Confounding the Masses

Over the past two weeks we have seen the markets push higher with the large-cap groups once again setting new all-time highs. In my scans I am seeing many new setups breaking out and now the number of SP500 Sector stocks that are above their rising 20 WMA's is at a level that suggests broadening participation at these new market highs. We like to see more stocks in uptrends and making higher highs while the market does so as well. The more stocks acting well, the stronger the underlying market health is, which suggests a more sustainable rally.

The SP500 has made a strong move away from the prior nearly 6-month trading range and looks to have more upside to come in the intermediate term. There are a lot of people saying the market is overbought here and extended. These are the same people that were saying a month ago that this market was so unhealthy it was likely headed for a crash. While I was in the concerned camp, the recent price action is telling me that stocks want to continue to push higher from current levels. Price can correct in two ways 1) through price pulling back and creating new support levels lower or 2) price can trade sideways through time and build a new support base at current levels. Scenario 2 is the most bullish option as it suggests current holders are unwilling to sell which keeps demand for new shares tight, causing new buyers to pay up a little more to get involved.

SP500 weekly chart

You can see the extended sideways trading action of late in the SP500 and the subsequent breakout. I personally don't feel a market is overbought only 2 weeks removed from a 6-month consolidation and base formation. My quantitative data does not support an overbought market currently either.

 Emotional traders and the media are so short term in their thinking that they constantly invoke a phrase borrowed from Jack Schwager's book, The New Market Wizards, called "the call of the countertrend". They spend so much time trying to pick every top tick in a runaway uptrending market that they lose the forest for the trees. The call of the countertrend makes it seem optimal to attempt to take your small profits now so you are less likely to give them back when the market goes through an orderly pullback. But what this conditions traders for is a situation where all immediate gains are taken quickly and therefore not allowed to turn into major winning trades that can make your whole year.

Have you ever heard of the 80/20 rule? The 80/20 rule suggests that 80% of your profits will come from 20% of your trades/investments. A successful system will have lots of small losses but when a big winner does come along, it will make more than enough to cover those losses plus grow your account balance over time. If however you are constantly taking small profits in accordance with countertrend thinking you will never be able to participate in those large, game changing trades.

The market programs us to think that it will take back any profits we make so we need to take what we can get quickly as to not lose them back to the market. This kind of conditioning is what the market does best: drain money from the majority's accounts and line the pockets of the minority. The market is designed to get the majority's money and failing traders fall into the trap of quick, small profits.

 It is said that amateurs go broke taking large losses, while professionals go broke taking small profits. It would logically follow then to make money one would need to let winning positions continue as long as possible and simultaneously cut losing trades quickly as to not incur large losses. Keep losing trades small and allow winning trades to win big...That is the way of the minority and the way of a winning trader. It will go completely against your natural instincts as a human (the concept known as Risk Aversion)
but is absolutely necessary for your success in the markets.


--We had one notable addition to our holdings list this week and we also had one trade from last week to discuss as well. Over the last two weeks we received an add signal for PPG and a new buy signal for Ford. Lets take a look at these new developments to be positioned correctly heading into next week.

PPG (3/3)

Last week PPG broke above its 13-week support base to the upside and signaled yet another trend resumption. This stair stepping action is exactly what a sustainable trend is all about and we will take this new signal and add to our existing holding. We can now slide our stops up to the $188 swing low, making this a continued winning trade for us going forward.


F (2/3)

Ford was able to take out its prior swing high this week and did so in strong fashion. There is a lot to like about how Ford handled its recent correction. Since signaling our exit, the stock orderly pulled back to retest the prior inflection point at $14.50. Once that level was tested, buyers came right back in and price slowly reversed the weakness and this week triggered our Buy. For initial positions a stop at $15.50 makes sense here as that would signal a failed breakout, it would also violate the rising 20 WMA and the prior swing low.

There is some long-term supply likely at these levels and just ahead, but we take our signals based on our prefered intermediate term trend direction and let the rest take care of itself through time. Also don't forget that there is a massive support base forming here since the '99 correction.

  This is the Monthly view going back 15 years. Since making a new low in late 2008, price has stabilized well and has the look of a bullish Inverse Head/Shoulder base. A breakout above $18 would set this into motion on the monthly chart. This base formation projects a potential 100% upside move and all we have to do is enter a position currently with a $1.50 risk per share. That is a stellar risk/reward proposition and one that will make you a lot of money over the long term probabilities.

Chart of the Week 

Treasury Bonds (TLT)

Treasury bonds make the Chart of the Week this week due to thier typical inverse relationship to stocks. With stocks on the verge of another big breakout move, TLT is finding itself getting squeezed between long-term downtrend resistance and a strongly rising 20 WMA. This will soon be breaking one way or the other and that move will likely have strong implications to the direction of the overall stock market. It should tell us whether this stock rally is likely to fail or if it has the legs to continue the uptrend. We need to watch bonds closely here.

Two weeks ago our stop was near the $109 area, but with the movement of the 20 WMA we will slide that stop up to the original $110 inflection level, which is where the 20 WMA currently sits. If we get a close below just about $110 it will be time to set aside in TLT and we would expect stocks to continue to outperform.

Zooming in and taking a look at the Daily chart, TLT is working through a very typical reversal setup. We have seen a steady trend of higher highs and higher lows for the last several months, but the last two weeks of trading action suggest a change is upon us. Take a look:

We saw price gap higher through the downtrend resistance level only to show no upside follow through and then fall back into the prior downtrend. What makes this gap and pullback different from others is the fact that this is the first time we have seen price make a lower low on that pullback. On Tuesday of last week there was a swift move through the prior swing low and we have spent the last couple days throwing back to that prior swing point. When you see a strong new high followed by a rapid pullback that creates a lower low that is a major warning sign that the trend may be changing.

We will need to watch this closely in the week ahead to see if it can hold here and make another higher high or if it will continue lower through our $110 breakout level.

Lastly note the Relative Strength trend. It is sitting right on its uptrend support going back six months. That should provide a great hint to the strength or weakness of the next move to come. We have been long TLT for a while now and the trade has been good to us. But don't forget we need to continue to manage risk in all environments. This one may be telling us soon that stocks, not bonds are the area of strength going forward.