Weekend Update: Shake and Bake

The market has taken on a new form and seems to be changing its stripes, at least for the short term. We are seeing breakouts being sold and more volatility day to day than we have seen in some time. This does not mean the market will definitely trade lower, but it also means that our job will be tougher in the near future than it has been for the past 8 months.  I think it is only reasonable to expect more sideways trading action with some large swings day to day. We simply have to curb our desire to chase breakout moves and instead shift to buying pullbacks. The market is rewarding buying dips and selling rips now rather than chasing momentum. These environments can change quickly so we need to be on the lookout for key support levels to buy off of AND hope to see some breakouts hold their gains.

Last week we were watching the reaction from the first retest of the key breakout level on the SP500 at 1,600. What we saw was a strong bounce from the 1,600 support level which seemed like the same 'ol game plan. We wanted to see a move and close above the 1,648 resistance level to trigger a move back to all-time highs or a slight pullback that set up the right shoulder of our reversal pattern. We expected the market to throw a curveball earlier last week and trap the consensus theory as to how the pullback would play out. What ended up happening though was that Monday morning's initial move to breakout was resisted and we traded traded sideways just below the 1,648 level. Tuesday morning we saw the pullback type trade to set up the right shoulder. After an initial attempt to retest the breakout level, sellers came out in force and took the market down for two days to retest the uptrend channel support and 50 DMA. To me that seemed to be the fake-out move we were waiting for, where the market trapped all those who bought into the prior Friday rally. Sure enough we saw a strong bounce from the support area and ripped back to the resistance area the next day. Today's action was weaker than I had hoped after the strong finish we saw Thursday and we are now in between key support and short term resistance.

As of now we really have nothing to trade upon and no setups to really watch. Basically what we have is a range developing between the key support at 1,600 and resistance at 1,640-1,648. Until a decisive move either above or below those levels occurs we don't have much to go from.

An interesting note to the resistance levels above: they are exactly where the declining 20 DMA sits and if you remember from the moving average post, when prices are stuck below a declining moving average we are much more vulnerable to corrective price action. So be aware of what we are dealing with now. We are basically in a long term uptrend, intermediate term uptrend and a short term consolidation period. All in all, not a bad place to be considering the run the markets have had. But none the less we need to be much more vigilant of the downside risk that is in front of us now.

The slope of the 20 DMA has not trended lower since the rally began last November. However there is still no imminent risk because the key level at 1,600 is holding, the uptrend support from November is still being defended, and the 50 DMA is up trending and price is holding above it. Until we see the trend support break and 50 DMA roll over, the 20 DMA signal is just a warning. This is still more or less an orderly pullback and don't make too many portfolio altering decisions until we get confirmation from price that the rally is over.

I increased my accounts stock allocation slightly this week on Wednesday's pullback and am now holding roughly 80% stocks 20% cash. I will likely stay at this allocation until we see a breakdown of the key support we are watching. Cash can still be deployed on pullbacks to support and should be trimmed into strength. Do not chase strength right now; if you are going to do some buying you should wait until we get a nice 1% decline into key support. But I feel that being this close to the "line in the sand", with major supports still in place, you can be heavy stocks here. Sure its more risky in terms of how people feel about the market short term, but intermediate term you should be using pullbacks into trend support to buy, not to be afraid of what might happen. When the trend breaks, we can sell then. But buying this close to our stop creates less downside risk.

Portfolio Update

Now lets take a look at the new Blog Portfolio that I have been putting together and see where we stand on our open positions. There were no changes to our holdings this week as the market held key support and many stocks churned with no real breakouts or break downs.

I want to clarify what I'm looking for in making buy/sell decisions:

1. I will only buy a stock that is trading above its rising 20 week moving average. This signals that the intermediate to long term trend is up. A stock we hold may trade below its 20 WMA at some point, but it is not an automatic sell signal. However I will not initiate a new position that is below the 20 WMA. We are looking for uptrends and high probability setups. This strategy will not pick tops and bottoms but it will keep you within the white meat of a trend.

2. For initial purchases I also want the relative strength in an uptrend and either breaking through a resistance level or bouncing off support. This shows us that our investment is being made into a strong and outperforming stock or group. Our whole purpose is to find the lowest risk/ highest reward trades; we want to own strength and sell weakness.

3. Selling out of a position will be determined by a key price support breakdown on a closing basis.

Currently we own 12 positions:
XLF, XLY, XLK, XLI, XLE, XLV
HAIN, WFC, F, PBW, HD, DDD

Currently 7 positions in Cash:
XLB, XLP, XLU
MOS, AAPL, CMI, ENB

We will be looking at the Weekly charts unless otherwise stated.

XLF

Financials look strong still even though on the week they were the weakest performing group. That weakness however didn't even print a lower low on the weekly bars. All in all as long as the relative strength continues and price is above that rising 20 DMA, we will stay long the Fins. They could certainly see a pullback here, but that wouldn't be too bad of a thing considering the that price is currently 10-15% above key trend support.

This is the reason I am so high on the financials. Here is a monthly chart showing the 2008 market crash and the subsequent base that was formed off the lows. There was a breakout of that $17, 5 year resistance at the beginning of the year and they really haven't looked back since. I would expect a retest of that area soon before continuing the move higher.

XLY

Discretionary has managed to hold its uptrend as well. As long as the trends hold, so will we. A breakdown of $55 will signal a change in character. $52.50 would be the nail in the coffin.

XLK

Tech is holding up near the upper range pretty well. The relative outperformance is managing to hold a decent trend as well. Not too much to worry about above $29.

XLI

Industrials are trending nicely and still are setting higher highs and higher lows. A move below $42 would be notable.

XLE

Energy on a weekly basis is holding trend and consolidating at range highs. Holding $75 will be very important.

The Daily view is not quite as appealing. Relative strength is having a hard time outperforming, holding the trend support will be key.

XLV

Healthcare has been on the ropes the last two weeks but has managed to stay relevant by closing at the highs of the week just at trend support. We will be waiting for a confirmed failure of the Relative Strength trend and a 20 WMA breakdown for exit. A Head/Shoulder formation can be seen possibly forming, but still a break of $46.50 would be needed to trigger a move like that.

The remaining sectors continue to underperform and/or trade poorly. I will continue to monitor those as we go forward. A case could be made for going long XLP (Staples), I just haven't liked the strength supporting that space for a while. One problem with being long defensive sectors like Staples and Utilities is that when the market corrects, they will outperform on a relative basis. The problem with that is they still often trade lower just not at as fast a rate as the broader markets. So you can still be losing money even though they are outperforming. I tend to shy away from owning those as trades because of that fact. When offensives are performing they are trading higher; when defensives are outperforming, half the time they are still trading lower, just not as much. That being said, if you are looking to OWN stocks forever, defensives are good bets for that because they tend to not lose as much when the market swoons.

HAIN

HAIN looks great here. Above its base breakout consolidating just below all-time highs. Relative Strength is still in a beautiful uptrend and the 20/50 WMA cross is another bullish sign. Stay long above RS support and base support at $62.50

WFC

Wells has looked strong recently, but is showing some short term signals that it may take a breather soon. Price is 10% above the 20 WMA and this week we saw a pretty big reversal move from new highs. Still strong though, still in an uptrend and nothing intermediate term to be concerned about.

F

I'm showing a candlestick plot setting here to emphasize something. Last week Ford put in a candle called a "hanging man"; a hanging man candle will show up at or near intermediate term tops. This past week's downward move also gives some confirmation that we may see some weakness ahead. Frankly, we need to see a retest of the breakout from prior highs and pullback to the uptrend support which price has really moved away from in the past two months. I'm just looking for a mean reversion trade here, nothing endangering the longer term move. Price is almost 20% above the 20 WMA! That will not be the case forever.

PBW 

Here is another interesting candle formation. This is called a spinning top and signals indecision. As you can see after a straight up rip on the base breakout price is now attempting to digest some of those gains. The breakout is intact above $4.85 and should be owned above that level. There is an initial price target at $6.25 where some profit should be taken.

HD

Home Depot remains in a strong uptrend. There will likely be some tests ahead, but so far so good.

DDD  

DDD seems to be stuck in a range now and is bouncing back and forth. You can see the long "wicks" on each weekly candle. That shows the upper and lower range for the stock each week. When the body of the candle is far away from the end of the trading ranges is shows trader's bias to one direction or another. In this range we can see that traders are selling the stock in the $50-$52 area and willing to step in and buy it in the $42.50-$44 area. This is perfectly normal after the massive rise this stock has had over the past few months and we are perfectly happy holding it while is works off some of those overbought conditions. If you want to trade this thing a bit I would look to be a buyer near the lower end of the range and a seller at the upper end. There is 20% difference between the upper range and the lower range. That makes for a good short term trading opportunity. If you are a buyer near the lows you likely risk a couple % of downside vs. 20% of upside. Those are trades you want to look for! Any decisive break above or below will set up the next leg.

We never saw the confirmation on the initial buy signals we got from AAPL and CMI last week, so those remain on the sidelines. ENB presents an interesting case for a buy but it violates two of the trend following criteria I am using for this longer-term portfolio:

Its a little hard to see but that's because I want to show the scope of the uptrend. Price pulled back violently from the upper range 2 weeks ago and sliced right through a flat 20 WMA. The long term Relative Strength trend failed to hold also, which is something we haven't seen for years. These two things concern me that this move is not a typical pullback but could be something more. If I am wrong then we will just jump back on board when price retakes the 20 WMA and it begins to turn upward.

The short term price action however signals a buying opportunity, but for the purposes of this portfolio, I am taking a longer view and right here I am willing to let this one shape up a little better before plunging back in.

Here is the 30 minute chart on ENB. As you can see its set up to bounce off the support lows and at least fill the gap that was made on May 29th. If this can fulfill this pattern to completion, fill the gap and retake the 20 WMA, then it would mean that what we saw at the end of the month was simply profit taking and not a major trend reversal. You do almost have to give this one the benefit of the doubt because of its massive uptrend. I have added to my positions in shorter term accounts, but the longer term accounts are still waiting for stronger conviction.

What we have right now are strong uptrends across the markets that are beginning to show a desire to cool off a bit. There is nothing wrong with that, you just have to make sure you are trading/investing within your time frame and not letting small ups and downs shake your conviction. If we get a pullback then the market can refresh, that's a good thing. If it keeps on rallying then we can play on that too. We just have to stay focused on our goals and risk management, and leave the market to show us the way ahead.