May 16, 2013

Logical Market Update: Choppy Trade Continues as the Pain Threshold Rises – Don’t Ignore the Divergences!

Choppy Trade Continues as the Pain Threshold Rises – Don’t Ignore the Divergences.  

The Bears are getting Hoarse – Are the Bulls getting Tired?  When Will the House of Cards Crumble?   

To say patience is a virtue would be a huge understatement when it comes to waiting for the U.S. markets to put in more than an hour-long correction.  As the broader indexes churn higher day after day under the guise of anything but the actual basis is now much more difficult that watching paint dry or being akin to an animal chewing off its own leg that has become ensnared in a trap (in this case a bear trap) as the shorts are forced to cover.  It may be safe to say that the only buyers are the shorts covering and that is evident in both directions at the moment. 


What is behind the eternal bull (market that is) – it’s the government pure and simple.   As long as the Federal Reserve and the U. S. Treasury continue to flood the system with fresh new dollars via “ QE stimulus” and ultra low interest rates (clearly stated by the FED to be held low through 2014) the bull should continue to run rampant.  What is happening and will likely continue to happen is that the smaller investor is now getting sucked into the “mill” in search of higher returns over what banks are willing to pay out.  It is a trade that has netted the TBTF boys billions over the last 4 years.  The uphill climb seen in the big banks has been breath taking with all the TBTF banks participating.  Against all odds some would say – but it is a trend that has continued in spite of the “ducks quacking”.   


Market Divergences not to be ignored

Divergence is defined as “a deviation from a course or standard.”source


Divergences occur when things that normally run together (in the same direction) begin to go in opposite directions.  Technically, as a trader it is important to recognize when they appear and to adhere to the “warning sign.”  This does not appear to be the case lately, as many seem to think there isn’t much need of divergences since the markets only move in one direction – up – right?  Wrong – divergences are clear signals that an impending change is on the way.  Denying their existence does not mean what is being signaled won’t happen.  The markets will correct on both a small and large scale.  It is not a matter of “if” but of “when”. 


Here are a few market divergences that can be added to the growing list of “why the markets will correct”:


  • The S&P 500 is up over 7% in two months with the past few weeks producing a more parabolic vertical rise with the a few sparse down days here an there.  Copper on the other hand is down over 7% in the same two-month period.  The divergence is notable because historically, copper and stocks almost always move in the same direction. 
  • The Volatility Index (VIX) is also signaling divergence.  The VIX has normally moved lower as stock prices move higher.  Over the past two months, as stocks have rallied  – the VIX has gained nearly 10%.  With stocks and indexes trading a new all time highs, the expectation would be for the VIX to be hitting new 52-week lows.  It’s not.
  • Baltic Dry Index is produced by the Baltic Exchange in London and reflects the cost of shipping dry goods overseas.  Here is a divergence for those that seek economic reasons for the markets to move.  Over the same two-month period the BDI is down 5%.  If the markets are rallying because the economy is improving then the BDI should be moving up with the markets suggesting an increasing demand for shipping goods.  It’s not.


Elliott Wave – Extension(s) Update


Extensions occur with frequency within the first, third or fifth wave of a five-wave sequence.  Most often it is within the third as this sequence is usually the longest and the strongest with the larger “wave”. 


Last week I discussed how the broader indexes were moving through the process of completing extended five wave sequences.  This remains the case today, however, it appears that one additional “new” high is needed before the sequence is complete and a larger correction begins. 


The S&P 500 (SPX daily chart) below shows the details (click to enlarge):



The markets remain extremely overbought and with declining volumes continue to point to the end of the current rally and not the launching point for another surge higher.  Longer term I continue to expect additional new highs as the current larger advance that began off of the March 2009 lows continues.   I continue to see signs of exhaustion within the current move.  A time when buyers and sellers are not willing to step in leaving the daily grind to day traders and the algorithmic computers.   


Remember, an efficient market will always trade to volume.  At the moment the search for volume remains to the upside, even though so many remain suspicious that the volume will be found at lower levels.  So it becomes a game of patience.  The shorts are not budging and the longs aren’t either – not yet anyway. 


The sector rotation out of biotech and into technology continues to carry the bulk of responsibility for the rally.  Should a pull back on a larger scale take place I would be looking to add MSFT, AAPL, and INTC to name a few of the titans.



The Diversified Trading System used together with Trade Manager should continue to produce numerous trading signals in the DJIA, YM (mini), S&P 500, ES (mini), RUT, TF (Russell 2000 mini), AAPL, AMZN, GOOG, NFLX, and LNKD, GS, and Tesla Motors (TSLA).    


Here is an updated list of the markets where I have found that DTS (all three birds) are producing numerous signals:

  • DJIA future (e-mini available)
  • S&P-500 future (e-mini available
  • US$/Euro futures (e-mini available) – very highly recommended
  • GS (Goldman Sachs)
  • AAPL (Apple Computer) – very highly recommended
  • GOOG (Google) – very highly recommended
  • LNKD (LinkedIn) – solid intraday range
  • NFLX (Netflix) – solid intraday range
  • TSLA (Tesla Motors) – highly recommended
  • 30-yr Treasury Bond future – may get quiet
  • 10-yr Treasury Note future
  • TLT (Treasury Bond Long ETF)
  • TBT (Treasury Bond Short ETF)


Day Trading vs. Position Trading


The necessity to toss out most if not all of your old trading ideas and join the ranks of algorithmic trading remains important.  Day trading has increasingly become my first choice as the markets become more difficult to “read” and trade.


I advocate the use of overbought/oversold indicators and momentum oscillators to indicate where money is flowing, where an imbalance of buyers or sellers occurs and a  “bull trap” or ”bear trap” forms.   


I believe that it only gets more confusing going forward as the market ignores “the writing on the wall” and continues higher with a false sense of security built on negative input.  Price volatility has increased with the broader averages easily moving 2 to 3 percent and as high as 10 percent intraday.  Many stocks have seen daily trading ranges average between 10 and 15 points, with one day being 15 points higher and the next being 10 points lower. 


This type of action is the primary motivation behind my advocating switching strategies if necessary and focusing on day trading and less on position trading.  I do believe there are discernable longer-term positions investors should consider and implement, but the near to mid-term market gyrations have produced far more profitable day trading opportunities without overnight risk. 


I continue to recommend the best trading platform available to a broader range of traders from novice to expert.  The Diversified Trading System offers a cost effective product that allows a trader to enter into the “chaos” and trade more effectively.  


Trade Manager from Indicator Warehouse automatically calculates the correct amount of contracts or shares based on your account size or market volatility.  Automated stop-loss management and position sizing eliminates most of the problems most individual traders have.  Day trading and position trading both require (actually demand) good risk management.  Trade Manager does the job across the board and is an essential trading tool that ensures that you take the maximum profit from all your trades.