Short Analysis

I have missed my Sunday post, therefore I'm writing during the week. Coming back to my previous "S&P 500 Technical Analysis" post on September 20, 2009 I may say that since then we have had the market (Nasdaq 100, S&P 500 and DJI indexes) moved as was predicted: sideway trading first (from September 21 until noon on September 23) and then a correction down.

Looking at the price movement it looks like the correction down is coming to the end – the indexes are moving up from their September 25 lows. However, taking a look at technical indicators I do not think that many traders see positive and promising signals. Right now my technical analysis on hourly charts shows following:

1. SBV (Selling Buying Volume) – bullish on the Nasdaq 100 and DJI and neutral on the S&P 500;
2. MVO (MarketVolume Oscillator) – the same as SBV bullish on the Nasdaq 100 and DJI and neutral on the S&P 500;
3. Advance/Decline Oscillator could be considered Bearish, yet close to the oversold levels on all main indexes (Nasdaq 100, S&P 500 and DJI);
4. MACD is neutral by moving basically sideway;
5. RSI and Stochastics reading are mixed, yet, I would say that they are more Bearish than Bullish;
6. McClellan Oscillator started to decline, yet, it is still positive.

As you may see the technical analysis is mixed at this moment and may suggest recovery from the correction as well as further developing of a deeper correction. The main point that makes me worry, despite positive volume signals, is that volatility is increasing. You may see that ATR (Average True Range) and VIX index are climbing up and this is a bearish sign.

As a rule in case like we have now (mixed technical analysis results) a good decision could be waiting for more clear signals. Right now the indexes clearly defined the resistance line: for S&P 500 and DJI indexes high levels on September 17, 18, 22 and 23 and for Nasdaq 100 high on September 23. At the same time we may draw some support line that would go through September 25’s low. Furthermore, conservative way could be waiting for indexes breaking one of these lines and checking the technical analysis at that point.

S&P 500 Technical Analysis

A week ago in my "Technical Analysis" post on Sunday September 13, 2009 I have pointed to a bearish sentiment and overbought signals on majority of technical studies. However, in the same post I mentioned: "As a rule, when market comes to some overbought level it is stuck at this level for a couple of trading sessions and moves side-way before a decline." As you may see the history analysis helps in making a correct decision not rushing into a short trade even in situation when technical analysis is in favor of a correction. In one trading session, on Thursday September 15, 2009 the stock was back in the up-trend. On that day (September 15), all technical indicators on the Nasdaq 100, S&P 500 and DJI turned from bearish into bullish.

Now, by the end of this week we have a similar picture. Again, many of technical studies on the Nasdaq 100, S&P 500 and DJI charts point to overbought (short-term) levels and bearish sentiment. And again, I would recommend taking look through the history of these indexes. You should see that in the resistance (before a correction) we have a few sessions of sideway trading. In opposite an exit from a support is sharp and strong. This is not a 100% rule, yet, I would say that the odds of having a sideways trading in resistance are quite high.

The last two weeks’ rally up (from September 3, 2009) has push the stock market and indexes into overbought condition ( for a short term at least). A correction down would be healthy for the market. However, a possibility of sideway trading still exists and personally I would watch the Nasdaq 100, S&P 500 and DJI indexes for stronger bearish signals.

Right now the technical analysis applied to hourly charts shows following:

1. High volume surge on September 15-16, 2009 during the price advance (see big green MVO) suggests a possibility of reversal down.
2.  The RSI (Relative Strength Index) and Stochastics have dropped below 70 and 80 lines respectfully and both these indicators are in decline which is a bearish sign.
3.  The Advance/Decline Oscillator declines and is close to the center (zero) line. This could be considered as a bearish signal as well.
4. The MACD moves up, yet, this move is almost flat. Even this indicator is bullish, it’s not a strong signal and it could turn into bearish signal very easily.
5. The SBV Oscillator declines slowly which indicates bearishness, yet, it is still has high positive readings. It would be nice to see it dropping closer to zero line before considering it as a strong bearish signal.
6.  McClellan Oscillator is neutral on the Nasdaq 100 and S&P 500 indexes - it moves flat at a zero line. However, McClellan Oscillator applied to the DJI index is positive (above zero line and in flat move).
   

The S&P 500 Chart with elements of technical analysis.

Stop-Loss Trading Strategy

Many traders face a question what strategy to use in order to protect portfolio from big losses. In most cases this question is narrowed to a selection of a stop-loss strategy. A stop-loss strategy choice is very important, yet, is very confusing and can put even an experienced trader in a corner. The problem is that there is no straight answer on what system to use. A stop-loss selection completely depends on a selected trading vehicle, a personal trading style, risk tolerance, invested money and in addition it depends on the stock market itself.

I will try to go through some of the factors that may affect the stop-loss strategy.

1. Selected Trading Vehicle: Depending on what you trade, a stop-loss would be different. If you are buying and selling stocks 2-5% stop-loss could be sufficient for your trading system. However if you are buying options then 2-5% stop level could be hit very easily and you could be willing to look for 20-50% stop-level. If you trade uncovered options you could even think about setting stop-loss above 100% of the premium received. Even if you are trading stocks the stop-loss level could greatly differ from stock to stock. More volatile stocks would require bigger-stop-loss than the less volatile stocks.

2. Personal Trading Style: There are different trading system and different trading styles. Some traders are buying equities for long-term investments of pension funds and they make one trade per one-two years. These traders could be ready to set stop-loss to 10% and above. On the other hand a short-term trader who makes 5 trades per week may not be willing to risk setting stop-loss bigger than 1%.

3. Risk Tolerance: Twenty years old trader may lose everything and he/she still will have time to make some money and come back to trading and investing. However if you are close to retirement you should know the edge when it is better to get out of a game. If you are seventy years old you could be willing to set tighter stop-loss than.

4. Invested Money: If you have only $2,200 on your account and you invest all of them on margin ($4,400) in one trade, your stop-loss should be below 5%. Otherwise you risk losing more than $200 in a single trade and you may lose your ability of trading on margin. At the same time a trader who invest a $1,000 into a trade and who has $100K on the account could be ready to lose all 100% of the invested money (all $1,000).

5. Stock Market: The market condition is the most important factor that many traders skip. The market has periods of different volatility. During a steady uptrend, as a rule, the market is less volatile than during a recession and the market is extremely volatile during a stock market crash. It is logical to adjust a stop-loss trading strategy to the market volatility. It is unusual situation when the long-term uptrend (when market is less volatile) to see bigger than 2% DJI index moves within a single session. Furthermore, a short-term DJI trader would be looking for tighter than 2% stop-loss. At the same time, during a recession when market is more volatile the odds are very good for bigger than 2% DJI moves up and down within a single session and the same short-term trader, who is brave enough to trade in volatile market, could be willing to consider less tight stop-loss.

As you see stop-loss selection is not as easy as it seems from the first view. A lot of factors should be considered and there is no straight answer. Each trader has to find it out by him/herself. A trader should not copy any other trader - what works well for one trader does not necessary will be good for another trader. You can and you should look what other traders do, but not mimic them. If you decided to use somebody's style, learn it first and then use your knowledge to build your own trading strategy or adjust existing one to you personal trading needs. Do your own homework and do not think that your trading system is invincible and you will never have a negative trade.

Technical Analysis

Nice week. As all indicators were bullish last Friday (see my last week "Volatility" post on September 6, 2009) the stock market rallied up strongly. Now taking look at hourly charts we may see that majority of the technical indicators started to show some bearish signs:

- McClellan Oscillator declined below zero line - bearish sign;
- Stochastics and RSI dropped below 80 and 70 lines respectfully - bearish sign;
- MACD declines - bearish sign;
- Advance/Decline Oscillator declines - bearish sign;

I think closed attention should be paid to the high MVO on September 8-10, 2009. This indicates high volume activity during the price advance. As a rule such high volume could reverse a trend and we already saw slow down in up-move.

The SBV Oscillator is the only indicator that could be considered slightly bullish. It declines, yet, the SBV reading are still at high positive levels.

Overall, taking a look at technical analysis applied to the hourly charts ( see my previous posts for hourly charts setting) I cannot say that the market is very positive. In opposite, there are many signs that suggest a correction down. However, we have just had a strong rally. Taking look at the history I do not see many occurrences of sharp reversal after such up-move. As a rule, when market comes to some overbought level it is stuck at this level for a couple of trading sessions and moves side-way before a decline.

Volatility

In my previous post on August 30, 2009 ("Swing in Trading")  I have talked a lot about swing at the market open on August 28, 2009 by encouraging everybody to take a look at history to see what usually happens after such spikes in price during a side-way trading. I think, now, those who did not have chance to take a look at history understand what message I wanted to deliver. The massage was that this is important having access to historical charts. Ability to see the past gives you a tool to compare present price movement to the past, find similar patterns and act accordingly. I think the correction down we saw at the first half of this week (after my post) is the best witness of my words.

From my communications with other traders I know that many of them ignore analyzing history. The most popular way of trading is to take the most popular technical studies, apply the most popular setting and use the most popular trading strategies to generate signals. No offence, but personally I call it "gambling". With the same success you may go to casino.

The last person I communicated called himself an "experienced trader" and he was upset that a technical indicator does not work as it is told in the book… Again, no offence, but my answer is bs. This is great that people read books, go to the universities and receive education. However, real life, real job and real trading differ a little bit from what you read in a book and study in the university. Books and university gives you general knowledge and basic tools. However in real life, on real job in real trading you have to adjust what you learned, improve it and learn how to use it on practice. If you do not do it then you always going to be upset that a technical indicator does not work as it is told in the book and blame everything around in bad trading signals.

Most technical indicators were introduced 20-30 years ago, when nobody had access to intraday data and intraday charts. Most of the mentioned in the books setting for technical studies are for daily data and long-term trading. It is not a good idea to use the same indicators setting in intraday trading. It simply does not always work. When you look at 10-year chart you may ignore the market volatility because in 10-year frame you see market decline, market crash, recovery, up-trend, etc. Basically, you see different markets with different volatility in one time-frame. When you dig into intraday charts you cannot ignore volatility. On intraday levels, price trend acts differently in down-trend (high volatility), during the crashes (extremely high volatility), recoveries (middle volatility) and up-trends (low volatility). Respectfully, on intraday level a technical indicator setting should be adjusted in accordance to the market condition.

The simplest way of adjusting a technical indicator to the current market is

1. Find in the history periods with similar to the current market volatility and similar longer-term trend.

2. Find out what indicator setting would work best for you in those periods in history.

3. Try to apply the same indicator setting in current market.

In my understanding, the history is the strongest weapon in the arsenal of a trader and the most important component in technical analysis.

I think, I went out of my weekly posts topic. Coming back to it - see below the S&P 500 chart with the sentiment on technical studies I track. By the end of the week all technical indicators are bullish. The Nasdaq 100 and DJI technical analysis results look the same which is a good sign. There is still a room to the upper sensitive level.

The S&P 500 Chart with elements of technical analysis.