Trader’s Narrative

I’ve updated the list of social networking website devoted to trading/investing with these four:

• Cake Financial
• MarketGuru
• Mint
• Wikinvest

Is this completely new to you? Then you are in for a treat! Think of it as facebook meets Wall St.

If you are already familiar with one or two, or even be a member of a site… it’s worth looking over the list because you might find a more interesting community that offers you more: Guide to Social Investing Websites

You are either a novice, hungry to learn more about investing or trading for yourself. Or an experienced trader or investor, interested to enter a community that will allow you to continue learning or maybe even profit from your knowledge. Which ever you are, you’ll find just the right community for you.

Oh and by the way, Mint’s new investment feature is in beta but you’ll find a link to an invite if you follow above link!

The market is bumping its head against a resistance range from 1400 to 1450. This area was of course, support just a few months back.

Starting from April 18th, I noticed a change in the market tone. Whereas pretty much every single indicator had been flashing buy in January, February and March, one by one, they started to point to caution:

• too many stocks above their 10 day moving average
• a fourth attempt at the 1400 level
• AAII sentiment back to October 2007 bullishness and the ISE call put ratio too high
• trading volume low enough to cause concern
• 78% of S&P 500 stocks above their 50 day moving average
• “Sell in May and go away!”
• market stretched above its 50 day moving average
• AAII sentiment inches even more to bullish excitement
• number of S&P 500 52 week highs compared to 52 week lows signals caution

The best scenario for the bulls would be for the market to pause here and digest this overbought condition and then continue to move higher, breaking above the flag or pennant formation.

Market breadth is what goes on inside the stock market. Most people pay attention to price, like the Dow or S&P 500 index. Market breadth looks at the number of stocks that are advancing or declining within an index or an exchange. It is a great way to measure the “health” of the market. After all, if the majority of securities on an exchange are falling, we can’t expect it to keep rising, right?

Or can we?

Every once in a while the bears point to the “negative divergence” in the Nasdaq index and the Nasdaq cumulative breadth. They get worked up over the fact that market breadth does not correspond to the market price. Here is the recent Nasdaq breadth, showing a waterfall decline, in contrast to the Nasdaq Composite index:

It sure looks ominous. Once you zoom out though, you realize that there’s something seriously wrong with this way of looking at the market.

NASDAQ Cumulative Breadth
Just for kicks, let’s go back to 1998. From there, the Nasdaq cumulative breadth fell consistently until October 2002. That’s right. Even though the Nasdaq was screaming higher, then topping out in early 2000, its breadth just barreled down paying it no attention.

Breadth continued falling until it made a sort of double bottom in early 2003, just as the Nasdaq was ending its bubble bear market. The recovery in breadth was short lived because it again started to fall in early 2004 and has been falling consistently since!

So it is obvious from this slice of history that Nasdaq breadth and the Nasdaq composite are completely decoupled. In fact, if we go back further in time we see that breadth has been falling continuously since, well, since I have data for it.

NYSE Cumulative Breadth
The other broad measure of breadth, for the securities on the NYSE, is not all that different. From a top in 1998 it fell continuously until early 2000. For the rest of the year it stabilized and in late 2000 started to rise. NYSE breadth found a top in May 2002. Yes, you read that right! As the market was going to hell in a hand basket, breadth was rising! For some reason, it decided to not rise in 2002 - I guess in sympathy to the stock market. But then in early 2003 as the market was rising, so did NYSE breadth. And it has continued to rise to this day.

My point is that we have so many positive and negative divergences between breadth and indices they purport to represent that cumulative breadth is basically useless.

I agree that a trend simply can not continue if less and less securities are participating in it. Eventually it exhausts itself and crumbles under its own weight as it becomes unsustainable.

The problem is that no one knows when, exactly, this will take place. And cumulative breadth certainly provides no insight whatsoever into this.

This is why I prefer taking a much simpler measure of breadth: the moving average of net advancers and decliners:

The above chart is the 30 day moving average but you can use any number you like, as long as it doesn’t introduce too much lag into the equation. It gives you not only timely signals, but it also pinpoints most, if not all, intermediate bottoms with ease.

I’ll show the long term charts of cumulative breadth for both Nasdaq and NYSE in an upcoming post. It really is eye opening.

Last summer I pontificated about the future of Apple Inc. (AAPL) wondering if it was time to sell:

All the smart and “hot” money has been trading it and riding it higher. And you can bet they will run for the exit at the first sign that the party is over. Which is why I watch Apple so closely. I’m seeing a confluence of things which gives me reason to believe that the ride may be over.

So how did I do?

Well, Apple thoroughly spanked me. The only tattered consolation I can cling to is after writing that, the rocket ride known as Apple paused for the rest of the month of June. The only thing that knocked it out of the sky was the general market tumble in mid July. It found footing where it had paused earlier and off it went again when the market recovered.

I’m bringing this up for two reasons. One to review a past call and award myself a meager C- and two, to talk about entry into momentum stocks. Most technical traders agree that momentum stocks provide a great opportunity. As the saying goes, “the trend is your best friend”. Or, bodies in motion tend to stay in motion.

This is especially true when the market has corrected and is about to find its footing again. It is a very rare momentum stock indeed that can completely buck the general market tone. Apple certainly didn’t and it was one of the best performers in 2007.

The general market is like the tide or the waves of the ocean. It is a background element common to all boats (stocks). But some boats have better hulls and more hydrodynamic shapes. So they will react differently to the same common element.

Apple carved out a rounded bottom at $120/share, just as the S&P 500 found its footing. For AAPL that level also coincides with previous important points of support. From there it launched into an astounding recovery which left other stocks in the dust. While it has now easily reached the heights it once claimed in late 2007, the S&P 500 is still more than 8% below its highs of October 2007.

Although most would agree that it is smart to ride the momentum of stock like Apple, but can’t agree when exactly they should enter it. I would suggest that the best time is when the market has exhausted itself within a correction and is about to bounce back. This allows you to define your risk and base it on support levels, removing guesswork.

Here’s yet another market indicator which is suggesting caution. I’ve been noticing these pop up for a while now. And although we have now broken above the problematic resistance level of 1400, there are several reasons to reign in any rampant bullishness in the short term.

Among them, sentiment as well as the High/Low Indicator that I’ve mentioned before a few times. It measures and compares the number of highs to lows in the S&P 500 index. It is a ratio of the highs to the sum of the highs and lows. So when it is a low number, we know that there are ample lows but little or no highs. And the reverse when it is a large number: many highs with few lows.

Like many others, this metric is much better at pinpointing a bottom than top. This year has already brought two crazy oversold situations in the market. The first in January and the second, mid-March. You have to remember the blue line in the above graph is a moving average, which means that we spent many days with a tonne of new 52-week lows and zero 52 week highs.

At the same time, we aren’t yet pushing the other extreme. Clearly the extraordinary situation in early 2008 has been resolved and the S&P 500 has bounced back - around +10%. And even if the High Low Index did get red-lined, it is no guarantee that the S&P 500 will top out instantly.

But the important thing I take from this metric is that we no longer have that deep oversold condition from which to catapult higher. Been there, done that. The easy money has been made in that trade. Now the longs have to keep their wits about them.