Trading

Black Friday came in several ways this year.  Yes, there was shopping.  However, the markets had a dark few days, too, as the world markets quaked at the news of Dubai's sovereign debt default.

I've always believed that you can tell a lot about the current character of the market based on how it responds to news. Sometimes markets go up on good news, and go down on bad news. That seems normal. On the other hand, I take it as a bearish sign when markets sell-off after good news. Likewise, I take it is a bullish sign when markets go up, despite bad news.

So, it wasn't surprising that markets reacted negatively to the largest sovereign debt default since Argentina. It was, however, somewhat bullish that the US equity indices went down as little as they did. Yes, I know that our markets were closed on Thursday (when most of the damage was done globally) because of our Thanksgiving holiday. And I also realized that Friday was a half day and had relatively light volume. Nonetheless, it could have been worse; much worse.

Here is a link to a post I wrote that I think is worth reading at this point in the markets. I called it "What My Dogs Can Teach Us about Markets".  It's really about how perceived danger puts us on alert; and why the second perceived danger often receives an even greater response. The point is that the world is now on alert, and I'm watching how calmly (or not) the market reacts to news.

Market Commentary.

The markets continue to hold up well on the surface.  Underneath, I'm seeing signs of weakness (poor breadth, weak up-volume, fewer new highs, more negative divergences, etc.).  Nevertheless, price has stayed above important levels.

With that said, here are some patterns worth watching.  This chart uses 15-minute bars to get an intra-day look at the S&P Mid-Cap Index throughout November. The most notable thing I see is a character change in mid-month.  The Bullish Break-Away Gaps seen at the beginning of the month are followed by two Bearish Island Reversal patterns (marked by the yellow boxes) in the second half of the month.  This type of pattern can be seen at market tops.  It starts with a gap-up (shown by the green circle) and ends with an exhaustion gap (shown by the red circle). You can click this chart to see a full-size version.

To understand what this pattern shows, you can think of it as the last buyers
rushing to get in (pushing-up price so fast that it creates a
break-away gap), only to find that there are no new buyers (causing a
price drop and the resulting exhaustion gap).  This gap down can signal
the beginning of a change in trend. Two of them in a row makes me more watchful.

David Corna reminded me that this pattern shows-up differently on a higher time-frame. For example, on a daily candlestick chart, the intra-day Island Reversal manifests as two classic reversal patterns, a Hanging Man followed by an Evening Star. Their very names are onomatopoetic to their meaning. These candlestick formations will almost always be found at the end of a trend and the beginning of a reversal.

Chart.ly from StockTwits is a Good Source of Ideas.

Many traders use charts and technical analysis to gain insight and perspective on what's happening in the markets.  I'm always looking for resources that help me do that.  Recently, I've found a lot of good content on the Chart.ly website.  It is part of StockTwits, and has a strong user community.  Here is an example of a chart I found there this week.

I like the analysis, and concur that the bottom trend-line (and the area on the far right of the chart marked by the blue circle) points to a key price area.  Staying above that is important for the rally to continue.

How bullish has the rally been in real economic terms?

What the Dow Priced in Gold Tells You?

This chart shows the Dow Jones Industrial Average priced in Gold.  In other words, how many ounces of gold does it take to buy the Dow's price?  So, for example, when the Dow is at 10,000 and Gold is $1,000 per ounce, it would take 10 ounces.

Here is a similar chart, limited to the past ten years.

As you can see, it took over 40 ounces of Gold to pay for Dow in early 2000.  It now takes around 8.75 ounces. From this perspective, it looks like the Dow lost 80% of its value. That seems significant, even though the Dow's price is back close to the levels traded in the year 2000.

I don't normally put too much stock in charts that show one asset priced in another.  If it was supposed to be priced that way, it would be … However, this comparison seems more relevant to me because gold is a form or currency.  Also, as people decide what to invest in lost opportunity cost is a factor.

How is the Economy Doing?

Here is a chart from Russell Investments that identifies a few key economic and market indicators to help assess the current economic health and trend.  Click the chart for an interactive version.

Business Posts Moving the Markets that I Found Interesting This Week:

• Reasons Gold Is Rallying  … (Jesse's Café)
• A Good Old-Fashioned Panic & Not Just in Our Equity Markets. (Macro-Man)
• Stating the Obvious: Why the Stock Market Should Crash. (Of Two Minds)
• Kass: Is it Time to Anticipate a Reversal of Fortune? (TheStreet)
• NBC-Comcast Move Closer to Deal. (TDB)
• Betting on Bytes: is IT Rebound a Sign that the Economy's Improving? (Economist)
• More Posts Moving the Markets.

Lighter Ideas and Fun Links that I Found Interesting This Week

• Alpha Males Must Trade on More than Machismo. (FT)
• America's Healthiest and Unhealthiest States. (MSN Health)
• In Tough Economy, Tighter Belts Mean Thicker Waists. (WSJ)
• Man in ‘Coma’ Heard Everything for 23 years. (MSNBC)
• Clicker's Online TV & Movie Guide Impresses. (Newser)
• Answers to 15 More Google Interview Questions that Will Make You Feel Stupid. (Insider)
• More Posts with Lighter Ideas and Fun Links.

Black Friday came in several ways this year.  Yes, there was shopping.  However, the markets had a dark few days, too, as the world markets quaked at the news of Dubai's sovereign debt default.

I've always believed that you can tell a lot about the current character of the market based on how it responds to news. Sometimes markets go up on good news, and go down on bad news. That seems normal. On the other hand, I take it as a bearish sign when markets sell-off after good news. Likewise, I take it is a bullish sign when markets go up, despite bad news.

So, it wasn't surprising that markets reacted negatively to the largest sovereign debt default since Argentina. It was, however, somewhat bullish that the US equity indices went down as little as they did. Yes, I know that our markets were closed on Thursday (when most of the damage was done globally) because of our Thanksgiving holiday. And I also realized that Friday was a half day and had relatively light volume. Nonetheless, it could have been worse; much worse.

Here is a link to a post I wrote that I think is worth reading at this point in the markets. I called it "What My Dogs Can Teach Us about Markets".  It's really about how perceived danger puts us on alert; and why the second perceived danger often receives an even greater response. The point is that the world is now on alert, and I'm watching how calmly (or not) the market reacts to news.

Market Commentary.

The markets continue to hold up well on the surface.  Underneath, I'm seeing signs of weakness (poor breadth, weak up-volume, fewer new highs, more negative divergences, etc.).  Nevertheless, price has stayed above important levels.

With that said, here are some patterns worth watching.  This chart uses 15-minute bars to get an intra-day look at the S&P Mid-Cap Index throughout November. The most notable thing I see is a character change in mid-month.  The Bullish Break-Away Gaps seen at the beginning of the month are followed by two Bearish Island Reversal patterns (marked by the yellow boxes) in the second half of the month.  This type of pattern can be seen at market tops.  It starts with a gap-up (shown by the green circle) and ends with an exhaustion gap (shown by the red circle). You can click this chart to see a full-size version.

To understand what this pattern shows, you can think of it as the last buyers
rushing to get in (pushing-up price so fast that it creates a
break-away gap), only to find that there are no new buyers (causing a
price drop and the resulting exhaustion gap).  This gap down can signal
the beginning of a change in trend. Two of them in a row makes me more watchful.

David Corna reminded me that this pattern shows-up differently on a higher time-frame. For example, on a daily candlestick chart, the intra-day Island Reversal manifests as two classic reversal patterns, a Hanging Man followed by an Evening Star. Their very names are onomatopoetic to their meaning. These candlestick formations will almost always be found at the end of a trend and the beginning of a reversal.

Chart.ly from StockTwits is a Good Source of Ideas.

Many traders use charts and technical analysis to gain insight and perspective on what's happening in the markets.  I'm always looking for resources that help me do that.  Recently, I've found a lot of good content on the Chart.ly website.  It is part of StockTwits, and has a strong user community.  Here is an example of a chart I found there this week.

I like the analysis, and concur that the bottom trend-line (and the area on the far right of the chart marked by the blue circle) points to a key price area.  Staying above that is important for the rally to continue.

How bullish has the rally been in real economic terms?

What the Dow Priced in Gold Tells You?

This chart shows the Dow Jones Industrial Average priced in Gold.  In other words, how many ounces of gold does it take to buy the Dow's price?  So, for example, when the Dow is at 10,000 and Gold is $1,000 per ounce, it would take 10 ounces.

Here is a similar chart, limited to the past ten years.

As you can see, it took over 40 ounces of Gold to pay for Dow in early 2000.  It now takes around 8.75 ounces. From this perspective, it looks like the Dow lost 80% of its value. That seems significant, even though the Dow's price is back close to the levels traded in the year 2000.

I don't normally put too much stock in charts that show one asset priced in another.  If it was supposed to be priced that way, it would be … However, this comparison seems more relevant to me because gold is a form or currency.  Also, as people decide what to invest in lost opportunity cost is a factor.

How is the Economy Doing?

Here is a chart from Russell Investments that identifies a few key economic and market indicators to help assess the current economic health and trend.  Click the chart for an interactive version.

Business Posts Moving the Markets that I Found Interesting This Week:

• Reasons Gold Is Rallying  … (Jesse's Café)
• A Good Old-Fashioned Panic & Not Just in Our Equity Markets. (Macro-Man)
• Stating the Obvious: Why the Stock Market Should Crash. (Of Two Minds)
• Kass: Is it Time to Anticipate a Reversal of Fortune? (TheStreet)
• NBC-Comcast Move Closer to Deal. (TDB)
• Betting on Bytes: is IT Rebound a Sign that the Economy's Improving? (Economist)
• More Posts Moving the Markets.

Lighter Ideas and Fun Links that I Found Interesting This Week

• Alpha Males Must Trade on More than Machismo. (FT)
• America's Healthiest and Unhealthiest States. (MSN Health)
• In Tough Economy, Tighter Belts Mean Thicker Waists. (WSJ)
• Man in ‘Coma’ Heard Everything for 23 years. (MSNBC)
• Clicker's Online TV & Movie Guide Impresses. (Newser)
• Answers to 15 More Google Interview Questions that Will Make You Feel Stupid. (Insider)
• More Posts with Lighter Ideas and Fun Links.

Obama's China Visit.

President Obama asked for patience about the economy.  Nonetheless, a Gallup poll showed his job approval rating had dropped to 49 percent, the first time he has fallen below 50 percent in this survey, as Americans express dissatisfaction with his handling of the economy and other issues.

Unfortunately for him (and us) that wasn't the only voice of dissatisfaction he's heard lately.

Also, here is a skit from Saturday Night Live.  Like most good humor, it is funny because of how much is true.  I'm not posting it for partisan reasons … rather, it made me laugh.  Hope you enjoy it too.

Market Commentary: Spotting an Island Reveal Pattern.

In general, the markets held-up again this week.  As I scan the charts, there is little new or opinion-changing information.  However, I spotted an Island Reversal pattern on an intra-day chart of the S&P 500.  This is often seen at market tops.  It starts with a break-away gap (shown by the green circle) and ends with an exhaustion gap (shown by the red circle and the big red arrow). 

To understand this pattern, you can think of it as the last buyers rushing to get in (pushing-up price so fast that it creates a break-away gap), only to find that there are no new buyers (causing a price drop and the resulting exhaustion gap).  This gap down can signal the beginning of a change in trend. 

In this particular case, we are coming into a holiday-shortened week (often characterized by light trading).  So I'm not expecting anything dramatic.  Still, it seems worth watching to see if the market trades back up above the exhaustion gap.

Something Changed: Small Caps and Techs are Not Leading The Way.

Here is something else that caught my eye.  The chart below shows that the Russell 2000 Index (shown in green below) has led the way throughout the recent rally.  The S&P 500 Index (shown in red below), represents the broader market.  While the Dow Jones Industrial Average (shown in blue below) lagged.  You can click the chart image below to launch an interactive version on Stockcharts.com.  This chart shows the relative performance of these indices during the past year.  You can adjust the date range by dragging the date bar at the bottom.

The next chart shows the same information, except limited to the past month.  Notice that the relative performance of these indices has reversed. 

I'm watching this rotation to see if small caps recover or continue to show weakness.  They could be the canary in the coal-mine for a bigger correction.

Business Posts Moving the Markets that I Found Interesting This Week:

• Fed Eyes Dollar Drop, But Clings to Low-Rate Pledge. (FluentNews)
• Goldman Outlines Fed’s New Dashboard Indicators. (WSJ)
• Buffett Says His Businesses Have Bottomed (Reuters)
• Memo to Buffett: Put Down the Pom-Poms & Tell Us the Truth. (HuffingtonPost)
• New Market Bubble is Brewing: It's Déja Vu All Over Again. (Newsweek)
• While U.S. Economy Struggles, China's Rises. (NPR)
• More Posts Moving the Markets.

Lighter Ideas and Fun Links that I Found Interesting This Week

• Is Too Much Science Thwarting American Innovation? (FastCompany)
• 15 Google Interview Questions. Answers at the End. (BusinessInsider)
• How Ritz-Carlton Stays At The Top.  Interesting. (Forbes)
• Twitter: People Tweet 27 Million Times a Day. (HuffingtonPost)
• Let Them Eat Dog. (WSJ)
• Forbes Blog Post on How Leaders Balance Urgency & Patience. (Forbes)
• More Posts with Lighter Ideas and Fun Links.

Obama's China Visit.

President Obama asked for patience about the economy.  Nonetheless, a Gallup poll showed his job approval rating had dropped to 49 percent, the first time he has fallen below 50 percent in this survey, as Americans express dissatisfaction with his handling of the economy and other issues.

Unfortunately for him (and us) that wasn't the only voice of dissatisfaction he's heard lately.

Also, here is a skit from Saturday Night Live.  Like most good humor, it is funny because of how much is true.  I'm not posting it for partisan reasons … rather, it made me laugh.  Hope you enjoy it too.

Market Commentary: Spotting an Island Reveal Pattern.

In general, the markets held-up again this week.  As I scan the charts, there is little new or opinion-changing information.  However, I spotted an Island Reversal pattern on an intra-day chart of the S&P 500.  This is often seen at market tops.  It starts with a break-away gap (shown by the green circle) and ends with an exhaustion gap (shown by the red circle and the big red arrow). 

To understand this pattern, you can think of it as the last buyers rushing to get in (pushing-up price so fast that it creates a break-away gap), only to find that there are no new buyers (causing a price drop and the resulting exhaustion gap).  This gap down can signal the beginning of a change in trend. 

In this particular case, we are coming into a holiday-shortened week (often characterized by light trading).  So I'm not expecting anything dramatic.  Still, it seems worth watching to see if the market trades back up above the exhaustion gap.

Something Changed: Small Caps and Techs are Not Leading The Way.

Here is something else that caught my eye.  The chart below shows that the Russell 2000 Index (shown in green below) has led the way throughout the recent rally.  The S&P 500 Index (shown in red below), represents the broader market.  While the Dow Jones Industrial Average (shown in blue below) lagged.  You can click the chart image below to launch an interactive version on Stockcharts.com.  This chart shows the relative performance of these indices during the past year.  You can adjust the date range by dragging the date bar at the bottom.

The next chart shows the same information, except limited to the past month.  Notice that the relative performance of these indices has reversed. 

I'm watching this rotation to see if small caps recover or continue to show weakness.  They could be the canary in the coal-mine for a bigger correction.

Business Posts Moving the Markets that I Found Interesting This Week:

• Fed Eyes Dollar Drop, But Clings to Low-Rate Pledge. (FluentNews)
• Goldman Outlines Fed’s New Dashboard Indicators. (WSJ)
• Buffett Says His Businesses Have Bottomed (Reuters)
• Memo to Buffett: Put Down the Pom-Poms & Tell Us the Truth. (HuffingtonPost)
• New Market Bubble is Brewing: It's Déja Vu All Over Again. (Newsweek)
• While U.S. Economy Struggles, China's Rises. (NPR)
• More Posts Moving the Markets.

Lighter Ideas and Fun Links that I Found Interesting This Week

• Is Too Much Science Thwarting American Innovation? (FastCompany)
• 15 Google Interview Questions. Answers at the End. (BusinessInsider)
• How Ritz-Carlton Stays At The Top.  Interesting. (Forbes)
• Twitter: People Tweet 27 Million Times a Day. (HuffingtonPost)
• Let Them Eat Dog. (WSJ)
• Forbes Blog Post on How Leaders Balance Urgency & Patience. (Forbes)
• More Posts with Lighter Ideas and Fun Links.

What do you think is the most bullish indicator of our markets?  It's not a trick question; the answer is "price".

The markets have held-up nicely, throughout this rally, despite lots of bad news about the economy. And that, in-and-of-itself, is bullish.

It doesn't matter what technical analysis indicator you use (increasing negative divergences and selling on down days … or less positive momentum and market breadth), the markets have given us a clear message recently. Price is the primary indicator, and it has stayed above support. 

For example, here is a daily chart of the Russell 2000 Small-Cap Index.  It is holding its gains; yet, sitting at a decision point. 

Last week I posted a chart showing the Elliott Wave count of this index.  Nothing in this chart changes that analysis.

We can't abandon the discipline of looking to technical analysis, just
because early indicators haven't tipped us off to the end of rally, yet.  All that means is that the rally hasn't ended, yet.

The trading action during rallies is often characterized as "climbing a wall of worry".  So, how long can this rally last?  The next section suggests that a rally can last a lot longer than this one has, so far.

How Does This Rally Compare With Historical Rallies?

The Dow made another rally high this week, as it moved further above the 10,000 level.

To provide some perspective to the current Dow rally that began back in March, all major market rallies of the last 109 years are plotted on the following chart from Chart of the Day.

• Each dot represents a major stock market rally as measured by the Dow.
• The Dow has begun a major rally 27 times over the past 109 years,
  which equates to an average of one rally every four years.
• Also, most major rallies (73%) resulted in a gain of between 30% and 150% (29.8% to 150.5% to be exact) and lasted between 200 and 800 trading days (9.5 months to 3.2 years).
• These "typical rallies" are highlighted in the blue-shaded box.

As it stands right now, the current Dow rally (noted with the yellow highlight) would be classified as both short in duration and below average in magnitude.

On a different, but related, topic … I think it's time to pay some attention to what's happening to the U.S. Dollar.

What Happened to the U.S. Dollar – Or … Why Is Everything Else Going Up?

Here is a Performance Chart showing how the major world currencies have performed since last March.  This chart made me think of the Sesame Street song "One of These Things is Not Like the Others". Notice that all the currencies, except the U.S. Dollar, are up since then.

To me, this implies that the government made a decision near the March lows. Here is a link to an insightful post on why you should care about the strength of the dollar.  In general, there is a strong inverse relationship between the strength of the U.S. Dollar and the strength of the U.S. Stock prices.  Here is a chart showing what that looks like.

At some point, the economy will be more important than the market.  To that end, U.S. Treasury Secretary Timothy Geithner said a strong dollar is in the nation’s
interest; and that the government recognizes the importance it plays to the
economic health of the United States and the global
financial system.  We'll see.

Business Posts Moving the Markets that I Found Interesting This Week:

• Cisco's Profit Falls 19% – Shares Rise Anyway. (WSJ)
• Roubini: Bernanke Can Avoid A Crisis by … Actually He Can't. (BusinessInsider)
• Congressman Ron Paul Says Be Prepared for the Worst. (Forbes)
• Fed Sees No Need to Raise Rates Soon. (NYTimes)
• Buffett's Unusual Train of Thought on Burlington Northern. (WSJ)
• A VC Win: Greylock Partners Raised a $575MM new fund in six weeks. (WSJ)
• More Posts Moving the Markets.

Lighter Ideas and Fun Links that I Found Interesting This Week

• Moon Crash – While Public Yawns, Scientists Celebrate. (PhysOrg)
• Manhattan Providing Incubator Office Space for Businesses to Grow. (NYTimes)
• Learning in the Womb: Newborn Babies Cry in Native Tongue. (LiveScience)
• Hands-Free Parallel Parking in Your Next Car. (WSJ)
• Does Being Sad, or Complaining, Make You Smarter? (MarginalRevolution)
• Brain Scanners Can Tell What You're Thinking About. (NewScientist)
• More Posts with Lighter Ideas and Fun Links.

What do you think is the most bullish indicator of our markets?  It's not a trick question; the answer is "price".

The markets have held-up nicely, throughout this rally, despite lots of bad news about the economy. And that, in-and-of-itself, is bullish.

It doesn't matter what technical analysis indicator you use (increasing negative divergences and selling on down days … or less positive momentum and market breadth), the markets have given us a clear message recently. Price is the primary indicator, and it has stayed above support. 

For example, here is a daily chart of the Russell 2000 Small-Cap Index.  It is holding its gains; yet, sitting at a decision point. 

Last week I posted a chart showing the Elliott Wave count of this index.  Nothing in this chart changes that analysis.

We can't abandon the discipline of looking to technical analysis, just
because early indicators haven't tipped us off to the end of rally, yet.  All that means is that the rally hasn't ended, yet.

The trading action during rallies is often characterized as "climbing a wall of worry".  So, how long can this rally last?  The next section suggests that a rally can last a lot longer than this one has, so far.

How Does This Rally Compare With Historical Rallies?

The Dow made another rally high this week, as it moved further above the 10,000 level.

To provide some perspective to the current Dow rally that began back in March, all major market rallies of the last 109 years are plotted on the following chart from Chart of the Day.

• Each dot represents a major stock market rally as measured by the Dow.
• The Dow has begun a major rally 27 times over the past 109 years,
  which equates to an average of one rally every four years.
• Also, most major rallies (73%) resulted in a gain of between 30% and 150% (29.8% to 150.5% to be exact) and lasted between 200 and 800 trading days (9.5 months to 3.2 years).
• These "typical rallies" are highlighted in the blue-shaded box.

As it stands right now, the current Dow rally (noted with the yellow highlight) would be classified as both short in duration and below average in magnitude.

On a different, but related, topic … I think it's time to pay some attention to what's happening to the U.S. Dollar.

What Happened to the U.S. Dollar – Or … Why Is Everything Else Going Up?

Here is a Performance Chart showing how the major world currencies have performed since last March.  This chart made me think of the Sesame Street song "One of These Things is Not Like the Others". Notice that all the currencies, except the U.S. Dollar, are up since then.

To me, this implies that the government made a decision near the March lows. Here is a link to an insightful post on why you should care about the strength of the dollar.  In general, there is a strong inverse relationship between the strength of the U.S. Dollar and the strength of the U.S. Stock prices.  Here is a chart showing what that looks like.

At some point, the economy will be more important than the market.  To that end, U.S. Treasury Secretary Timothy Geithner said a strong dollar is in the nation’s
interest; and that the government recognizes the importance it plays to the
economic health of the United States and the global
financial system.  We'll see.

Business Posts Moving the Markets that I Found Interesting This Week:

• Cisco's Profit Falls 19% – Shares Rise Anyway. (WSJ)
• Roubini: Bernanke Can Avoid A Crisis by … Actually He Can't. (BusinessInsider)
• Congressman Ron Paul Says Be Prepared for the Worst. (Forbes)
• Fed Sees No Need to Raise Rates Soon. (NYTimes)
• Buffett's Unusual Train of Thought on Burlington Northern. (WSJ)
• A VC Win: Greylock Partners Raised a $575MM new fund in six weeks. (WSJ)
• More Posts Moving the Markets.

Lighter Ideas and Fun Links that I Found Interesting This Week

• Moon Crash – While Public Yawns, Scientists Celebrate. (PhysOrg)
• Manhattan Providing Incubator Office Space for Businesses to Grow. (NYTimes)
• Learning in the Womb: Newborn Babies Cry in Native Tongue. (LiveScience)
• Hands-Free Parallel Parking in Your Next Car. (WSJ)
• Does Being Sad, or Complaining, Make You Smarter? (MarginalRevolution)
• Brain Scanners Can Tell What You're Thinking About. (NewScientist)
• More Posts with Lighter Ideas and Fun Links.