Removing Prospect Mosaic(MOS), Introducing PPG (PPG)

Our weekend update lesson couldn't have been timed better. This weekend we discussed why we use price action as our primary investing/trading strategy and used Mosaic and PBW as our example. Please read the Weekend Update if you have not seen that post yet. But the example shows why we try to identify the strength and weakness present in the market and avoid the latter. Today MOS showed enough weakness that I am removing it from our prospect list. When the original thesis for a trade/investment no longer exists, you must admit defeat and move on. Our primary objective is to cut our losses short and let our winners run; while we never held a position in MOS within the Portfolio, I did have hope for it to materialize into a winning investment. Here is what happened today to eliminate it from our consideration going forward:

The trade below the Inverse Head/Shoulder "Head Low" effectively kills this pattern setup. This was my 1st, 2nd, and 3rd reason for being interested in this stock. Now that the setup is gone, there is no more need to waste our time and resources on it. We are moving on.

New Prospect 

PPG (PPG)
Sector: Basic Materials/Specialty Coatings/Chemicals

Replacing MOS in our Top 10 prospector list will be PPG. PPG is in the Basic Materials sector and is an global supplier of paints, coatings, optical products, specialty materials, glass and fiber glass. They are an industry leader and also (my personal favorite) Relative Strength monster!

As you can see, this is in a monster uptrend, all-time highs every few weeks it seems, and is a serial outperformer vs. the SP500 since the 2009 low. What is nice about a trend like this is the risk is very well defined as all we have to do is follow the uptrend and when that fails we see an easy exit. That's all it takes to follow a trend folks. Use the prior swing low as your stop loss and anything above that level is a hold. Our most recent swing low is at the $144 level and that is the level we will trade against.

We are seeing the potential for an entry very soon here. The Relative Strength shows a potential breakout from an 8 month wedge pattern and if prices close the week above $159 it would signal an all-time weekly closing high. If we see a close above that level, our Blog Portfolio will enter near the close of trading on Friday. Watch that $159 level closely!

Entering 3D Systems (DDD)

We got our entry signal for a long position in DDD today. With a close above the prior high @ $49, we will be entering the position today. Here is a look at the chart and why we like it here:

Based on our longer term signals this stock has never been in a poor position. However when I initially built the portfolio the short term setup had some concerning looking issues and the risk/reward was not in our favor. Over the past 2 months though it has held its massive gains from the March lows very well and is now breaking above the consolidation zone.

This trade doesn't come without its wrinkles however. DDD will report its earnings for the quarter tomorrow morning before the market open. This "event risk" will no doubt create some volatility in the shares and could very well end our trade right away. If the market doesn't like what it hears in their report, the shares could sell off pretty hard and we would be stopped out. But that is part of the market, you take calculated risk and get out quickly if you are wrong.

We are playing the breakout of this congestion area which has formed a bullish Cup/Handle pattern and projects a very substantial gain from current levels. Our risk will be limited to a failure of the low at $45. If that level is violated we will need to move to the sidelines and reevaluate our plans for this stock going forward. I trade what price is telling me, not what "might" happen in the future. Right now price is saying that this stock wants to continue higher from current levels and we have a very defined risk/reward setup that is advantageous for our portfolio going forward.

Weekend Update: The Bears are Licking Thier Chops...Will They be Licking Wounds Instead?

This week we saw a little fatigue in the markets as the SP500 approaches the widely targeted 1,700 level. There are some notable momentum divergences showing up in some of the indexes and key sectors on the short term and the Bears are coming out of the woodwork getting ready to call this a Double Top. We will discuss the possible implications of this so called "Double Top" in a moment, but first I would like to point out that on the weekly view of the SP500 price made yet again another all time high this week and put in another higher low on the weekly range. This is still very bullish activity regardless of what the pundits and fear mongers are spouting about. I was reading a blog this week highlighting a short position in Home Depot (HD). This is exactly the kind of overeager, aggressiveness the Bears are dealing with at these levels. Now I'm not saying the thesis for this trade is flawed in the short term, the author made a good case for his position. But it also is back to the idea that you should be trying to pick tops in a runaway market and leading stock. This idea is something I DO NOT agree with in my trading and investing strategy. There is certainly some short term money to be made fading moves to new highs from time to time. My issue with the trade is that it is a counter trend trade; I like to trade in the direction of the longer term trend. It just seems odd to me that if someone thought the market was in for a correction that they would go after the strongest stocks in the rally year-to-date. If I was going to get short a position in this market I would be looking for stocks that are rolling over and in weak longer term trends, not stocks that have been making new all-time highs for the past 8 months (like HD).  

This is just an example of how smart the Bears think they are and their eagerness to finally be proven right. They want to call tops and fade all-time highs, they want to be the genius, but to me it just seems they are playing with fire. There are weak stocks and markets out there that would make much better bets to short should the market top out at these levels. However it is exactly this Bear mentality that shows to me that this market will continue higher. Part of the reason the market keeps making new highs is due to the Bears aggressively shorting every rally in the hopes that "this is the big one!". When the shorts get squeezed out of their positions they are forced to buy-to-cover and that then propels the market higher. Needless to say, I like seeing so many out there trying to pick the top and shorting every rally. Those trades are fueling the fire to keep this market chugging higher. Just as in the HD trade, we have been riding this trend for a long time now and its been a big winner. Everytime this has made a new high the bears have come out against it and repeatedly gotten run over. Will this time be any different? I don't know, but I'm going to stay on the side of the long term trend as that has been the winning setup so far. Think about the guy on the other side of our HD position...Poor bastard, hard to imagine he even has an account balance left.

The point is you have to stick to the long term trend and try not to fight it. When the trend breaks, then we can get bearish. Just because the market or a stock makes a new high doesn't mean a big drop is imminent. So far we have seen many new highs that continue to lead to more new highs. That's my whole strategy with the markets, be bullish the uptrend, be bearish the downtrend, and be willing to shift your positioning should price indicate a change in that trend is present. It's really as simple as that, buy stocks going up, sell stocks going down and watch for the turns in those trends. 

Here is a look at the Daily chart of the SP500 showing what is making everyone so nervous:

This chart shows the SP500 making a new high above the May peak. It also is showing that momentum (shown by the MACD) is making a lower high, not confirming the new high in prices.
This is called a negative divergence. We look at divergences all the time when a stock may potentially be bottoming, but they work the other way too. Basically when prices make a new high, we want to see momentum confirm that high. If it does not confirm the new high in price, it is a signal that a weakness is building under the surface.

Know though that when we have a divergence, negative or positive, it is not a direct buy or sell signal. It is simply a warning that a change is developing and something to keep in mind. If you look at this chart above there was another negative divergence from February to mid-March where momentum did not confirm the new price highs. However this divergence never came to fruition and prices continued to make new highs and soon momentum was confirming the new high made in mid-May. Divergences have their place in our study, but again only something to keep in mind. Fortunately for the Bulls, many of the Bears out there are playing directly on this divergence and lining up their short positions because they are sure this will roll over. That's what keeps the bull market running, all these overeager Bears betting that this time will be different.

The news media can talk about whatever they want to in terms of this market and where they think it will go from here. I simply don't care what they say. This is what I care about, here is a look at the weekly view of the SP500:

 Here is what is important to me:
-We have a strong uptrend of higher highs and higher lows going back to the 2009 lows
-Price is above an upward sloping 20 WMA
-There was a 6% pullback over the past 2 months that broke out decisively and has seen follow through confirmation.
-The SP500 has held its gain and is staying firm at all-time highs.

In my opinion, this is what matters. We have strong price action and the market seems poised to continue to make new highs. We may chop around here a bit and digest some of this recent pop, but overall things are looking very positive.


We had no changes to our Blog Portfolio this week as the market continues to consolidate these recent, breakout gains.

We are Long:
XLF, XLY, XLK, XLI, XLE, XLP, XLV
HAIN, F, HD, PBW, WFC

We are sidelined in:
XLB, XLU
MOS, ENB, AAPL, CMI, DDD

Let take a quick look at a few of the more interesting charts from our list this week.

HD

Taking a look at Home Depot this week, I can see what the Bears are interested in; price is getting stuck a bit at the highs and momentum is diverging. This will be something to watch going forward, however there is no real damage done here and I will not be too concerned until prices break the uptrend support and then the prior lows. This has been a monster trend and we need to do our best to stick with it. I couldn't show it here but the Relative Strength is beginning to look as though it may roll over as well. This is also something I will be watching closely. We like to invest in stocks outperforming the SP500 and if that trend breaks, we may want to look elsewhere.

AAPL

This chart is basically the same one we looked at last week. AAPL announced their earnings for the quarter this past week and produced a better than expected result. Price has now gotten above the 20 WMA which turned positive by 1 penny this week from last week. Also the RS wedge we are watching below shows an attempt to breakout to the upside. We will be watching this one very closely in the coming week(s).

F

Ford reported a strong quarter this week and prices rallied strongly off the news. The rest of the week though it tried its best to give most of those gains back, closing out the week near the lows. Last week I did say that the Double Bottom pattern we have been tracking achieved its target @ $17 and we should expect to see some consolidation. The trading action this week also seems to tell a similar story. This weeks' chart bar has the look of a "shooting star" formation which signals an intermediate term trend reversal. We need to see some more confirmation of this next week, but I expect some choppy action for the near future. Still no reason to sell our positions, the trend is up, its strong and we are will above the uptrend support. Let's just be patient with this one up here.

ENB

Enbridge almost signaled a buy recently but this shows why we wait for confirmation of an entry signal. Early in the week price made a break above the 20 WMA, but as you can see that move was faded into the close on Friday. We still need to see more here before we look to enter. As I discussed last week, it would be nice to see another test of the lower trend support creating the right shoulder for a reversal setup. That would make a move above the 20 WMA very strong.

MOS

We haven't talked about Mosaic much recently as there hasn't been much to talk about. This has been a disappointing performer year-to-date as it has gone nowhere while the SP500 has rallied strongly to new highs. But I felt discussing this now would be educational on several levels.

First, the statement that "you cannot time markets" is a very uneducated and dismissing way to look at trading. What these naysayers are getting at is that its a fools game to try to trade and you might as well just hold onto the stocks you own and ride it up and down. What I would say to that is, its a fools game to try to pick tops and bottoms. No one can do that regularly and anyone who says they can is likely lying or had a bit of luck once or twice. But that is not what timing the market means to me. I try to buy more when things look favorable and sell more when things look unfavorable. Naturally we will be wrong about those times occasionally, but as you can see by using some basic signals and common sense you can avoid poor situations and investments like this one here.

Second, just because we "like" a stock for a particular reason, we cannot get married to a position and ignore what is being shown to us by the price action. This had looked promising to us because of its longer term setup and I was very high on the prospect of this being a big winner. But as you can see it simply hasn't panned out as being a good risk to take. Which leads to the next lesson this can teach us:

Just because a pattern is setup, you cannot trade based on that setup UNTIL it triggers the pattern and holds. Here is a look at the Inverse Head/Shoulder (setup) we have been tracking:

 As you can see it never triggered with any conviction. It poked through the neckline one time but the next week had given back the breakout and subsequently rolled over and has nearly killed off all hope of it recovering. If we had just used our initial hunch about this setup and ignored the lack of breakout, we would be looking at roughly a 20% loss so far this year. Always wait for the pattern to trigger and hold.

This then leads us to the exact reason why we follow price and ignore feelings when it comes to making investment/trading decisions. Here is a look at a stock that had virtually an identical setup to MOS, but it did in fact breakout and we have been trading it successfully for some time now:

PBW 

This was setup eerily similar to MOS, but this one has managed to work in favor of the Inverse Head/Shoulder setup. It should be clear to you now (and to the doubters out there) that following price action works as an investment strategy and should be used within any strategy for superior returns. Had we ignored price confirmation and simply bought both MOS and PBW based on the pattern potential we would be looking at basically a zero return between the 2 holdings. But by using some simple analysis we managed to avoid the laggard and buy the winner. Since PBW broke out of its base pattern the week of May 10th, I advised trading the signal and has since returned 15% from the May 10th weekly closing price.

Weekend Update: It's The Broken Record Market...New All-Time Highs, Again and Again

Boring old market, same tune over and over, new all-time highs, blah blah blah. This is the situation we are dealing with this year. Any and all pullbacks are shallow (1-6%) and each one has lead to the market setting a new record high. This is just classic bull market stuff, I'm not making this up. At this point, even nearly a 15% decline from current levels would still keep this market within its long-term, recovery uptrend. Its goes without saying, this is a market you should be invested in and still have plenty of downside cushion as a safety net should the highs not hold. I'm not advocating going all-in here if you have not yet participated, but you have to be taking nibbles at winning stocks.

In my short term accounts I have done some re-balancing this week. I took some profits in UNH this morning as it ripped 10% this week alone. I also took some gains out of HAIN (in short term accounts, long-term I am not acting here) after it has gained 15% this month. I sold out of my INTC holdings due to the intermediate support breaking after a weak quarterly report and transitioned those funds into one of my long time favorites, UNP, as it broke to new all-time highs. I opened a position in APA which is setting up for a nice risk/reward move; I feel APA could be a very nice longer term hold and value from current levels. I also added to my DDD position in short term accounts. I don't feel this is quite set up for longer term accounts just yet as the risk/reward is still a bit high on the weekly time frame. This short term position is a more aggressive trade and I don't feel it is appropriate for our time frame here just yet. But I will be watching for the longer term signal to generate so we can open a position for our blog portfolio.

When the market makes new highs it is often time to check out your holdings to make sure they are performing up to the high standards of a record market. Here is a weekly view of said "record market":

  Just very nice action here. That rising 20 WMA has acted as strong support and the SP500 has rallied hard off of those levels. This has the look of a bull flag pattern; what we typically expect to see with a bull flag breakout is a quick surge above the prior high and then a throwback type trade back to the breakout level. Aggressive, short term traders take some profits on the initial breakout and more conservative traders setup new positions on the retest. The pattern is then expected to continue in the breakout direction after the throwback. That will be something to watch for in the coming weeks. The current invalidation point to this breakout will be a failure of the June low at 1,560. If that were to be the case, I would look for the 1,470-1,500 uptrend as support.

Lets take a look at some interesting charts from our list after this weeks action.

XLK (Technology)

After disappointing results from GOOG, INTC and MSFT this week, the Tech sector took it on the chin. Our RS rolled over from the prior low and has gotten our attention here. I was very close to closing our position today, but the price action still shows a steady uptrend and is above key support. We will be watching this with a close, skeptical eye. AAPL reports earnings this coming Tuesday and will either be the stick-save for Tech or the straw that broke the camel's back. I will keep you posted.

XLE (Energy)

Our newest position got off to a nice start with today's 1.39% gain and showed strong follow through of Thursday's breakout. We saw today's move come on increased volume and also have RS breaking out of a 5 month downtrend. All good things, and very good things to see as confirmation of strength in a new position.

XLF (Financials)

When the Financials go higher, the market goes higher. Its just one of those things. This is a longer look at the XLF from the 2009 crisis lows. There was a 4 year base setup after the monster crash and just since the end of last year, price has broken out of that base. This is huge for the market and a big reason as to why I have been a believer in this rally all year. Most of the big banks have reported quarterly earnings over the past 2 weeks and every since one has just hit it out of the park. There is still lots of upside to come. The reversal pattern in the base breakout projects an initial target near $23.40.

XLV (Healthcare)

Even when Healthcare broke down from its 6 month uptrend, Relative Strength never confirmed the breakdown. This is a reason why we follow strength so closely, it will often hint whether something is better under the surface than it may seem. Since the trend failure, price has consolidated orderly and now broken back to new highs. This is setup similarly to the SP500 with a bull flag type pattern. Looks to be moving higher from here.

XLU (Utilities)

Utilities could get interesting here soon. Price seems to have broken the down trend by taking out the prior high at about 38.50 and is now testing the underside of resistance from the April breakdown. We want to see a break above the resistance level here and also hope to see Relative Strength break above its horizontal trading range. Something to watch.

CMI (Cummins)

CMI is coiling up here, getting ready for a big move either above or below the range. For 6 months price has gone nowhere for Cummins, bouncing back and forth between 122.50 and 103. While price has been coasting, RS has been forming a triangle coiling pattern of its own with higher lows and lower highs. Think of a triangle pattern acting as a spring. As price moves closer the the apex, the trading range gets tighter and tighter until something gives. Whether its a strong earnings report or some other extraneous event, price gets so tight that it finally pops in the direction of the breakout. After trading in a narrow range for the last 6 months and a wider range for the last 2 1/2 years, something is about to happen here. The move is likely to be violent. We will have to watch and see which side wins before we act ourselves. I am a fan of CMI and would be very interested in the stock should it break out of its shackles and move to the upside.

ENB (Enbridge)

Enbridge looked to be breaking down as it was falling below its long term trend support and prior highs support. But it appears that it was a false breakdown and is trying to push back into rally mode. It still has some work to do as it needs to trade back above 45 to take out the prior lower high. I think it may take a rest at these levels after running pretty hard to get back what it had lost. I have drawn a possible bullish outcome here if it can consolidate a bit it would setup for a reversal inverse head/shoulder pattern and get ready to break higher. I will be watching this closely in the coming weeks to see how it handles this resistance.

DDD

Here is the daily look at DDD. After trading above and below its triangle formation, the pattern has made more of a flag type range now. For short term trades, you can take a position right against these lows and the rising 20/50 DMA's. For the longer setup to trigger I would need to see a sustained break above 49 creating a higher high. With a break above 49 the new stop would be just below the breakout resistance and low set here at 47. That is the risk/reward situation I would like to setup from here. If we bought for the longer term time frame right here, our stop would still have to be the low near 42. I do think this trades higher, but the market doesn't care what I think and I need to let the price prove itself before I take a longer term setup at these levels. This chart is all kinds of bullish though; a big cup/handle is being formed and a break above that $49 level would set this into motion. The trend is up seems to want to power ahead.


As of the close Friday our Portfolio currently holds 12 open positions:

XLF, XLY, XLK, XLI, XLE, XLP, XLV
HAIN, F, WFC, PBW, HD

Cash:
XLB, XLU
DDD, ENB, AAPL, CMI, MOS

While we added one position this week, it looks as though some of our cash positions are very near entry points. With AAPL's earnings this week and the close tests that DDD, ENB, CMI, and XLU are up against, next week could prove to be an active one for our portfolio.

Entering XLE (Energy)

So the XLE has gotten back above an important resistance level and is poised to close at multi-year weekly highs. If you recall, during the recent market correction, I closed our position in the XLE due to what I felt were higher risk circumstances. However since that time, oil has broken out from a multi-year triangle formation and has been steadily moving higher, lifting the entire energy sector along with it. Now some may say that oil has run too far and we are buying into a hot run in Energy. While there is some truth to those statements, we are not in the business of trying to guess the future, we simply follow what price is telling us; right now price is saying that Energy is ready to make new recovery highs very soon.

This is what we like about the XLE. Steady uptrend and lots of higher lows. A breakdown of that pattern would be our signal to exit. This was also my primary road map in our previous trade, except I tried to get to cute and anticipate a move lower (thats why we should always do our best to stick to our stops and not make emotional decisions). I said it in a previous post that, its ok to be wrong, ITS NOT OK TO STAY WRONG. Energy is showing us that our sale was wrong and that its time to right our wrong.

Now this entry is not without some risk. A couple things that I will need to see resolved to be more comfortable with this position will be a stronger move by the Relative Strength to prove its outperformance vs. the SP500. I would also prefer to see a little more volume on a potential breakout like we are seeing today. But price leads and we will defer to that for our initial entry here.

The Relative Strength has broken out of its long-term downtrend, but shorter term its been meandering around just below the downtrend line shown above. If this were to weaken significantly from here we would be inclined to exit. Also you can see the volume that is coming in on this move today...Not very impressive, and potentially hinting at a lack of conviction. But price has rallied back above the prior lower high and has broken the downtrend. With such a defined uptrend in place, I feel that its worth a buy and has a reasonable risk/reward.

Weekend Update: The Bulls Are Running Again!

With a close at new all-time highs for the SP500, Dow Industrials, and Russell 2000 this week, it is safe to say the Bulls are back in charge. A breakout to new highs does one major thing for us a trend traders, it allows us to move our stops on current positions to the most recent significant low. This is always a welcome event for us as it allows us to lock in that much more profit on our positions. Lets take a look at our current holdings and our new invalidation points.

Current Holdings:
HAIN, WFC, HD, F, PBW
XLF, XLY, XLK, XLI, XLP, XLV

Cash:
AAPL, MOS, ENB, CMI
XLB, XLE, XLU

HAIN

HAIN saw a big move above prior highs and posted its second highest weekly closing price ever. Lots to like in this one. Our stop is placed just below the rising 20 WMA and base support at 62.50

WFC

Wells broke out to new recovery highs this week after reporting a very strong Quarterly result Friday. The Financials are still running strong and Wells is one of the strongest in the group. We will look to sell if the $39 area is violated on a closing basis.

HD

Home Depot set a new all-time weekly closing high this week and continues to defy gravity. Our invalidation point on this one is still the trend support and prior low near $72. Our stop is roughly 10% below current prices, so we are giving this one quite a bit of room. But that is the nature of long-term trend...LET IT RUN!

F

Ford just continues to rip to new recovery highs. This week we achieved our Double Bottom target at $17. That doesn't mean we are automatically done with the trade, but it does mean we should expect some consolidation around these levels. Current stop is just below the rising 20 WMA and prior breakout high at $14.25.

PBW

After retesting its base breakout support 3 weeks ago Clean Energy has rallied strongly off that level and closed above the prior highs. The initial target for this reversal pattern is $6.25 and our stop is at the prior low and neckline support at $4.90

XLF

Financials continue to lead the market. With strong earnings reports from Wells, JP Morgan and Citi, the sector group made a new recovery high and continues to move away from the massive base breakout level near $17. Our stop moves up to the $18.50 prior low.

XLY

The US consumer remains strong and the Discretionary sector is ripping to new all-time highs. Big move this week! Our stop is at $54 at our new prior low.33333


XLK

Tech is still riding that uptrend and seems poised to continue higher. Our stop will be trend support with a follow-through confirmation at the $30 level.

XLI

Industrials posted a new all-time high this week and is a market leader. Our stop will be below 42-41.50 level.

XLP

Our newest holdings, Consumer staples, made a strong move this week. Our stop rests just below $39-38.75 level

XLV

Healthcare set a new all-time closing high this week and our new invalidation point is below the support area at $46.50

Overall a very good week for our Portfolio and we will continue to ride these new all-time highs!

Entering XLP (Consumer Staples)

Today we will be entering a position in the XLP, which represents the Consumer Staple sector. Several of the holdings within the fund include: Coca Cola, Procter and Gamble, Phillip Morris and Costco. These are the Mega Cap companies, the household names for products you and your family have used forever. Typically this is a defensive group that pays solid, growing dividends and consistently produces solid yet unspectacular returns for shareholders. The chart is setup very nicely for us and has triggered a buy signal.

The first chart is a look at the daily view. What I like here is the breakout above the prior high. Not only did the XLP close above that prior high, it traded on higher volume indicating further strength and confidence in the move. Also you can see that the long term Relative Strength is trading right above a key uptrend support vs. the S&P500. The long term Relative Strength has been present in XLP, but recently the price action has been poor. Now we have the price confirmation to enter the position.

Our second chart is the weekly view and shows how price has retaken the rising 20 WMA after closing below it for 3 consecutive weeks. The breakout this week can also be seen clearly here on the weekly chart. Our stop will be placed initially right near $40. That area represents the rising 20 WMA and the prior support, turned resistance that this week's breakout triggered from. I would also be willing to exit this position should the Relative Strength begin to fail.

---There are a few other positions that I am watching very closely as well. We are nearing buy signals in:

DDD
AAPL
XLE
XLB

DDD

 Looking at the daily chart of DDD we had a false breakdown of this triangle pattern, but price has recovered and is now sitting above the downtrend resistance, prior triangle support and above the 20/50 DMA's. The final evidence that we will need to believe that this "breakout fake-out" will follow through to the upside will be a close above the prior high at $48.90. A close above that level and we will reenter the position. From false moves, come fast moves. And we want to be a part of this trade if a move above the prior high confirms. This will be something I am watching Friday and may enter at the close should DDD gain that 1% and close higher.  

AAPL

Apple has begun to show further signs of finally putting in a bottom. We are seeing a positive divergence in momentum suggesting a change is building (take a look at the MACD or RSI on the weekly view). Price has been making new lows while momentum has made higher lows.

 After a long downtrend like this, a stock will typically form some sort of base of support. Within the support base, a pattern will likely emerge giving some hint to the future direction of the eventual breakout. I believe we are seeing a possible Double Bottom formation here from the lows in mid-April and the low of the last week of June. If you remember back to our discussion of reversal patterns, for a Double Bottom to trigger we need to see a break above the high that formed in between the two bottoms. So, the most important thing to watch for will be a break and close above the base highs at $453.

We can also see that the 20 WMA, which has been declining steadily, is beginning to flatten out. This suggests that downside momentum is slowing. Ultimately I will want to see price move above the 20 WMA and then see that average turn and begin to slope higher.

Lastly, Relative Strength vs. the SP500 has been forming a wedge pattern. The direction of the breakout will be very instructive as to whether this will be a successful position for us or not. A break above the wedge resistance will signal our bullish thesis, a break below will keep us sidelined.


XLE (Energy)

After exiting this position 2 weeks ago it has broken back through resistance and seems to be wanting to move higher. When we sold this I may have been a little hasty and tried to out think the setup. What I was seeing was a false breakout above key resistance, a weak bounce attempt (low volume rally after a breakdown) that failed at the underside of the flattened 20 WMA and a weakening Relative Strength reading vs. the SP500. All those things contributed to me making the call that we should wait and pick a better spot. However our stop at $75 was never breached (this shows why you should always stick to your stops and not try to anticipate a move).

Since the decision to sell was made, a likely better situation may be near. Now that price has moved back above the 20 WMA, we need to see confirmation from Relative Strength of out-performance, and we need to see the prior weekly closing high at 82.12 taken out. With those signals in place we would then re-enter the position. This is again another setup that could trigger with today's action, although I expect a little more time may be needed.

**An important lesson can be made here: When trading the markets its okay to be wrong on a position, but IT IS NOT OKAY TO STAY WRONG. If we think one thing but the market gives us another, we need to be flexible enough in our methods to accept that we are wrong and correct the situation. Staying wrong can get you into the uncomfortable position of taking too big a loss that your investing capital is deeply damaged...not to mention, your poor damaged ego. Although it was your ego that got you in too deep in the first place. We will be wrong a lot, what we can't do though is dig our heels in and try to force our will onto the market. Believe me, the market will only laugh at your pain and take your money. If you are wrong admit it quickly and take your small loss. There will always be another setup that comes along, you just have to make sure you still have an account balance and can take advantage of the next one.


XLB (Materials)

Materials are in a similar boat as Energy and we need to see the prior resistance highs taken out and for Relative Strength to breakout of its downtrend. But a decent uptrend none-the-less. We will keep watching.

Weekend Update: Yet Again, Another Strong Jobs Report

Yesterday's trading session showed a positive response to another increase in non-farms payroll. Not only was the June report better than expected but both April and May's payrolls were revised higher. The continuing improvement in the labor market has made markets nervous recently due to the likelihood of a reduced easing policy from the Federal Reserve; it appears to me that the market is on its way to pricing in the effect of a QE reduction. It would seem to make sense that an actual improving economy would trump easy money policy and low interest rates, but as we discussed the other day, the market rarely behaves in a logical way; if you approach the market logically, you will likely end up very frustrated and in the red. This is why we don't press our personal views onto the market, the market simply doesn't care.

 So what are we to do then? If we can't approach it logically does that mean chaos and irrationality reign? Well, some yes and some no. We can't ever have a uncompromising bias on market direction, but we also can't just throw darts and hope randomness prevails for us in the end. We need to make calculated decisions that are based in fact and need proper risk management techniques in place in case our ideas are wrong.     Simply, we need to listen to what the market is telling us, about what groups should work in a "reduced" QE state and what groups will not.

What's interesting in this market recently is that while the averages as a whole have been showing signs of transition, SO many individual names are making new all-time highs or breaking out of consolidations. Usually a sign of a weak market (especially when a uptrend begins to transition) will be a breakdown under the surface in key individual names and sectors. But in this market we are still seeing Financials, Discretionary and Industrials leading the market on up days and holding up better on down days. All the while defensive groups like Utilities, Real Estate Investment trusts, Treasury Bonds, Gold...ALL  of these groups are getting crushed. The market is trying to show us what will work when interest rates begin to rise and free money flow is reduced. It is saying that banks, economic improvements in terms of building and repair, and the consumer will be strong going forward. Its also saying that rising interest rates will force prices down in inflated Treasury Bonds. Gold is showing that uncontrolled inflation and economic crisis will be off the table in the intermediate term future. Over the past decade when markets have struggled, these defensive groups have thrived, until recently when the SP500 was lower, gold and bonds would be higher. Now we are seeing Gold and Bonds being taken to the woodshed whether the market is up or down; they are behaving like underperforming assets...Not up enough when markets are up and down more when markets are down. Both Bonds and Gold have had nice runs over the past decade, but it appears now to be a time of correction. These are the inter-market relationships that we need to watch for. These will be the key hints to how we need to position ourselves in our portfolios. While it is true that all these factors could reverse, for now this is the game-plan we have to deal with.

Lets take a look back at the SP500, Treasury Bonds and Gold showing the relationship of the three recently:

SPX

 The SP500 has found support at its rising 20 WMA and is now testing the short term downtrend resistance. It is still in its well established uptrend from the 2009 lows.

 Treasury Bonds (TLT) 

Treasury bonds have broken down and are now trading well below a declining 20 WMA. Price broke major support in the past month and should likely head lower.

Gold (GLD)

Gold is in the same boat as Treasuries except it has been at its downtrend for a while longer. Still ugly action here.

This is the response of these assets since the "QE" revolution in our financial markets. Gold rallied on fears of economic contagion and rampant inflation. Treasuries rallied on similar fears and unprecedented Federal Reserve Bond purchases. Stocks have been drinking the Kool-Aid too as they have rallied strongly from the crisis lows and the introduction of aggressive QE policy. However the major difference that I am noticing is that while the "taper" or reduction of QE conversation is crushing Bonds and Gold, apparently stocks didn't get the memo. While Bonds and Gold have been breaking down from major support, the SP500 has been breaking out from major resistance.

If this were the start of a meltdown for the market I believe we would see Treasuries and Gold starting to build bases to rally from, as historically they have out performed when stocks have struggled. But we are seeing no, ZERO evidence of a bottom in these assets. These are in full crash mode. Until there is a definite consolidation in these groups I just don't see a lot of value in worrying about the stock market too much at these levels. Short term there is still some work to be done to completely right the ship, but longer term, stocks look like a winner from my view. In fact something that could play out here is that stocks in fact continue to correct through the summer back to the long term trend support. While Bonds and Gold stabilize and rally back a bit as they are heavily oversold. That scenario would then create the opportunity for Stocks to take a breather, then rally on to new highs.

The point I'm trying to make here is that while it would make sense for stocks to correct here a bit, there is really no evidence on the longer term view of them being in any trouble. As defensive groups get crushed and offensive groups make new highs, the thesis for higher prices is still intact longer term. When the defensive groups stabilize and reverse their downtrends we will adjust our positioning as well. But as of now those groups are under performing and in downtrends. Here we buy uptrends and short downtrends. As long as these continue their current course, so will we.  

Holiday Prep for Job's Friday

Hi everyone, sorry for my absence last weekend. My family and I traveled to Homer, AK for my cousin Alexa's wedding. I was unable to post a weekend update due to location and family obligations, but I'm back in the saddle again and want to ready you for Friday's trade.

Today as you all know is Independence Day and markets are closed for the holiday. Tomorrow we will be receiving the June Jobs Report around 5:30am pacific time, so be prepared for some volatility in the markets. Especially after a day off, traders will be looking to use tomorrow's job's headline to make up for the lost trading day this week.

Basically what we will be watching for will be a resolution of the downtrend either higher and breaking through resistance or a continuation move lower. As we have been discussing over the past few weeks, the markets seem to be in a transitioning phase after the 8 month rally. The major indexes have all put in a lower high and a lower low within the past month and that is the first signal of a downtrend. While it appears that the market should trade lower from here technically, would it really be a surprise if it just continued to move higher throughout the summer? It would seen illogical for it to move higher, but the market is one place where logic holds little sway. So we need to be prepared for the likely outcome (continuing lower short term) AND also being mindful of where the downtrend becomes invalidated should it move higher from here.

Lets take a look at the anatomy of the rally from a 6 month daily chart:

 
You can clearly see the string of higher lows and higher highs from January though May. But then you can also see how a lower high was made and then followed by a lower low. We may be seeing a second lower high here as price has gotten stuck below the 20 and 50 DMA's.

Our primary focus needs to be on how the market handles this short term down trend and whether it can break above its resistance line and make a higher high.

For the downtrend to be broken and making us bullish on stocks here again we need to see a few things:

First, the market needs to trade back above both of its key moving averages, the 20 and 50 DMA's.
Second, we need to see price break, close and follow through above the downtrend resistance line.
Lastly, we want to see the follow through move take out the prior "lower high" at 1,654.

With those 3 conditions in place I would be convinced the downtrend is broken and it would be time to get bullish on stocks again.

Until that happens however, we have to assume that the market is undergoing a deeper correction and we need to protect the majority of our capital. There are some opportunities out there to be had now, but they should be treated cautiously and with one foot out the door on your stops. Generally its dangerous to be buying when the market is shifting into a down trending cycle, so make sure, if you are doing some buying here to keep purchases to only the strongest individual names and with only a small portion of your available funds.

In a down trending market I like to put on "Pair Trades". Basically you buy an outperforming asset and short an under performing one against it. For example I bought some small amounts of HD, F and TWX earlier this week and then shorted the SP500 against those positions. The way this trade works is I buy a stock or ETF that is outperforming the SP500 and then to hedge (protect) my bet I then short the SP500. If the market trades higher I then expect to make more on my outperformers than I lose on shorting the under performer. If the market goes down I expect my stronger holdings to hold up better than the market and lose less, while my short position makes money, lessening the blow to my account.

Its a fairly basic concept and by following our model portfolio we already do half of the trade. We already buy outperforming stocks and ETF's, so basically one easy way to protect against the down market is to short the under performing asset while still keeping your strong holdings. Pairs can come from any two assets you choose to compare. You could buy Europe and short China, that is a popular trade that All-Star Charts has been mentioning (fantastic blog btw). You could buy Discretionary's (XLY) and short Staple's (XLP) against it. These are just a couple examples of how a Pair Trade can be put on. The basic gist of the concept is to be long the winner and be short the loser. That way if the market rallies, your winner makes more than you loser and if the market goes lower, your loser loses more than your winner. This is just a hedging strategy however and should only be used when the market is transitioning and you are trying to reduce overall market exposure. With a pair trade you will never make as much as you could picking only one side of the trade, but it reduces your risk of a big negative move by the markets if you anticipate trouble ahead.

Heading into Friday, our blog portfolio is still roughly 50% invested as that is invested on the longer time frame. We had one more casualty this week as I sold the XLE when its bounce into resistance seemed weak. It is currently trading just at the underside of the 20 WMA and I was simply not pleased with how it was attempting a rally. As for my personal accounts I am only net 25% exposed to the long side of the market. I have roughly 50% of my funds invested, but as discussed above I am holding a few pair trades that are balancing and reducing my overall exposure. I have a feeling tomorrows report will set the tone for the next leg here as we move back into earnings season. The next couple weeks should be largely dictated by the reaction to tomorrow's news event. Make sure you don't miss it.