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DENSE GRID SETTINGS CONSIDERED HARMFUL

Hello Fellow ChartWatchers!

Spring has finally sprung here in the Pacific Northwest and we are very glad that it has.  I hope the weather is as nice where you are as it is here.  This edition of ChartWatchers contains some great articles - not all of them quite so sunny.  John Murphy points out that the sector rotation picture is changing and may have "regressed" somewhat in recent weeks.  Arthur Hill looks at the picture for Energy stocks, Carl Swenlin talks about the differences between SPY and $SPX, and Tom Bowley examines the influence that Market Makers have on options expiration day.

And me?  I'm going to point out a simple change you can make to your charts that can speed things up - possibly dramatically.

DENSE GRID SETTINGS CONSIDERED HARMFUL

Most of us don't pay any attention to the Grid settings for our charts.  Members have the ability to change the number of grid lines that appear on their charts using the "Advanced Settings" controls in the "Chart Attributes" area of the SharpCharts Workbench.  Most people are content to use the "Normal" grid settings which looks like this:

IBM-Normal

There are two other grid settings that are available however.  Here's what the "Dense" grid setting looks like:

IBM-Dense

And here is what the "Off" setting looks like:

IBM-Off

Now, deciding which of these settings to use is actually a little trickier than you might think at first glance.  The reason is that the grid setting can have a very big impact on the size of the chart - not the screen size, but the amount of data that needs to be sent accross the Internet in order for you to see the chart.

Here are the statistics for the simple charts you see above:

  • Normal Grid: 12,090 bytes
  • Dense Grid:   12,680 bytes
  • Grid Off:       10,361 bytes

That may not seem like a big difference - and with such a small, simple chart, it isn't - but even in this case, the chart without a grid is 18% smaller than the chart with a dense grid.

If you use charts that are much larger, say something with a size of 1280 and 4 additional indicator panels, the difference is more significant.  Here are the statistics in that case:

  • Normal Grid: 83,766 bytes
  • Dense Grid:   89,678 bytes
  • Grid Off:       65,963 bytes

That's a 26% difference between the size of a chart with a Dense grid and the size of a chart with no grid at all.  If your Internet connection is not superfast or you are downloading lots of charts, that different will be noticeable.

Now, of course download speed is only one factor to consider when choosing a grid setting.  But I wanted to make sure that it was something that you did consider.  From time-to-time we have people write in to our support team asking why our site is so slow and it turns out that they recently turned on the Dense Grid setting.  The bottom line here is that if you can live with the grid Off on your charts, you will see a noticeable speed improvement especially if you have large charts or a slow Internet connection.

- Chip

P.S. In case you were wondering, the name of this article is a take-off on a famous letter from the early days of computer programming.

"THE TRADING JOURNAL" - SECTOR SUMMARY IMPROVEMENTS - PUBLIC CHARTLIST NOTIFICATIONS

WELCOME GATIS ROZE AND "THE TRADING JOURNAL" BLOG - In case you missed it, we've added another great author to our collection.  Gatis Roze is not writing articles in our free Blogs area for "The Trading Journal" blog.  His first article, titled "Double Your Money - Buy on Rumors" was very well received and this latest effort, "Talk to Your EGO Before You Trade!", is also generating lots of buzz.  Be sure to check them out.

OUR NEW SECTOR SUMMARY AREA CONTINUES TO IMPROVE - Our new Sector Summary area lets you drill down into the various sectors and industries that make up the stock market showing you the strongest performers at each level.  We've just added the ability to see MarketCarpets for each level as well as the ability to select different time frames for performance calculations.  To get started, simply click on the "Sector Summary" link on the homepage located just under the yellow "Today in the Market" chart.

PUBLIC CHARTLIST UPDATE NOTIFICATIONS START NEXT WEEK - Our Public ChartList area continues to get lots of visitors as the authors continue to improve their content and readers continue to vote for and follow their favorites.  If you haven't visited the Public ChartList area recently, be sure to stop by today and see some of the great content you've been missing.

Next week, we will roll out another big improvement for PCL readers - an email-based notification system that will let you know whenever any of the lists your are following have been updated.  You can choose to be notified immediately after any of your lists are updated, or via a once-a-day digest message that summarizes all the changes for the previous 24 hour period.  You can also choose to disable notifications entirely (or simply unfollow whichever lists are annoying you).

Public ChartList authors will also be able to earn a new perk that will allow them to add a personal message to the notification messages that get sent out.  Watch for more details to appear during the week.

 

 

MARKET MAKERS SCORE AN EMPTY NET GOAL

Once a month, the stock market provides us a unique opportunity.  In basketball terms, it's like the market makers have the ball with time running out in the quarter - or the game - and they nearly always bury that critical three-pointer.  For those more predisposed to hockey, think about the "empty net" goal to close out the game.  That's probably more fitting because the retail trader is mostly defenseless as the market puck sails into the net.

Options expire the third Friday of every month.  It's a day of reckoning for options traders.  When the option trader buys or sells contracts, think for a minute who's on the other side of the trade.  With the most fluidly traded options, it can be the retail trader on both sides of the trade.  But many stocks don't have the kind of contract volume on a daily basis that's necessary to match up retail buyers and sellers and you see "open interest" build. 

Enter the market maker.

Let's assume you buy 10 calls on ABC stock and the market maker sells you those calls.  To appropriately manage risk, that market maker can then turn around and buy 1000 shares (10 calls represent 1000 shares as each call gives the purchaser the option to buy 100 shares at some future point at a fixed strike price).  It's a familiar covered call strategy.  Therefore, if ABC continues rising, the market maker is protected as they own the stock.

But think about what happens if ABC moves higher for a period of time and builds a lot of net in-the-money call premium, then reverses suddenly (and, in many cases, temporarily).  The market maker owns 1000 shares, so they can potentially benefit from the gain leading up to options expiration Friday.  What if that market maker sells their long position, then begins to short ABC as options expiration Friday approaches?  They effectively close out their long position with a gain no doubt.  Then as ABC mysteriously falls, market makers make money again on their new short position.  As ABC falls during options expiration week, what happens to all of the net in-the-money call premium?  It vanishes as the market maker rings the cash register again.

It's an empty net goal.  Game over.

Every month, the week before options expiration, I calculate "max pain" for the SPY, QQQ and IWM.  I define max pain as the point at which in-the-money call premium EQUALS in-the-money put premium.  It's the market makers' version of the "perfect storm".  Once I calculate max pain, I do NOT look for the major indices to reach the level of max pain.  Instead, I simply use max pain as a directional indicator as I would the MACD.  It's a part of my overall strategy, not my entire strategy.  Last week, for instance, the SPY and QQQ showed a max pain level very close to its then current price.  The IWM, however, traded at $79.54 with a max pain level of $81.65.  Tuesday's high on the IWM was $81.55.  Check it out:

IWM 4.21.12

There was net in-the-money put interest, which suggested that IWM (small caps) would have a gravitational pull higher in the very near-term.  In order to benefit from this potential move, you could trade the IWM or find individual stock alternatives with a similarly skewed net option interest on the put side. 

On Thursday, April 26th, I will be hosting the latest in our Online Trading Series, "Profiting from Max Pain".  For details, CLICK HERE

Happy Trading!

DEFENSIVE SECTOR ROTATION

One of the ways to measure the mood of the stock market is to see what sector rotations are taking place beneath the surface. Chart 1 shows that sector rotations over the past month reflect a market mood that is turning more defensive. The four sector lines are plotted "relative" to the S&P 500 which is the flat black line. In other words, the four sector lines are relative strength ratios that measure their performance "relative" to the S&P 500. The blue line shows the Technology SPDR (XLK) leading the market higher since the beginning of the year. Technology leadership is a good thing for the market. The XLK:SPX ratio has started to drop during April, however, which shows short-term loss of that leadership. In fact, technology was this week's weakest sector. The other three lines show the relative performance of the three defensive sectors which are consumer staples (pink line), healthcare (green line), and utilities (red line). Those three sectors underperformed the S&P 500 since December as the market rallied. Notice, however, that those three relative strength ratios have turned up over the last month. In fact, utilities, healthcare, and staples were this week's three strongest sectors. That's normally a sign that investors are turning more defensive and are protecting themselves from a possible market correction.

20120421001-sc

SPY VERSUS SPX

A subscriber brought something to my attention that I wish I had thought of before. We think (at least I did) that the SPY (ETF) and SPX (S&P 500 Index) perform pretty much the same except for some minor tracking error. However, this is not the case because the SPY historical data is adjusted for dividends, whereas the SPX is not.

For all practical purposes, the SPY is a stock, and when the SPY pays a divdend, its historical data must be adjusted so that it maintains the correct relationship with the current dividend adjusted price. This happens on all stock, ETF, and mutual fund data. (To learn more, click here.) While it may be technically possible, historical data for an index like the SPX is not adjusted for dividends, so the effect of dividends is not considered for indexes.

Let's take a look at what this means. On this SPX chart we can see two major tops, 2000 and 2007, challenging the same level of overhead resistance at about 1550. The top of the current bull market is still about 200 points below this resistance.

Swenlin-1

Now, looking at the SPY chart, which has been adjusted for dividends, we can see that the 2007 top exceeded the 2007 top by about 15%. And of more immediate interest, the current bull market top is virtually equal to the 2007 all-time high. This encounter with long-term resistance could spell immediate trouble for the bull market.

Swenlin-2

There is a new index, the S&P 500 Total Return Index ($SPXTR), that appears to accommodate dividends by using a positive adjustment to the current price, but there is not even a full year's data collected on it yet, so it is not likely to be a useful technial analysis tool during my lifetime. Besides the SPY already does the job and we have nearly 20 years of data on it.

Conclusion: The fact that indexes are not adjusted for dividends can cause them to present a different technical picture than their ETF counterparts. While many of our timing models are driven by indexes, one should always use the chart of the trading vehicle (ETF) to finalize a trading decision.

ENERGY SECTOR IS THE WEAKEST OF THE NINE

The Energy SPDR (XLE) broke key support in late March with a sharp decline and has yet to reach the next key support level. The chart below shows XLE consolidating in the 69 area over the last two weeks. This consolidation looks like a rest within the downtrend. A break below 68 would signal a continuation lower and target further weakness towards the next support zone in the 64 area. Support here stems from the lows in late November and mid December.

120420xle
Click this image for a live chart.

Three indicators confirm relative weakness in XLE. The price relative, XLE:SPY ratio, has been trending lower the last six months and the decline accelerated since late February. The StockCharts Technical Rank (SCTR) also peaked in late February and moved sharply lower. Notice that the SCTR is trading below 20, which makes it the lowest of the nine sector SPDRs. The last indicator window shows the  Bullish Percent Index moving below 40 this month, which is also the lowest of the nine sector SPDRs. This means that fewer than 40% of the components are on PnF buy signals. Put another way, more than 60% of the components are on PnF sell signals. 




SPRING INTO SMALL CAPS

I'm not quite sure why, but there definitely is a positive bias towards small cap stocks as we approach the Spring season.  April and May are the 2nd and 3rd best calendar months in terms of annualized returns on the Russell 2000.  Only December boasts a better monthly record since 1988.  Over the past five years, the absolute performance of the Russell 2000 during April and May are as follows:

2011:  +0.6%
2010:  -2.5%
2009:  +18.6%
2008:  +8.8%
2007:  +5.8%

2007 through 2011 has been a tumultuous period, but the action in small caps has been mostly positive during this April through May time frame.   Thus far in 2012, April has started off a bit rough with the Russell 2000 down approximately 1.5%.  Further deterioration in prices in the near-term could become an opportunity based on historical trends.

Technically, the Russell 2000 is in decent shape although there is downside risk in the near-term.  Given the weak job numbers on Friday, more selling is a definite possibility this week.

Let's take a look at the bigger picture.  Below is a 4 year weekly chart on the Russell 2000:

Russell 2000 4.7.12


There are a number of ways to view the stock market technically.  There are bullish and bearish takes.  But the above technical pattern could certainly be argued in a bullish light and that's the position I'm taking until further signs of technical deterioration surface.  We've seen an obvious uptrend off the March 2009 lows.  It's been an extended period of buying, only temporarily derailed on a couple of occasions.  If we consider the move from March 2009 through April 2011 to be "the uptrend", then a bullish consolidation pattern - the inverse head & shoulders pattern - could be a springboard to further gains later in 2012 and beyond.  I'm not saying it will happen, but technically it's one pattern worth watching.

During the first six months of 2011, the Russell 2000 held price support at 773 on multiple occasions, which would represent the inverse left shoulder.  Once that support level failed, the inverse head printed on the early October low.  Note that the subsequent rally into the latter part of the first quarter of 2012 tested the neckline first established back in July 2011.  One technical possibility is that we could be in the midst of a period of short-term weakness to print an inverse right shoulder.  773 support would be a very key price level to watch on this potential bout of selling.

Should this pattern continue to play out, the truly exciting part is the measurement, which extends from the neckline down to the inverse head, or 250 points.  Therefore, an eventual breakout of this inverse head & shoulders pattern would measure up another 250 points from the 850 breakout level.  That would be another 30% upside to 1100.  Given other bullish big picture signs, I believe this to be a probable outcome, though certainly no guarantee.  We need to see the pattern develop and a breakout occur to confirm the pattern.  In the meantime, an aggressive approach would be to accumulate the Russell 2000 (IWM is an ETF that tracks performance in the Russell 2000) during the printing of the right shoulder down to 773.  The closer the Russell 2000 moves to 773, the better the reward to risk of long entry.

For Monday, April 9th, I've included a small cap stock that appears to be under significant accumulation as our Chart of the Day.  If small caps do hit a rough patch near-term, aggressive traders could look to a pullback in this stock as an opportunity for a trade.  CLICK HERE for more details.
 
Happy trading!

MIDCAPS STALL AT OLD HIGH - NYSE WEAKENS

Although I generally look at the S&P 500 to get a feel for the market's trend, it's a good idea to see what other stock indexes are doing. Two of them are giving warning signals. Chart 1 shows the S&P 400 Mid Cap Index (MID) starting to meet resistance along its 2011 highs. That's a logical spot to expect some profit-taking to develop. Chart 2 shows the NYSE Composite Index which has also yet to clear its 2011 high. I suspect that's because of its heavier weight in commodity-related stocks which have been market laggards. Chart 2 shows the NYSE slipping below its 50-day average which is a sign of weakness (blue circle). Its RSI line (top of chart) and MACD lines (along bottom) have turned down. That's another warning sign.

20120405004-sc

20120405005-sc

4-YEAR CYCLE APPROACHING CREST?

We don't look at the 4-Year Cycle chart very often, but a subscriber's comments reminded me that now would be an excellent time to view the progress of this important cycle.

On the chart below the vertical lines show the location of all nominal 4-Year Cycle troughs since 1948. The normal expectation is that the price index will arc from trough to trough, but sometimes other forces override normal cycle pressures, and the magnitude of price lows associated with the troughs are not always as pronounced as we would expect.

Swenlin-1

To me, the most obvious feature on the chart was that the last completed 4-Year Cycle (2003-2009) was actually over six years long, which emphasizes that we can't set our watches by this (or any) cycle. As for why that cycle was so long, we can speculate that unrealistically low interest rates fueled bubbles in stocks and housing, overriding the normal ebb and flow of the underlying cycle pressures.

The most important feature is that the current cycle is about three years old, and prices are approaching a very strong level of long-term resistance just above 1500. All things being equal, it is reasonable to assume that the 4-Year Cycle (and prices) will crest later this year, probably in the area of when 6-Month seasonality switches to bearish at the end of April.

Until prices actually crest, it is difficult to project the next trough (price low), but, assuming a crest (beginning of a bear market) in the next few months, I would assume that the bear market and 4-Year Cycle low would arrive around the middle of 2013. This is not a prediction, just a template for anticipating what prices might do in the context of the 4-Year Cycle.

The subscriber also asked for clarification on the monthly PMO. Keep in mind that the monthly PMO is not final until the close on the last trading day of the month. Currently, it is rising. When it tops, it would be a very bearish signal because it confirms that the price action to which it is reacting is worse than a normal correction.

Conclusion: Assuming a "textbook" 4-Year Cycle progression, the market is probably very close to forming a major top. The Cycle is three years old, and major overhead resistance will soon be encountered.

ARE BATS REALTIME CHARTS RIGHT FOR YOU?

Hello Fellow ChartWatchers!

Having the right subscription level can save you a significant amount of money OR depending on how you use it, it can cost you a lot of money in the form of bad trades.  At StockCharts, we offer several different membership levels - Free, Basic, Extra, ExtraRT and PRO.  I want to make sure everyone knows the difference between those levels.

Our ExtraRT and PRO services provide you with charts based on complete, realtime data from the NYSE, NASDAQ and TSX exchanges.  Unfortunately, those plans are also our most expensive - partly because those exchanges force us to tack on a monthly surcharge for that realtime data.

Our other three plans also provide realtime data (for most US stocks, sorry Canada) without the need for that additional surcharge.  How is that possible?

It's possible because the realtime data on those charts comes from the BATS exchange.  BATS (which stands for "Better Alternate Trading System") is a growing electronic exchange based in Kansas City that provides all of its trading data for free(!)

So what's the catch?  Well, there are a couple:

  • As I mentioned, BATS data is only available for US stocks
  • Volume data from the BATS exchange is significantly less that the volume data from the NYSE/Nasdaq
  • Price data for thinly traded stocks can be different from the price data from the NYSE/Nasdaq
  • Not all thinly traded stocks are covered by BATS

Because the volume data is different, we only use BATS data to fill in the most recent 20 minutes on our charts.  After that 20 minute delay, we replace the BATS price-only bars with the price+volume bars from the NYSE/Nasdaq.  You can see that process on the following slide:

BATSRealtimeData

This slide shows a 1-minute price chart that a typical Basic or Extra member would see. It shows how we highlight the BATS price-only bars in yellow (because they are subject to change) and how we suppress the BATS volume data as well as volume-based indicators.  None of those restrictions happen for ExtraRT members.

Below I have two more slides that show how BATS data and NYSE/Nasdaq data differ.  The next slide shows the differences for a fairly liquid stock (INTC).  The BATS version is on the left and the NYSE/Nasdaq version is on the right.

BATSIntel

And here's a similar slide for a more thinly traded stock (EW):

BATSEdwards

If you look carefully, you'll see that the price bars for INTC match pretty closely (but not exactly!) and that the price bars for EW have lots of differences.

If those price differences are important to your analysis or if you don't like the 20-minute delay on the volume data (or if you need realtime Canadian data) then you'll want to use either our ExtraRT or PRO service.  Otherwise our less expensive Extra service should work well for you.

(Members can use the "Your Account" link at the top left corner of any page on the site to change their service level.  Non-members can learn more about our different plans by clicking here.)

- Chip

Regional Banks and Housing Stocks Maintain Strong Correlation

The Regional Bank SPDR (KRE)  and the Home Construction iShares (ITB) have led the market higher since October. ITB is up over 50% since early October and KRE is up over 40%. The chart below shows ITB in black and KRE in red. Notice how these two moved step-for-step over the last 18 months. Both peaked in January 2011 and then bottomed in early October. Both ETFs recently recorded new 52-week highs when they exceeded their 2011 highs in February and again in March. While the trend since October is clearly up, these two are overbought and ripe for some sort of corrective period, which would involve a pullback or sideways consolidation.

120406kreitb
Click this image for a live chart.

The indicator window shows the Correlation Coefficient (KRE,ITB) confirming that these two have been positively correlated for most of the last 18 months. In fact, the Correlation Coefficient has been above .50 most of this time, which shows strong positive correlation. With this in mind, chartists should watch the Home Construction iShares (ITB) for clues on the Regional Bank SPDR (KRE) and visa versa. As the two market leaders, chartists should also watch these two closely for signs of a broader market correction.

Good Trading,
Arthur Hill CMT

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