America Is in a Recession of Confidence: Kleintop

When we last spoke with Jeff Kleintop in late May, I characterized the optimistic Chief Market Strategist at LPL Financial as being “a zig in a world of zags” as he talked about upside in a market that was consumed with pessimism. Today, his counter-trend style splits the economy and the recovery in two.

“Economic data is not actually pointing to recession,” Kleintop says. “But if you look at sentiment indicators, they are weak; consumer and business sentiment is soft.”

On this front, Kleintop has a point.

“The actual data — things we count, actually produce – we’re still seeing some pretty solid numbers there,” he says, using July Durable Goods and Industrial Production reports as examples.

On the flip side, he says a sharp market sell-off following the much weaker then expected report from the Philadelphia Fed Survey released on August 18th, is a good example of the rift. Kleintop says investors mistakenly viewed the regional data as a measure of actual manufacturing production, when in fact it is about manufacturing sentiment.

Ultimately, Kleintop thinks the problem will solve itself. “Confidence will come around and connect to that data,” which he says are coming in a lot better and aren’t “even near recession territory.”


Kleintop’s recession worries don’t come in to play until next year. “I don’t see a negative GDP print in Q3 or Q4. Where we’re at risk of a negative print is somewhere in 2012, but the market is not focused on that today.”

As for the Fed and “Gentle Ben,” they could help the confidence crisis by giving some “more lip service.” But Kleintop has greater confidence that a strong back-to-school season and good jobs data out this Friday will do more to mend to minds of the weary.

Kleintop suggests investors be patient, wait it out, and let the perceived slowdown correct itself. I hate to say it, but I have my doubts that resolution of the power outage or the confidence rut is going to exceed my already low expectations.




Wednesday, August 31st, 2011 Uncategorized No Comments

Stocks add gains after factory data

On Wednesday August 31, 2011, 10:12 am

NEW YORK (Reuters) – Stocks extended gains on Wednesday after data showed new orders for factory goods rose more than expected in July.

The Dow Jones industrial average (DJI:^DJINews) gained 126.62 points, or 1.10 percent, to 11,686.57. The Standard & Poor’s 500 Index (^SPXNews) added 14.72 points, or 1.21 percent, to 1,227.64. The Nasdaq Composite Index (Nasdaq:^IXICNews) rose 26.55 points, or 1.03 percent, to 2,602.66.

Equities earlier rose on continued hopes of more Federal Reserve stimulus for the struggling economy a day after minutes of the latest central bank meeting were published.

The S&P 500 was still on track for its worst month since May 2010. After the United States credit rating was downgraded in early August, the index posted one of its worst weeks since the depths of the financial crisis in 2008.




Wednesday, August 31st, 2011 Uncategorized No Comments

The Myth Of Tight Stops

By Dave Landry

As a way to control risk, tight stops seem to be preached universally. This is either directly, by suggesting that you only risk a small fixed-point amount per trade, or indirectly, through phrases like “control you losses,” “cut your losers quickly,” and so on and so forth. The truth is, in many cases, tight stops may actually increase losses. From a swing trader’s perspective (2-7 day holding period), we will look at why tight stops often do not work, how to adjust stops to accommodate a market’s normal fluctuations and how to compensate for this added risk. Finally, we’ll also look at cases where tight stops can and possibly should be used.


Years ago, I remember testing my first mechanical systems. When I wrote my first profitable one, I began to think, OK, I’ll put in stops and it’ll really make some money. To my surprise, the system actually began to lose money. Why? Because the positions were stopped out long before they had time to work. The normal noise of the market alone was enough to hit these stops before the predicted move ensued.


I recently received an email from a swing trader who had seven losses in a row. What frustrated him was that soon after he was stopped out, these positions went in the direction of his intended trade. Under an ideal situation, you enter your position, place a tight stop and wait for the market to move in the direction of your trade. The reality, as this gentleman painfully discovered, is that the market often moves in the direction of your trade but only after some chopping around–also known as noise. This noise is often enough to take out tight stops and is illustrated in the figure below.

Calculating And Adjusting For Noise

Obviously no one knows exactly where a stock will trade in the future. However, judging by past performance, you can get a pretty good idea where the stock will likely fluctuate over a given period. This can be measured with statistically based methods such as historical volatility and average true range. It can also be measured by a simple “eyeballing” of the chart.

Average True Range

As the name implies, the average true range considers the true range of a stock by accounting for gaps. Looking to Juniper Networks (NasdaqNM:JNPR – News), a very volatile stock, we see that over a five-day period the stocks has an average true range of over 6 points (6.54). Longer-term (50-days) the stock has an average range of over 7 points (7.21). Therefore, if you intend on swing trading (holding two to seven days) a stock like Juniper which a travel range of at least 6-7 points per day, you’re kidding yourself if you think you could use a tight stop (say 1-2 points) and not be stopped out.

Historical Volatility

Historical Volatility (HV) is the standard deviation of day-to-day price change expressed as an annual percentage.(1) Whew! Essentially, all that means is that historical volatility is a measurement of how much prices fluctuate over time. Suppose a stock or commodity is trading at $100 and its historical volatility is 10%. At the end of the year the market will likely (statistically a 66% chance, assuming a normal distribution and that volatility remains a constant, see appendix if you are interested in the math) be trading somewhere between $90 ($100 – 10%) and $110 ($100 + 10%).

If you take the longer-term historical volatility reading and reduce it down to the intended holding period, it gives you a good idea of where the stock has the potential to trade (2). I have plotted this calculation below on Juniper Networks based on the assumption that you intend on holding the position for five days. As of 04/30/01, this gives it a potential range of 46 1/2 to 71 1/2. This means in order to help ensure (but not guarantee!) that you won’t be stopped out during this holding period, your stop would have to be at least 12 1/2 points away.

Eyeball It

As a chart reader, a lot of my analysis is done by simply looking at the chart. A simple “eyeballing” of a stock that trades from 40 to 50 one day, down to 39 the next day and then back up to 50 is a volatile stock. Therefore, I know that I’m kidding myself if I think that I can trade such a stock and use a 1-2 point stop.

Don’t Forget To Adjust For Risk

When trading more volatile stocks, you obviously can’t just loosen your stop out without compensating for risk somehow. You must look at total risk and adjust your position size accordingly. Risking 1% to 2% of your trading equity per trade is a good rule of thumb. Therefore, in general, you can trade more shares of a less volatile stock such as a consumer non-durable or a utility that normally fluctuates 2 points in a week and maybe only 10-20 points in a year than a wild-and-crazy technology stock that fluctuates 10-20 points in a day.

Avoid Anthills

Keep in mind that I am NOT suggesting you run out and use looser stops without a complete money management plan in place. Specifically, you must make sure that, on average, you are taking much more out of positions than you lose. For instance, you can’t risk 5-points on each trade and only make, on average 1-point. Mark Boucher refers to such strategies as “Anthills.” Ants can make a significant mound with little pieces but all it takes is one big footprint to knock it all down. Therefore, make sure your profits are large enough to justify the looser stop.

A Case For Tight Stops

Now that we have discussed the pitfalls of tight stops, there are instances where tight stops can and sometimes should be used. This depends upon the technical pattern and/or if you are willing to re-enter positions if your tight stop is taken out.

Pattern Based

In many cases, a stock should not break a technical pattern. If it does, it may suggest that the stock is failing. Therefore, in these cases, the stop can and likely should be placed below that pattern (for longs) even though this is often well within the normal noise of the market. An example of such patterns are low short-term volatility situations such as a high-tight bases. For instance, notice in the figure below that the hypothetical stock makes a narrow consolidation after a strong up move. The stock should not take out the bottom of this base. If it does, then it suggests that the stock may have topped out. Therefore, this provides a logical place to put your stop.

Keep in mind that in trading, everything isn’t always “cut and dry.” Sometimes, markets will make a false move below a consolidation before resuming their longer-term trend–a sort of “shaking of the tree” or “head fake”, if you will. However, you must honor your stop because at the time it is occurring you have no way of knowing if it will turn out to be a false move (a) or a failure (b). This brings us to our next point–re-entering.


If you are willing to carefully monitor positions and have the discipline to re-enter if stopped out, then tighter stops can be used, even on volatile stocks. This is especially true in low short-term volatility situations such as the one described above. However, in general, keep in mind that many small losses can and often do add up to much more than one large loss, especially when you factor in the frictional cost (commissions and slippage) of all the additional trades. Also, keep in mind re-entry strategies are probably best suited for those with day trading experience who are used to taking numerous small losses and have the discipline to re-enter. If you can’t watch a screen or psychologically aren’t prepared to buy a stock that you just got stopped out of (sometimes over and over) then you’re much better off using a somewhat looser stop and letting the position unfold as you think it should.

A Happy Medium?

The tighter the stop, the more likely you are to be stopped out. However, placing a stop where the statistics suggest is often too far away for most. Therefore, you can strike a happy medium and place your stop somewhere in-between. In this case, you know that your stop is within the normal noise of the market but it’s less likely to get hit than a very tight stop.

In Closing

Tight stops, which many assume reduce the risk of trading, may actually increase risk as they are more likely to get hit due to the normal noise of the market. This reality must be factored into your trading plan. Above we have barely scratched the surface of the subjects of volatility, money management and technical patters. If you are to succeed as a trader, I strongly urge you to dig further.


Q. How do you manage your protective stops? Statistically? Pattern based? A happy medium? Tight stops and re-enter?

A. I use all of the above. I mostly eyeball a stock to get an idea of where it has the potential to trade. I then look for a logical place that a stock should not violate. For longs, this can be the bottom of a pullback, the low of a setup, below recent lows, the bottom of a base, etc. In short-term volatility plays, I often use a tight stop and look to re-enter if it looks like a fake-out move.

Q. Is there a maximum percentage risk that you adhere to, regardless of what the statistics suggest?

A. As I wrote in my book, I normally don’t like to risk more than 5% of a stock’s value. However, there are cases were I might trade fewer shares and loosen that parameter.

Q. Such as?

A. If the overall market and sector conditions are choppy, if the stock is very volatile and/or if I know I won’t be able to (or simple don’t care to) watch a screen closely.

Q. OK, looser stops for an extremely volatile stock and for when you don’t want to watch a screen makes sense. Can you explain market and sector conditions further?

A. Sure. If things are choppy then, I know that there is a high likelihood that stocks will fluctuate more before heading in the intended direction. On the other hand, if the market and sectors are really in gear, then I tend to use tighter stops.

Q. Define “in gear.”

A. If the market and sectors have been trending, and/or I have market bias signals, then I might even use a tight stop.

Q. For instance?

A. Last week (late April), the overall stock market began coming out of a cup and handle. Biotech was on fire. In cases like these, I use a tight stop knowing that if I’m stopped out, I can either re-enter or probably find another stock in the sector that’s moving.


Calculating Historical Volatility

As with any indicator, I strongly urge you to purchase software with the indicators already programmed and would never suggest anyone attempt this by hand. With that said:

Let Length = length of volatility to be calculated and ln = natural logarithm

Historical Volatility(length) = standard deviation(ln(close/yesterday’s close),length) * 100 * square root (256).

In English:

Divide today’s close by yesterday’s close.

Take the natural log of #1.

Take the standard deviation of #2 for length desired (the number of trading days, i.e., 50)

Multiply #3 by 100.

Multiply #4 by the square root of the number of trading days in one year (around 256).

HV is based on a one-standard deviation move

For those familiar with the bell curve and standard deviations, statistically, this suggests that approximately 66% the market should trade within these ranges. If you double the HV, which gives you two standard deviations, then this gives you a statistical probability that 95% of the time the market will trade within this range. A three standard deviation (3 * HV) would suggest that the market would trade within that range 99.7% of the time.

Keep in mind, however, that these calculations assume a normal distribution and are based on present volatility (volatility is constantly changing). Natenberg said it best in Option Volatility and Pricing Strategies: “(You) shouldn’t confuse unlikely with impossible.”

Using HV to set protective stops

In Connors on Advanced Trading Strategies, Larry Connors shows that historical volatility can be used to determine where stops should be placed. Calculation of these stop points are as follows:

Divide 260 trading days by the number of days you intend to hold the position.

Take the square root of #1.

Divide the historical volatility by #2.

Take the stock price and add (for shorts) and subtract (for longs) #3 from it.

Footnotes 1,2. Connors On Advanced Trading Strategies, Laurence A. Connors. See the appendix for the formula for HV.

Additional Reading

Option Volatility and Pricing, Sheldon Natenberg

Dave Landry On Swing Trading, Dave Landry

Connors On Advanced Trading Strategies, Laurence A. Connors

Dave Landry is a co-founder of TradingMarkets.com. A Commodity Trading Advisor (CTA), Mr. Landry is principal of Sentive Trading, a money management firm, and a principal of Harvest Capital Management, a hedge fund. He is the author of the well-respected trading book, “Dave Landry On Swing Trading,” found at TradersGalleria.com.




Monday, August 29th, 2011 Uncategorized No Comments

Larry Connors: Breakdown in Correlations

By Larry Connors | TradingMarkets.com | August 25, 2011 08:58 AM

Some notes of interest today.

1. The 50-day rolling average of the correlation among S&P 500 stocks is the highest it’s been in 3 decades (it’s above .80). It just surpassed the correlation highs seen in October 1987 and has easily surpassed the correlations seen in 2008.

2. While the S&P correlations are occurring, there is a decoupling of correlations among asset classes with Gold and Stocks now moving in opposite directions. (The CME raising margin rates late yesterday was the worst kept secret in the world).

3. Much of the above is being caused by major hedge funds panic-exiting gold and shorting U.S. stocks (and raising cash levels ahead of Jackson Hole on Friday). Soc Gen is reporting that hedge funds have their highest equity short positions since 2008.

Overall the market is overbought and is beginning to trigger some short signals in the major ETFs (very early stages) along with some early buy signals in gold due to the pullback. The potential for one very large move in stocks and gold in one day is high and that move could happen as early as tomorrow after Bernanke’s speech at 10 am ET.

The above is from Larry Connors’ Daily Battle Plan.

To learn more about the Daily Battle Plan – including access to Larry’s daily ETF trading signals, click here for more information.

And for more on ETF trading, be sure to visit us here to check out the book that Stocks, Futures and Options (SFO) Magazine called one of the best trading books of 2009: High Probability ETF Trading: 7 Professional Strategies to Improve Your ETF Trading.

Larry Connors is founder and CEO of TradingMarkets.com.

Thursday, August 25th, 2011 Uncategorized 1 Comment

We Are Talking Ourselves Into Recession: Najarian

By Jeff Macke | Breakout

This was supposed to be a subdued week. That was the working plan amongst trader types. Today a huge wrench was thrown into that plan when renewed fears of European bank contagion and more weak US economic data sent the Dow Jones Industrial Average down 3.7% to 10,991, the S&P 500 down 4.5% to 1,141, and the Nasdaq down 5.2% to 2,380.

At this point both the selling and lunacy are playing off one another, each exacerbating the other. Markets sell off, then politicians come up with some idea to help; like several EU nations banning short-selling. And the markets sell-off again. Then another European plan to comes to fruition: Let’s implement a financial transaction tax. Lather, rinse, and repeat until we all panic.

“We’re talking ourselves into a recession,” says Jon Najarian, co-founder of OptionMonster.com. Consumer confidence is at 31-year lows and periods like the last 3-weeks only make matters worse. There are even fewer people who need convincing that the recession is already here.

We can belabor these points and what Nesto refers to as “a drought of ideas” tomorrow. Trust me, the problems will be here in the morning. For now let’s focus on what the good “Dr J” Jon Najarian is looking to buy as the whirlwind of selling picks up steam. Somewhat surprisingly for a trader, he’s looking for dividend plays. To be clear, he’s not “trying to catch a falling knife” but he does have a shopping list.


Specifically, Najarian is looking to put money to work in SeaDrill (SDRL), Annaly Capital (NLY), Chimera (CIM) and Exxon Mobil (XOM). All dividend plays with yields ranging from Exxon’s heady 2.7% to Chimera’s bizarre 17% plus. Obviously the yields present in today’s market reflect a stunning level of risk-aversion, some of which may be justified.

As is the strategy often discussed on Breakout, Najarian is putting his money to work in blocks, rather than calling the bottom all at once. He’s also using diversification and options to mitigate some of his risk.

The bottom line: He’s not panicking, he’s staying constructive, and looking for things to buy. That’s the way pros do it, even when their vacations have been canceled.

We’ll be back tomorrow to try to turn that frown upside down.

Thursday, August 18th, 2011 Uncategorized No Comments

“Obama Doesn’t Get It”: More Stimulus Won’t Help, Stockman Says – And We Can’t Afford It

By Aaron Task | Daily Ticker

Seeking to revive the economy (and his reelection prospects) President Obama has been on Midwest swing this week, talking about jobs. Today, the White House announced the President will make a major speech after Labor Day focused on (what else?) job creation.

The White House says the Sept. 5 speech will include new ideas beyond those already mentioned, including an extension of the payroll tax cut, tax credits for hiring veterans, a further extension of unemployment benefits and the like.

But “it’s too late for stimulus,” according to David Stockman, former budget director for Ronald Reagan. “Even though it’s nice; you can’t afford it. The credit card is maxed out — it’s done.”

America has “reached the end of the road” when it comes to deficit spending and “I believe Obama doesn’t get it,” Stockman says.

What’s different between today and the early 1980s, when the Reagan administration used deficit spending to pay for the arms race vs. the USSR even while cutting U.S. tax rates, is the state of America’s balance sheet, he says.

“If you were at 30% debt-to-GDP like in 1980, it’s one thing to add a little more,” but not when the debt is at 100% of GDP and projected to rise from here, he says. “It’s time for a wake up call — you can’t keep burying yourself in debt.”

Instead of throwing more money at the problem, the best thing the government can do right now is “get out of the way and let the private economy slowly heal itself,” according to Stockman.

The former Congressman says it’s also time for elected officials to level with the America people: “We had a party for 30 years [and] now we have the hangover. It’s going to be painful [and] difficult but we have to work our way through.”


Aaron Task is the host of The Daily Ticker. You can follow him on Twitter at @atask or email him ataltask@yahoo.com
















Thursday, August 18th, 2011 Uncategorized No Comments

David Stockman: Rick Perry Is Right, the Fed Is “Totally Wrong”

By Peter Gorenstein

Texas Governor Rick Perry made headlines in only his second day on the presidential campaign trail when he said the Federal Reserve’s money printing policies are almost “treasonous.” President Obama reacted Tuesday saying the GOP hopeful should be “a little more careful” with his words.

The Daily Ticker’s guest David Stockman agrees with Obama about Perry’s poor choice of words but also wholeheartedly agrees with Perry’s sentiment. ” I think he was dead on in his thought,” the former director of the Office of Management and Budget in the Reagan administration tells Aaron Task in the accompanying clip. “I think it’s time Republicans woke up to the fact that is the fundamental problem in our economy today.”

Stockman, who has long been a critic of the Fed’s low interest rate policy, says it is “totally wrong.” Stockman says “exceptionally low” interest rates have resulted in excessive speculation on Wall Street “that is utterly destroying our capital markets” and adding to the already unsustainable debt crisis. He goes on to say, “The fact is the Fed is the number one problem holding back this economy, punishing savers, savaging low income people trying to buy food, energy or fuel.”

Stockman fears the worst is yet to come when current tax breaks and stimulus come to an end in 2013. “The mother of all Keynesian contractions is coming in 2013 — when all these tax cuts expire, when all this stimulus is gone.”

What results will be another recession caused by a necessary but painful period of austerity that will crimp growth and job creation. Therefore, current deficit projections will have to be revised downward as tax revenues fall behind and the millions of new jobs Congress anticipates never materialize.



Wednesday, August 17th, 2011 Uncategorized No Comments

Backtesting: Interpreting The Past

by Justin Kuepper

Backtesting is a key component of effective trading-system development. It is accomplished by reconstructing, with historical data, trades that would have occurred in the past using rules defined by a given strategy. The result offers statistics that can be used to gauge the effectiveness of the strategy. Using this data, traders can optimize and improve their strategies, find any technical or theoretical flaws, and gain confidence in their strategy before applying it to the real markets. The underlying theory is that any strategy that worked well in the past is likely to work well in the future, and conversely, any strategy that performed poorly in the past is likely to perform poorly in the future. This article takes a look at what applications are used to backtest, what kind of data is obtained, and how to put it to use!

The Data and The Tools
Backtesting can provide plenty of valuable statistical feedback about a given system. Some universal backtesting statistics include:

  • Net Profit or Loss – Net percentage gain or loss.
  • Time frame – Past dates in which testing occurred.
  • Universe - Stocks that were included in the backtest.
  • Volatility measures  – Maximum percentage upside and downside.
  • Averages – Percentage average gain and average loss, average barsheld.
  • Exposure - Percentage of capital invested (or exposed to the market).
  • Ratios- Wins-to-losses ratio.
  • Annualized return- Percentage return over a year.
  • Risk-adjusted return – Percentage return as a function of risk.

Typically, backtesting software will have two screens that are important. The first allows the trader to customize the settings for backtesting. These customizations include everything from time period to commission costs. Here is an example of such a screen in AmiBroker:

The second screen is the actual backtesting results report. This is where you can find all of the statistics mentioned above. Again, here is an example of this screen in AmiBroker:

In general, most trading software contains similar elements. Some high-end software programs also include additional functionality to perform automatic position sizing, optimization and other more-advanced features.

The 10 Commandments
There are many factors traders pay attention to when they are backtesting trading strategies. Here is a list of the 10 most important things to remember while backtesting:

  1. Take into account the broad market trends in the time frame in which a given strategy was tested. For example, if a strategy was only backtested from 1999-2000, it may not fare well in a bear market. It is often a good idea to backtest over a long time frame that encompasses several different types of market conditions.
  2. Take into account the universe in which backtesting occurred. For example, if a broad market system is tested with a universe consisting of tech stocks, it may fail to do well in different sectors. As a general rule, if a strategy is targeted towards a specific genre of stock, limit the universe to that genre; but, in all other cases, maintain a large universe for testing purposes.
  3. Volatility measures are extremely important to consider in developing a trading system. This is especially true for leveraged accounts, which are subjected to margin calls if their equity drops below a certain point. Traders should seek to keep volatility low in order to reduce risk and enable easier transition in and out of a given stock.
  4. The average number of bars held is also very important to watch when developing a trading system. Although most backtesting software includes commission costs in the final calculations, that does not mean you should ignore this statistic. If possible, raising your average number of bars held can reduce commission costs, and improve your overall return.
  5. Exposure is a double-edged sword. Increased exposure can lead to higher profits or higher losses, while decreased exposure means lower profits or lower losses. However, in general, it is a good idea to keep exposure below 70% in order to reduce risk and enable easier transition in and out of a given stock.
  6. The average-gain/loss statistic, combined with the wins-to-losses ratio, can be useful for determining optimal position sizing and money management using techniques like the Kelly Criterion. (See Money Management Using the Kelly Criterion.) Traders can take larger positions and reduce commission costs by increasing their average gains and increasing their wins-to-losses ratio.
  7. Annualized return is important because it is used as a tool to benchmark a system’s returns against other investment venues. It is important not only to look at the overall annualized return, but also to take into account the increased or decreased risk. This can be done by looking at the risk-adjusted return, which accounts for various risk factors. Before a trading system is adopted, it must outperform all other investment venues at equal or less risk.
  8. Backtesting customization is extremely important. Many backtesting applications have input for commission amounts, round (or fractionallot sizes, tick sizes, margin requirements, interest rates, slippage assumptions, position-sizing rules, same-bar exit rules, (trailing) stop settings and much more. To get the most accurate backtesting results, it is important to tune these settings to mimic the broker that will be used when the system goes live.
  9. Backtesting can sometimes lead to something known as over-optimization. This is a condition where performance results are tuned so highly to the past that they are no longer as accurate in the future. It is generally a good idea to implement rules that apply to all stocks, or a select set of targeted stocks, and are not optimized to the extent that the rules are no longer understandable by the creator.
  10. Backtesting is not always the most accurate way to gauge the effectiveness of a given trading system. Sometimes strategies that performed well in the past fail to do well in the present. Past performance is not indicative of future results. Be sure to paper trade a system that has been successfully backtested before going live to be sure that the strategy still applies in practice.

Backtesting is one of the most important aspects of developing a trading system. If created and interpreted properly, it can help traders optimize and improve their strategies, find any technical or theoretical flaws, as well as gain confidence in their strategy before applying it to the real world markets.

Tradecision (http://www.tradecision.com) - High-end Trading System Development AmiBroker (http://www.amibroker.com) - Budget Trading System Development.


Justin Kuepper has many years of experience in the market as an active trader and a personal retirement accounts manager. He spent a few years independently building and managing financial portals before obtaining his current position with Accelerized New Media, owner of SECFilings.com, ExecutiveDisclosure.com and other popular financial portals. Kuepper continues to write on a freelance basis, covering both finance and technology topics.

Read more: http://www.investopedia.com/articles/trading/05/030205.asp#ixzz1VJOsGWdX

Wednesday, August 17th, 2011 Uncategorized No Comments

Bearish Head and Shoulders Pattern Still Hasn’t Been Picked Up In Mainstream Media

What is Next for the S&P 500

I’ve been urging to reduce risk and raise cash for the past two weeks.  By acknowledging risk ahead of the debt ceiling debate I was able to sidestep one of the worst weeks in U.S. financial markets since 2008.

Armed with cash and my emotional capital intact, I am going to be able to take advantage of price action in coming days and weeks. I am expecting a bounce in the near term, but the downgrade of U.S. debt on Friday by the S&P rating agency could have a dramatic impact this week. I intend to remain in cash until the news is digested by the marketplace.

We examined the bearish head and shoulders S&P 500 (SPX) (SPY) pattern and potential top in early July, which illustrated the bullish and bearish position of the market at that time ahead of the debt ceiling debate in Washington.  The head and shoulders pattern is a typical characteristic of a topping formation that is often found at several major historical tops.   See the chart below:

SPX Daily

This particular head and shoulders pattern is not getting a lot of recognition in the media which lends it a bit more credence. If we start hearing about this pattern on CNBC or FOX Business I will expect the pattern to fail. Call me a contrarian, but in the past when major television personalities are constantly talking about chart patterns they almost always fail.

Besides just technical data points, continued worries stemming from the European sovereign debt crisis helps the bear’s case further. In the event of a major default in the Eurozone, the implications to the financial sector of the U.S. economy will come into focus. It is widely expected that a banking crisis in Europe could spread to some degree to the large money center banks in the United States. Clearly this would have negative implications on price action in domestic equity markets.

In addition to the European debt crisis, the United States government has a looming credit crisis of its own. With politicians currently arguing over whether to raise the debt ceiling, bears point out that if the United States defaulted on its debt (unlikely) the implications would be severe. However, many traders and economists point out that the end of QE II may have dramatic implications on price action as well. The current uncertainty around the world lends itself in favor of the bears.”

Clearly the head and shoulders pattern has played out and barring a breakout over the 2011 highs on the S&P 500, an intermediate to long term top has been carved out. In fact, I believe we are likely entering the next phase of the ongoing bear market that started back in 2000.

Panic level selling pressure has been registered and the S&P 500 is in an extremely oversold condition as is evident by the charts below:

Stocks Above 50 Period Moving Average

Stocks Above 200 Period Moving Average

The charts above illustrate that we are extremely oversold in the intermediate term time frame and that we are nearing extreme oversold conditions in the longer term time frame as well. I am expecting a bottom to form in the next few weeks which should offer outstanding risk / reward long entries for short to intermediate term trades.

Another indicator that is showing some extreme fear in the marketplace is the Volatility Index (VIX). The VIX has traded in a choppy pattern for quite some time before finally pushing higher the past few weeks. The daily chart of the VIX below demonstrates the fear in the marketplace:

VIX Daily Chart

Almost every indicator that I monitor is screaming that the current market is extremely oversold and fear levels are running at or near 2011 highs. When the masses are fearful and the S&P 500 is this oversold, I want to be looking for opportunities to get long risk assets.

While consistently picking bottoms is nearly impossible, there are a few key levels on the S&P 500 that I’m going to be monitoring. The weekly chart below illustrates the key support levels which could hold up prices and also future targets for the likely reflex rally:

SPX Weekly Chart

Once a bottom has been carved out, the use of Fibonacci Retracement and/or Extension analysis will help me determine more precise resistance levels. We could see further selling pressure this week before we see a pronounced bottom carved out. With volatility at these levels price action will be pretty wild. I intend to use smaller position sizes with wider stops to start layering into exposure as opportunities present themselves.

By sitting on the sidelines during this downside move, I’m ready to take advantage of lower prices to get long. Now the interesting part will be how Mr. Market handles the downgrade of U.S. debt this week . . .

Courtesy of JW Jones – http://www.optionstradingsignals.com/specials/index.php

Tuesday, August 16th, 2011 Uncategorized No Comments

Toni Hansen: a New Way to Time Market Reversals

By Toni Hansen | TradingMarkets.com | January 28, 2008 03:00 PM

Over the years, a number of different tools have been developed or utilized
to analyze price action in the market and guide traders and investors alike in
their decision on when to buy or sell a particular security. Some of these tools
are extremely complex, while others are too general to be useful. One of the
mainstays for any market participant relying on technical analysis, however, is
the importance of being able to identify and apply basic support and/or
resistance levels. These are price levels in a security, or the market as a
whole, where the current price trend is likely to stall or reverse.
Support/resistance levels have been used for centuries and, once understood,
they can be applied to any marketplace, whether its securities, forex, e-minis,
There are dozens, and perhaps even more, types of support/resistance
configurations employed by market professionals. In my experience, however, none
are more potent than pure price levels. Most indicators, such as moving
averages, are based upon mathematical equations which factor in price action. If
a person understands how to read the price levels themselves, s/he is less
likely to rely on other crutches to recognize shifts in price action.
Within the category of price support/resistance itself exist a number of
different forms of support/resistance. The ones which I will discuss in this
piece include whole number support/resistance, prior pivot highs and/or lows,
prior congestion zones or trading ranges, equal or measured moves, and gap
What are Support/Resistance Levels?
In a discussion of what exactly a support or resistance level is, consider
support to be like a floor in a high rise and resistance as a ceiling. Support
levels can break lower, but eventually when solid ground is hit, it cannot be
penetrated. Yes, I know, we can bring out the digging equipment, but just like
it becomes more and more difficult to dig deeper in the ground, it also becomes
more difficult for security prices to push lower once they drop into they penny
stock category. Resistance, on the other hand, can be
broken higher, but most securities also run into trouble when they get too
extended on the upside and the air becomes rather thin.
When thinking of support/resistance levels, it is very common for most people
to think of them in terms of absolute price levels. For instance, if they are
looking at $50 as a resistance level, they mean exactly $50. On the other hand,
if they are looking at moving averages as a support level, they will check to
see what the exact price of the moving average is, such as $50.78.
In reality, support/resistance levels are not exact prices, but rather price
zones. So, if the resistance level is $50, then it is actually the zone around
that $50 level that is the resistance. A stock, for instance, may hit only
$49.87 or it may hit $50.25 and still hold the $50 as price resistance.
The main factor in determining exactly how much the exact prices are tested
by is how quickly or slowly the prices move into that resistance zone. For
instance, if the zone hits very quickly on a large momentum surge, then it is
more likely to hit that $50.25 level. This is also the case if the stock is a
rather volatile one with a wide price range intraday. If the security spikes
higher and does not quite hit the price resistance, such as a spike into $49.70,
then it may round off into $50 with slightly higher highs and never exactly
touch the $50 price resistance zone before turning over due to the slowdown in
momentum into that resistance. The larger the time frame, the greater the price
zone is as well. A resistance zone at $50 on a weekly time frame may have a
range of $1 on each side of $50. Where traders tend to run into trouble is in
thinking that because the stock has traded over $50 by more than just 10 cents
that the $50 has broken, so we often hear of people “buying the highs” in such a

Whole Number Support/Resistance
The first type of support/resistance I am going to introduce is one that is
likely very familiar: whole number support/resistance. Whole number support/
resistance refer to the price levels most of us have in our head right away when
we think of support and resistance. They are levels such 14,000 in the Dow Jones
Industrial Average. CNBC does not get excited by the Dow hitting 13,884. No, it
is when it pushed above 14,000 and then when it closed 14,000 that it really
made headlines. When a security, or the market overall moves into these larger
price levels, rounded to either the dollar in most stocks, or the 10s, 100s,
etc., people tend to react the most. It’s second nature. My third grader has
just spent several weeks in school earlier this year learning how to average and
to round up or down. It is something that has been ingrained in us since
In Figure 1 below is a recent chart of the Dow. Even though the Dow
technically broke 14,000 in terms of the exact price, when we think of the Dow
in terms of a larger time frame move, we have yet to see the 14,000 zone
penetrated. At 14,198.10, the Dow was STILL at the 14,000 price resistance zone.
To futures traders, a primary price support/resistance noticeable in the NQ
is its tendency to gravitate to levels broken into 5 point increments. Examples
are 1850, 1845, etc. If the volatility is high and the intraday range wide, then
the 10 point levels, such as 1850, 1840, or 1830 will hold better. In the YM the
10 point increments, and particularly the 100 point levels catch people’s
attention and reversals or consolidations tend to form at those zones. In the
chart of the Dow Jones Ind. Average (Figure 1) we can see how it often moves
towards those 100 point increments as well. Many of the places it stalls at are
almost exactly at a 100 point price level. This included the all-time highs
which were within just a few ticks of 14,200. The greater degree to which a
price is rounded, the stronger that price zone is. Rounding to 1,000 as the
greatest, 100 next, 10s, then 5s. In smaller securities a trader can even round
to the 50 cent level.
Figure 2 displays another example of price support/resistance. This time it
is in a security most traders have all heard of: JetBlue Airways ( JBLU | Quote | Chart | News | PowerRating). It is
very common for prices to swing back and forth between whole number levels.
Often they push through the exact whole number a bit more the first time it hits
and then to a lesser degree on continued testing of those levels. An example of
this took place in the summer of 2007. At the start of May, JBLU hit the $10.00
price support zone with an exact low of $9.72. A second test of that same zone,
in early June, scored a low of $10.05. In both cases, those lows were a part of
the $10 support zone.
Before a congestion zone breaks, it may not even make it back to one end of
the price range. This is what happened in October when JBLU bounced back up to
$10 for the final time before breaking lower into November. Although the prior
two tests of the highs in September and early October came within just a couple
of cents of $10, the final push higher towards the end of October only managed a
high of $9.77. This type of price development is indicative of higher odds for a
breakdown, since the previous test of the lower end of the range in the $9 zone
hit $8.97.

Pivot Levels as Support/Resistance
The second type of price support/resistance is closely tied to the first. It
deals with retests of previous pivot highs or lows. A “pivot” is simply a level
where prices reverse. They tend to look like the letter “V” or an upside down
“V”. When they occur within a congestion zone, it may be necessary to drop down
to a smaller time frame to be able to identify them well. Sometimes these price
pivots correspond to whole number support/resistance. Sometimes they do not.
In the example of the Dow which we looked at earlier, it does correspond to
the whole number support/resistance levels. This is shown in Figure 3. Look at
the 14,000 level. This hit in July for the first time and then retraced back
into the prices from the first quarter of 2007. The Dow hit the 14,000 zone for
the second time at the end of September after coming off a sharp rally
Even though the second time the Dow hit the zone of 14,000, it was able to
push into nearly 14,000, the “zone” of the 14,000 high was where all the price
bars overlapped at the initial July highs. The stronger upside momentum on the
second test of the 14,000 resistance level allowed the Dow to push somewhat past
the exact high to form a slightly higher high before the momentum reversed and
led the index back into the previous lows.
Initial lows following the first test of the 14,000 level in the Dow were
established in August on extreme downside momentum. Since the pace was slower
into November on that second retracement off the 14,000 highs, it did not quite
hit the exact lows from August, but only came into the support “zone” of those
lows. The third test of the same level into January was again on stronger
momentum. This time, although it stalled at that support for several days, it
was able to punch through to break the support zone in mid-January.

support resistance
Another example of price support/resistance levels goes back to an example I
gave you in JetBlue Airways (JBLU). This involved the $10 level from early May
and early June. While $10 hit and held on the first day into the $10 level in
April, it then rolled over a bit off the lows, like the Dow did off the second
highs, and made somewhat lower lows at $9.72 before bouncing. The second time
around, that previous low served as support. Even though it did not hit that $10
support exactly the second time around, it still retested the “zone” of that
support when it returned there in June. As in the Dow, the second test of the
support/resistance was also a pivot price support/resistance in addition to the
whole number support/resistance which had held with each initial test.

market reversals
Congestion Zone Support/Resistance
Whole number support/resistance can also be tied into the third type of price
support/resistance: congestion zones. When a security falls into a trading
range, congestion zone, base, coil, or whatever you wish to call it, that zone
becomes support/resistance on any retracement once it has broken out of that
zone. A breakout to the upside from a trading range, for instance, will mean
that the range itself becomes support on any retest of it. This also means that
any break lower from a range will lead to resistance if the zone from the
trading range is tested on a bounce. These trading ranges often take place
around whole numbers.
One example of a congestion zone serving as support/resistance can be seen in
Figure 5 of JBLU. I talked earlier about the $10 level as support, but before it
even dropped into $10 JBLU had been in a trading range. After breaking lower out
of that range, the range itself became resistance. It tested the very lower end
of the range in May, but it is common for a price move to push back into the
middle of a range before it continues lower in the case of a downtrend. This
took place in early July. Not only was the July test of $12 a return to the
whole number as price resistance, but it was also resistance from the middle of
that earlier congestion level.

Equal/Measured Move Support/Resistance
The fourth type of price support/resistance deals with comparing previous
price moves to current price moves. Essentially, if a price move is followed by
a congestion, such as a base, flag, etc., then as long as the congestion breaks
at about the same momentum as the move into it, it will have the strong
potential to hit an equal move level on that continuation. This equal move level
can also be called a “measured move.”
JBLU in Figure 6 displays two examples of a measured move. The first involved
the comparison of April’s breakdown from the March to early April congestion to
the downside move in February and early March. A larger example came on the
breakdown into November and December as compared to the move just prior to the
August-October trading range. That prior move had taken place in July and into
the first half of August. In both examples the secondary move mimicked the
first. In the first set, each wave was around $2.50, while in the second set
each wave of selling lasted for just under a $4 move.

Gaps as Support/Resistance Price Levels
A final type of price support/resistance deals with gap levels. Gaps occur
most often when a security ends a trading session at one price level only to
open at a different price level. Most gaps fill eventually, meaning that the
prices will return to the pre-gap levels. The closure of a gap itself is one
form of price support/resistance.
In the example of the Diamonds ( DIA | Quote | Chart | News | PowerRating) below, there are two examples of a
morning gap. The first one highlighted took place into the open on the 22nd of
January, 2008. The second occurred the following morning on the 23rd. In each
instance, the downside gap itself exhausted the market and the buyers quickly
appeared. Before the morning was over the gap zone had been closed on both days
and the price level from the previous day’s close served as price resistance,
leading to a correction off those prices heading into noon.

market reversals
Additional Support/Resistance Tidbits
When making comparisons on support/resistance levels, it can be difficult at
times to know just how much room one should give a support/resistance zone
before concluding that it has broken. It can also be difficult to determine
whether or not a certain support/resistance level will hold since not all will
hold well. There are a couple of things to keep in mind when giving this
consideration. First of all, smaller time frame support/resistance levels will
always be easier to break than those on a larger time frame, but the
support/resistance zones on the larger time frames will be wider. Additionally,
support/resistance levels which have the greatest number of types of
support/resistance hitting at the same time will hold best. In other words, a
support level which is hitting whole number support and gap support tends to be
stronger than one which is just hitting gap support. Since the exact prices of
each type which hits may not be exactly the same, this is another reason to
consider support/resistance levels as zones. When market professionals focus on
these simple forms of price support/resistance it gives them a leg up on any
competition relying merely on price patterns, as well as those who are so bogged
down in indicators that they can barely make out the price bars through all the
lines and squiggles!
Toni Hansen is
one of the most respected technical analysts and traders in the industry with a
high reputation for accuracy in both bull and bear markets. Her style of trading
and market analysis transcends both time as well as market vehicles, making it
attractive to investors and trader of stocks, futures, options, ETFs, and even
the FOREX market. Toni is a frequent lecturer at trading clubs and industry
expos. She is also a popular market columnist and is a repeat contributor to SFO
Magazine. She recently co-authored High Profits in High Heels from Marketplace
Books and SFO’s Personal Investor Series book Online Trading.
Email Toni

Monday, August 15th, 2011 Uncategorized No Comments