Archive for August, 2010

Sunday, August 29th, 2010

High Frequency Trading is not new to the markets, it has been around for more than a decade. Why are we suddenly aware of these trades, because when they disappear, the market seems to crack. The “flash crash” was a picture of high frequency trading on drugs. Computers are programmed to look for purchases or sales of issues that our of price alignment. The computers will automatically trade until or unless something goes out of order. At that point, the computers may be programmed to shut down or may manually be turned off and will wait for discernable patterns to return to the market, so they can resume trading. True computers today are faster and better than they were in the past and the programs have morphed as the hardware used and available speed has improved. Today, an individual can program a computer to find inefficiencies in the markets and trade on them. They are not looking for the big kill but rather the little scalp. It is like the discount store owner, his margins are small but the volume more than makes up for the tighter margins. That is a description of some of the noise in today’s markets. The question is how to beat these computers. Obviously the small investor will not have the fastest computer so, the answer to the question of how to win in today’s market is, by looking and the chart and letting the market tell you where you should be invested. A chart is a picture of supply and demand. It really doesn’t care about anything more than the price action of an issue. If you feel that there is too much noise in the market then, I suggest you use point and figure charts to eliminate some of the daily distortions that these fast computers cause. Remember these computers are searching for price inefficiencies not long term trades. You, on the other hand, are looking for points on a trade and not price inefficiencies.

As a day trader on the electronic e-mini platform, we look for direction. We look for a reason to buy or a reason to sell. If you are more comfortable selling you can make money even in a bull market. The markets do not go straight up nor do they go straight down. They move in both direction one will be the primary direction the other direction will be a reaction to the primary trend. If a market rallies, it will have periods of retreats within the major uptrend. If you are more comfortable trading contra rally you can do so. Just remember that if you are going against the trend, you have to be very short-term and very careful with your stops. The fallacy in the market is to believe that if it is going up, it won’t stop to digest some of the gains.

As we enter September, the worst month of the year you will notice that the market volume is contracting. A long-term view is that we will likely see a rally begin in the market as we approach the November elections and then once the elections are over. It seems clear that we will see the expiring Bush tax cuts on dividends extended, which will also give the markets a boost. People are looking for dividends and will likely move back into the market once they congress renews the tax preference on dividends. Will this solve our economic problems, absolutely not, but it will give some relief to the market and an opportunity for a decent rally. This is not a declaration of bullishness but of reality as we see it. We continue to believe that eventually, we will have to pay for all the expenditures and will have to repay the huge debt we are building.

We hear some talking about inflation and about worries of deflation. Well, looks like we have stagflation rather than either.

This is the end of the month and we should expect to see some gyrations in the markets at portfolio managers scramble to dress up/down their portfolios. We also have the jobs report this week which will add to the fire-works leading to the Labor Day Holiday.

Monday: July personal income/consumption is released at 8:30.
Tuesday: August Chicago PMI is released at 9:45, August consumer confidence is released at 10:00 and the Fed releases the minutes of the last FOMC meeting.
Wednesday: July construction spending and August ISM index are released at 10:00.
Thursday: 2nd quarter productivity is released at 8:30, July factory orders are released at 10:00 and the European Central Bank announces its interest rate decision.
Friday: August nonfarm payrolls and unemployment rate is released.

From August 15, 2010 letter: “We believe that the US Dollar Index can rally further but will see some resistance at 83.64. The weekly chart for the US Dollar Index looks impressive but supports the resistance level of 83.64. We see further resistance at 84.65 and at 85.70 or so. The point and figure chart also supports these targets. Above 85.70 we should see a melt to the upside, should the US Dollar Index rally to that level.” We continued in the same pattern with resistance at 83.64 and then at 84.65 and at 85.70. The world hasn’t changed materially for the US Dollar index. We do see a downtrend line at 83.23 which needs to be removed to restore the more bullish view of this market. We do see support at 81.99 and then at 80.16. There is a doji candle on the chart as a result of the Friday trading session. This candle tells us that neither the bulls nor the bears had enough strength to move the market. It also warns us that although we have seen selling pressure on the US Dollar index, the bears are losing their control of this market and it is likely that the bulls will take control, albeit just for a little while. The longer picture is more ominous with the US Dollar index closing below the uptrend line on the daily chart. The 5-day moving average is at 83.143. The top of the Bollinger band is at 84.139 and the lower edge is seen at 80.138. This market needs to stay above 82.665 for the bulls to stay in control. The point and figure number is 82.70 either way, the US Dollar index needs to stay above that level or risk a trip to 82.00, 81.70, 81.30, 80.60 and then 80.20. Looking at the market profile chart, you can see the importance of 82.70 and the “watch out below” level of 80.195. The stochastic indicator is overbought and sort of pointing lower, it is losing velocity on its direction. The RSI is flat on the positive side of the neutral level. The Thomas DeMark Expert indicator is issuing a sell-signal and our own indicator is flat. We are below the Ichimoku clouds for the daily time-frame and above the clouds for both the weekly and the monthly time-frames. For the traders; if you want to buy the possible bounce, keep your stops tight because you are trading against the trend. Yes, we believe that there will be a bounce in the US Dollar index but the larger trend is to the downside. We will give up that bearish view should the US Dollar index close above 83.65.

The rally seen in the Friday session was a very impressive one leaving a bullish engulfing candle on the chart. Not only was it a bullish candle but the market was able to close very close to the highs of the day. More interesting to us is the low that was printed of 1037.25. This was the second test of this level, actually the previous low was 1037.00 but it is close enough, and now becomes an important level for this market to avoid penetrating. It is a level which would be a good spot for longs to place their stops and shorts to initiate a trade. Naturally the level that would be chosen for the stops or the shorts would be slightly lower than that number. Still, on the point and figure chart, we wouldn’t want to be long below that level. Look at the market profile chart, 1041.60 pops out as a level which should support this market. On the upside, we have a downtrend line at 1065.56 on the daily chart and a horizontal line at 1080.54 and another horizontal line at 1100. The market profile chart shows that if we can get through 1094, we will likely see 1104. The 5-day moving average is at 1055.70. The top of the Bollinger band is at 1142.24 and the lower edge is seen at 1034.38. We are below the Ichimoku clouds for the daily time-frame, in the clouds for the weekly time-frame and below the clouds for the monthly time-frame. Although the strong performance of the Friday session, we continue to see a weak market. When looking at the weekly chart, you will notice that we continue to the downside. The indicators on the weekly chart support that view. On the daily chart, we are getting buy-signals from all the indicators that we follow. Should the stochastic indicator close above 39.08, it will break out of the bearish pattern that we have seen since the beginning of August. We see a divergence in the indicators making a higher low on the Friday test of 1037.25. This should warn us that things could be changing. The top of the downtrend channel line is at 1067.97 and the lower channel line is at 1028. Remember this is the last few days of August and adjustments to portfolios will be made. We also have the inflow of pension funds into the market on the first of the month. This with the upcoming holiday should add some strength to this market. Remember also that this market is in a downtrend so until that trend reverses, the trend should remain your friend.

The NASDAQ 100 had an impressive rally in the Friday session but not as impressive as was the rally in the S&P 500. The reason for this is that the S&P 500 managed to print and higher high than was seen in the Thursday session while the NASDAQ 100 was unable to do so. The NASDAQ did, however print a lower low. We do see some divergences in the NASDAQ 100. The lower low came with higher lows on the indicators. This is a sign that warns us to look for a possible change of direction. The 5-day moving average is at 1785.95. The top of the Bollinger band is at 1936.25 and the lower edge is seen at 1749.54. All of the indicators that we follow herein are issuing a buy-signal. The down trend top channel line is at 1807.75 and the lower channel line is at 1738.57. We are below the Ichimoku clouds for the daily time-frame, above the clouds for the weekly time-frame and in the clouds for the monthly time-frame. If this market can close above 1794 we will likely take off to the upside. If we had to pick either the S&P 500 or the NASDAQ 100, we would pick the S&P 500.

And the winner is…….the Russell 2000 which takes the award for the best rally in the Friday session. We see a bullish engulfing candle on the chart. We did not see a probe of the lower levels for the week. We did see a lower low when compared to the Thursday session but that low was not near the week’s low of 586.40. The Russell 2000 close the Friday session just 30 cents from its high for the day. We are in the comfort level (what the market perceives as fair value) on the market profile chart. So long as the Russell 2000 stays above 586.40, there can be more room to the upside. Once 617.60 is removed, we will open the door to 633. All the indicators that we follow are issuing a buy-signal. We see the same divergences as seen in the other charts in the Russell 2000 chart. This warns us that we could have more action and room to the upside. We are below the Ichimoku clouds for the daily time-frame and above the clouds for the weekly time-frame. The 5-day moving average is at 627.74. The top of the Bollinger band is at 727.67 and the lower edge is seen at 575.85. The top of the down channel line is at 617.60 and the lower edge is at 577.

Crude oil is very interesting. This market enjoyed a three-day rally this past week, clearly breaking the short-term downtrend line opening the door to the medium-term downtrend line at 77.01. There is an uptrend line at 71.53 and if crude can manage to stay above that line, it will open the door to 78 and 82.97. The point and figure chart also warns that there will be trouble for this market should we close below 71 and 69. On the downside, this market needs to stay above 71.53 or the bears will regain control and push this market lower to 70 and then 68. The 5-day moving average is at 73.15. The top of the Bollinger band is at 84.22 and the lower edge is seen at 69.77. The indicators are pointing higher. We are inside the Ichimoku clouds for the daily and weekly time-frames and below the clouds for the monthly time-frame. We are about to get a buy-signal on the monthly chart and already have a buy-signal on the daily chart.

Gold left a doji-like candle on the chart in the Friday session. This candle signifies that both the bulls and bears were equally matched in the session. The channel lower uptrend line is at 1219.81 and the upper channel line is at 1255.53. We are somewhat overbought but have plenty of room to the upside. The 5-day moving average is at 1233.92. The top of the Bollinger band is at 1250.92 and the lower edge is seen at 1178.91. We continue to like gold although we would prefer to buy it on dips rather than chasing it higher. Gold is an inflation play, a currency play and a fear play. You have a market that is disinflationary, with lots of currency risk and a lot of fear therefore, gold will be a good trade. The market is above the Ichimoku clouds for all time-frames. We see resistance at 1242.70 and above that, the old highs.

Our take on the VIX: the VIX has to say above 23.40 or risk a quick trip to 21.36. This market has more room to the downside. The 5-day moving average is at26.328. The top of the Bollinger band is at 28.41 and the lower edge is seen at 20.70. Right now, this index closed below the uptrend line and likely will test the aforementioned support levels.