Increase in Volatility

It was a volatile week. Strong opening on Monday, then tree negative sessions in a row (Tuesday-Thursday) and then again strong opening on Friday which basically made the past week positive. Even the Tuesday-Thursday's move down is quite shallow it is the strongest one since the beginning of September.

I'll try to be short this time. From one side my technical analysis suggests that the indexes are overbought and we may see some strong move down in the future. From other side we still did not see any confirmation signals of beginning of such move. Additional negative sign is that the past week has brought increase into volatility on the longer-term chart.

My expectation from the coming week are neutral. If we do not see strong decline on Monday, then I would expect to see side-way trading. Even if we see decline, I would expect the indexes be above September 23's low in side-way action.

Index Trading

side-way trading on the S&P 500 and DJI indexes and eight straight in a row positive trading sessions on the Nasdaq 100 index - this is what we have by the end of the week. There is quite different picture on other indexes. As an example, the Dow Jones Utilities (^DJU) index is already in the correction down since September 9, 2010.

Overall, we have not seen negative moves on main market indexes over the past week. However, the same as I mentioned in my few previous posts, I would say that intensity is growing.

Some points to consider, which I think are important.

• The advance/decline issues and volume ratios are moving down on all three indexes (Nasdaq 100, DJI and S&P 500). On the DJI and S&P 500 indexes the advance/decline ratio is already negative. This indicator tells that the majority of stocks are already in decline. The indexes are not down because of the strong earnings reports and strong moves on some big companies (one company make 5% up and five companies make 1% down each - you have index flat).
•  We had big bullish volume surges on many indexes over the past couple of trading sessions. The strongest bullish volume surges were noted in the insurance and internet market sectors. Such surges indicate that big institutional traders make a decision to fix profit at the top and sell big number of shares to greedy retail investors. Personally, I would stay away from the investing into insurance companies, especially by knowing that the Government is putting hand on the health insurance which will take away some profit from the insurance companies.
•  Taking into account big bullish volume accumulation on many indexes over the past two weeks, the stock market could be considered overbought. The indexes (Nasdaq 100, S&P 500 and DJI) did not have any noticeable correction over the past two week.
•  We have negative divergence on many technical indicators - when the price moves up and make new highs yet an indicator does not make new highs. As a rule this suggests changes in the stock market sentiment.
•  All over the media you may hear positive news, like there are no negative news at all - this is a negative sign for me. I consider it like attempt to manipulate sentiment of small traders and make them buy while "big boys" (who invest big and who express opinion on news) are dumping.

Some positive signals

• Longer-term volatility is down - this is a positive sign.

In summary, I would say that that technical analysis suggests that the market is predisposed to move down. Some indexes and market sectors are already in decline, yet, main market indexes are still at the top. My opinion is that we may face bearish trend, yet I could be wrong. If the market is predisposed to move down it does not necessary mean it will go down - we still may see side-way trading. A conservative trading strategy could be waiting for confirmation signals before investing.

P.S. Some interesting quote from the news - something negative that is not strongly highlighted in the media: "Regulators on Friday shut down three Georgia banks and one each in New Jersey, Ohio and Wisconsin, boosting to 125 the number of U.S. bank failures this year … The number of bank failures is expected to peak this year and be slightly higher than the 140 that fell in 2009. That was the highest annual tally since 1992, at the height of the savings and loan crisis. The 2009 failures cost the insurance fund more than $30 billion. Twenty-five banks failed in 2008, the year the financial crisis struck with force; only three succumbed in 2007."

Intensity is growing

Seven trading sessions in a row the Nasdaq 100 have been positive. The rest of the indexes are forth session in a row in the side-way move. Intensity is growing...

Advance/Decline ratios on the S&P 500 and DJI are already negative...

Nasdaq 100

The indexes continue to move almost flat, with exception of the Nasdaq 100 index. It looks like the indexes are ready to go down, yet they wait until the Nasdaq 100 collect more overbought power.

The are two interesting thins happened today.

We had extremely strong volume surges in the Nasdaq Insurance and Nasdaq Internet market sectors. Keep in mind that this is sixth positive trading session in a row on the Nasdaq 100 index. These surges in the Nasdaq sector indexes would push the Nasdaq in stronger overbought condition.

Another point worth mentioning is very low volatility by the end of today's session on all indexes. I have already mentioned several days ago in the "Volatility Down" post (on September 9, 2010) that such drop in volatility is considered as "The Squeeze" and very often noted before sharp and strong swings. In addition, such low drop in volatility is very unusual in period of futures expiration - this Friday we have options expiration, futures expiration and index options expiration ("Triple Witching Week").

Increase in Volume

As I mentioned two days ago "sharp drop in volatility (also known as "the Squeeze") could be nicely seen on Bollinger bandwidth on hourly chart. Such Squeezes to the volatility lowest levels are usually noted before strong and sharp moves." - we had yesterday strong and sharp up move.

Another point that is worth mentioning is an increase in daily trading volume (nicely seen in the Nasdaq 100 sector) over the last three trading session. While technical analysis continue to remain bullish it could be "too close" to the "to late" to open a long position. At the same time it would be too early to play short.

DJI, S&P 500 and Nasdaq indexes have hit their resistance levels seen in the middle of June and at the beginning of August 2010. The indexes bounced twice from the levels they are right now and there is a possibility we may see the third break down. Still, it could be nice to see a couple of sessions of side-way trading prior to that.

Volatility Down

As I mentioned in my previous post ("Trading Strategy" post on September 5, 2010): "it is still difficult for me to believe in strong recovery (Yet, I could be wrong). Because of that I would not be playing long at this moment. At the same time there are no bearish signals and because of that I would not be playing short either" - the past week has gone mostly under side-way pattern with some positive bios.

By taking look at technical indicators, I may say that majority of them continue to be bullish and suggest possibility of further development of up-move. However on many technical indicators you may notice negative divergence - when price makes new high, yet an indicator does not makes new highs. Such divergence in technical analysis usually signals change in the sentiment with possible reversal in the near future.

Another point worth mentioning is that the volatility has dropped over the past week. While volatility still remains high on daily charts (1 bar = 1 day and higher time-frames), on lower time-frame charts (hourly charts and lower) we may see substantial drop in volatility. Overall this could be considered as a positive sign. At the same time sharp drop in volatility (also known as "the Squeeze") could be nicely seen on Bollinger bandwidth on hourly chart. Such Squeezes to the volatility lowest levels are usually noted before strong and sharp moves.

The third point I would like to drag your attention to is that the indexes (S&P 500, Nasdaq 100 and DJI) came close to the resistance levels seen in the middle of January 2010, in the middle of June 2010 and at the beginning of August 2010. No doubt that this level is sensitive to mid- and long-term traders and mostly their sentiment would define the further trend.

Overall, I would say that we may see some strong moves in coming days. Because of the negative divergence and overbought indications on the shorter-term charts, I would expect to see some correctional move down. Since we do not see strongly overbought indications on the longer-term charts, it is difficult to say at this point of time whether this correction (if it occurs) could grow into stronger down-move.

Trading Strategy

Last week in my "Side-Way Trading" post I mentioned about a possibility of short-term up move, yet, I was skeptical about strong up-move. It appeared to be that I was wrong. We did have a strong up-move. One more time the stock-market has proved that sooner or later everybody makes mistakes in analysis and stop-loss strategy should be used not just to cut losses but to protect profit as well.

During the last four positive sessions the indexes (Nasdaq 100, S&P 500, DJI, etc) have come close to their June's and Augusts' high levels. So far, the odds are good (from technical analysis prospective) we may see the indexes third time at those levels. Twice the stock market (indexes) has bounced down from these levels and most likely we may see slow down again.

Majority of technical indicators continue to be bullish and as I already mentioned, the technical analysis suggests that we may see the indexes moving higher. There are only two negative sings from my point of view.

First thing is high volatility level. The stock market continue to be highly volatile and this is a bearish sign. In such volatile market we could have strong down move in the same short period of time as we had the current 4-day up-run.

Second negative thing, from my point of view is that the market was not strongly oversold, yet it did make strong up-move in short period of time. It is more like some institutional investors came back from vacations, they saw stocks cheaper than a month ago and they started to buy. What is going to happen when their buying power became exhausted?

Because of these two points above, it is still difficult for me to believe in strong recovery (Yet, I could be wrong). Because of that I would not be playing long at this moment. At the same time there is no bearish signals and because of that I would not be playing short either.

One of the rules in my trading strategy is staying in cash until I see a pattern. I missed the last up-move - I did not lose money on that, I just did not make as much as I could. Still, the fact is that I missed this move and now it is better to stay in cash in order to avoid another mistake. My view on the current stock market condition is that I would expect to see indexes at their June's and Augusts' high levels. Then, depending on how those levels are hit (is they are hit) I would built further analysis.