Trading on Dubai World Worries

Last week, in my "S&P 500 Advance/Decline" post (on November 21, 2009), I mentioned about very low Advance/Decline quotes readings on the S&P 500 which signaled oversold stock market sentiment. I have pointed to the higher odds of the up move at that time. The indexes (S&P 500, Nasdaq 100 and DJI) indeed reacted on that oversold signals by the strong up-move on November 23, 2009. However, this gain was shadowed by the "Dubai World financial worries" that hit the market and pushed it strongly down on November 27, 2009.

I would say that on my opinion, there are two good and two bad things about this sharp drop down. The Friday's decline at the market open is one of the strongest declines within a single session since the end of recession (March 2009). This is the first bad thing - it shows us that the stock market is on the stage when it could become unstable very easily and that the sentiment among investors is not as bullish as it was 6 months ago. Actually, it confirms my conclusion expressed in the "Long-Term Technical Analysis" post on November 17, 2009 that the stock market is not the same as it was 6 month ago.

Strong decline on November 19, then strong advance on November 23 and then strong decline on November 27, 2009 - all of that suggest an increase in the volatility and that is not very good (second bad thing). If you take a look at volatility indicators (VIX index, ATR, Standard Deviation, etc) you will see that the volatility is still at low level which is good. Yet, should volatility continue to increase we could face a possibility of a correction down.

The first good thing is that the indexes have been very little time at their lowest level on Friday 27, 2009. The Nasdaq 100 index started to move up on the second minute of trading, the S&P 500 index reversed up after only 2 minutes of decline and DJI index has started to recover in ten minutes after the market opened. It looks like (it is an assumption only) on Thursday November 26, 2008 (when the "Dubai worries" started to spread out) a lot of bullish traders (investors) who were in long position have placed stop-loss orders, those of bullish traders who were in cash have canceled their buy orders and bearish traders placed sell orders. After the market open on Friday, it took about 10 minutes to satisfy demands of all traders who were in panic (who placed stop-loss order and who placed sell short order) and execute their orders. Then, those bullish traders who were in cash and decided to cancel "Buy Long" orders on Thursday, on Friday's morning were attracted by low barging price and started to buy by overbuying "bearish traders in panic" and by pushing stock market up. If the first bad thing is that we have big group of investors whose sentiment is unstable and who could push market down, the first good thing is that we still have a lot of traders (investors) who is looking for a good bargain price to buy.

The second good thing is that during the recovery on Friday we had very strong volume, especially taking into account short trading session. I would say it could tell us that the number of investors trying to buy at low is quite big.

Overall, the stock market is in sideway trading since November 11, 2009 - it is very clearly could be seen on the S&P 500 chart. The upper sideway trading line is going through the highs on November 16, 23 and 25 and the lower sideway line goes through lows on November 13, 19, 20 and 27. By not going deeply into technical analysis a conservative trader may say: let's wait when one of this line is broken and stock market trend is defined more clearly.

In general I'm still slightly bullish by the following 3 reasons:
 - over the last 2 week we had 3 times very low oversold advance decline readings;
 - volatility is still low, yet it very close to the the dangerous level;
 - on Friday the indexes have break lower line of sideway trading, yet they climbed back above it very fast and did not continued to decline.

Despite the fact that I'm slightly bullish the danger of a strong move down is quite big...

S&P 500 Advance/Decline

Last week in my "Technical Analysis" post on November 15, 2009 I have expressed a possibility of a correction down. Yet, at the same time, I have mentioned that I would not wait for a strong move down, but rather for a short-term decline. Now, after 3-day decline on November 18-20, 2009 we may say that we had a shallow decline: the Dow Jones Industrial is 1.1% down from its high, the S&P 500 is 1.7% down and the Nasdaq 100 dropped for 2.6%.

I think that this is a time to check the index charts again to see if the current decline may grow into a bigger and stronger correction. Last week I brought to attention two points that would suggest only a short-term correction: a) absence of bullish volume surges during the November 2-13, 2009 up-move; b) low volatility. Taking look at the same indicators one week later, I may say that we still have not seen any high volume during the price advance (MVO remains at zero), and in addition, even the last three day of negative trading did not bring any increase into volatility (ATR and VIX index remain at the same levels they were a week ago). So, these two factors would still suggest that the current correction should be a short-lived only.

Now, taking a look at other indicators I may say that technical analysis is mostly bearish: SBV is flat and negative, Advance/Decline Oscillator and McClellan Oscillator are at low negative levels, Stochastics is below 20. All of that would suggest higher odds of further decline. There are still a few positive signals: RSI just crossed 30 line on its way up and MACD is close to move from negative into positive area. The other positive sign is high volume during the price decline on November 20, 2009 (see red MVO), yet it is difficult to say that this was a strong bearish volume. Overall, technical analysis is bearish at this moment.

Despite the fact that technical analysis is bearish I would still stay on the same note I was a week ago - current decline may not be a strong. Furthermore, I would not bet on short trading. One more factor that gives me more confidence in not believing in strong decline is very low advance/decline quotes on the S&P 500 on November 19, 2009. I have already mentioned in my "Advance/Decline" post on November 1, 2009 the importance of the S&P 500 advance/decline issues and volume quotes monitoring. The low advance/decline readings in the S&P 500 index suggests strongly oversold condition that usually could be seen before a reversal up (unless it is a recession or stock market crash). We had low advance/decline quotes on October 28 and 30, 2009 and strong up-move after that. At that time, on November 1, 2009 I pointed to good odds of the up move. The same is now, because of the very low Advance/Decline quotes reading in the S&P 500 sector on November 19, 2009 I would consider that the odds are good that up-move may be resumed in near future.

I am sorry I have not brought chart snapshoot this time. You may see the chart setting I usually use and indicators I mentioned above in my "S&P 500 Chart" post. I would highly recommend checking charts and quotes by yourself before relaying on anything I say.

Long-Term Technical Analysis

As was promised in my previous "Simple Trading Strategy" post, I am bringing to your attention some points from my personal longer-term technical analysis.

Various techniques are used to analyze the stock market long-term trend. Some analysts focus on 5-year to 10-year charts, others focus on economic factors, etc. I would like to draw your attention to the interesting on my opinion fact that could be seen on daily charts (1 bar = 1 hour).

In the S&P 500 chart below (the Nasdaq 100 and DJI charts are very similar to the S&P 500 chart), you can see that the stock market has been in a recovery movement since the first half of March, 2009. This is when the "2008 Stock Market Crash" ended. Since then, the stock market has been in a steady upward movement, interrupted by shallow corrections from time to time. If you take a look at these corrections, you will see that the further from the bottom indexes (S&P 500, Nasdaq 100, DJI and other indexes) are, the smaller are the overbought signals that are required to push the stock market into a downward correction. You can see that this divergence between price's new highs and technical indicators (price makes new highs, but smaller, overbought indicators signal a correction) on the S&P 500 chart below on SBV, Stochastics and RSI. I think that you may find the same tendency with other technical indicators as well.

The S&P 500 Chart with elements of longer-term technical analysis

Such divergence between price and technical indicators is nothing new in technical analysis. You can see something similar more often in smaller timeframes. It usually can be seen before a stronger change in a market trend. That means that the stock market is not the same as it was six months ago when a majority of shorter-term, overbought signals were ignored, while indexes continued their rally. I am not saying that the market will crash tomorrow - not at all. The indexes and the market may continue to move up. What I want to say is that the market may become predisposed to a change in its behavior.

If this divergence between new price highs and technical indicators continues to develop in the same direction, there could be several possible scenarios: we may face a stronger downward correction than we saw and then the recovery may continue; we may go into a sideways market like we were in during 2004 after a strong recovery in 2003 that followed the 2000-2003 stock market crash; we may fall into a slow depression like there was after 1929 crash; or there could be something new.

There is still another possible development. In the same S&P 500 chart above, you can see that we had two waves of divergence between price and indicators where the second wave was smaller (less Bullish) than the first one. There is a possibility that a third wave of divergence might develop that could be smaller than the second one.

Another factor that could support the above-mentioned possibility of changes in stock market sentiment is timing. It soon will be a year since the recovery began. That means that the period of "expectation beating reports" could be over very soon. During the crash in 2008, many public companies reported losses and, by the end of 2008, everyone had lowered their expectations. Furthermore, in 2009 everyone has had "expectation beating" reports that have attracted investors and money into the market and which feed the recovery. How many companies do you think will report an "expectation beating" increase in profit in 2010 in comparison to 2009? If not many, other economic factors (unemployment, sales, GDP, borrowed money from China, etc) may begin to play roles in the market's direction.

I don't want to dig deeply into a fundamental analysis of the economy and economic factors that move the long-term market. I just want to say that I see some predisposition to changes in long-term market sentiment and market behavior. Since I am not a long-term trader, I am not going to attempt to predict where the market will be in six months. What I'm trying to define right now is where the market may continue its move. Will it move up by going into a third wave of divergence or will it begin to change its trend direction? I think it could become clear by simply monitoring higher-timeframe index charts within the next couple of weeks.

What affects me is how the market reacts to the overbought and oversold signals and how I should adjust my trading strategy in order to avoid encountering an unpleasant situation. If I see that the market starts to react differently to trading signals generated by my technical analysis (my trading system), I usually take a look at longer-term index charts to see the general market stage. Right now, I am looking a little ahead. The indexes (S&P 500, Nasdaq 100, DJI and other) still move up more easily then dropping down and we still may see new highs and further upward movement. Yet, from a prospective of my technical analysis, I see that we are in a period in which the stock market could become predisposed to changes in the long-term trend.

Simple Trading Strategy

A few weeks ago I promised to take a look at the longer-term charts and longer-term technical analysis. I think it's time to check the general stock market trend. It is my strong believe that a trader, no matter what he/she trades, has time on time to apply technical analysis to the longer-term index charts (Dow Jones Industrials, S&P 500, Nasdaq100 charts) and to evaluate the current stock market stage in order to adjust or change used trading strategy.

A trader can develop and have permanent trading system (set of technical indicators and rules that generates trading signals). Yet, if a strategy of using this system is not adjusted to the general stock market stage then, no matter how good a trading system is, this trader risks to face the system failure sooner or later. The stock market is a live creature. It is in the constant move, it is in the constant change and it is in the constant adapting to the new trading rules, to the new generations of traders, new values of the society, etc. If you are looking for some "Golden Trading System" that require no studying, no monitoring, no work, but just sitting on the couch and calculating a profit then instead of becoming a trader you should spend your money on beer and recreations - at least you receive emotional satisfaction.

There are several examples of simple trading strategies that adjust a system to the longer-term stock market trend. I just want to mention a few of them as a reference to my point of importance of longer-term technical analysis.

Simple Trading Strategy Example #1:

If the longer-term trend could be defined as an up-trend then the strategy of using trading system can put more weighting on "Buy" signals:

• ignore weak "Sell" signals and trade only strong and confirmed "Sell" signals to open a short position;
• trade all "Buy" signals, including the weak ones;
• have a tighter stop-loss strategy when short trade is opened;

Controversially, when the longer-term trend could be defined as a down-trend a trading strategy of using a system could be emphasized on using "Sell"’ signals

• ignore weak "Buy" signals and trade only strong and confirmed "Buy" signals to open a long position;
•  trade all "Sell" signals, including the weak ones;
•  have a tighter stop-loss strategy when long trade is opened;

If the results of the analysis show that the stock market is in a sideway move then a trader may apply equal weighting to "Buy" and "Sell" signals – treat them in the same way.

Simple Trading Strategy Example #2:
(even simpler than the previous strategy)

Stop trading and stay in cash when the longer-term stock market trend could be defined as down-trend and go back in to the stock market when the stock market is in the up-trend.

Selection of a trading strategy depends on what you trade, how you trade (how many trades you made) and how much you trade (how much you invest into a trade). It is essential time on tine to take a look on the general market picture and see where the longer-term trend is going. If you have longer-term technical analysis behind your trading strategy then the odds your trading system is successful are much higher.

In my next post I'll try to show my personal view on the longer-term technical analysis with a reference to theS&P 500 chart.

Technical Analysis

In my last "Trading Strategy" post on November 8, 2009 I have mentioned a possibility of the indexes (Nasdaq 100, S&P 500, DJI, etc) stacking in a sideway action at their October's high levels. The next day, on Monday November 9, 2009 we still had a strong advance and since then the rest of the week we may see that the indexes have been trading mainly sideway (see the S&P 500 chart below): the S&P 500 index exactly at its October's high levels, the Nasdaq 100 index a few points higher and the DJI index has made new 13-month high.

The S&P 500 Chart with elements of technical analysis:
Selling/Buying Volume Oscillator, Advance/Decline Oscillator, MarketVolume Oscillator,
MACD, RSI, Stochastics, McClellan Oscillator, Average True Range in Percents.

In technical analysis it is common to take a look at the history, and from the history you may see that in majority cases sideway trading at new high level ends with a correctional move down. As a rule during this sideway trading you may see strong bearish signals. If you take a look at the chart (S&P 500 chart above) you would see that on Thursday, November 12, 2009 all technical indicators (except volatility indicators) have generated strongly bearish signals. Yet, on the next trading day (Friday, November 13, 2009) the indexes bounced up from their lower level of the sideway corridor (see the same chart above).

Last week I mentioned: "At that time (in September and October) the indexes have been moving sideways for several trading days … we may see some sideway action at this level again ... If the market starts to move sideways the odds are high that the technical indicators will become bearish." That is what we saw on charts: sideway move and bearish signals on Thursday. However, in the same post I have brought some reasons why I would not consider these bearish indications as strong signals, and why I would rather consider waiting. There were two main reasons why I would avoid trading short at that moment: a) no high volume during the up-move and b) no increase in volatility.

Absence, of high volume during up-move indicates that this up-move was not strong enough to generate greedy buying when investors start to rush into the stock market with the hope to jump into "the last wagon of the running train" - as a rule such action leads to a misbalanced in the supply/demands and at least to the short-term correction down. Absence of increase in volatility indicates that the current sideway move did not generated any panic among traders which suggest there were no increase in the number of bearish traders as well. These two reasons kept me last week from trading short, and the same two reasons still keep me out of it.

Right now technical indicator on the major index charts (S&P 500, DJI and Nasdaq 100 charts) are mixed. You may see Bullish indicators as well as some indicators remain bearish:

 - SBV (Selling Buying Volume) Oscillator is moving sideways at this moment which is a neutral sign. Yet, the bullish volume (accumulated since November 4, 2009) still could be considered as a force which is strong enough to push the stock market down into a correction.

 - The absence of the Bullish volume surges (no green MVO) suggests the higher odds of further up move.

 - The advance/decline oscillator is almost flat, yet, it moves up from its most recent low which could be considered as modestly bullish signal.

 - The same as A/D Oscillator, MACD is almost flat, yet, it is moving up from its recent low which is bullish sign, on the other hand it is still in the negative area which could be considered as bearish sign. Overall, MACD could be considered bearish with tendency to become Bullish.

 - General RSI direction is down and this is bearish sign in technical analysis.

 - General Stochastics direction is up and this is a bullish sign in technical analysis.

-  McClellan Oscillator is still in the negative territory which is bullish, yet, it is very close to cross the center (zero) line which in technical analysis is considered as a "Buy" signal.

 - ATR remains on the same level and this is very nice indication (as already mentioned above) of bullish sentiment."

Overall, I would consider technical analysis mixed at this point of time. There is still an existence of a danger of a correction down. At the same time, some technical indicators push me to believe that even if we see a correction it should not be a very strong move down, unless I see at least changes in volatility sentiment (increase in volatility). At the same time indication of resuming of up-move are not strong enough to be strongly Bullish.

I am not stating that I am always right, and that my technical analysis is perfect. I am just trying to share my thoughts about current stock market sentiment and possible development of a future market trend. It helps me to put my thoughts in the order and I hope it may help somebody in avoiding a mistake that can become "financial suicidal". I would rather recommend doing your own technical analysis and checking all my statements by yourself before even considering to follow them.

Trading Strategy

Those who follow my blog should remember what I said a week ago in the "Advance/Decline" post on November 1, 2009: "Yes, if we take a look at major technical indicators (beside volume and advance/decline) we will see that almost all of them are bearish and suggest the higher odds of further decline. However, I would not be very sure in this and personally I do not hold any short position right now. Yes, we still may see some decline, however based on my experience working with volume and advance/decline data I would consider possibility of coming reversal and I would monitor index charts more closely for bullish signals that may confirm my analysis."

Now, you may see that indeed extremely low advance decline readings in the S&P 500 index indicate coming reversal and uptrend. If you take look at the hourly index charts (S&P 500, Nasdaq 100 and DJI) you will see that already on Monday November 2, 2008 by the end of the trading session MACD and Stochastics have became Bullish, shortly after the market open on November 3, 2009 Advance/Decline Ratio and RSI became Bullish and by the end of the trading session on the same day McClellan Oscillator and SBV Oscillator indicated Bullish sentiment.

Strong up move during the rest of the week has pushed S&P 500 and Nasdaq 100 indexes to their high levels on September 17-23, 2009 and DJI index to its high on October 16-22, 2009. At that time (in September and October) the indexes have been moving sideways for several trading days. Furthermore, I would say that we may see some sideway action at this level again. Actually, we already started to see slowdown in the recent rally up and some of the technical indicators started to show tendency to become bearish. If the market starts to move sideways the odds are high that the technical indicators will become bearish. However, personally, if this is a case and technical analysis starts to generate bearish trading signals I would not wait for a strong correction. There are several main reasons why:

 - The recent correction has generated high volume surges at its support level, yet we have not seen any increase in volume during the resent recovery. Furthermore, I may say that the recent recovery did not generated waves of greedy buying which could change a supply/demand balance.

 - The market becomes less volatile which could be clearly seen on the VIX index (volatility index) decline. As a rule a decline in volatility suggest that the market becomes more stable and higher odds of up-move.

 - During the recent decline we saw twice the S&P 500 hitting extremely low advance/decline readings (on October 28 and October 30, 2009). This suggests that the marker became strongly oversold at its support level. So far I do not see any indication of market becoming overbought.

Overall I would say, yes, if technical analysis starts to generate bearish signals we may see some sideway move and even a correction; however I would not consider the bearish trading signals as a reason to open a short trade in the current market stage. One of the conservative and safe trading strategy when the longer-term trend could be defined as bullish could be described in two simple rules:

Rule #1: Open a long trade when you see Bullish signals;

Rule #2: Stay in cash and wait for Bullish signals when you see Bearish signals.

Advance/Decline

In my previous "Advance/Decline and Volume" post on October 26, 2009 I have expressed that from the point of my personal technical analysis I see a dominance of Bearish market which was confirmed by decline on the stock market during this week. In the same post I have mentioned that I do not know when to expect a reversal, yet, I have pointed that I would monitor indexes (Nasdaq 100, DJI and S&P 500) for high volume surges during the price decline and the S&P 500 index for low advance/decline readings.

Actually we had very low advance/decline volume and issues ratio reading on the S&P 500 index on October 28, 2009. However on that day the critically low Advance/Decline readings were not supported by high volume. Still we had strong bounce on the next day (on October 29, 2009), which looked very promising, yet on Friday October 30, 2009 we had record decline again.

October 30, 2009 is an interesting day. On that day we had high volume on all major indexes and advance/decline volume and issue ratios have dropped to critically low readings again. (You may see the S&P 500 index advance/decline reading at
http://www.marketvolume.com/quotes/advance_decline_sentiment.asp?s=SPX). These two factors suggest that there is a possibility that the market become oversold. In this case volume and advance/decline indicators perform as leading (trend-predicting) indicators that suggest a possibility of a reversal. Yes, if we take a look at major technical indicators (beside volume and advance/decline) we will see that almost all of them are bearish and suggest the higher odds of further decline. However, I would not be very sure in this and personally I do not hold any short position right now. Yes, we still may see some decline, however based on my experience working with volume and advance/decline data I would consider possibility of coming reversal and I would monitor index charts more closely for bullish signals that may confirm my analysis.

As a rule the indexes always react on high volume and low advance/decline data during the price decline by a reversal. There could be occurrences when it could be ignored, however it usually happens during the longer-term recessions or during the stock market crashes. I do not think that the logger-term market is in any of those stages right now. Furthermore, despite bearish signals on many indicators I would rather stay in cash and wait for some bullish signals that may confirm my analysis.

In one of my next post I will try to show my thoughts about longer-term trend. I think, now, the stock market is not the same as it was six month ago and I think it could be interesting to take a look at longer-term index charts (S&P 500, DJI and Nasdaq 100 charts) to see the general tendency of the market movement.