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GOLD STOCKS TOP 200-DAY AVERAGE

The Fed's midweek surprise announcement that it was buying Treasury bonds had a fairly predictable ripple effect through the various financial markets. Naturally, Treasury bond prices jumped and yields collapsed. The big drop in bond yields pushed the dollar sharply lower and commodities higher. As Arthur Hill described during the week, gold experienced an impressive upside reversal and may have reverted back to an inverse relationship to the dollar. One of the top stock groups on the week was precious metals. A month ago, I turned cautious on the short-term outlook for precious metals when the Market Vectors Gold Miners ETF (GDX) fell back below its 200-day moving average. Chart 1, however, shows the GDX closing well above that resistance line and on the verge of a new six-month high. That puts precious metal assets back in the fast lane. The main reason for the jump in gold and other commodities is the belief that a weaker dollar resulting from the Fed's printing of so much money will increase inflation pressures. One way to hedge against that possibility is to own some precious metal assets. Another way is to own some TIPS.

FOCUSING ENERGY ON COMMODITIES

The FOMC has now become very serious to put an end to the financial crisis. To put it simply, Wednesday's FOMC  announcement that they plan to roll the printing presses in order to buy $200 billion in longer-dated treasury paper is certainly a "positive." This will no doubt create more inflationary tendencies than we care to talk about, for the FOMC will be forced to buy far more in treasury paper than
anyone believe, so let's just call this the FOMC's "initial position." The fact of the matter is that it will be positive towards the commodity markets; and this is where we should focus our energies.

If one wants to get exposure to commodities other than through a futures contract, one can use the DB Commodities Index ETF (DBC), which includes the energies; the grains and other stuff the index is
made out. Moreover, we find that given this fundamental positive for the commodity markets, we also find that the technicals are syncing up with them as well - meaning the risk-reward dynamic favors being long
DBC now and on pull backs for the foreseeable future.

In particular, we are interested in fact prices moved to new lows and then rallied sufficient to breakout above trendline and 50-day moving avearge resistance levels, and did so not less on a "breakaway gap
higher." In our opinion, this is a powerful combination that should lead to mean reversion to overhead trendline resistance at $27.50, or even perhaps the 250-day moving average currently crossing at $31.00.
Given that DBC is currently trade at $21, we would only risk $2 to $19; thus the risk-reward is clearly skewed towards "reward" at this juncture.

Good luck and good trading,
Richard

LIGHT AT THE END OF THE TUNNEL?

The market performance the last two weeks was very impressive.  Was it simply a sequel to the bounces we saw in October and November?  That is certainly a possibility, but we saw a few sparks in this rally.  For instance, the volume that exploded in financials must be respected.  Perhaps more important, however, was the relative breakout in financials as shown below:

 

On the surface, the annihilation of financials on Thursday and Friday seemed to potentially crash the party.  I'd like to point out, however, that option expiration likely played a significant role there.  Let me give you a perfect example - Bank of America (BAC).  At Thursday's early morning high, BAC traded at 8.57.  There were hundreds of thousands of in-the-money calls ranging from strike prices at $3 all the way up to $8.  There were nearly ZERO in-the-money put options.  That left BAC quite vulnerable to downside action on Thursday and Friday and that's exactly what we saw - downside action.  BAC fell nearly 30% from Thursday morning's high to Friday's close, erasing $MILLIONS in net call premium.

Use this as a lesson.  If you're considering buying a stock during options expiration week, check out the underlying option activity.  Specifically, look to see how many in-the-money calls vs. in-the-money puts there are before taking a position.  More often than not, it will save you or make you money.

It was probably more than coincidental that Citigroup (C) didn't participate in Friday's financial selloff, instead gaining two pennies.  Max pain (the price at which in-the-money calls equal in-the-money puts) was situated between $2.50 and $3.00 and there were a TON of in-the-money calls at $2.50 to offset in-the-money puts at higher strike prices.  So it closed above the $2.50 level.  Coincidence?  You be the judge.

In addition to financials beginning to show relative strength, semiconductors also joined the fray.  In fact, we've seen semiconductors outperforming the S&P 500 since early December.  Check out the chart below:

 

Financials and technology (especially semiconductors) are two key components in any new bull market emerging.  Early signs are pointing to a possible reversal in market strategy.  For the last several months, it's been clear that the bear market was raging on.  While it's important to note that the end of the bear market has not yet been confirmed, the possibility is definitely growing.

SPY HITS RESISTANCE

After a sharp advance the last two weeks, SPY hit a classic resistance zone and pulled back over the last two days. Three items confirm resistance in the low 80s. First, broken support around 80-81 turns into resistance. Second, the falling 50-day moving average marks resistance. Third, the advance retraced 50% of the Jan-Mar decline, which is typical for a retracement.

In addition to resistance, there were also signs that SPY was overbought. The bottom indicator shows the Commodity Channel Index (CCI) moving above 100 for the third time this year. The first two overbought readings marked the early January peak and the early February peak. Also notice that the 7-day Rate-of-Change surged above 17%. This was the biggest 7-day surge in over six months. While such a sharp advance shows strength, it also reflects overbought conditions.

Overbought conditions can be alleviated with a correction or consolidation. SPY could retrace 38-62% of the prior surge with a pullback or we could see a choppy trading range evolve to consolidate the gains. Either way, it looks like the market is ready for a rest after such impressive gains.

There is also a video version of the this analysis available at TDTrader.com - Click Here.

NEW LOOK, NEW FEATURES, NEW NAME FOR OUR MARKET MESSAGE SERVICE

Today we're unveiling several design changes to the "John Murphy" area of our website.  These changes include:

• A new, cleaner design that echos the look of our free commentary areas - i.e. out blogs (i.e., this page!)
• Email notifications that let subscribers see the title of each post along with the author's name without having to visit the website.
• A new name - "StockCharts' Market Message with John Murphy" that reflects our approach of supplementing John's commentary with content from Arthur Hill and others.
• A new video version of the Market Message that will debut soon.

John and I free that these changes will help Market Message subscribers get even more value for their money by increasing the amount of content that's available.  We hope you agree.

As always please let me know if you have suggestions for more improvements.

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UPDATE:  Some nice feedback on the new look has already come in -

Just a quick comment to welcome Arthur as an official commentator, with the redesign of the webpage.  I love John and Arthur both and their different styles give a well rounded look at the markets.

Nice! I can read the comments and see the chart at the same time. Much improved.

Today we're unveiling several design changes to the "John Murphy" area of our website.  These changes include:

• A new, cleaner design that echos the look of our free commentary areas - i.e. out blogs (i.e., this page!)
• Email notifications that let subscribers see the title of each post along with the author's name without having to visit the website.
• A new name - "StockCharts' Market Message with John Murphy" that reflects our approach of supplementing John's commentary with content from Arthur Hill and others.
• A new video version of the Market Message that will debut soon.

John and I free that these changes will help Market Message subscribers get even more value for their money by increasing the amount of content that's available.  We hope you agree.

As always please let me know if you have suggestions for more improvements.

---

UPDATE:  Some nice feedback on the new look has already come in -

Just a quick comment to welcome Arthur as an official commentator, with the redesign of the webpage.  I love John and Arthur both and their different styles give a well rounded look at the markets.

Nice! I can read the comments and see the chart at the same time. Much improved.

TECHNICAL ANALYSIS 101 - PART 4

This is the fourth part of a series of articles about Technical Analysis from a new course we're developing. If you are new to charting, these articles will give you the "big picture" behind the charts on our site. if you are an "old hand", these articles will help ensure you haven't "strayed too far" from the basics. Enjoy! 

(Click here to see the beginning of this series.)

Line Charts

Line charts are created by plotting a line between the closing prices for each period set on the chart.  On a daily chart, a line is plotted between the daily closing prices.  Line charts are useful to help visualize the direction of prices.  The extent of rallies and reactions in trends can also be quickly deduced. 

 

A five month price SharpChart of Apple, Inc. (AAPL) is plotted above in a line format.  Higher highs and lows are annotated with green dashes and lower highs and lows with red dashes.  Between March and mid-May 2008, the direction of prices is readily apparent with higher highs and lows.  After mid-May 2008, prices began to make lower highs and lows.

A line chart is plotted by default when only end-of-day (closing) prices are available for a symbol.  Examples of such symbols include all mutual funds and some market indices.  However, weekly and monthly price bars can be charted for ticker symbols with only end-of-day (EOD) quotes.

OHLC Charts

Open-High-Low-Close (OHLC) bar charts provide volatility information that line charts lack.  The attributes of an OHLC bar are shown below.  The chartist can evaluate volatility by the height of the bars and the conviction of the buyers and sellers by the price range between the open and close marks. 

 

For the left price bar, the CLOSE mark is above the OPEN mark indicating price ended higher for the day, known as an up day.  This price bar is considered bullish.  Bullish sentiment is present when greed for gain exceeds fear of loss and prices move higher.

With the price bar on the right, the OPEN is higher than the CLOSE indicating price ended lower for the day, known as a down day.   This is a bearish price bar.  Bearish sentiment is present when fear of loss is greater than greed for gain and prices move lower.

The SharpChart of AAPL above illustrates the OHLC format.

Notice how intraday price swings pass through the red and green reference marks made at the closing price levels on the previous Line chart.  This illustrates why line charts are useful for visualizing price direction.

OHLC Bar Colors

 

When the ‘Color Prices’ option is selected on the Chart Attributes workbench, the price bars will be colored black or red, depending on how a price bar’s closing price relates to the previous day’s closing price.  If the closing price is higher than the previous day’s closing price, the price bar will be black.  If the closing price is lower than the previous day’s, the price bar will be red.  With this convention, it is possible to have a black price bar with the close being lower than the open.

 

Colored OHLC price bars are shown in the AAPL SharpChart above.  As discussed earlier, the color of the price bar is only based on the previous day’s closing price, not the current day’s opening price.  ‘Up day’ and ‘down day’ price bars are usually black and red respectively, but that is not always the case as shown in the chart above.

Next time, we'll get into the specifics of Candlestick charts.

SHORT-TERM TOP

Quite a few years ago I used to write a daily newsletter, but I decided to give it up because it got tiresome trying to invent new ways to say the same thing over and over. More important, having to form an opinion on the market every single day, especially during volatile times as we have been experiencing, can build a of stress. Also, since I am primarily focused on the intermediate-term and long-term time frames, it can be counter productive to put too much effort into short-term analysis.

This week was especially challenging due to the Fed's announcement, which caused big rallies in stocks, bonds, and commodities, and a big decline in the dollar. Also, a number of market and sector indexes switched to buy signals. (Standby for more whipsaw.) The question remains as to whether the Fed's announcement will have a lasting effect, or if it will prove to be another flash in the pan.

On our first chart we can see that prices moved slightly above important resistance levels, but they have not made a clear breakout.

The next issue is that the market is short-term overbought. The Climactic Volume Indicator (CVI) is extremely overbought, as is the Short-Term Volume Oscillator (STVO), which hit its second highest level ever (the highest was in January). Since we are still in a bear market, chances are very high that the market has hit a short-term top, and that a short-term correction is under way.

 

On an intermediate-term basis, internal conditions are neutral, as shown by our intermediate-term breadth and volume indicators. This allows for a short correction and the resumption of the up trend; however, bear market conditions demand that we consider that a more negative outcome is possible.

 

Bottom Line: The surge in prices this week has given bulls some encouragement, but my overall expectations remain bearish.

SITE NEWS FOR MARCH 7, 2009

NEW "WHAT'S NEW" AREA - We've reworked the "What's New" area on the "Members" page so that it now shows you all of the latest posts from our various blogs.  I know that some of you just look at your charts and never read the "What's New" area but please do yourself a favor and click the "Members" tab every now and then to look for interesting articles and announcements there.

BLOGGING FOR THESTREET.COM - Our new blog "Don't Ignore This Chart!" is pretty popular.  So popular in fact that it has been picked up by TheStreet,com's new website, StockPickr.com!  If you haven't checked it out, click here to see a collection of articles on charts with "interesting" technical developments.

MORE STEP-BY-STEP TUTORIALS - We're continuing to add more tutorials to our Step-by-Step area.  Or first two were about how to create charts with multiple stocks on them - either overlaid or side-by-side.  Since then, we've been cranking out tutorials that can help you make sure your computer is configured correctly.  Look for more charting-oriented tutorials soon.

LOOKING TOWARDS SECTOR ROTATION

This year has seen the S&P decline by -24.3%; with the building crescendo of "fear" likely to provide for a bottom that can be traded sooner rather than later. We're looking towards sector rotation to play a large part in our trading strategy; and we're quite interested in the fundamentals as well as the technicals regarding a "long Industrials/short Healthcare (XLI:XLV)" pairs position. Quite simply, the Industrials have underperformed the S&P by -10.2% YTD, while Healthcare has outperformed by +7.5% YTD - this notes the obvious safety factor inherent in the Healthcare sector given its "less volatile" nature. However, the Obama Administration's tackling of the US healthcare system has sent XLV prices lower in the past two weeks. Moreover, there will likely be pressure upon XLV for the foreseeable future as Healthcare "safety" becomes a source of funds for those stocks - such as the Industrials - that have been beaten down. This is the fundamental argument.

Technically speaking, the XLI:XLV ratio has fallen rather precipitously in the past year from above 1.20 to a new low at 0.70; but it is precisely this "plunge" that has put the distance below the 130-week exponential moving average at historic proportions, with the 30-week stochastic falling below the oversold 20-level. We are mean reversionists at heart; and given this distance and the prior instances of the 30-week stochastic turning higher - then we are very interested in putting on this trade as the risk-reward is in our favor. Now, it hasn't turned higher yet; but once a catalyst appears...we'll be doing so.

Good luck and good trading,
Richard

DOW THEORY STILL IN DOWNTREND

At the start of the 20th century, Charles Dow invented the Dow Theory. It was a simple idea. He created two stock indexes -- one for industrial stocks and one for the transports (which were exclusively rails). His reasoning was that both indexes should rise together in a healthy economy. While industrial companies made the goods, the rails transported those goods to market. One couldn't function without the other. Although he was applying that idea to the economy, his Dow Theory became a basic part of traditional technical analysis. When both indexes are rising together, a bull market exists. When they fall together, a bear market is present. Charts 1 and 2 compare the Dow Industrials and Dow Transports over the last three years. Both are in major downtrends which is bad for stocks and the economy. Although the transports turned down first in the second half of 2007, they retested their old highs in the spring of 2008 before finally peaking. The transports fell sharply during the second half of 2008 and are now trading at the lowest level since 2003 (the industrials have already broken that low). Since most attention is given to industrial stocks, I'd like to examine some driving forces behind the transportation plunge.

BREAKDOWN!

At the end of last week the S&P 500 had declined to and had settled on the support created by the November lows. It was poised to either rally and lock in a double bottom, or break down. On Monday prices broke down through support, and by Thursday's close it could be said that the breakdown was "decisive". When a breakdown is classified as decisive (greater than 3%), it means that chances are very high that the market will not be able to gather enough strength to rally back above the recently violated support. Reaction rallies back toward the support are possible, but not guaranteed.

The monthly-based chart below provides a better perspective of the seriousness of the breakdown, and we can also see the location of future support levels. The next support is at 600, at the low of the medium-term correction in 1996. I do not consider this an important support level. The first important support I see is the line drawn across the 1994 consolidation lows -- around 450 on the S&P 500.


The market is now very oversold in the medium-term and long-term, but in a secular bear market this is not a cause for rejoicing. Bear markets can crash out of oversold conditions.

Bottom Line: The S&P 500 has decisively violated important support, and the most likely consequence is that prices will continue to decline, with 600 on the S&P being the most obvious level for us to see a bounce of any significance. While we could see a bounce before then, I think we should be more concerned that the decline will accelerate into a crash. There are still investors who have endured the decline from the bull market top and who were hoping that the 2002 bear market lows would mark the end of the current bear market. Now that long-term support has been clearly broken, another round of panic selling could be just around the corner.

WHERE'S THE FEAR?

Significant market bottoms generally share many key characteristics.  I like to see a spike in volume to get that last wave of selling in place.  During this "panicked" phase, it's also important to see pessimism rise to a relative level where we can be fairly confident that a rally can last more than an hour or two.  Obviously, oversold momentum oscillators like stochastics and RSI are in play at a bottom.  My favorite momentum oscillator - the MACD - can provide clues as to the duration of any potential rally.

On the Dow Jones chart below, notice that the MACD is pointing straight down on the daily chart.  It's unusual to see a long-term bottom form when momentum is so negative.  So at this point, if the pessimism ramps up to a point where a bottom forms, I'd only be looking for a short-term rally to follow.  In order to see a more sustainable rally ensue, I need to see this momentum slow and begin to reverse.  That's where long-term positive divergences come into play.  The market showed much more stability after the November lows and the positive divergence formed on the daily chart.  Check out the Dow Jones chart below:

 

While I acknowledge that market bottoms can be carved out without extreme pessimism, this type of pessimism usually does form during emotional markets.  I would certainly be much more confident about trading a rebound in the market if the pessimism reaches an extreme level first.  On the S&P 500 chart below, I've highlighted recent market bottoms, the 5 day moving average of the equity only put call ratio at that time, and the subsequent gains realized off of the panic bottom.  It's important to note that the average equity only put call ratio reading since the CBOE began providing the data in 2003 is .67.  The average since September 1, 2008 is .79, much higher due to the increased fear overall.  From these numbers, you can see that any move of the 5 day moving average above .90 should be respected.  Here's the chart:

 

For free educational videos of the put call ratio and how to successfully incorporate them in your trading strategy, go to www.investedcentral.com/putcall.html.

Happy trading! 

TECHNICAL ANALYSIS 101 - PART 3

This is the third part of a series of articles about Technical Analysis from a new course we're developing. If you are new to charting, these articles will give you the "big picture" behind the charts on our site. if you are an "old hand", these articles will help ensure you haven't "strayed too far" from the basics. Enjoy! 

(Click here to see the beginning of this series.)

Chart Construction

Charts are created from data - Price data and Index data.  After discussing the various types of data used, we’ll look at how charts are constructed.

Price Data

Exchanges record the price and number of shares for each stock transaction.  These individual transactions are called tick data.   Tick data is compiled over different periods of time to construct price bar data.  Price bars show the beginning, highest, lowest and ending prices for a chosen time period.  Individual price bar time periods can range from one minute to one year.  Daily, weekly and 60-minute price bars are other common examples.

Price bars less than a day long are known as intraday price bars. Intraday price bars range from one minute to one hour and are typically used in technical analysis by day traders who hold positions for a matter of minutes or hours.

A daily price bar is constructed of all the transactions during a full day of trading.  Daily price bars are most often used in technical analysis by investors who hold positions from days to years. 

The number of shares traded in each transaction is called volume.  Volume is recorded as tick data just like price.  Volume tick data is added together to construct volume bars and are then charted with their corresponding price bars for technical analysis.

Index Data

Data for hundreds of indices, published by financial service companies and the major exchanges, are provided to StockCharts.com through third party data providers.  Indices are not tradable financial instruments.  Indices represent domestic and foreign market averages, industries, commodities, currencies, bonds and many other price, volume and breadth measurements of market activity.  Examples of market indices include the Dow Jones Industrial Average ($INDU), NYSE Healthcare Index ($NYP) and the New Zealand Dollar ($NZD).  The financial service companies are responsible for the accuracy of the indices they publish.

Breadth indices measure how many issues move within a particular market index.  Breadth indices give analysts insight into investor sentiment.  Examples of breadth indices include NASDAQ Advance-Decline Issues ($NAAD), NYSE Advance-Decline Volume ($NYUD) and AMEX Issues Unchanged ($AMADU).

Price Chart

A price chart is a graph which shows how price and volume changes with time.  Price charts on StockCharts.com are called SharpCharts.  (Time-independent charting methods like Point & Figure charting will be discussed in detail later.)

 

The diagram above illustrates the layout of a typical SharpChart.  Price data, volume data and technical indicators are displayed on a SharpChart.  A technical indicator is a mathematical expression of price and/or volume which can provide insight into future price movements.  We will talk more about technical indicators later. 

Price data and overlays are plotted in the Price Plot Area.  Overlays are technical indicators that are normally expressed in terms of price.  Non-price values of overlays are displayed on the left axis as shown above.

Technical indicators that cannot be expressed in terms of price are normally plotted in the Indicator Panels.  Although only a single Indicator Panel is shown above, SharpCharts can be created with multiple Indicator Panels displayed above and below the Price Plot Area.  Additional date/time axes can be added between the Indicator Panels if needed.  The legend for both the Price Plot Area and Indicator Panel contain the information used to create the SharpChart.

Next time, we'll get into the specifics of Line charts, OHLC Bar charts, and Candlestick charts.