Relative Strength Works

HOW WE USE RELATIVE STRENGTH

If you recall we had a few stops triggered during the last pullback. We lost PPG, CMI, and newly entered HON. But since that time the markets have bounced right back and through the prior highs. Within the bounce we have received new entry signals in BRK.B, ECL, and HAIN. If you are counting at home that's 3 gone and 3 added for a net neutral position change. But if we take a look at the 3 exits and 3 entries you will notice something interesting. Let's see if you can spot the key difference...

EXITS TRIGGERED

-PPG 

-CMI

-HON

ENTRIES SIGNALED 

+BRK.B

+ECL

+HAIN

Can you tell what's different between the two groups? It looks to me like the 3 we sold, while participating in the bounce back as well, not a single one has made a new high along with the market. If you look at our 3 new buys it's clear that each has been breaking out to new all-time highs. 

This is what happens with Relative Strength investing. During pullbacks/corrections some positions fail to sustain their strength, while others step into a leadership role. What we attempt to do is position our funds toward the best and away from the weakest. While this does encourage a little extra movement within our accounts and therefore higher trading costs, it assures us that we will protect against the downside by eliminating our most vulnerable holdings, but then also participate in the upside with our remaining strong holdings and new entries into the best performing stocks in the market. 

In case you were feeling remorse for selling your previous positions, you can see that we more than made up for the exits by repositioning as the market suggested into even better opportunities. This is what we do here. We ride winners until they fail and we constantly look for ways to improve our current positioning. That requires we sell the weaker names and target the strongest available. 

THIS MARKET IS SET UP TO CONTINUE HIGHER

It's not a stock market, it's a market of stocks. People often forget that the market indexes are just collections of individual stocks that will behave largely as a group. If the underlying stocks within the market are showing strength or weakness you can expect the market as a whole to follow the direction of those individual stocks. 

When we look at general market health we look at a metric called breadth. We want to see how the stocks under the surface are behaving and whether they support a continued move higher or if a reversal is building within the individual stocks. Breadth can be quantified in many different ways, one of my favorite ways to discern breadth health is simply to observe the positioning of important stocks in individual sectors. I want to see if individual stocks are set up to rally or are breaking support and moving to lower lows. 

What I am finding are stocks across all time frames and many different groups strongly positioned for increased upside. 

-VZ and IP 30 min bars continued from last week's chart

Stocks in the shorter-term seem to have new positive momentum after breaking bullishly out of support bases. Both VZ and IP were on our close watch-list this week and they were able to break to the upside.

-XLY and XLF NEW HIGH WEEKLY BREAKOUTS

Both Discretionary and Financials continue to breakout to higher highs. I have previously discussed the importance of these two sectors for a continued market rally. So far, so good.

-LONG TERM BASES IN MOTION...INTC, X, NEM, YHOO, TWTR 

INTC Monthly chart with 10 year base breakout in motion. 

US Steel (X) Weekly chart, breaking out from a nearly 4-year base formation. 

Yahoo Monthly chart showing long-term cup/handle base potential...

And YHOO on a 1-year, Daily view showing another base formation in motion currently

This is one of my favorite setups in the market right now as it offers opportunity on multiple timeframes. The shorter term base seems to be leading the longer term setup and could be the catalyst for a breakout. 

Newmont Mining (NEM) Daily chart of the leading gold miner breaking out from an 18-month base structure.

Twitter Daily chart showing reversal signals following its post IPO selloff. 

With the exception of TWTR (newly public company), these bases are not short term wiggles, these are long-term trend reversal formations. And while shorter term in duration, the implication of the Twitter base looks quite similar to how Facebook looked after it's infamous IPO period. 

--I feel that with multiple time frames appearing bullish, you have to be positive on the market as a whole here. Things can always change, but as of now we want to be aggressively long this market and can be doing so on any prefered duration depending on your investing preference. There are very long-term setups triggering, intermediate trends are firing on all cylinders, and even recent short-term pullbacks are finding support and reversing above key levels.

I am currently Long all of the above base setups for private accounts. 

Chart of the Week- TESLA (TSLA)

Q4 2013 Daily view

At the beginning of 2014 TSLA began a breakout move that led to a price gap to all-time highs. The subsequent price action went as follows:

Price rallied to a new high of $270, another 37% above the entry price.

Take a look where prices currently sit:

Q2-Q3 2014 Daily view

Where have we seen this action before? How about just before the last +30% rally. This has a very similar appearance to what we saw one year ago. Even volume confirms a similar pattern. The bears are awful loud and obnoxious about this one, but they are standing in front of a freight train. Anyone still Short TSLA shares as of Friday's close is simply not practicing any sort of risk management. This has higher prices written all over it. Initial targets are in the mid to lower $300's and stops can be placed just below the breakout swing low at $248.

I have been Long TSLA for private accounts since early June and have been adding to my holdings as this move has progressed. I still think there is plenty of upside left in this one.