interesting prospects you see.
  2. This brings up a list of all the charts of the companies in that group (the “stocks” bar tells you how many companies)
  3. Click on CHART CONTROLS to setup the charts the way you prefer them (it remembers your preferences if you sign-in
  4. I use the following: Six month charts, candlesticks, daily, simple moving averages 20, 50, and 200
  5. Next (important) go to FILTER CONTROLS
  6. Filter down as desired – I use ‘average volume’ = 400,000 and ‘minimum price’ = $25. Use your own filters
  7. View the general trends of multiple charts
  8. Make note of any ‘outstanding’ stocks up or down and view them with your normal charting program/website

Here’s an example of a “strong stock” from a “strong industry” as displayed in the chart scan screen:

A couple of notes from personal observation:

  • Stocks in strong industries tend to show greater relative strength and vice versa for weakness
  • Money flow is graphed left to right (date-wise).
  • The ideal pattern is red on the right, yellow in the middle, green on the left. This shows money is flowing IN to the group.

The “26” means it was in the 26th percentile of all stocks, then moved to the 47th and 62nd percentile, and now it’s in the 90th percentile.

  • You will generally find the above pattern in the upper-middle of the chart.
  • Ignore industry groups with less than 10 stocks in it. One stock can skew the results and provide erratic chart jumping behavior
  • Clear industry flow with a great number stocks in the industry tends to provide more reliable signals and candidates
  • This is no magic bullet system. You still need to overlay candidates into your system and practice money management/risk control.
  • There are always stocks on runaway uptrends and dismal downtrends no matter what the general market is doing. Always.
  • It is probably best to stay away from the ‘muddy middle’ of the chart because there isn’t much interest
  • For short candidates, scan the opposite pattern where money is flowing OUT of an industry
  • You can test your ideas historically simply by clicking on a date on the top of the chart (below the months) and the chart will refresh with that date as current and you can scan and see what ‘would have happened’ if you made decisions based on the readings of a particular date.
  • You can alphabetize industry groups by clicking on “Industry Group”
  • There are so many ways you can use these scans. Experiment.
9 Comments

Ominous Signs Ahead from Sector Rotation Model

Jun 4, 2007: 1:30 PM CST

For those who study sector rotation as a method for understanding the broader market, there are ominous signs on the horizon for the broad market if the model is correct.

In a summary, sector rotation theorists believe the market functions in an orderly progression where certain sectors outperform at certain phases in the business cycle, and this creates the market cycle of sector strength and corresponding weakness. The stock market is said to lead the economy by three to six months.

I recommend studying the model much deeper, and there are texts which address the subject far greater than any website or blog can do.

Here is the most recent chart from StockCharts.com of sector flow:

sector-flow-june-3.jpg

What we are seeing is that energy is outperforming all others, and the progression is marching forward as expected. The chart is set-up to show the proper flow of money/sector strength from left to right (as the cycle progresses). Here is a basic explanation chart from StockCharts.com:

rotation-model.jpg

I have drawn in the hand myself, where I interpret the model is placing us in the current cycle. Notice that when energy prices outperform for an extended period of time, the market tends to peak before the economy begins to slow. The market is anticipating the effect of higher energy prices on the consumer and businesses and forecasting they will have to cut back on production to meet the slowing expenditures of the consumers (because higher energy prices serve as a ‘tax’).

Again, if this is correct, we are close to a major peak in the cycle which began around 2003 at the bottom of the bear market from 2001-2003. Cycles tend to last 3-5 years as the economy experiences expansion and contraction. It’s possible we’ll have a mild correction, similar to that of 1996 (flat market) and avoid a major downturn, but you’ll have to consult other sources to determine your views on this. The sector rotation model is only one way of interpreting the data.

Nevertheless, we see the perfect ‘stairstep’ pattern expected with the model, and this tells me that a market peak is nearing its completion, and a downturn in the market is ahead of us prior to economic weakness (which is already being forecast by many economic prognosticators).

This is part of macro-analysis and probably will not mean as much to a day trader or even a pure swing trader, but macro-investors and position traders should take note when establishing long positions at potential market peaks – the risks may outweigh the rewards in the near future.

Combine this snap analysis with the fact that the market tends to languish during the summer months before picking up steam around November and you have a tenuous market condition at best for investors.

Please be careful and don’t bet the farm on your longer-term trades. Maintain disciplined risk-control and don’t overload the boat because the market has been kind to you the last few months. Also, don’t confuse ‘brains’ with a bull-market where everything tends to rise.

6 Comments

Industry Strength and Weakness – June 3

Jun 3, 2007: 1:08 PM CST

Here are a few charts and stock watchlist ideas from Prophet.net’s Industry Group screener:

Strongest Industries of last 3 months:

top-industries-june-3.jpg

Weakest Industries of last 3 months:

weakest-industries-june-3.jpg

Industries showing strong buying money flow of last 3 months (best trade ideas come from here):

rising-industries-june-3.jpg

Remember to read the charts from right to left in terms of monthly progression.  When you see red (right) to yellow (middle) to green (left) as you do in the Beverages and Wholesale Computer industries, this is a good sign institutional money is coming into these industries, and you should concentrate money in stocks that have strong relative strength, or rising trends as identified by you.

You can use the free tools at Prophet.net to view snapshot charts of each stock in each industry and quickly view up or down trends for your watchlist and further analytical study for possible trade entry.

Of note, Aluminum stocks and Mineral Mining stocks have shown the greatest relative strength of the last three months while it is no surprise to most investors that industries related to housing (REITS, construction) have fared the poorest during the recent market rally.

Seeing beyond the headlines and index readings to the inner components can provide greater returns and reduced risk, and as Jim Cramer is apt to say, “There’s always a bull market somewhere.”

3 Comments