Cliffnotes For Offense And Defense

"So much of what you do physically happens because you've thought about it and mentally prepared for it."

Dan Fouts
Hall-of-fame Quarterback
San Diego Chargers


This is a very simple statement that in the fast paced world of investing and trading can often go unheeded. It is easy to get caught up in "today's" news and become drawn into the latest talking points by so many of the news outlets that bombard us at an ever increasing rate. Getting caught up in the heat of the battle is something that happens to everyone from time to time, but it is important to take a step back and regain the macro perspective. It is important to always have a goal and to not let emotions and hope take us away from our game plan. If a goal is to make x% return in the first half of the year, it is important to review these goals periodically or when they are met. At times we can set our goals higher, in others a dose of realism is need to get the ship back on course. No matter the situation, it is important to know when to be aggressive and when to be cautious. This can be determined by the market just as much as by our own personal management style. The key is to have a plan in advance, but be flexible enough to adapt to the environment without losing sight of the objective and goals.



This is a chart of the S&P 500 Index from the start of 2007. A simple idea can be applied to create a type of map for where the market is and where it might go. In an earlier article about gaining intra day direction from the opening range, this concept was applied on a smaller time frame. In this chart the High of the first three days of 2007(1429.42) is compared to the low of the first three days of 2007(1405.75). This gives us an opening range of 23.67. This is a key number now for the year, it will be the basis for what size swings can be expected.

The next step is to add 23.67 to the high of the opening range and subtract 23.67 from the low of the opening range. This gives +1 swing up 1453.09 and -1 swing down 1382.08. Both of these levels are marked by the red dashed line. We will do the same thing again with these numbers, adding the opening range width to give us +2 and -2 swing levels. This is repeated until more levels are complete.

-2= 1358.42 Green
-1= 1382.08 Red
+1= 1453.09 Red
+2= 1476.76 Green
+3= 1500.43 Blue
+4= 1524.10 Red

These levels act as targets once the market is out of the opening range. When these levels are reached, it is important how the market acts. They often act as resistance when first encountered and after time can turn into support levels for the next move. This year the S&P 500 reached +1 Swing up, but could not sustain prices above that level. When weakness in the Chinese market carried over to the U.S. market, the market moved back down to the opening range, and went right through it. It tried to find some support at the lower part of the opening range, but more selling caused it to complete the -1 Swing down. This level ultimately acted as support, and the move back up to test the lower end of the opening range was under way. Often during this move back up to the opening range, there is a fair amount of short covering and the move can carry right to the top of the opening range.

We tested the top of the opening range and then made a series of rallies towards the upper swing levels. Once the market hit the +2 Swing level, it tested this level before making the +3 Swing level move. The market is now above the +3 Swing level, and will test this level over the next few days. If it can hold, and this system is true, then 1524 area is the next upside target. If the market can not hold the +3 Swing level,then look how the market reacts when it approaches the previous swing levels. It should set up some trades, both long and short, with defined stops and targets.

Having a map of where the market has been can help in developing a trading plan and goals for the rest of the year. This is not an end all and be all system, but it is a helpful chart to print out and draw the levels for future reference. Below are a couple other charts with the same system applied.






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Advance/Decline moving average is pointing to some weakness.

Global Economies and Commodities

"When your neighbor loses his job it's a slowdown; when you lose your job, its a recession; when an economist loses his job, its a depression."

Anonymous





This is a chart of the Nasdaq Composite Index,with an indicator showing the moving average for the advance/decline line. This moving average is sloping down as prices go higher, showing that fewer stocks are making the gains in order to carry the index higher. Key this week will be Cisco Systems' earnings release Tuesday after the close, and the Federal Open Market Committee(FOMC) meeting Wednesday. These two events should be a pivotal point for the direction of the market. Expect most of the activity to happen after these events are out of the way later in the week.



This chart of the NYSE Composite Index is very similar to the Nasdaq. Fewer stocks are carrying the load as the indexes move higher. The stocks carrying the load are mostly larger-cap companies and those that have a percentage of their business outside of the United States. The weakness in the US Dollar makes the goods and services these companies provide cheaper because of the exchange rate. Below is a chart that compares the large-cap stocks to smaller-cap stocks.



The slope of the green line on the right side of the chart marks the out-performance of the large-cap stocks.

Below is a chart comparing the large-cap stocks in the United States to an index tracking international equities.



This shows that equities tied to international economies have been in an uptrend for a while and have out preforming the U.S. Market. One area that is always of interest to look at is the commodity sector/natural resources. The chart below compares the international equity market(EFA) to the Goldman Sachs Natural Resource Index(IGE). Since the February sell off related to comments China made about their economy and markets, commodities have been slightly stronger in relative terms.



If we take the oil segment out of the commodity index, it shows even greater strength. The chart below shows the relation between the Goldman Sachs Natural Resource Index(IGE) and the U.S. Oil market ETF(USO).



This clearly shows that commodities other than oil are out performing and a leading group over all. Below are some selected commodity charts with accompanying warehouse inventory statistics.













To put the moves of some commodities in perspective it is good to look at the 5yr chart of Nickel and Lead. They have had tremendous moves, along with the Chinese economy. These moves are not over, but it is worth being patient and waiting for a chart pattern to form that gives a cleaner entry point. Some other ideas from an earlier post can be seen clicking here.







Some interesting comments from Jim Rogers on the big picture and commodities.



Interesting Bloomberg commodities article. Click Here

Manufacturing data

This chart compares the manufacturing job sector to the over all population. Hard to make a case for the trade imbalance getting better unless that up trending red line of people slows consumption. Our manufacturing job base is obviously declining and has been since the 1980's. With China's economy growing at +10% and their cheap labor, our manufacturing base sure looks like it is going to keep going lower. Combine that with the population growth, it is hard to see how inflation isn't the main concern of the Federal Reserve. We will know more with the unemployment number today, and with the FOMC meeting next Wednesday. Rising unemployment and rising inflation is a bad combination.



This chart shows the interest rates over the past couple decades. Do rates go down to help cushion the weakness in the job sector seen later this year, or do they go up to curb inflation?

Some other surveys of data from Pricewaterhouse Coopers on the Manufacturing outlook on the economy.

It Was The Thursday Before.....

"Avoid having your ego so close to your position that when your position falls, your ego goes with it."

Colin Powell
Former Chairman,Joint Chiefs of Staff

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This is a weekly chart of the S&P 500 showing how close the year 2000 closing high of 1527 really is. This level seems to be acting like a magnet, as fewer and fewer stocks are carrying the rally. None-the-less, it still looks there is going to be a serious attempt to get there. How soon will probably depend on the unemployment number released this coming Friday morning. The anticipation of the release of this economic number will probably be on the minds of every trader today, especially in the afternoon.

The chart below gets boring, but it makes a point that as this rally continues, fewer and fewer stocks are carrying the load. The advance/decline average is sloping down as we go higher. This could be a bearish sign but it could also be setting up a type of spring-board action to propel the market to that old high. So much depends on Friday's number.





This chart is similar to the adv/decl moving average, except it uses the percentage of stocks trading above their 40period moving average. It has shown some key divergences in the past, and is worth keeping an eye on for a macro view.



Below are the Broker Dealer Index (XBD) and the Dow Jones Transportation Index. If both of these indexes were following the last part of the rally in the overall market, it might take some of the skepticism away from the move. If they join in, getting that old high will not be difficult to accomplish. Might be a big "If".





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The above charts are comparing the Nasdaq Composite Index to the NDX Nasdaq top 100 stocks. Lately the rally is mostly concerned the larger cap names and has not been as deep including the smaller cap issues. This is really illustrated in the second chart which compares the advance decline moving averages of both indexes. The larger cap names are where the action is taking place.





Juniper Networks and Cisco Systems are two examples of large-cap stocks leading this rally. Cisco reports earnings next week.

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Kennametal Inc. (Kennametal) is a global supplier of tooling, engineered components and advanced materials consumed in production processes. It provides metal cutting tools and tooling systems. Kennametal specializes in developing and manufacturing metalworking tools and wear-resistant parts using a specialized type of powder metallurgy. It also manufactures and markets a line of tool holders, tool holding systems and rotary cutting tools by machining and fabricating steel bars and other metal alloys.

Kennametal is a stock that should be looked at on a fundamental basis as well as a technical one. If Dow Jones is reportedly worth $100 a share like some opinions voiced yesterday, then Kennametal is worth taking a look at. They are both in different sectors, but there is value there. With all the leverage buy outs taking place, KMT should get a look.

Advance/Decline Ratios and Intra Day Futures

This chart of the S&P 500 shows that the index is at an important juncture. There was a test of the recent trend line, and it held yesterday. The top pane in the chart is showing the advance/decline moving average is not confirming the last part of this rally. Fewer stocks are carrying the load. This is not always a bad thing, if some of the other stocks start to play catch up, but with earnings partly out of the way, what the next catalyst will be to carry things higher is unknown. There are some great individual stock charts, but the market as a whole is approaching short term over bought. Below is an intra day chart of the S&P 500 Index futures from Monday and Tuesday.



This chart shows the sell off Monday afternoon and the trading day yesterday. The market spent the morning below the opening range, but in the afternoon the test of the morning lows couldn't even come close, and short covering started and took the market back to high of the opening range. Today is an important day to watch the opening range. A review of this concept can be seen clicking here

The market is currently at about the 50% retracement of the sell off started Monday, so today should be a key day and could provide market direction and carry things into the weekend.



The NDX futures in this chart show a similar pattern to the S&P 500. A key difference was that the NDX make a lower low in the afternoon before the short covering/buying started the move back to the top of the opening range. Some days it is important to watch these two side by side if day trading, look for divergence and some great trades can jump off the screen.




This day chart of the Nasdaq Composite shows the test of the trend line just like the S&P 500. Today should be an important day to watch the advance/decline ratio and how the market acts going into the afternoon with about 90 minutes left in the day. The weekly chart below shows what could be setting up as an expanding triangle. This pattern can be very profitable to trade, but often catches most investors off guard. The NDX 100 is also approaching a longer term upper channel line.



It is time to at the very least to consider playing some defense. This can be done in many ways without abandoning long positions, but it does depend on how long a portfolio is and what weighting and sectors the stocks are in. A put spread on the QQQQ going out a few months or doing a pairs/spread trade with some related stocks might be in order. Consult your broker and remember--he will trade your money until it is all gone!

PS. No one has yet to correctly name the starting 11 in Red Right-20 Bingo Cross from the last post from Monday.