Trader’s Narrative

Let’s check in with the latest Lowry Research proprietary indicators. As persevering readers will recall, Lowry arrived late to the (bullish) party with their intermediate buy signal in August. Since then, they’ve continued to monitor their indicators and diagnose the uptrend as healthy: Rally Continues Strong. No indicator, whether proprietary or otherwise is perfect and no one has a crystal ball.

HAving said that, personally, I respect the oldest technical analysis firm on Wall Street not just for their heritage but also because they refuse to be swayed by emotion and always root their approach in a methodical study of the market.

Here are some notes from the latest interview with Tracy Knudson of Lowry Research (you can listen to the whole podcast at the bottom):

• S&P 500 bouncing off its 50 day moving average
• near term, we could get a move down to that MA
• around 1045-1050 which is a converging support area
• the trendline from March and July lows also meets in that area
• this area will act like magnet to draw market lower
• volume is sending a clear message: weakness on upside and more strength on downside
• S&P 500 tried several times to clear the 1100 level
• it has approached that level on contracting volume
• but volume expands on downside days
• this telling us demand weakening and selling more intense
• so the market is gearing up for a correction
• last short term pullback occurred in late Sept to early October
• that began with a downside reversal day
• this is when the market made new high then wasn’t able to sustain it and made a new low

Continue reading ‘Lowry Research: Turbulence Ahead, Uptrend Intact’

It is only six weeks since Lowry Research gave an intermediate trend buy signal. Since then the market has gained appx. 6%. Here is update on where the oldest technical analysis firm on Wall Street stands. You can listen to the Bloomberg podcast at the end of this post.

If you’re new to Lowry’s, many of the terms below may be confusing. For example, Pim refers to “Lowry stocks” which is a misnomer. What he means is OCO (operating company only) breadth, which is Lowry’s response to the pollution on the NYSE. This measure strips out ADRs, CEFs, REITs, bonds, ETFs, etc. and only shows market breadth for operating companies. For more background like that, as well as an explanation of Lowry’s proprietary indicators, take a look at my post late last year outlining Lowry Research’s position on the then market conditions.

Here are some notes from the recent Bloomberg interview with Tracy Knudson of Lowry Research:

• from Lowry’s market newsletter: “strong rallies but there are flaws”
• potential growing selectivity within the rally
• breadth momentum % above 10 day moving average declined last week as
• this indicator was at 88% (time of interview) - extremely overbought
• now it is lower at 82.6% (see chart above)
• also there are overbought price momentum indicators
• demand volume weak: NYSE up volume 52% (Sept 15th) of total up+down volume
• this is another blemish on the aging rally
• S&P 500 trading envelope: overlay 21 day moving average then +/-3% range
• this provides and indication of overbought/oversold condition
• right now the S&P 500 index is hugging its upper trading envelope
• we’ve seen this happen before during the rally - this is the 3rd time since early June
• each time as the S&P hugged this upper envelope, we also had deterioration in the momentum indicator (% above 10 day MA)
• the confluence of waning breadth momentum and the overbought condition lead to corrections
• the first correction was 7%, the second less
• not a signal of an important market top but evidence mounting for a correction
• LT indicators are telling us the correction will be short term & shallow correction
• new highs in advance/decline line, and Lowry’s proprietary indicator: Buying Power index continues in an uptrend
• as well Lowry’s Avg. Power Rating index which measures demand across stock market has tripled since March low
• strong indications of demand so correction will probably be shallower than 5-10%
• price momentum is also very overbought (short term condition pointing to correction)
• traders have been expecting a correction since the market can’t move up in a straight line
• but the market has been very resilient
• even so, we haven’t seen panic buying which precedes important corrective points
• if we see complacency and sharp move higher = panic buying and look out below
• have not seen true panic buying from the March lows
• OCO advance/decline line is confirming new highs in major market averages
• no divergence - that would be seen at an important market top
• any selling is met with a renewed wave of buying which overwhelms it
• watch to see if “buy the dip mentality” fades - watch for waning intra-day resilience
• Nasdaq advance/decline line was lagging but is now at a new high as index leads
• this rally has not run its course
• during a pullback, if market internals deteriorate proportionally more than the market, we’d reevaluate our stance

Tracy Knudson of Lowry Research (Bloomberg):
Pim’s interview with Tracy is at the beginning of the podcast so just press play and listen:

We looked at momentum earlier in the month through the advance decline numbers. Using historical data, we saw that such intense thrusts usually continue far longer than most anticipate. Since then the S&P 500 is little changed. But the McClellan Summation Index continued to go up, even as the market’s rally was put on pause.

It reached 1393 (see below for chart) higher than it had been since January 2004. The McClellan Summation Index, is a long term measure of market breadth and right now it is saying that - at least in the short term - the stock market’s momentum has waned.

Here is the McClellan Summation Index for the Nasdaq:

The most recent readings from this measure of the market’s internal health are noteworthy because it rarely reaches these extreme levels. Here’s a chart of the S&P 500 index showing the instances in the past 10 years when both the Nasdaq and NYSE McClellan Summation Index went to an extreme high:

While historically such extreme levels of momentum from the McClellan Summation indicator are followed by sideways trading or retracement, they do not normally hinder more long term moves. This dovetails with the sentiment data which we reviewed last week.

I’m expecting the market to soften a bit and even give back a significant portion of the spring rally. But rather than detract from the ‘bottom’ thesis, this could help the bulls in the long term. One possibility is that we could settle into a nice wide trading range where peaks and valleys offer trading opportunities. Or perhaps by shaking off the weak hands that have become way too giddy, a correction would increase the longevity of this rally.

One of my favorite breadth charts is the Bullish Percent Index. It isn’t as common as advance decline measures because it is based on point and figure charting.

Point and figure charting itself is based on pure price action and ignores both time and even small price movements. In P&F charts the X represents demand (or bid or buying) and the O supply (or selling). Unlike candlestick or bar charts, it is perfectly normal for a point and figure chart to not need to be updated (when price doesn’t move beyond a threshold either up or down). This is the great advantage of point and figure charts.

Other than that, the basics of technical analysis such as support and resistance apply to point and figure charts. Also, point and figure charts can provide systematic buy and sell signals - something that ‘normal’ charts leave open to the traders discretion. The simplest buy signal is the chart to the left - when price breaks above a previous high (without the column of O’s breaking below their previous low).

So to calculate a Bullish Percent Indexes, we simply take a look at each and every stock compromising an index and track how many of them out of the total constituents are in a point and figure buy signal. If, 120 out of the 500 stocks in the S&P 500 index are in a buy signal for example, then the Bullish Percent Index for the S&P 500 for that day would be 24%.

Doing this by hand would be extremely cumbersome, but thankfully we have computers that can do the calculations in a fraction of a second. Here is the chart of the Bullish Percent Index for the Nasdaq Composite:

According to the traditional interpretation, a Bullish Percent Index of 70% and higher is considered overbought. And if there it experiences a 6% (or more) decline, it will offer a sell signal. Personally, I prefer to not wait for the sell signal. Once you know that the market has weak legs, you can use other indicators to give you more short term guidance.

Right now we are seeing almost every single measure of the market provide extreme breadth levels from the Bullish Percent Index. Normally seeing the bullish percent indexes for so many markets and sectors reaching this high in synchronicity would be a red flag. However, there is an argument for such strong momentum to be a signal of a protracted rally.

This was the same concept that I shared earlier this week about incredibly powerful thrusts measured from the advance decline breadth. These short busts of powerful buying are usually precursors to lasting uptrends. Think of it as a turbo booster on a rocket which lifts it through the heavy atmosphere before it can glide easier through the thin air of space.

Consider that the last time the Nasdaq composite BPI was this high was back in 2003-2004 during a powerful bull market. It is the same case for the NYSE, and the Nasdaq 100 index. This is how oversold can become meaningless.

Bullish Percent for Major Indexes:

• NYSE Index — 77%
• Standard & Poor’s 500 — 83%
• Nasdaq Composite — 70.55%
• Nasdaq 100 Index — 90%
• Dow Jones Industrial — 77%

Bullish Percent for Sectors:

• Financial — 86%
• Consumer Discretionary — 79%
• Consumer Staples — 73%
• Energy — 60%
• Healthcare — 79%
• Technology — 87%
• Industrial — 71%
• Materials — 85%
• Telecom — 56%
• Utilities — 62%
• Transportation — 75%

Every once in a while, the market has such strong momentum that the 10 day NYSE Advance Decline goes above 2:1. The historical data below is from Wayne, a regular reader and experienced CTA. As you can see, the latest one was just last week on July 27th 2009:

Wayne continues:

“I have advance/decline data going back to 1970. Note the only failure occurred in 1987, a year in which the S&P was up sharply for 3 and 6 mts before crashing 10 months later under the pressure of rising interest rates.

The concept is that market rallies are similar to rocket launches. Without the proper momentum they will not have the strength to leave the earths atmosphere. One way to measure the strength is a measure of broad participation via the A/D line over say a 10 day period. If the A/D over a 10 day period can achieve a level close of 2 (actually about 1.91 is the optimum level), then history suggest that there the market has the strength to sustain a meaningful rally.

These type of strong thrust moves have left many traders at the station. This most recent one is no different. There are very few who actually believe that this rally is the real deal. As well, this dovetails with the Lowry 90-90 days that show similar extreme thrust moves. You can see the extremely strong breadth in the NYSE and Nasdaq Summation Indexes as well:

Also, with today’s close we had 91% of the S&P 500 index components trading above their 200 day simple moving average. That is the highest for at least 5 years! The last time this indicator was this high was in late February 2007 - when the Standard & Poor’s 500 was trading at 1460.

Based on these sort of indications, my hunch is that we are going to continue higher in the medium to longer term but with a short term pause or correction. The flag pattern comparison was right on the money, if I do say so myself