General Market Index (GMI) table

Crash coming? Only 3rd day of new QQQ short term down-trend

@ 7:04 pm
GMI0/6
GMI-20/9
T210811%

I have thought all weekend about what I should post Monday morning.   Everyone is trying to predict what will happen on Monday.   That is not my game.   No one knows what will happen and surely the media will tout the few persons they are aware of who get it right, simply by luck.   With all of the predictions out there, someone has to be right.

So, what do we know right now?   First, we now know why the market had so much trouble rebounding from the debt deal mess.   Insiders who knew what S&P was about to do unloaded stocks or took up short positions last week.   That is the nature of the stock market.   This shows the folly of fundamental analysis.   Earnings of many companies are good and PE ratios are low, so the fundamentals of the markets are quite good. But that means nothing!   PE ratios will probably get even lower this week. It is investor psychology that drives stocks, cycling from extreme optimism and greed to fear and panic.   The use of fundamental analysis alone misleads us.   Only technical analysis can warn us of a change in trend.   As Darvas wrote, it allows us to discern what insiders are doing. I therefore always concentrate on the direction the market is moving.

So, my trend indicators as measured by the GMI, have been flashing warning signals.   The GMI has been below 4 since July 27.   I have written many times that I become defensive when the GMI is below 4. In fact, with the exception of one day since July 27, the GMI has been below 3. For this reason, my IRA and margin accounts are almost 100% in cash.   Unfortunately, my university pension is still invested 100% in growth mutual funds–I was afraid to get out again because it would have triggered their market timing rules.   I got out too soon a few weeks ago and then got back in. This will be an expensive lesson for me.   No one should stay in an investment vehicle that prohibits them from going to cash when they want. That is why exchange traded funds (ETFs) offer investors so much more of an advantage over traditional mutual funds   to manage market risk–one can buy or sell them intraday–at will.

So, there are a few technical indicators that concern me.   Investment sentiment surveys, at least for last week, are too bullish.   We want to see   more bears than bulls for a bottom to occur.   Most disturbing to me is that my short term trend count for the QQQ is only day 3 of the new down-trend.   Down-trends often last for many days.   Finally, I have an   indicator that has been below 20 at almost all major bear market bottoms, going back to 1933.   That indicator is currently around 83.   During the quick decline in 1987, that indicator only went to 40, primarily because the market snapped back quickly and did not produce a multi-month decline. So, we are left with the fact that the major equity markets are in down-trends.   We do not know how long the decline will last.

However, the following chart makes me question the strength of   this decline.   The weekly GMMA chart of the QQQ shown below puts the current decline in perspective; it shows that the shorter term averages (red) remain above the longer term averages (blue), suggesting that we have not yet entered a serious down-trend phase, at least compared with the pattern in 2008. (Click on chart to enlarge.) Thus far, the current decline looks more like the consolidation period we experienced in 2010. A major decline will have the red lines declining below the falling blue lines. Maybe I should not be swept up in the current bearish hysteria.

For those of you who are in cash, good job!   Those of us who still own mutual funds have the tough choice of determining how far we want to ride the down-trend.   This is a personal decision based on one’s tolerance for risk and one’s personal financial situation.   I can tell you that the Worden T2108 is at 11%.   In 1987 it reached a low below 1%.   In 2001 and in 2002 it got to around 7%, and in 2008, it got close to 1%. So, at 11% the T2108 is in oversold territory, but it could go much lower if this turns into   a multi-month decline. This has been a very rapid decline thus far.   I will be watching to see if a rebound rally occurs. The strength and duration of any rebound may provide clues to the actions I must take. Furthermore, after every decline has ended, I promise that during the next one I will buy a bullish index ETF (QLD) if the T2108 goes into single digits.   Will I have the courage this time?

Be careful and thank you for the nice feedback on my blog.   I just talked to my stock buddy, Judy, who urged me to post tonight so that my readers can have the benefit of my thoughts.   She thinks it might help them have a balanced perspective on the current situation. I hope it does.


Split market with techs showing strength; FFIV Stage 4 decline?

@ 7:00 am
GMI2/6
GMI-23/9
T210832%

The market is showing a strange split similar to the one that occurred in early 2008 when the SPY showed a lot more weakness than the QQQ.   This is because the financial stocks in the SPY were cratering while the Nasdaq 100 index, which has no financial stocks, held up better.   We are faced with a similar market. The DIA and SPY are below their 10 week averages but the QQQ remains above its 10 week average.   This divergence will end with the SPY and DIA joining the QQQ in a renewed up-trend, or in the QQQ joining their down-trend.   By my count, the QQQ reached the 22nd day of the current short term up-trend on Friday.   Another show of strength is that some important market leaders,   GOOG, AAPL,   CMG, BIDU, and PCLN, remain in up-trends.   When good earnings can propel a growth stock like GMCR up 16% on Thursday, it does not look like the market is entering a period of bearishness.   I may be completely wrong, but this market looks to me like it has a lot of underlying strength, at least for growth stocks.

So, even though the GMI is now at 2 (reflecting only the strength in the QQQ) and IBD considers the market to be in a correction, I am staying with some long positions in the leading growth stocks and in QLD.   However, a few more days of weakness could cause me to sell out, if a new QQQ short term down-trend   begins. The gridlock in raising the debt limit   is scary stuff, but I rely mainly on the market’s behavior, rather than politics to guide my trading decisions.   While the SPY and DIA are now below their 30 week averages, these averages are still rising and not even close to a Weinstein Stage 4 decline.

Speaking of Stage 4 declines,   I have been watching FFIV for months   trying to find a good place to short it.   The developing Stage 4 pattern is just too perfect for me to ignore.   (I do own a put on FFIV now.)   After breaking out in April 2009 around $25, FFIV steadily climbed until it topped around $145 in January, 2011.   In late January it had a huge volume down week, with far greater weekly volume than any since the up-trend began.   It had another large volume decline in March and then began a rebound that ended in early July.   Note that the 30 week average (red line) is now curving down, and the 10 week average (blue dotted line) is below the 30 week average. This stock looks very sick to me and I bought a longer term put option that will give FFIV time to decline.   If the market continues to weaken, I think this stock will decline a lot. Remember, the bad news tends to come out after a stock’s turn, so I do not look to company news in order to decide whether to short a stock. (Click on this weekly chart to enlarge.) It should not take an experienced technician to see that FFIV’s up-trend has ended and a classic Stage 4 decline has likely begun. I believe FFIV is also showing the ideal shorting pattern that William O’Neil describes in his excellent book on shorting stocks ( book is listed at lower right of this post). On a daily chart, FFIV is very oversold and may be due for a counter-trend bounce within the longer term down-trend.

My strategy for trading stocks that will advance $25 per share in a month

@ 7:00 am
GMI5/6
GMI-26/9
T210869%

I am going to share with you   a strategy that has helped me to make money the past year.   It conflicts with most of the truisms that we have been taught about the market. But if we trade like most people do, than we can expect to have the results most have— to not make money.   One has to   pursue one’s own ideas to be successful trading.

So, first note that the title to this post involves finding stocks that will appreciate $25 in a month, and not a percentage increase.   I have been told by many, and it is mathematically true,   that a rise from $5 to $10 is the same percentage increase as a stock that goes from $50 to $100. But psychologically, I find it easier to trade a stock that is rising $50 on the way to a double, than   a stock that must go up $5 to double.   In other words, it is not the percentage move that I am after, it is the   number of points in the rise.

Let’s assume for this discussion that the typical stock that breaks out of a base goes up 20% before it consolidates or reverses.   A 20% move in a $10 stock is only $2, but it is $20 in a $100 stock.   I have more time (at least psychologically) and courage to add to a position in a stock that is rising for $20 than to one that is only on the way to a $2 rise.

So I want to hop on board a stock that is breaking from a base or support and that is likely to advance $20+ if I am right. How do I find such stocks?   Well, I used TC2000 to look at all stocks that advanced $25 or more in the past 30 days.   I found 21 stocks as of Friday.   The most consistent characteristic of these stocks was that 90% (19/21) were priced at $80 or more 30 days ago;   17 were greater than $100 per share.   I have done this analysis before and it always comes out the same.   Most stocks that   rise $20 or $25 or more in the past 30 days were above $80 at the beginning of the period. During this period, GOOG rose +$101, AAPL +$61 and ISRG +$63.

So, if I want to ride a stock that will advance a lot of points, I should be looking at stocks that are already expensive, more than $80 per share. Other reasons I like expensive stocks is that the in and out high frequency day-traders are less likely to have the money to play with these stocks. And expensive stocks are there for a reason, people, mainly funds, are bidding them up.

So, trading expensive stocks may be a fine strategy, but   many people, you say,   cannot buy many shares of an $80+ stock.   This is true, but the missing ingredient is deep in the money (DITM) call options.   I use DITM call options to buy expensive stocks for 10%-20% of the cost of the stock.   What I do is to find an expensive stock that I think is bouncing off of support or breaking out.   Once I find one, I look for a near month call option that has 3-6 weeks before expiration and which will cost me under 20% of the price of buying the stock.

This example should illustrate the strategy.   If I believe that NFLX, which closed Friday at $276.58,   is in an up-trend and bouncing off of support, I go to yahoo.com and look up the August call options.   I find that the August 230 call can be bought for about $49 per share, or $4900 (each option covers 100 shares).   This option would give me the right, but not the obligation, to purchase 100 shares of NFLX at $230 each through August 19.   Since I am paying $49 per share for the options, if I were to use the option to buy the shares, my cost or break even point is $279 (230+49), just about $2.50 above the current price of NFLX.   (With a DITM option the break even price is close to the current price of the stock.) Once NFLX rises above $279, I make $100 per point, just as if I owned the 100 shares of stock.   If NFLX rises $25 to around $301 per share before the option expires in August, my profit would be about $2200 (301-279 x 100).   And I never have to buy the 100 shares of NFLX because I could now sell the option that I bought for $49 for the price of $71 (301-279).

So what we have manged to to with a DITM call option that cost $4900 is to control 100 shares of NFLX, which would have cost $27,658.   In a sense, we only had to put down and risk   about 18% of the price of the stock.   I say risk, because it is accurate.   If I bought the 100 shares of NFLX and it fell to zero, I could lose the entire cost, $27,658.   But with a call option, the most I could lose is the $4900 that I paid for the option.   If the stock is below the strike price, $230, at expiration, it expires worthless.   But I would never wait for that to occur.   If NFLX declines below support. I would just sell the option at the best price available at the time.   For example, if on August 19, NFLX is trading around $270 per share, my option would trade for about $40 (270-230 strike). In other words, at expiration someone would use the option to buy 100 shares of NFLX at $230 and be able to sell the stock immediately in the market for the current   price of around $270, a $40 per share profit.

So this all comes down to that, all other things being equal,   if one wants to buy a stock with a better chance of appreciating many dollars during the next month, it is preferable   to buy a very expensive stock by using DITM call options. Chapter 7 of Jim Cramer’s latest book, Getting Back to Even,   gives some examples of the uses of DITM call options. I assign Michael Sincere’s book, Understanding Options,   to my students who want an options primer…….

The GMI closed the week at 5 and the GMI2 at 6.   So I am comfortable being long.   It looks like the money is rotating into tech stocks again, so I own QLD as a way of riding this trend.   QLD is a leveraged ETH that aims to rise or fall each day twice as much as the QQQ, or Nasdaq 100 index. Once the short term trend changes, I slowly accumulate QLD (for up-trends) or QID (for down-trends).   On Friday the QQQ completed its 17th day of the short term up-trend. The QQQ and SPY have now closed above their critical 10 week averages for 4 weeks.

I try to trade consistent with the market’s direction, and to ignore all other factors, including the news and politics.   The market has a mind of its own and I msut trade in synch with it.