Charting the Market

A statement from the last FOMC meeting included dialogue essentially stating it was their job to increase inflation. Thus, the Federal Reserve has shifted its focus from inflation to deflation. The stimulus has not worked in terms of jump starting economic growth and the Fed doesn’t want to see the economy become stagnant. Quantitative easing by the Fed is seen as inflationary by the bond market longer term.

The bond market looks differently at the Feds views and comments. If the Fed isn’t concerned about a little inflation and deems it to be positive for economic growth, investors see opportunity in the Treasury Inflation Protected bonds (TIPS). In fact if we take a look at the chart below of iShares Barclays TIPS Bond ETF, (TIP) we see the gap higher following the FOMC meeting September 21st. The bond has moved up nearly 3% since.

The chart shows the acceleration of the uptrend since the low in April. Trendline number 4 is the result of the comments following the Fed meeting. It is interesting to note the yield on the 10 year Treasury bond has moved to a new low of 2.36% during that same period of time prompting a similar rally in the ten year Treasury bond.

Jumping over to the dollar in response to this discussion, it has dropped as a result of the stimulus talk and inflation factor. The weaker dollar is impacting the price of commodities as well. Base metals, energy, and agriculture commodities have all moved higher as a result of these comments.

Precious metals have been an equal benefactor with Gold being seen as an opportunity relative to the inflation talk as a hedge for one, and two, an alternative to the dollar as a currency play. Silver (SLV) has outpaced gold (GLD) during this period showing the precious metals are responding positively as well to the this potential move by the Federal Reserve.

Friday, the Labor Department will release the Consumer Price Index (CPI) for September. The estimates are for an increase of 0.2% from August. It is up 1.1% for the trailing 12 months which is well within the target range of 1-2% general desired by the Federal Reserve. However, Mr. Bernanke is more worried about deflation and a stagnant economy. That puts him squarely on the track of quantitative easing to simulate growth, and if a little inflation is a by product, he is willing to accept the trade off.

The technology sector was hit by downgrades and profit taking yesterday. The Morgan Stanley High-Tech index lost 1.6% as the cloud computing stocks were hit by a round of what was termed profit taking.  Equinix, Inc (EQIX) lost 33% on news they had cut prices to keep customers. That rippled into Citrix Systems (CTXS) moving down 14%, F5 Networks (FFIV) lost 12.2% and Rackspace Hosting (RAX) gave up 11.1%. These stocks have seen a significant rise based on the outlook for the sector as well as merger and acquisition activity. Is this just a pullback on profit taking or is there more downside risk? Pullback is the initial response from analyst and investors and it is definitely worth watching.

Downgrades have been prevelent in the technology sector as well. Microsoft (MSFT) was downgraded earlier in the week and Xilinix (XLNX) and Altera (ALTR) were hit yesterday with downgrades. Why the shift by analyst towards the tech stocks? Concerns over margins and inventory build up in the semiconductor space. The slowdown in the summer relative to the economy is the drag on the outlook according to analyst. Valid concerns obviously as the sector has continued to struggle over the last four months. The chart below of the Morgan Stanley High-Tech index shows the break from the trading range and the current test of the breakout in progress. A retracement back to the trading range would be a test, below that point would be a big negative short term.

Fundamentally the sector has been improving with top line revenue and earnings growth. The downgrades by analyst are in expectations of the fundamental data changing. As we approach the peak of Q3 earnings the answers will come soon enough. As an investor our primary goal is to manage risk. With that in mind, adjust your stops accordingly as this plays out. Remember, you can always buy your positions back should the upside continue. As seen by yesterday’s declines in the cloud computing stocks, stops are important as the impact of one stock can change the outlook for all overnight.  

Scanning the sub-sectors we find there is strength worth watching. Networking (IGN), Software (IGV), Internet (FDN) and Hardware have all broken through the top line resistance of their respective trading ranges. Semiconductors (IGW) continue to be a laggard in the sector. Watch to see how each play out. If each of these sub-sectors move lower it will not be positive for the broader sector overall. Watch and play accordingly.

Tech has been one of the leaders for the broader market as well, a pullback or breakdown would have an impact on the broad markets. However this plays out, it will be an indicator that creates opportunity, we will either sell protecting principle and gains, or we will add to positions on the successful test of support and a new leg higher.

If you scan the headlines or read much in the financial section, there has been plenty of chatter the last couple of days relative to the S&P 500 index breaking through the top of the four month trading range (see chart below). From a technical view this is bullish and generally indicates more upside ahead. However, upon further review… there could be some challenges ahead for the broad market index.

The first came with the FOMC meeting on Tuesday when the Fed left investors guessing about what deflation, not enough inflation, slowing growth, but we will step in if we need to, comments meant? The hangover from the comments impacted Wednesday’s trading as well. The pullback near the breakout point is not a huge negative, but the volume on the selling was higher than the volume on the buying?

Turning our attention to other major indexes their charts give a different view. First the NASDAQ 100 index below shows a breakout nearly two weeks ago and is starting to look extended on the current move. This could be a hindrance to the breakout ofas  the S&P 500 index.

The Dow Jones Industrial Average below shows a different pattern as well, a rising wedge or trading range. The move to the top of the range failed to break through resistance on the move parallel to the S&P 500 index. With the resistance on the index coming into play, it could point to a push lower towards the bottom of the range short term. The Chart of the NYSE composite shows a chart similar to the Dow and it failed to break above the top end of the range as well.

The S&P 600 Small Cap index below equally shows a trading range similar to the 500 index, but failed to break through the top of the trading range. The reversal yesterday was more than other indexes. The small cap stocks should be leading on a break higher and in this case they are heading the other direction.

Sentiment is another indicator to take into consideration when measuring the upside potential of the broad markets. 93% of advisers were bearish (negative) on bonds. As a contrary indicator it would lean towards bonds continuing to move higher. The last two days  TLT (iShares 20+ Year Treasury Bond ETF) rose more than 2%. Two days is not a firm conclusion, but it does give indication the fear trade is alive and well. AAII (American Association of Individual Investors) showed 51% bullish (positive) on the broad market. Above 60% is a contrary indicator for the markets. The sentiment indicators are leaning towards an overbought market currently and thus a challenge for a continued move higher.

If the breakout on the S&P 500 is an “obvious” move to the upside, and signaling it is safe to go back into the water… then why are so many of the other charts and indicators saying maybe a pullback is in order first? I am not saying the rally to the upside is over, but it would be prudent to raise your stops or at least watch the other indicators for confirmation to the upside. Caution never hurt anyone.

Last night in our Market Spotlight I reviewed the major index activity and the current trading range dilemma for investors. There is a damned if you do, and damned if you don’t mindset building towards the broad market. This is where your emotions can get the best of your logical self. The feeling you know what is going to happen before it happens trap. Guessing or anticipating the markets next move is a dangerous game. First, take a look at the chart of SPY, SPDRs S&P 500 index ETF.

For more insight, charts and videos add Jim Farrish as your friend on FreeStockCharts.com

We are making our third attempt to break above the $113.20 level as resistance. Each attempt to break through a ceiling brings more baggage, so to speak. In other words, each attempt brings with it the ‘baggage’ or reasons from the last failed attempt plus the new luggage it has picked up since. It becomes more difficult to break higher without a catalyst formidable enough to embolden investors to believe in the upside opportunities the market presents.

It is difficult not to have a bias relative to the direction we believe the markets will take. For that reason, it is important to build your bias on fact versus fiction (feelings). Let’s take a step back and survey the surroundings:

• If equities are rising bond prices should be declining. Taking a look at TLT, ishares 20+ Year Treasury Bond ETF the price has been declining. Hitting a high near $109 the ETF retraced near the $102 level as support. It has bounced the last couple of trading days back near the $104 mark. This could be an indication of investors anticipating the breakout will fail, and they are selling SPY and buying TLT. Whatever the case, watch the activity of of bonds versus stocks as this plays out.
• Stronger stocks prices would indicate a belief the US economy is getting stronger. A stronger economy would lead to a stronger dollar, yet a look at the US dollar shows weaker performance and for a bonus a drop below support at the 82 level on the dollar index yesterday.
• Volume is an important indicator relative to price. When prices are rising volume tends to be stronger during that period as investors have show greater confidence. Looking at the move off the lows in August, it shows a decline in volume. That raises the question, how strong of a move is this relative to investor confidence.

These points would give me a bias towards a test or pullback into the trading range before a break higher. It does not have to retrace the low end of the range however. In this case we could see a test of the $110 level, and then a move higher through resistance at $113.20. If that is the case, the volume should drop on the test and rise on the move through the top of the range. That would validate there is more belief in the upside opportunity than the downside risk. As they said in Jerry McGuire, “show me the money!” Let the move validate itself before you act.

As an investor it is important to plan your actions, then take actions on your plan. To often investors react to the market versus taking a proactive role in manage their money relative to the market. There are two scenarios for an upside play in SPY. First, you already own it and want maintain your position. In this case, survey the risk of holding the position relative to a pullback near the $110 mark (2.4%). If you are comfortable with the risk set your stop accordingly and move forward with confidence you have done your homework. Second, you want to add a position in SPY on a test of support or a break above resistance. To add on a test of support, set an entry point you are comfortable with off the successful test of support. For example, $111.05 would be a good spot for an entry point. If you want to wait for the break through resistance you would pick a strategy for entry on the break above $113.20. For example, the price would need to close above that level in order to enter the position. The point is have a plan for the entry, the exit (stop) and the target. Determine your time frame for the position as well as the risk/reward of the opportunity.

Charting or technical analysis paints a picture for you to determine an investment strategy. Used properly it can be a powerful tool in your arsenal of investing strategies. If you would like to learn more, join SectorExchange.com today.

The old saying, “a picture is worth a thousand words” applies to investing as well as Polaroid. The picture below is a daily chart of the S&P 500 index for the trailing 12 months. It paints a very clear picture of what has taken place in the broad market index over this period. As an investor it has been a trying time psychologically. The drop from 1220 to 1020 in April was bad enough, but the trading range of 1040 to 1130 has added to the frustration. Throw in all the market commentary, political rhetoric and fear mongering and we have the perfect trading opportunity? Not so fast! This has been one of the more difficult trading and investing environments since the fall of 2008. It also has been a good teaching tool for you and I to improve not only our investing skills, but to understand the role of patience in investing.

It is easy with hindsight to say there were opportunities to trade during this period and make money. The reality is you may have been able to make money on some trades, but you had equal opportunity to loose money on some trades. The bottom line for many of the strategies, whether technical or fundamental, ended up in a tie when it was all said and done. In other words, the winners were negated by the losers. Throw in the psychology of the trading process and many investors are frustrated. So, what is the solution? That is what we are going to discuss today.

Starting with the establish trading range currently in play, the index has bounced between 1040 and 1130 since May. Each bounce has been based on hope of the economy improving and each push lower has been the result of the economy not improving. The current bounce in play started last week on the news about manufacturing data in the US and China being better than expected. That sparked hope once again that the economy is back on the improvement side. The jobs report was better than expected last Friday and today the jobless claims were better than expected. Is there another disappointing story on tap? Europe put some out earlier in the week with concerns over sovereign debt being an issue in banks throughout Europe. How bad is yet to be determined, and investors are hopeful, resulting in some money being pushed into the markets. Note the term some! Market volume remains on the weak side, if everyone has returned from the summer lull, the volume should be rising. This alone leaves room for doubt relative to the current push toward the top of the trading range. Thus, I remain cautious relative to this market overall.

The 1130 resistance (red line) is well established and it will take a catalyst of some kind to push through this level. We also have the 200 day moving average (white)  just overhead which could present some issues as well. Bottom line, we need improving economic data (jobs are a good start), and confidence to be restored for the markets to move higher with any sustainable growth.

On the plus side we are breaking above the downtrend line (green), but 1130 is only 25 points away. Is it worth the risk? Your decision, but I am willing to wait for confirmation. Fundamentally the earnings were positive for the second quarter. There is a big question mark hanging over the third quarter data based on the confirmation of the economic data slowing. We have seen downgrades to Intel and Hewlett Packard numbers recently. Is that a sign of what to expect in October when the earnings data is released? The doubt has been enough to negate the positive from the fundamental data. Again, this goes to my point of waiting for confirmation.

The last point I would like to throw out for consideration is the ten major sectors of the U.S. market. Three (basic materials, industrials and consumer staples) look very similar to the S&P 500 index chart, hitting against resistance within the established trading range. Five (technology, financials, consumer services, healthcare and energy) are hitting resistance at lower points within the established trading range and two (utilities and telecommunications) are breaking higher. Not exactly a overwhelming break when you consider the two sectors account for less than 8% of the index. This again points to waiting for confirmation on a move higher.

Patience is the hardest tool for investors, yet it keeps you from excess brain damage derived from too much trading good or bad. Watch for the break above 1105, 1115 and 1130 as the next hurdles for the broad market.

Each week we find examples from the current market to illustrate the use of technical analysis for research. The chart below is the PHLX Semiconductor Index (SOX). There is plenty to learn from the chart since making a high in April at the 400 mark. Since that point the index made five attempts to hold support at the 324 level. Last week the index broke just below that mark to catch support at the 313 level which was the February low. The next support would be 307 and then 287, but 287 mark is the support should the major indexes (S&P 500/NASDAQ) break lower.

I want to put this chart in perspective for those who are still learning to use technical analysis. Over the last ten years I have returned to the simple approach to technical analysis. Why? Because it is easy to see and easier to build a trading strategy around. The strategies have a lasting quality to them as they work in most market cycles. Finding short term trading opportunities around support is a good example for this chart.

First, look at the trading range of 324 to 375. This range was in play until the bottom in early July hit 345 and bounced. It did the same two weeks later shortening the bottom of the range to 345. Thus, support went from 324 to 345 as the index traded sideways looking for direction or it was trendless. Note the 200 day moving average was also in the 345 vicinity. Thus, 345 was an important support level during July and part of August.

Second, what would happen if the price broke below support at 345? The next obvious level would be 324 and set up a potential trade opportunity to be short. The gain potential would be 21 points. The risk would be a move back above the 345 level with resistance at 355 or 10 points. The risk/reward is not the best in the world, but worth trading using SSG, ProShares UltraShort Semiconductors ETF.

Third, volume should move higher in relationship with the break lower in this example. On the second and third test of the support at 345 volume was higher by 60-100%. That is an indication buyers and sellers are fighting it out for direction. If the downside volume is higher and the price bar breaks support the entry is established.

Thus, the trade is set up based on a break of support at 345 on the SOX index with rising volume. The important point to make relative to this support, it had been tested three times prior to the break (twice on higher volume) below the 345 mark. Thus, it was a tested support level, and one if broken, would invite sellers to join in and push the index lower. As you can see the third test broke and closed below 345 on 60% higher volume, and equally important the price closed below the 200 day moving average. That established the entry bar for the short trade.

The index has continued lower since this break and continues to be an active trade based on a stop now at 318. If the stop is hit at 318 it would lock in a 27 point gain. Since you cannot trade the index you would equate the trade to SSG which can be traded. It is important to note the fund is 200% leverage and carries much higher risk for the trade.

Building a strategy for trading short term on the break of support lines on the downside is a beneficial tool to use in a down trending market. In up trending markets you would look to play a bounce off support to the upside on rising volume. The trend of the major index or broad market index is important for which strategy to deploy. Volume is the other indicator you would want to combine with this strategy. If volume is below average on the bars breaking down, wait for volume to be 20-50% above average (50 day simple) before taking the risk of the trade. This is equally true in an up trending market playing a bounce to the upside. If volume doesn’t jump, pass on the trade. There are too many opportunities to force a trade.

If you have questions about this example, feel free to send an email to info@sectorexchange.com and we will be happy to assist you. Watch for the ETF Spotlight to cover this in video format, as I explain further how to look at support trading opportunities.

Technical analysis of the stock market has become more mainstream. When I first started in the financial services business it was referred to as voodoo analysis. More and more investors refer to pieces of technical analysis as an accepted science. That said, fundamental analysis is still the most accepted form of research on Wall Street. From my view both are a study in statistical probability using a different set of parameters. Both take faith on behalf of the person using them to put their money at risk based on the statistical calculation which draw a specific conclusion. The key to both is having a disciplined strategy for implementing the process. Without discipline neither will succeed.

With that in mind, today I wanted to look at a chart that has many implications to both sides of the table, interest rates. The yield on the 10 and 30 year bond have been in a decline since the S&P 500 hit a high on April 15th. Why the shift? Primarily the shift in economic outlook combined with fear from the investor seeking shelter from a declining equity market.

As you can see on the chart above (10 year Treasury yield) The decline started several weeks prior to the equity markets moving lower from a peak. Was this an indicator of money moving away from stocks? With hindsight you could say yes, but at the time it was not that clear. As yields broke below the 3.7% level however, you knew something was up. Bonds are a great indicator of fear or perceived problems in stocks relative to a specific event.

There are several points of interest on the chart worthy of learning from. The first was the break below the 3.15% mark. This corresponded with the peak of S&P 500 index hitting 1130 on a bounce off the 1040 low in May. The next two weeks the index fell to 1022 or approximately 10%. The index then rallied back to 1130 again in early August, but the yield on the 10 year Treasury stayed in a narrow trading range only to break lower below the support at 2.88% as the market started its present decline.

As an indicator the yield may not always be right, but it does bare watching relative to investor sentiment. When investors lose confidence in the equity market they shift to safety and that is predominately Treasury bonds.

The chart below is the 30 year Treasury yield and you can see a similar correlation to stocks, but the decline in rates has not been as steep as the 10 year during this cycle. However, in 2008 the drop was more significant to reflect the decline in stocks. The credit crisis took a bigger toll on the long end of the yield curve and the recession has had a bigger impact on the middle of the yield curve. Either way they are worth tracking relative to investor sentiment and in this case benefiting from owning bonds.

The current levels would indicate caution relative to holding bonds. The yields can go lower, but a near term bounce or consolidation would be more likely. That would mean a short term rally in stocks, well worth considering and watching for short term opportunities.

Don’t forget tonight’s FREE LIVE WEBINAR!

Telecom has been on the rise again. This has been a tough sector for investors to hold over the last year. The net gains have been minor and the volatility has been major. Looking at the chart of IYZ, iShares Telecommunications ETF you can see the result and the volatility. However, from a technical perspective the chart has made another failed run at breaking above the resistance at $20.80 . The pullback is testing support at $19.75  and is important short term. If the sector can hold and bounce back towards the high with some momentum/volume, maybe it finds the necessary catalyst to break higher.

Sifting through the sector you find plenty to like and dislike rather quickly. The winners are easy to spot (IDT, BCE, AMT, Q & VMED) as the uptrends are well established and continue to show strength. The losers are equally easy to spot (CBB, LVLT, LUK & LEAP) with the down trends established and showing continued weakness. The inbetween group of stocks is where the interest lies for me. Many have established a trading range and like IYT, they are in a position to break higher. If they establish themselves on the upside with some momentum to break out, the broader sector will break higher as well.

Returning to the chart and focusing on the technical data, note some key points of interest:

• The long term uptrend line is still in play.
• The resistance near the $20.80 level have been consistent at each attempt to break higher. Respect this level and don’t cheat your entry.
• The short term downtrend (off the April high) was broken on the move higher (off July low), but it is acting as support on the test and pullback last week. If it holds as support look for the upside opportunity. A trade back to $20.80. If it can break above resistance the play could extend higher.
• Some support at the $19.60 level, if it holds look for a trade opportunity. If it fails the long term trendline comes into play as support. (Held in yesterday’s trading and close to an entry point potentially.)
• Weak volume on the selling could be an advantage to bounce off the support at $19.60. 

The current market volatility is making every sector a big question mark. The fundamentals in this sector have improved over the last quarter and the opportunity is attractive. As with any opportunity you must define the entry, exit and target. This allows you to measure the risk reward and it establishes the necessary discipline to put in place.

For specific instruction on this opportunity go to the Watch Page for theETFexchange.com.

Gold hit $1217 yesterday and all the buzz is about the price jumping higher. We can talk about the reasons why gold will break higher from different perspectives. Choosing from two of the most common, first, the fear factor of the global markets relative to the global economy and second, too much money supply and inflation. Supply and demand could be thrown in the mix as well, but the technically speaking the chart below shows some hurdles in front of gold if it is to move higher near term. 

Using GLD as a proxy for gold the $119 level is the next hurdle of resistance. This would equate to the $1225 level for gold. If it can break through this level with confidence (volume) the upside target would be the June high ($123.50).

Some technicians are talking about the reverse head-and-shoulder pattern. The neckline is at the $119 level on GLD and corresponds to the resistance line drawn on the chart above. If you you measure the head to the neckline is almost correlates to the June high, interesting. The $1225 resistance on gold has been strong and I would look for confirmation on the break above this level.

Fundamentally I find no reason for gold to move higher. But, if enough investors see the pattern and believe in the outlook for gold, it could be a self-fulfilling prophecy. It worth watching for a trade opportunity based on this strategy, but you need to define your entry, target and stop prior to putting your money at risk.

Chart of the S&P 500 index below shows the twists and turns the market has been through since hitting the high in April. The questions surrounding the outlook for the economy have become the latest news items detracting from any definitive direction relative to the future outlook.

The turn lower at the April high started with the Greece debt problems which overlapped into the European debt crisis. The potential rally off the double bottom formation failed as the U.S. economy started reporting slowing economic data which brought a test of the 1040 support level. The break below this level brought forecasts of a drop back towards the 875 support mark. Then second quarter earnings gave an oversold market a lift and back to the 1120 resistance mark. The push above that level has not gained any momentum and the questions remain relative to the economy and a potential test of the low (1020) is back on the table.

The break above 1120 brought projections of a move to the January high near 1150 or 1180. The last week has brought more questionable economic data and stalled the efforts. The topping formation over the last six trading days lends itself to a test of the move prior to a follow through on the upside or a retest of lower support levels. The upside is therefore in question, set your stops accordingly if you want to hold any positions relative to the index or tighten them if you want to protect gains from the move higher. 

You can see on the chart that not all technical patterns work as forecast. This is why you have to define your entry points with the target and stop in mind. This allows you to control the risk of such trades. The chart also shows the lack of foresight the market has and how quickly it can change direction based on the inconsistent data.

It is important that you measure your risk and determine your strategy prior to putting you money to work in the market. Sometimes in markets like this the best course of action is to sit it out in a safe haven and wait for the next trend to develop with clarity and opportunity.