Trader’s Narrative

I use Interactive Brokers as my primary broker because of their price and offering but also because they consistently improve and add new features. They put the Japanese companies to shame when it comes to kaizen.

Usually they follow the requests made by their clients - I’ve been with them long enough to remember a time they grudgingly gave in to demands for trailing stop losses because Thomas Peterffy believed they weren’t good for the health of markets (I am not kidding!!). But they also innovate and surprise their fans with new features.

They recently announced a raft of new features, products and markets. If you are a serious trader and looking for a broker, check them out.

Here are the recent additions:

New Products & Markets

• US Treasury Bonds and Notes
• Vanguard No-load Mutual Funds
• Mexican stocks, futures, and options
• Spanish stocks

The first two are huge news because as far as I can remember, we’ve been pestering IB for it. The even better news is that fixed income will be expanded soon to include T-Bills and that other mutual fund families will be added as well. IB was at one time proud that they stuck to just derivatives and equity markets. Finally, they are branching out to other financial products.

The expansion to Mexico and Spain are also welcomed. Especially since I have familiarity and interest in the Spanish equity market. IB has offered Spanish derivatives for some time but now the lineup is complete.

IB Block Desk
The biggest news is this! Interactive Brokers is opening up their institution block desk to retail customers. Now if your orders are big enough (100+ contracts), you can call them up and get a tighter spread or more liquidity than electronic markets. The desk also offers you access to the Spoos (the S&P 500 open outcry market or pit), OEX, NDX (and their options).

Answering calls will be experienced, knowledgeable traders who can tackle anything you throw at them, including complex derivative trades. But this is a very surprising development since Interactive Brokers has adamantly refused to do anything but push deeper into electronic markets through sophisticated trade matching computer algorithms.

IB Risk Navigator
This is a relatively new built in quantitative tool that will monitor and manage your risk exposure across countries, markets, currencies and securities. Think of it as your very own risk manager. IB has added a few extra capabilities to it but unless you trade a gamut of securities spanning markets or dabble in options heavily, then you probably don’t need it. In case you’re interested, IB is offering two Webinars to explain it in more detail: March 26th and April 23rd.

Trader Work Station
The TWS is the trading platform from IB and most people fall into two camps: they either love its simplicity or hate its clunky look (and Java-ness). In any case, IB isn’t going to chuck it any time soon so if you’re thinking of opening an account with IB this may be the only deal breaker. You can always use their web based interface but it has very limited functionality compared to the TWS. IB has finally tried to mollify its critics by adding skinning, so you can customize the look of the TWS.

I can’t help but think that a lot of these uncharacteristic new features and markets are a result of Interactive Brokers becoming a public entity last year.

If you’re shopping for a broker, click to see last year’s best broker ratings from Barron’s.

Looking at the percentage of stocks above their 50 day moving average is a quick and dirty way to find out where the market stands in the medium to short term. Looking at the percentage above 200 day moving average provides a much broader perspective.

Line In The Sand
The 200 day moving average is like the proverbial “line in the sand”. If a stock can’t hold above it, technically speaking, things are really rotten. But while that may be negative for one individual stock, when as a whole the market crosses that threshold, it usually is a sign that things have reached an extreme and are about to return to normal.

Right now, the percentage of stocks above their long term moving average are at levels which in the past have seen a resumption of the bull market. The index that got the most oversold was the Nasdaq Composite (COMPQ) which reached 34%. The next one was the S&P 500 (SPX) which got as low as 43%.

Large Cap vs. Small Cap
But there is an obvious dichotomy. Whereas the broad indices (containing a mix of small caps and large caps) show an extreme low reading for this indicator, the large caps are almost unscathed. The Nasdaq 100 (NDX) index, for example, has 60% of stocks above their 200 day moving average while the S&P 100 (OEX) has 62%.

This is no surprise since we all know that the small caps have gotten crushed in this correction. A cursory look at the Russell 2000 (RUT) shows it correcting about 12% (from recent high to recent low) - almost double that of the large caps.

Unless for some reason you believe that we are heading into a new bear market, this is as bad as it is going to get. I reiterate that this is a buying opportunity if you have a medium to longish time horizon. Especially the financial sector.

Here’s the chart for the NYSE and the S&P 500. Notice the difference between a bear market bottom and bull market inflection points:

Most technical analyst junkies are already familiar with the percentage of stocks above moving averages. This is where we look at the percentage of stocks within a group that closed above a certain moving average.

The shorter the moving average, the more short term the significance of the signal. Although, Lowry’s has intriguing research which shows that very short term measures (10 day moving average) can indeed be a sign for more long term signals as well.

Rather than look at this indicator as most do, I give it a twist by calculating a ratio between the medium term and the long term. That is I take the percentage of stocks in the S&P 500 trading above their 200 day moving average and I divide them by the same for the 50 day moving average.

Why do that? Well, for one it gives me something which few look at. And for another, it easily identifies instances where although the long term market was healthy (generally trading above the 200 day moving average), there was a short term correction.

This is ultimately what we want. That the major uptrend be intact and to buy a short term correction within that uptrend.

Right now, 47.8% of stocks in the S&P 500 are trading above their 200 day moving average. While that is quite low, it did get as low as 40% in the summer of 2004. Along with 18% being above their 50 day moving average, this gives us a ratio of 2.66 (see chart).

That spike you see in the chart below, like all previous spikes, is a bullish omen:

The only negative that I can find for this type of indicator is that the other market proxies aren’t as extreme. For example, among the major indices, the Nasdaq 100 Index (NDX) is currently showing the highest percentage of stocks above 50 day moving (at 39%). The S&P 100 is at 22%. I’d prefer to see readings closer to 20% myself but we never have all the stars align perfectly.

And you can’t argue with the largest and most significant index (S&P 500) showing only 18% of its constituents trading above their 50 day moving average. This is the level at which all our inflection points have arrived at since the bull market began in 2002.

The only time things got hairy was at the bottom of the 2002 bear market when it reached the dreaded 0%. That is zero stocks trading above their 50 day moving average!

I think everyone woud agree however that we are not in the same environment (fundamentally, technically and sentiment wise) as we were back then. So I put the probability of that happening as extremely small.

Since the last time I looked at the trend of the market, the S&P 500 has put in a higher bottom at 1235. This is the first thing we need for a change in trend. The next thing we need is a higher high.

Right now, it seems the market is working on that. If it can close decisively above 1280 and put in a higher high as well, the probability of a trend change will be very high. In the mean time the market is simply coiling within a tight range.

The Nasdaq 100 index, however, is much weaker having been unable to put in a higher low. The NDX seems to be still struggling with the 1525 resistance level.

Today Bernanke’s testimony on Capitol Hill stoked a rally as the market interpreted him to be more dovish than previously. Specifically, he said:

We must take account of the possible future effects of previous policy actions — that is, of policy effects still in the pipeline.

This was taken to mean that Bernanke is not in a hurry to push rates to extremes in an effort to control inflation but instead is willing to take a more relaxed approach to allow the effects of previous increases work themselves through the economy.

The market may think this is bullish, but according to James Stack of InvesTech, history shows evidence to the contrary:

…in the past 80 years, there has been over a 71 percent probability that stock prices will be lower six months after the final rate hike.

In any case, the market had a fantastic trending up day. In fact, it was so bullish that again, we saw more than 10 times the volume in stocks closing up than down. I wouldn’t be surprised if it was also one of those fabled Lowry’s 90-90 days too. This sort of market action is very rare because such skewed positive days don’t usually cluster this close together (we had two other ones in the past month). But eventhough they are rare, they are unmistakably bullish.

The volatility, as measure by the VIX index, got crushed again today falling intraday almost 18% ! To be honest, I’m getting tired of this. Uncharacteristically, it has been happening a lot lately. Historically it has been bullish but the reason I don’t really like it right here is because it shows a market that is too ready to abandon its skepticism. And as you know, skepticism, like virginity, should not be abandoned too readily.

We see this same phenomena in the Hulbert Stock Newsletter Sentiment Index (HSNSI). According to Hulbert, at the end of June, when the S&P 500 was at 1270, the HSNSI stood at 12.6%. Then days later on July 12th when the S&P 500 was lower at 1258, the sentiment reading was higher at 31.4%. And the Hulbert NASDAQ Newsletter Sentiment Index went from a -25% at the end of June to 0% on July 12th, eventhough the Nasdaq fell more than 40 points. Tsk, tsk. That’s not what lasting rallies are built on.

Here’s the daily Nasdaq 100 chart :

According to the classic definition: lower lows and lower highs; we are still in a clear downtrend. We’ve just put in our third lower low in fact. And unless the previous high is taken out and a higher high put in, we can’t really claim that the trend has changed. For that to happen, we would have to see the index climb all the way to close above 1600.

Is it possible? Sure. But if the market does go up from here, you can bet that it won’t be powered by the old has beens of yesteryear: Yahoo!, eBay, Microsoft, Dell, etc.

Instead, look for tomorrows leaders to be unknown, mid-caps, in unpopular sectors and possessing the ever important, strong relative strength.