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.