Understanding the Stochastics Oscillator
(Republished with permission from TheStreet.com)
The Stochastics Oscillator has stood the test of time since George Lane developed the classic indicator in the 1950s. Despite its senior status, the tool does an excellent job measuring relative strength and weakness cycles in the modern electronic market. However, the majority of traders fail to take full advantage of the calculations because they misunderstand its purpose and power.
According to popular belief, we’re supposed to sell when the Stochastics fast line (%K) crosses below the slow line (%D), and to buy when it crosses above the slow line. That sounds simple enough but the technique doesn’t work because the crossovers fail to pick up strongly trending markets. Fortunately, there are two better ways to apply indicator output:
- Use the wavy lines as a cycle tool for intraday and multi-day buying and selling decisions.
- Read the unique patterns as they gyrate between overbought and oversold levels
The first method works because the market shows cyclical pulses of buying and selling pressure. A well-tuned indicator sitting in the lower pane of a 15-minute, 60-minute or daily chart captures the flow of these repeating impulses. This is especially effective in trading ranges, picking up when a rally or selloff hits a turning point, offering a second entry or an opportunity to cut losses.
Look at the oscillations on the SPDR Trust (SPY) 60-minute chart in the last two weeks. The cycle peaks captured nearly every high within the broad sideways pattern in place since the February 3rd jobs report. Each oscillation down to the oversold line also corresponds with a pullback that defined a short-term low, and an opportunity to add to positions or take profits.
This type of clarity is the rule, rather than the exception, when using Stochastics as a cycle tool but markets don’t always move in perfect oscillating waves. As a filter, traders need to ignore buy and sell signals when the lines jam higher or lower, and then flatline. These patterns reveal one sided markets and the need to apply momentum tools, like MACD, instead of cycle tools.
This limitation hints at the second way that traders can use Stochastics to their advantage. The indicator prints all types of patterns as it oscillates between the upper and lower ranges. These formations converge or diverge with price patterns on the upper half on the chart. Alignment or misalignment between price and Stochastics patterns can be highly predictive.
Iron Mountain (IRM) shows an example of the lower high, one of my favorite Stochastics patterns. Look at the relationship between price and the signal lines in the last two months. Both hit new highs at about the same time during the first and second peaks. That changes on the third peak when price hits a new high but Stochastics hits a lower high, signaling a bearish divergence.
The price pattern supplies the missing information with a double top pattern that shows support near 31.25 (black line). It also fits the characteristics of a 2B Reversal, described in 1993 by Victor Sperandeo in his book Methods of a Wall Street Master The stock finally broke down on January 26th, confirming the bearish divergence in a sizable selloff.
The midstream fakeout is another effective Stochastics pattern. The indicator drops to the oversold level while price holds above the last swing low (red lines). It turns higher but stalls in the middle of the range and starts to roll over. Many traders see the crossover and dump positions but the small platform (blue box) actually marks a continuation signal, predicting higher prices.
This pattern offers a great entry if you’re kicking yourself after missing an important reversal. Pay close attention when Stochastics rises off the low and then jump on board when you see the indicator flatline for a few bars. It doesn’t happen every time, but the pattern shows up often enough that you’ll get many second chances to get positioned at low risk prices.
What settings should you use for the Stochastics indicator? I’ve applied the 5-3-3 settings for over a decade now but these small numbers do translate into higher noise levels and more false readings. If that’s a problem, I recommend trying out the 14-7-3 and 21-14-3 settings, comparing the signals to see which offers the best fit with your specific trading style.
Low Trading Volume Sends a Warning
(Republished with permission from TheStreet.com)
Volume has dropped through the floor so far in 2012, reflecting lower volatility levels and less public participation in the equity markets. This is a two edged sword because prices can be ramped up for days when institutional sellers are absent, inducing euphoria in the trading crowd and financial media, but then cut down just as quickly in vertical declines.
We’ve enjoyed one side of this equation since the start of January but, with technical indicators stretching at extremely overbought levels, quick and painful selloffs are now likely to upset the bullish tone on a regular basis. As a result, it’s a good time to protect intermediate positions with trailing stops, partial profits and/or options protection.
Limp trading levels are also making it harder to get valid breakout signals because volume-based accumulation-distribution indicators aren’t cooperating. For example, a notable breakout in 2010 or 2011 that triggered a 5 million share day on a small cap may now produce just two to three million shares traded. This is undermining On Balance Volume (OBV) readings, which generates accumulation patterns that should match or exceed price action at new support levels.
It’s one reason why intermediate price direction on Apple (AAPL) has been so hard to predict, following its January breakout. Note the stock posted three higher highs in 2011 but OBV spiked just two times, barely registering the October high near 427. It dropped to the October 2010 low (green line) and lifted off in a shallow angle of ascent that completely missed last month’s breakout.
This lagging behavior is triggering a bearish volume divergence that predicts the breakout will struggle, yielding a series of whipsaws and a potential failure. Neither has happened in the last two weeks, with price trading higher in a series of all-time highs. It’s real hard to tell folks it’s OK to buy Apple, right here and right now, with this conflict hardwired into the technicals.
You can see the culprit more clearly when placing a 50-day moving average of volume over the classic volume histogram. Average volume has been declining steadily since October, even though January traditionally yields strong public participation that should trigger a wave of above average volume spikes. That didn’t happen, except on the days just before and after earnings.
Now look at the horizontal black line, which notes the lowest average volume levels posted last year. Apple broke this line on the last trading day of December, with the indicator drifting lower throughout the first six trading weeks of 2012. This is crazy, given the stock’s icon status, the big breakout and a January market that should overflow with public and institutional transactions.
Please keep in mind that I’m using Apple as an example here and I’m not making a negative call, although the red flags are waving. Rather, this type of divergent behavior is flashing all across the 2012 equity markets. It’s less prevalent in the small caps than blue chips right now but the footprint of abnormally low participation is showing up just about everywhere.
This is big problem for technicians, trying to divine the market’s intentions, but it’s an even bigger problem for traders and the investment community because healthy bull markets can’t be built on apathy and robots. Of course, prices can drift higher for weeks when there are no sellers in the system but the uptrend will lack strong handed players ready to support falling prices.
This missing element sets up bad mojo when sellers finally have a reason to sell because there will be few strong bids under the market. Of course die-hard dip buyers will still buy dips but the hideous January volume, which reflects a failure to attract public buyers, has the power to create monstrous air pockets that rival last August in their ferocity and power to destroy profits.
In: Market Mechanics, TA, Wall Street
Ending The Rigged Game
Wall Street insiders expect retail investors to act like sheep and return to the market as we move higher. I think investors are gone for good because, after 2008, they know the game is hopelessly rigged.
Perhaps investors should reconsider the equity markets, but not until the following things happen:
1. Return the stock exchanges to non-profit status.
2. Consolidate all stock market transactions into one central location, with a quote book that reflects actual supply and demand, i.e. no icebergs, no flash quotes, no dark pools.
3. End the carried interest loophole.
4. Regulate HFTs, forcing them to provide liquidity and depth through all market conditions.
5. Require opening liquidity quotes, with mandatory maximum spreads.
6. Charge HFTs for quote cancellations.
7. End sub penny pricing.
8. Abolish leveraged ETFs.
9. Enforce naked short selling rules.
10. Regulate fund performance reporting to eliminate end of month and year mark-up.
Don’t Bet On The Banks
(Republished with permission from TheStreet.com)
Money center banks met low expectations in the fourth quarter, with critical issues here and abroad keeping a lid on profitability and their 2012 projections. JP Morgan Chase (JPM) and Wells-Fargo (WFC) investors shook off the modest numbers, lifting to multimonth highs. Citigroup (C) shareholders weren’t as forgiving, knocking the debt-laden institution to a two week low.
Given the buy-on-bad news impulse, is it time to shout an all-clear signal for the banking sector and throw more money at the rally wave that started in November? Well, not so fast because the group faces two major obstacles heading into the end of January, one technical and one logistical, before the institutional crowd finally gives their thumbs up or down to the group.
First, although we’ve heard from nearly all the big banks, the vast majority of mid-sized and small cap sector components will report earnings in the next seven sessions. That data flood will reveal the state of the industry away from Wall Street and in Middle America, which is highly dependent on more traditional commercial and residential loans.
Second, the KBW Banking Index (BKX) just completed the second leg of a mean reversion swing off the 2011 low and into the 200-day EMA. The rise into this critical level tells us that extreme selling pressure has washed out of the system, allowing price to float back to a central fulcrum. Saying it another way, the index is no longer oversold on a longer-term basis.
What is doesn’t tell us is more important. Simply stated, the bounce doesn’t reflect a healthy buying phenomenon typically seen in a bull market advance. Using a simple analogy, hold a rubber ducky under the bathwater and let it go. It will catapult into the air and then settle back on the surface. If you want it to stay in the air, a real live human needs to intervene and pick it up.
We can see this flatline behavior in the last seven sessions, which correspond with the first earnings release by JP Morgan Chase on January 13th. The index hasn’t budged since that time, remaining stuck like glue to a trading range between 42.50 and 44. This isn’t a necessarily a bad thing because a sideways pattern will support higher prices, as long as it finds real live buyers.
But it could just as easily mark a topping pattern, ahead of a steep decline into the upper thirties. Secondary technicals are raising a red flag in this regard because the numbers don’t support the positive price action. For starters, accumulation as measured by On Balance Volume (OBV) looks bleak, with a long series of lower highs and a pathetically slow rise off the October low.
The indicator is reacting to the limp volume that’s characterized this January market so far. The lack of investor interest is troubling because the banking sector is trying to climb out of a deep hole and needs enthusiastic shareholders to accomplish that task. Maybe that will happen after this week’s results, but typical mutual fund inflows should have hit the ticker tape by now.
Now look at the Fibonacci retracements off the 2011 high. The index has remounted about 50% of the February to October selloff and 62% of the July to October selloff. These are typical bounce percentages within a bear market environment. Sector bulls can still prevail but they’ll need to push the index up and over major clusters of resistance between 43 and 46.
Finally let’s see what the weekly chart is telling us. It’s troubling the index topped out in the first quarters of 2010 and 2011 (blue circles) because this fractal behavior will invite selling pressure. Those highs formed a broad double top that broke to the downside in August. Pattern resistance lies between 42.50 and 44.50, which makes sense given the index’s recent loss of momentum.
Meanwhile, weekly 5-3-3 Stochastics has now lifted into the overbought level, which isn’t earth shattering for bulls because it can support another few weeks of buying pressure. However, a selloff lasting more than two or three sessions is likely to trigger a rollover, shifting the balance of power back to bears and favoring a decline cycle that lasts one to two months.
Summing things up, sector price action has reverted to the mean after a tough slog through the second half of 2011. There’s been little reaction so far to fourth quarter earnings but that’s likely to change when the reporting cycle finishes up next week. Without strong results from mid and small cap players, banks could easily head for their 3rd straight year of inferior performance.
In: Market Mechanics, TA, Wall Street
Homebuilders Roar Back To Life
Homebuilders roared back to life in the fourth quarter, leading the upside in reaction to surprisingly resilient sales growth. However, the group covered little new ground during the rally, simply regaining price levels that were lost in the summer decline. While the V-shaped action didn’t trigger a big breakout, it generated technical improvement in the long-term patterns, which now point to even higher prices.
This is dovetailing nicely with an upturn in the banking sector, suggesting the fragile U.S. recovery will pick up steam heading into the November presidential elections, despite the European crisis. These emerging uptrends give long-minded traders and investors a choice between two sectors that have grossly underperformed the broad market in the last three years.
Now you might be thinking “why bother with housing stocks when I can go out and buy a few banks instead?” and you could be right but the financial sector requires a more complicated bet that includes assumptions about local regulation and international exposure, while the housing sector is a purely American play for 2012. So I think it will be the stronger performer.
No, I don’t expect foreclosures to magically disappear and new waves of buyers to ignite another real estate bubble. To be honest, that isn’t required for a new sector bull market because the 2008 collapse has been fully discounted by market players after three tortuous years, so even gradual improvement should attract a steady flow of buying interest.
The PHLX Housing Sector Index (HGX) dropped from 294 to 54 between 2005 and 2009, and then retraced less than 38% of the decline into the April 2010 high. It then rolled over in a two legged downtrend, finally bouncing in October about 20 points above the two year low. The index is now lifting toward resistance at a lower highs trendline (red line) and the 200-week EMA.
Even though the index turned higher well above the 2009 low, I believe the decline constituted a major test because many components, including Toll Brothers (TOL) and Ryland Group (RYL), actually undercut their lows in October, before reversing with the sector and broad market. If I’m right, the index will now lift into long-term resistance and break out in a new uptrend.
There are two ways to play a group recovery. First, buy the sector’s strongest components, assuming they’ll continue to lead in the next rally wave. Second, buy the laggards and hope they play catch up with their stronger peers. I think the first strategy will work better if first quarter data shows regional strength and weakness, while the second will work better if a healthy economy “floats all boats”.
Let’s take a look at a profitable play for each of these complimentary strategies.
Lennar Corp (LEN) is a sector leader that’s posted a series of higher lows off the bear market low at 3.42. It topped out near 21 in 2010 and dropped into a broad rectangle (blue lines) that’s still in play. The stock tested pattern support in October and has now risen to within two points of resistance. More importantly, it’s grinding out the final stage of a four-year inverse head and shoulders breakout pattern.
The stock will need to get above a red zone of resistance between 21.50 and 23 to complete a multiyear breakout and enter an uptrend that eventually finds its way into the forties. There’s too much risk until it pierces that level so I don’t recommend taking an early position. Instead, get this promising play onto your trading screens and watch the big resistance level.
Pulte Home (PHM) has struggled to keep its head above water in the last two years, finally breaking the 2008 lows (red lines) in August. It plunged to a 15-year low at 3.29 in October and bounced in a strong recovery that’s now stalled at resistance defined by the summer breakdown. Accumulation rocketed higher in the fourth quarter, with On Balance Volume (OBV) now sitting at an 18-month high (green lines).
This underlying enthusiasm signals a strongly bullish divergence that should generate a healthy breakout over 7 and a buying spike that tests the lower highs trendline (blue line) in place since July 2010. Aggressive players can open small positions when the stock pushes above the 2008 low and then add more exposure following a breakout over that resistance line.
Gold and Silver: Wait Until Next Year
Gold and silver bulls need to lower their expectations and stand aside because these futures contracts are setting up for lower prices in the first quarter of 2012. However, those declines should eventually come to an end and offer excellent buying opportunities, ahead of renewed uptrends that might last another three to five years.
Gold downside in the next few months should be manageable for positions opened in the last two years, with the yellow metal unlikely to break support around between 1400 and 1500. However, silver remains stuck in broken bubble mode, following a parabolic thrust to 50 earlier this year, and could easily fall another 35% to 40%, before turning higher and resuming its uptrend.
Precious metals mining stocks have underperformed their physical and futures counterparts since 2010 and should continue to do so in 2012. As a result, I recommend avoiding the group entirely when the buying opportunity finally comes, sticking with direct exposure, outright or through fund proxies, and save your equity capital for other stocks and sectors.
Gold hit the psychological 1000 level (blue line) for the first time in March 2008, reversing gears immediately and selling off through 700. It returned to resistance in 2009, completing a picture perfect cup and handle pattern, followed by a powerful breakout in October of that year. The contract then entered a channel-bound uptrend that went parabolic in July of this year.
The vertical buying spike above 1900 marked the rally’s end, yielding a sharp reversal down to the 50-week EMA, followed by a choppy bounce that stalled in early November. Note how last month’s turnaround took place right at the channel top that was broken to the upside during the final buying wave of the long uptrend.
This upper channel line was tested on August 26th, just after the first buying impulse above 1900. The support level held, yielding a secondary thrust that also failed, carving out a small double top pattern on the daily chart. The breakdown through the trendline on September 26th, followed by a failed bounce, now exposes the downtrend to a decline that tests channel support near 1560.
Price action looks like an A-B-C correction, with the contract headed into a selloff that’s proportional to the September decline. That would yield a downside target near 1420. I also expect the channel bottom to break, shake out retail stops and retrace 100% of the final parabolic wave. Interested buyers can open positions once the blue line gets hit or wait until the channel line is reclaimed with a buying thrust back above 1600.
Owning silver into the first quarter of 2012 will be a risky proposition because it’s working off a parabolic rally that started way down way down at 18 in June 2010. The buying frenzy up to 50 shows two sub waves, with interim support around 26. The bubble finally burst right at the top of the 1980 Hunt Brothers parabola, so it took more than 30 years for the contract to test that high.
The first selling wave after the April top carried into the 38% retracement of the 2008 into 2011 rally, with the second selling wave dropping price into the 50% retracement level. That zone also marks support at the 100% retracement of the January into April sub-wave. Saying it another way, most folks who are holding silver with a 2011 purchase date are now losing money
The daily chart show a more ferocious selling pattern than gold, with two vertical declines, interspersed with two choppy recovery waves. This is a typical setup for a five wave flag pattern that won’t hit bottom until the contract completes a third selling wave that’s proportional with the May and September declines.
If time is proportional with price, that selling climax will occur about four months following the last decline, or sometime in the first quarter, and carry into the lower flag trendline near 20. That downtrend would bring price into the realm of strong 2010 support above 19, as well as the 62% retracement of the 2008 to 2011 rally and mark an excellent spot to open new silver positions.
In: Market Mechanics, TA
Retail Winners and Losers
(Reprinted with permission from TheStreet.Com)
I offered my list of top retail picks for the 2011 holiday season in October, predicting that big box super stores would be prime beneficiaries, at the expense of specialty shops. Today, I’ll add a selection of small and mid-cap regional players, with these lesser known companies also set to outperform, regardless of worldwide political machinations or economic anxiety.
The majority of national retail chains are struggling to make their numbers these days, with a fickle customer base that’s searching for bargains, steep mark downs and red light sales. The recent and terrible fate of Abercrombie and Fitch (ANF) shows what can happen when these trendy companies push too hard against an unfriendly sales environment.
The company had an excellent run to a three year high earlier this year, with more optimistic shoppers opening their wallets to buy brands, instead of necessities. However, management marked down too many items during that fruitful period and then expanded international operations, at the same time the Euro crisis was rearing its ugly head.
The stock sold off from a triple top pattern when limp foreign sales data hit the newswires, dropping 40% in just three weeks. The vicious decline shows what’s at stake for retailers that miss their numbers in the next six weeks. From this perspective, it’s easy to see why small regional retailers are better positioned to fire on all cylinders than their larger competition.
Let’s start with Conn’s (CONN), an appliance and electronics retailer with 71 locations in Texas, Louisiana and Oklahoma. With a market cap of just 317 million, the company has woken up from the dead in the last two years, lifting out of a five year downtrend. This renaissance predicts continued sector leadership in the next twelve months, even if the US economy stumbles.
The stock returned to the 2010 high, just over 10, in July of this year and sold off with the broad market. It found support near five bucks and returned to the high in October, completing a cup and handle breakout pattern. The stock surged through resistance, hit a two year high at 11.72 and pulled back. It’s acting well at new support and could now head into the teens.
Pricemart (PSMT) is a Costco-style warehouse chain headquartered in San Diego but the majority of its 29 facilities are located in Central America. This interesting sales niche has paid off well, with the stock pushing above its March 2000 high in June of this year and entering a strong uptrend that’s added 50% its value and posted a series of all-time highs.
The rally stalled in the mid-seventies in September with price pulling back for a few weeks and then testing that resistance level earlier this month. Sellers returned, knocking price down to a rising lows trendline where it’s trying to turn higher. If successful, the uptrend will stay fully intact, supporting a year-end rally burst.
Hibbett Sports (HIBB) owns and operates nearly 800 sporting goods, shoe and apparel facilities in the eastern U.S. As we know, that’s a better location for retailers than the overbuilt western states, which are still trying to recover from the 2008 housing bust. The price chart confirms this regional advantage, with the stock breaking out to an all-time high earlier this year.
Price action since that time has been constructive compared to the broad market, with the stock testing support in a bowl-shaped pattern that yielded a secondary breakout (blue line) about two weeks ago. The rally has made little progress since that time but its holding above support at 43, building a decent base for a continued uptrend into the fifties.
In: Market Day, TA
Tape Reading Tells
Experienced tape readers keep a collection of key observations tucked away in their brains, so they can act quickly whenever the tape cycles into analogous price action. This hodgepodge of personal signals, setups and key tells can yield quick profits because the data comes through personal experience, instead of reading a book or attending a seminar. Mr. Market plays a constant game of misdirection, but our accumulated tape knowledge lets us see through the veil and decipher key elements of the daily grind. Let’s look at the most potent of these small portents of market direction.
Globex Futures – Look at pre-market index futures and see where they’re trading, relative to their day-session 15-minute 50-period moving averages. Expect a positive opening for stocks when index price sits on top of the average, and a negative opening when it lies below. If the SP-500 is above but the Nasdaq-100 is below, look for intraday rotation from tech and small caps, into the blue chips. Flip over this outlook when Nasdaq-100 is above and SP-500 is below. On those days in particular, watch for speculative four letter stocks to take over the leadership mantle.
Advancers/Decliners – Market breadth and up/down volume offer valuable data on hidden strength or weakness. Buy midday pullbacks when breadth shows greater than one thousand advancing to declining issues. Sell midday bounces when breadth shows less than minus one thousand advancing to declining issues. Up to down volume in both exchanges greater than four to one points to a trend day that favors the dominating side of the market. Assume there will be no intraday turnarounds when you see this type of price action. Instead, stop fighting the tape and focus intraday capital on 60-minute range breakouts or breakdowns that follow the prevailing trend.
Buy/Sell Flow – The NYSE TICK exposes the peaks and valleys of intraday swing cycles. Look for large-scale reversals after the TICK hits an extreme reading, like plus or minus 1400, for the third time in a single session. Use smaller TICK extremes to pinpoint intraday swings that will carry price they other way in a 60 to 90-minute cycle.
The experienced tape reader can decipher telltale action that’s overlooked by the crowd. For example, a slow creep rally into a resistance level that’s held back price for three to five sessions is an early signal for a breakout. Brandywine Reality Trust spikes into at 8.34 and pulls back. The stock reverses four times at that level in the next two days and then begins a slow and persistent uptick that gathers steam on the afternoon of August 3rd. Momentum escalates the next morning, triggering a vertical breakout.
In: Market Mechanics, Wall Street
First Hour Range Break Strategies
The opening bell brings fresh conflict, with buyers and sellers brawling for control of daily price direction. This battle of wills often generates a first hour range that sets boundaries for larger-scale rallies or selloffs later in the session. Trading the breakout or breakdown from this sideways pattern is an effective technique to capture short-term profits.
There are four key elements in a first hour range breakout and breakdown strategy.
Instrument - The strategy works best in highly liquid markets, so stick with stocks that trade over 5 million shares per day on average. Even better, use exchange traded funds that correlate with a major index or sector because they’re less vulnerable to news shocks. Build a watch list of possible candidates that you can keep from day to day. Assemble your list with groups that don’t all move in the same direction at the same time.
Entry Price – Buy when price rallies above the high of the first hour range, or sell short when it falls under the range low. Add a few cents to the upper and lower end of the range, when establishing your entry price, in order to avoid whipsaws. Realistically, the entry signal might come right after the first hour, or not until much later in the session. This is a short-term play so full position size should be taken immediately, rather than scaling in with smaller shares. After execution, look for the trade to move into a profit quickly. When it doesn’t, the odds for a whipsaw increase geometrically.
Stop Loss – Calculate the height of the first hour range, placing a stop loss 15% to 20% under the high for a breakout, or above the low for a breakdown. For example, a stock trades from a low of 22 to a high of 24 in the first hour. For a breakout, place the stop between 23.60 and 23.70. For a breakdown, place the stop between 22.30 and 22.40. Mental stops aren’t recommended because you’re working in close quarters, where a reversal can come quickly and you might not have enough time to react.
Profit Target – Identify your profit target by looking at the last two days of 15-minute price bars and finding the last major swing in that direction. If there’s no swing to work with, use a tight trailing stop and get out at the close, if the stop doesn’t get hit first. Make sure there’s enough profit potential to make the position worthwhile. If there isn’t, do not take the trade. A simple rule of thumb: look for trades in which the realized profit will be at least three times the risk of price rolling over and triggering the stop. For example, you enter a trade at 30,with a profit target at 30.70 and a stop loss at 29.80. The potential 70-cent gain is 3½ times the potential 20-cent loss.
Wait on the sidelines through the first 30 minutes of the session and draw horizontal trendlines on a 5-minute chart that correspond with the high and low over that period. Then, adjust those lines in the next 30-minutes to establish the first hour range. Continue to use the 5-minute chart for trade management, after picking out your intended profit target. Before entry, confirm the pattern will actually support your intended strategy. The first hour range is established by swings in both directions. Swing levels aren’t measured until there is a counter swing that generates a 5-minute high or low. You’ll find that many stocks are already trending at the end of the first hour, and not swinging back and forth. These issues should not be traded using this strategy.
The first hour breakout strategy works especially well when opening volatility is higher than normal. Yum Brands gaps up to 35.98 and then drops to 35.47. The 51-cent range holds until late morning, when a vertical breakout lifts the stock nearly a point over early resistance. A 20% stop placed at 35.87 manages the trade well, while a trailing stop protects profits during the strong uptrend.
Thoughts After A Monster Rally
A late night agreement on key Euro-debt issues triggered a worldwide rally that lifted index futures more than 2.5% by Thursday’s US opening bell. The SP-500 spiked right into H&S neckline resistance while the Nasdaq-100 opened at 8-day range resistance. Index prices dropped quickly under their opening levels, pulled back and posted their intraday lows at the end of the first hour.
The SP-500 turned higher mid-morning, rallying to a 2-month high at the lunch hour, with the Nasdaq-100 pushing over its opening high in the early afternoon. The good vibes continued into the final 30 minutes of the session, when a sell program dumped the indices well off their highs. The Nasdaq-100 closed well above the 2388 pivot while the SP-500 closed above the neckline but under the 78.6% selloff retracement and round number resistance at 1300.
The KBW Banking Index (BKX) gapped well above base resistance at 40, hitting a 2-month high, and headed toward the 200-day EMA near 44. The group still faces Euro risk but local issues could take over leadership in the weeks ahead. In that regard, October pending home sales came in much lower than expected this morning, reinforcing yesterday’s poor consumer confidence number. So, while Europe might survive for another month, evidence of an economic upturn on this side of the Atlantic is harder to find than an honest investment banker.
The euro broke out over the 200-day EMA and pushed through the 1.40 to 1.41 resistance band, hitting an 8-week high. The huge uptick continued into the 78.6% selloff retracement at 1.425 and we could now see whipsaws down to 1.39. However, this is a significant breakout, any way you slice it, and whether or not you believe the Euro deal has any substance or staying power.
VIX collapsed into the mid-20s, dropping to a 2-month low. This is really good news because it should ease the impact of fast moving HFT programs during the trading day. It could also herald the return of traditional stockpicking, thanks to lower correlation levels between indices and individual equities. That’s a big deal for swing traders, who rely on two-way market mathematics to find reliable entry and exit signals.
Crude oil bounced sharply at 90 overnight and returned to the 3-day high. This confirms new support at the 200-day EMA and sets the stage for an uptick into the next resistance, at round number 100. That’s a big level, given major economic challenges around the world, and I think it will take a real growth spurt to support another run into triple digits.
Window dressing is helping the market, with typical end of month buying activity, as well as end of fiscal year mutual fund portfolio realignment. We’ve also shifted from one inflection point to the next, with clearly drawn resistance at SP-500 1300 and the Nasdaq-100 2011 high at 2435. Bulls have the obvious advantage after Wednesday’s turnaround and could even enjoy a momentum market for a few days or weeks.
In: Market Day, Wall Street