Weekend Review

Markets were volatile this week, the DOW traded triple digits every day. Monday and Tuesday were sharply lower, followed by a strong bounce back Wednesday and then a big drop Thursday. Friday finished the week on a positive note as the weakness from Thursday was bought, helped along by a strong GDP number Friday morning.

It is becoming increasingly noticeable how jittery market participants are at these levels, its the "one foot out the door" mentality. We have seen this for a while now; as soon as the market suffers a down week, market participants get extremely negative very quickly. What this causes however are sharp snap back rallies once the selling subsides.

I'm taking two things away from the trading action this week:

1. Many Market participants are incredibly edgy and are looking for any excuse to sell 

2. Weakness continues to be bought at the slightest sign of exhaustion

What these dueling ideas create are sharp violent counter trend moves as traders begin to pile on in the face of any market weakness. But then the weakness is quickly absorbed as soon as short-term sentiment gets overly negative and support creates fast, snap-back rallies. 

In markets like this you have to be open to the idea that volatility increasing can lead to a larger correction if a bounce back doesn't occur. But at the same time you need to be sure the trend is failing before you abandon ship as well. I like to lengthen my time frames and give my winning trades plenty of room during these choppy volatile environments. That sometimes means reducing trade sizes to account for the added volatility and outright cutting weakening holdings that don't bounce back as quickly with the overall market. 

Some shorter term traders will tighten their stop levels when the environment gets choppy, therefore protecting their near term gains. However in this market it has not paid to get too negative too quickly which is why I prefer to place my stop levels well outside the range of "normal" market noise. 

That being the case, despite the movement up and down recently we have only made very small changes to our holdings over the past couple weeks. I have added a new position in GOOG and BMY, and also have exited SBUX due to its general lack of strength. 

For the most part our positions are still well out of harms way and it would take a meaningful market breakdown to shake too much of our conviction at these levels. 

-Exit SBUX

We took an exit in Starbucks this week. This was the third consecutive weekly close below the 20 WMA and our stop level at 75.20. While the market has been making new highs SBUX has been continually making lower lows. This is exactly what I mean when I say it is time to remove those positions that are weakening. The market's volatility is rising and any stocks not outperforming should be seen as a source of funds in case a correction does follow. 

I still like the setup here provided the lows at $68 remain intact. A break back above $79 would suggest the uptrend is resuming and I would want to renter at that time. Unfortunately now we need to step aside and pass the risk to someone else. 

+Enter GOOG

Google has been on my watch list for the better part of the last year. I never found an attractive risk/reward entry since the massive breakout in late October 2013. It has been a long time remaining patient and just watching for my signal to trigger, but last week that signal came. 

Price broke out to a higher high last week and now sets up the favorable entry point I look for. I love how the rising 20 WMA has cupped the price action during the last consolidation, that provides the launch pad for a new trend higher. 

Should the consolidation area fail to hold as support, this breakout would be in trouble and we would not want to be holders below $566 on a weekly basis. But above that support, I like the chances of GOOG going much higher. 

+Enter BMY

Bristol Meyers has undergone a lengthy consolidation/correction and now appears to be ready to move back higher. Last week price was able to break to a new 25-week high and Relative Strength confirmed by breaking its downtrend resistance. Pretty simple trigger from my view. Stops can be placed below the swing low point at $49 which makes this a very favorable entry. 

Chart of the Week

Nike (NKE)

While the market was freaking everyone out with its poor trading action, NKE exploded to new all time highs. After announcing a blow out earnings quarter and strong projected sales growth, shares rallied over 12% Friday. 

This setup looks surprisingly similar to the way TWX did after the rumored buyout offer from Fox. In that case I reduced my exposure by half after the news broke. But with NKE this is a very different situation in my opinion. I am not a seller here and this is one case where I look to a fundamental indication of the stock's reaction. A rumored deal is not the same as increased organic growth and increased EPS. NKE's rally was in response to strong company performance, while TWX was a rumored merger from an outside party. I make a point to reduce exposure on M&A rumors as they offen create a disappointing final outcome for the stock. However a strong change in company earnings expectations can be a catalyst to propel the stock for multiple months if not more. So while I rarely pay much attention to actual company news for my risk management, this is a case where the story can influence the thought process slightly. 

Stops should be adjusted to just below the breakout low and 10 WMA at 79.75. Above that and we are hanging on for the ride. 

Why The Trend Is Your Friend

You likely have heard the old Wall Street adage "the trend is your friend". While this is commonly spouted, human nature overrides this wisdom at any and every turn. While it makes simple and logical sense to buy stocks that are going up (because they are making money), we instinctually fight that thinking as being too easy, or that its bound to come to an end at any moment. We have this remarkable tendency to want to bet against the prevailing trend. However for long-term trading success, this instinctual "feeling" is EXACTLY THE OPPOSITE of what separates the winners from the losers. Losers continuously fight the trend and continually get themselves out of position against a major market move. This thinking often comes as a result of some predetermined bias.

Unfortunately for our more ancestral investors trading on emotions and narratives, the data simply does not support the idea that human instincts prevail over market forces. A simple market filter can prove that the concept of trading with the trend outperforms.

Something I do every week is tally up the combined returns of the 90 SP500 Sector stocks and calculate the performance using a basic trend filter. Here is my process:

1. Group the 90 SP500 sector stocks by whether or not they are in an uptrend or downtrend. This is filtered using the 20 WMA.

2. Stocks trading Above the rising 20 WMA are allocated to one group and those trading below are set into another group.

3. The stocks trading Above the rising 20 WMA are in uptrends and the stocks trading below are either moving sideways or trending lower.

The findings of this process over time are impressive. Each week as the markets move, new names begin to trend higher and some turn and trend lower. Each week those stocks are adjusted based on their relative positioning to the 20 WMA. After continuing this process for several weeks you begin to see established trends gain momentum. The most telling thing from tracking this is how quickly the stocks trading Above the 20 WMA begin to outperform vs the stocks that are below the 20 WMA. As time progresses the outperformance continues to rise in favor of the uptrending stocks.

*I highly recommend you do this exercise on your own as it helps with your emotions significantly during times of poor performance. The visual of the long-term probability helps reinforce the concept that you are doing the right thing.

How Has the Trend Performed in 2014?

As of Thursday's horrendous market close these are the stats from the 90 Sector stocks trading Above the rising 20 WMA and stocks trading Below. 2014, YTD

Stocks Above rising 20 WMA (55/90) 

Total running returns  +8.30%

46 Winners/ 9 Losers

Biggest running win  +39.83%

Biggest running loss  -4.07%

Stocks Below 20 WMA (35/90)

Total running returns  -2.18%

6 Winners/ 29 Losers

Biggest running win  +2.39%

Biggest running loss  -9.56%

Observations

The difference in average return is tremendously higher for the stocks trading Above. +8.3% vs -2.18%, a difference of +10.5%

You can also see how successful those trades tend to be. Having an 84% current win rate is remarkable. While the current win rate of stocks Below the 20 WMA is just 17%. 

The ability to sustain large winning trades is the key to success. Largest current winner +39.83%, compared with the current largest loser at only -4.07%. This means the system cuts losing trades quickly for small losses and lets large winning trends run.

--This is a very simplistic way of looking at trend systems, but shows how a basic filtering method for trend can make a tremendous difference to your trading success. 

Based on these findings it should be obvious that no one would ever want to be buying a downtrending stock. The odds of success increase dramatically by waiting for the downtrending stocks to stop trading lower and reverse higher BEFORE making an entry. 

Trends tend to persist. When you catch a big trend early in its cycle you can make a lot of money. This works both with uptrending and downtrending stocks. You want to be Long the strength and Short or sidelined in the weakness.

 

Holdings Reveiw

Markets continue to pause and await potentially moving news next week with both the Federal Reserve meeting and the highly anticipated Alibaba IPO. We saw pullbacks across the board in the major averages with the large-cap dividend paying stocks getting hit the hardest.

With the potential shift taking place in the market, it is a good time review our current holdings and see where we stand heading into next week. We took a couple exit signals this week in VZ, and F. There also were some close calls in TLT and SBUX but they managed to hold on for another week. The Portfolio added one new position, entering Goldman Sachs (GS) as it broke out of a multi-year base formation.

SP500

The SP500 had its first down week in the last 6 so there is not really anything wrong here. Price is still above both the 10 and 20 WMA's and well within the rising uptrend channel. If there is a concern to begin watching, it's the momentum divergence that is emerging. You can see from the weekly MACD that while price has made new highs on the recent peaks, the MACD line has made lower highs. Typically this is a warning sign (especially considering it comes on the weekly timeframe). It is true that divergences have mattered very little in this Fed enhanced environment but with the latest round of QE coming to an end next month, we may be seeing a change in character for the market.

This is something to be mindful of but we still need to see price confirm the weakening momentum before we get more worried. Above the 1,925 swing low the uptrend is intact.

Exits

Verizon (VZ)

After starting out hot, VZ has never been able to recover since the huge reversal that took place in early august. Price has languished at key support and this week broke to a new 18-week low. While the long term setup is still alive, short term it's time to transfer the risk to someone else. I like this setup and as long as price holds above $45 I will keep it on my close watch list. But for now we step aside. 

Ford (F)

Ford once again failed at the $18 level and has recently made a lower high. This week price gapped below the 20 WMA and made a lower low for the recent rally. Relative Strength also failed to break out of its long term downtrend and is now rolling over. Again it's time to transfer the risk to someone else.

Similar to VZ, I still like F long term and will be now waiting for a break above $18 to re-enter the position. A break above $18 sets a decade long base formation into motion and would be an opportunity to participate in. 

New Entry

Goldman Sachs (GS)

Goldman Sachs has been on our watch list for a while now and this week it triggered the base setup we have been waiting for. Price broke above a 5-year resistance level and looks ready to significantly move higher.

The breakout in price is confirmed by the 18-month RS breakout as well as the MACD trend confirmation I like to see. I discussed this the other day (here). 

This is a multi-year pattern formation, don't expect this to be a quick trade. There will likely be several opportunities to add to positions here so we don't have to go barreling in all at once. It is best to give this trade some room to move around and I want my stops down near the $164 swing low. The upside projection is near the all-time high at $250, our risk/reward sets up fantastically. 

The Best and the Rest

Hain Celestial (HAIN)

Hain had a great week considering the overall market performance. The follow through on the breakout from last month while the SP500 lost 1% is particularly impressive. We still need to keep our wide stop for now down near $85, so there is not much to do but sit back and let this one run. 

Wells Fargo (WFC)

Wells has been consolidating for the past 4 months and has seen some mild interest after testing it's long term uptrend support. Considering the strength that big banks saw this week due to rising interest rates I would expect this to begin to resume its trend soon. If price breaks below the uptrend support and swing low at $50 that would be enough for us to exit and wait for a better opportunity. 

I particularly like the financials here and think they are ready to continue higher. The recent pause that has taken place has built a solid suport base to launch a new move from. 

International Paper (IP)

IP sure had a solid week in a poor market environment and it was mainly accomplished on Thursday's huge 4% surge. This position has been a slow starter but after holding yet another higher low, it appears that price is ready to resume in the upward direction. Long term the setup is fantastic and a base formation this large could propel the stock MUCH higher from current levels. 

We also saw RS retake it's downtrend resistance this week suggesting it's trying to sustain another run higher. If this were to fail again we would not want to be holders below the 47.50 swing lows. But for now IP looks to be back on track. 

Nike (NKE)

Nike just hung out this week at it's all time highs. After a strong move last week it was very constructive to not see much given back at all. The relative strength here is very solid and this remains part of my bullish Consumer Discretionary theory. So far so good.

Berkshire Hathaway (BRKB)

With the addition of GS this week that now brings our XLF holdings up to 3, although it is debatable whether Berkshire is actually a financial company. But regardless of how it's classified it remains a key member of the XLF and remains in a massive uptrend. As long as price doesn't violate the swing low and support at $125 this one is just fine. 

Eco Lab (ECL)

Ecl continues to outperform and was actually up almost 1% on Friday when the SP500 lost nearly 1%. You can't ask for much more than that. Strong relative leader, strong uptrend, and large base support. Above $108.50 this is a winner. 

Time Warner (TWX)

Time Warner continues to move positively away from its large support base. Apart from that nasty sell off 6 weeks ago, the stock is a winner. The upside potential is massive in this name and I believe it's just getting going. Stops still remain just below the breakout level near $71. 

Starbucks (SBUX)

SBUX came about as close as one can to triggering a sell this week, yet it managed to hold on. As of now price is retesting its breakout from support, but it will need to turn higher immediately for us to remain long here. I still think the setup is good and expect higher prices from here. Hopefully this week was a good hard shakeout before the uptrend resumes but that remains to be seen. Stops are set just below $75.20. 

Enbridge (ENB)

Despite the volatility in ENB, the trend and price action continues to remain solid. You can see the large cup/handle formation still in motion and after a successful retest of the breakout, prices have moved higher. The action on Thursday and Friday this week were nothing to feel good about, but the overall trend remains intact. Stops still remain near the handle lows at $47, but soon we can hopefully slide it up to the breakout level. 

20+ Treasury Bonds (TLT)

Interest rates popped this week and took our long term treasury position down in sympathy. TLT nearly triggered stops on Friday but managed to stage something of a recovery right at the end of the day to hold the $113.25 stop I have. 

The Federal Reserve meeting results next week will likely dictate whether this one survives for us or not. If the Fed announces that it may raise interest rates sooner than previously expected, that would likely end the run in bonds. If however they continue their dovish positioning, bonds should still be fine and would likely bounce back. Keep an eye on this one next week.

Gilead (GILD)

GILD has the look of a stock that needs a correction. It remains to be seen if that will play out, but the rapid increase in volatility after the parabolic rally usually creates a short-term top for prices. That being the case this needs plenty of room to wiggle so we don't get caught out of position. Stops should still remain near the breakout level as there is no support above that. A consolidation and new base area would be very constructive and we could then look to move up our stops. 

We continue to take our positions on a case by case basis. Some fail to sustain their uptrends and others continue to make new highs. The best we can do is move out of the stocks not keeping pace as leaders and continue to focus our funds on the best risk/reward setups available. 

As long as the overall market remains in it's uptrend we want to be looking for the strongest opportunities. I continue to see constructive things across the markets and have no reason to doubt the rally when so many fantastic stocks are breaking out of multi-month and sometimes multi-year base formations. This is not "bubble" structure, when massive large cap companies are breaking from decade long base consolidations the upside is very healthy. These aren't companies with no earnings like back in 1999. Companies like INTC, GS, YHOO, Time Warner are massively profitable and have been around for decades. To see them emerging from the bases that they are suggests this rally could be just getting going. 

As long as you focus on strong risk/reward situations from companies with excellent profitability you will be just fine. If you find yourself flopping back and forth on every geopolitical headline or doom and gloom commentary you will never make any ground. The only way out is to develop a plan that removes emotions from your decisions making. There is no place for emotional trades within a successful investment approach.  

MACD Readings That (Actually) Improve Accuracy

One of the most popular and yet misused technical indicators, I feel, is the MACD (moving average convergence divergence). Being one of the most common indicators in charting packages, the MACD gets a lot of interest from amateur investors. One the surface it's a very simple signal generator and to the unlearned that simplicity is appreciated. However the problem with how most novices use the MACD is that they place too much importance in the basic crossover signal.

AAPL with Weekly MACD

 The MACD is essentially two moving averages and their relationship to each other; there is a moving average convergence line and then another "signal" line that is more sensitive to short-term price movements. The common use of the indicator is to buy or sell when the moving average line crosses above or below the signal line. Because this is the easy way to use this tool most just hope to take the shortcut and get rich. But the market is no dummy, if something were that easy then everyone would be rich. In fact if you were to simply take the crossover signal as your entry/exit criteria you would have a really hard time achieving any sort of sustainable return over time. Sorry folks, there's no easy way out.

The MACD is much better used as a trend health indicator and momentum signal. To add this indicator to your trading arsenal you have to interpret what the MACD is saying and not just flop your positions around each time the lines cross each other. The key thing to realize about the MACD indicator is that it is simply there to alert you to when the trend is turning from negative to positive and vice versa. It's hard to rely on it solely as a trade generator but used in conjunction with other price based signals, the MACD can add to increased trade success. 

My primary methods of use for the MACD are:

1. Momentum Divergences

2. Intermediate-term Trend Reversals

In my analysis I combine these two methods to create a high probability trade entry. These signals can be generated across any timeframe, but my preferred timeframe is with Weekly charts. 

When you open the MACD indicator you will notice the two signal lines and then another horizontal "zero" line showing whether the MACD is positive or negative. How the MACD behaves around the zero line is the key to using the indicator correctly. The hard part is that no two instances look exactly the same and the skill of the trader goes a long way in identifying the best setups. They say technical analysis is more of an art than a science and in this case that is absolutely correct.

What we want to look for are MACD pullbacks/corrections from above the zero line back into the zero area. When the MACD lines are above zero the stock is believed to be in a bullish posture, when the MACD is below zero it is said to be bearish in nature. What we want to see is when that pullback occurs, that it bottoms out and reverses above the zero line. It can dip below briefly, but we want that bullish crossover signal occurring after the zero area test holds. 

Generally it's not the initial move from below zero to above that generates a high probability setup, but rather once that move above occurs, price will consolidate as will the MACD. The important signal is when the consolidation holds at zero and then turns back higher. This shows that the pullback was just that, a consolidation of the previous uptrend and it is now resuming even stronger. I find this pattern to be highly accurate and profitable.

US Steel basing structure and behavior around zero line

When combined with a price breakout and Relative Strength confirmation, some of the best moves in the market come from this setup with exceptionally low risk of failure. 

I find this method works best on large, long-term base formation breakouts and on corrections of longer-term uptrends. So depending on your investing methods the signal can be used for long-term value reversals and also for trading big winners after they have regressed back to their trend average.

Yahoo after big rally and pullback, Up trend is intact.

Market at New Highs, Discretionary is Rocking

Discretionary is on Fire

When we talk about new highs for the stock market, we expect those highs to be accompanied by offensive, "risk-on" leaders pushing the indexes up. Consumer Discretionary is probably the most economically sensitive group, and this week we continued to see strength in that area.

A new addition to the Portfolio this week is Nike (NKE) who was leading the Discretionary sector higher all week.

Entering Nike (NKE)

This is exactly what I like to see from a leading stock; its breaking out to new highs, above a large and clean looking consolidation base. Also the breakout in price is being confirmed by Relative Strength suggesting this is once again assuming a leadership role.

This is the 4th stock from the XLY that we hold in our Portfolio and while that does make me a bit nervous, I feel that we are still properly spread out within the sector. Our current Discretionary sector stocks are Time Warner (Media), Starbucks (Restaurants), Ford (Autos), and now Nike (Apparel).

The issue with holding so many stocks from a particular sector is that you begin to get concentration risk by having too many similarly trading stocks in one area. We could see some issues here if the XLY decides to roll over, but I think the technicals line up in each of these stocks nicely and feel that the risk/reward being offered by each name is quite positive.

If NKE should not play out as we plan, stops need to be placed just below the recent consolidation and 20 WMA at $76.75.

This group is on fire right here and just starting to chug in my opinion. Almost every name in the group is breaking out to new highs. Home Depot (HD) has exploded over the past couple weeks, Comcast (CMCSA) is breaking out nicely this week-there was a close decision between NKE and CMCSA, but NKE presented better diversification and risk parameters. Time Warner and Starbucks are consolidating their initial rallies nicely, Ford looks on the verge of a big breakout, Disney has been a total beast for a while now. Everywhere you look at this group you are finding winners. I think its just getting started.

Energy Has Pulled Back, Now What?

A couple months ago I discussed the rally in energy and how it was getting ahead of itself. Names like EOG and COP were rocketing straight up and the trend was becoming unstable. Since then we have seen prices come in quite a bit off the highs and are now sitting on some pretty important support levels. Lets look at a few key names in the group.

EOG Resources (EOG)

EOG is one of my personal favorites and I am currently a holder in private accounts. Since touching its range highs 3 months ago, price has moved right back into the uptrend support. Price has broken below both the 10 WMA and 20 WMA, but is still holding the prior breakout level of $102. 

I feel this stock once again needs to be placed on the close watch list and for dip buyers, you could even put on a position here using the uptrend support and $102 as your stop. Based on the most recent correction back in late 2013 it would appear that this could even slide sideways for a few more weeks and still be just fine. We want to be aware of this stock above $102. 

Schlumberger (SLB) is in a very similar position, as are COP and HAL. These names lead the Oil Services group and how they handle this pullback will go a long way to determining whether Energy needs more of a correction or if the dip has ended and ready to continue higher. 

 Here is a look at Conoco (COP) and you can see a similar formation. 

The concern here is that the initial wave of selling has just paused and another move lower is coming. Take a look at the last decline at the end of 2013. Its very possible that we will see a similar type of shakeout move before any sustained upside can continue. 

This is why we need to watch how these Energy names handle the key support. A break above would suggest support has held and higher prices are coming. A break below the consolidation area and another sharp leg lower could be ahead. 

Speaking of Offensive Groups, What are Financials Up To?

Back in July I posted a way to use Monthly charts to find relative value in the market. The two groups I thought presented the best "value" were Discretionary (see above) and Financials. I continue to feel this is shaping up nicely and many names in the group are looking interesting. 

You already know about Wells Fargo (WFC) and Berkshire Hathaway (BRKB) because we hold them in our portfolio, but there are a couple other names that need our attention. Here they are ranked by relevance and setup:

JP Morgan (JPM)

JPM is further along than most of the major banks in terms of its recovery. It recently made a breakout to new highs and has since been consolidating. We need to see RS turn higher and start outperforming, but the structure of the base breakout seems solid above $52.

Goldman Sachs (GS)

Goldman looks great right here and is setup for lots of upside should it fight through the overhead supply. If/When this formation breaks out higher it has 50% potential and a date with its prior all-time highs. A clean break above $182 will set this into motion.

Bank of America (BAC)

As you can see BAC is similar looking to GS but quite a bit behind. The $18 level has been a major sticking point for rallies, but another test of that area could result in a breakout this time. This still needs work, but it should be on your radar. 

Exiting Freeport-McMoran (FCX)

We are taking an exit signal in FCX this week. Since breaking out to what looked like higher highs and a change of trend, price has been on a non-stop skid for 8 weeks. This week price sliced through the 20 WMA and came into our stop area near $35. 

I had previously placed my stop at $35 and while this closed at $35.02 I felt that the overall failed breakout and lack of any strength was plenty evidence to step aside. This is a very oversold stock at this point and will likely bounce a bit from here. But the simple fact that while the SP500 has been continually making new highs for the last few weeks, FCX hasn't even sniffed a bounce. 

What I try to do is find stocks with a higher than normal probability to outperform the market. When the market makes new highs and a stock continues to slice through support levels, you want to avoid that stock and find something else that is working. Sometimes we sell the bottom, but we look for the strongest opportunities with low risk, when that is no longer the case we exit and look elsewhere. 

Your equity is your investment ammo and you want it targeted at the most promising setups. Again, while FCX may bounce back a bit, its going to take an awful lot just getting back to even. I can regain the loss much quicker in a strong winner than I can in a languishing, oversold stock. Book the loss and move on.