Trader’s Narrative

When the market is weak, it is actually a blessing in disguise because it become even easier to find strong stocks. Here are just a few stocks that I found that have nice looking charts and high relative strength:

BEAV
METH
RJET
AAWW
PRGX
TESOF
DWSN
HDNG
LSPN

Quite a few of them come from the aerospace/airline sector.

Things are not going as they should in the market. And by that I mean that the market isn’t going the way I think it should go. Intelligent tells that have worked in the past almost unanimously pointed to an oversold market that is ripe for a snap back rally. And yet the market hasn’t obliged. Yet.

We had the sentiment measures coming in as very bearish, we had put/call ratios showing a very scared retail investor, we saw a rush into the safety of ETFs and out of individual stocks, we saw spikes in volatility, an increase in insider buying, etc… the list goes on.

So what gives?

Are we really in a new cyclical bear market? having never really left the secular bear market that began in 2000? A few, like Lowry’s, have said exactly that. Only time will tell if they were prophetic.

A lot has been made of the weakness in the SOX index relative to the broader market (S&P 500) and to the Nasdaq itself. Looks can be deceiving. For each of the major intermediate rallies in the past few years, initially the SOX lagged both broader proxies. Only after the rallies were truly underway did it join in the fray.

You can’t watch the semis as a leading indicator as they haven’t been for a while now. So the double bottom thesis didn’t work out. But what about the general market?

Looking at the classic measure of market internals, the bullish percent of the Nasdaq 100 is now below the critical 30 level:

This is deep oversold levels. According to traditional bullish percent analysis, if the market can now lift up above 30 by 6 percentage points, we have a new buy signal.

Looking at the percent of stocks in the Nasdaq 100 above their 200 day moving average we see a very similar deep oversold condition:

This metric is now as oversold as it was in the summer of 2004. Will we have another summer rally? or will things continue to meander downwards?

Honestly, I don’t have much conviction either way. I would like to believe that this oversold level will be a launch pad for the next leg up. However, when I look at similar metrics for the other broad measure of the market I find them not nearly as oversold as for the Nasdaq 100.

And yet, an almost infallible (contrarian indicator) is now as pessimistic as I’ve ever seen him:

I’ve got this train-wreck button on my “Mad Money” console — the sound effects board I use during my TV show — and I feel like hitting it a bunch of times right now just to emphasize what this market’s become. It’s 2000 all over again without the snap-back because of the geopolitical stuff.

I’ll briefly go over one of the methods I use for swing trading. First, I start with an overview of the general market, then focus in on a specific sector looking for an inflection point (top or bottom). Once I’ve identified that based on a combination of technical, sentiment and other indicators, I drill down into the sector to look for a specific stock to trade. Let me show you what I mean:

Recently, I wrote that the energy sector was bottoming based on the bullish percentage index. The general market was weak and the energy sector especially so. According to my analysis, it had become stretched to the downside and was ripe for a snap-back rally.

My next step is to look for stocks within the sector that were falling into clear support levels. When I find them, I don’t automatically rush in and buy though. Instead, I wait to see some indication that buyers have returned and that the tide is turning. After I see that and enter, I place my stop where it would clearly show that support has been violated. And finally, for my target, I usually use the previous swing high.

When I looked at the energy sector recently, several stocks stood out. One of the best candidates was Baker Hughes (BHI):

As you can see from the daily chart, BHI had been in an almost uninterrupted freefall since May 10th 2006. The decline had taken price down to an area of support around $77.50 (green line). This was the late January resistance which was expected to now act as support.

BHI formed a hammer candlestick as price was pushed down below this support level, but bounced back to close up for the day. This was a clear signal that it had found significant and aggressive buyers. A logical entry was going long at the break of the hammer’s high. The logical place for the stop loss was below the low of the hammer (red line). Were price to trade there, it would clearly violate the support that had been recently found and tested.

My exit target was the last swing high or around $86-88 (blue lines). BHI reached it in about 8 trading days. Of course, the tricky part is how you manage the trade. That is, how much room you give it and whether you use partial exits or not, and when. That goes beyond this discussion so I’ll revisit it in the future.

Getting back to the energy sector (XLE), we now see almost back to back wide range, engulfing dark candles. They are very forboding and should be of concern to anyone who is still long. We might even be looking at a possible intermediate top here.

Mark Hulbert is suggesting that the recent gold decline is just a correction, and not the start of a secular decline. He is basing this on the analysis of his gold newsletter sentiment measure. In late April, as the gold stocks were beginning to top, the Hulbert Gold Newsletter Sentiment Index was at 73.2%, almost at its all time high of 90%. Now it stands at 1.8%. This quick and massive retreat shows that people are not stubbornly insisting on gold stocks to go up.

On March 22nd, I suggested that it was time to ‘rent’ some gold stocks. Let’s take a look at a sampe gold chart to see how that was actionable:

Notice that on March 21st and 22nd, the Gold Bugs Index (HUI) had put in two hammers. On VGZ, for those two days, there were two back to back candles with long lower tails. The long lower tailed candles showed that there was considerable support at the $7 area. As well, this was an area of support from mid April (blue line).

A good entry long was above the high of the two candles ($7.60), with a stop loss below them (see green and red lines). You could have also put a stop loss below the $7 level to make sure you avoid potential whipsaws.

The target would be the congestion area at the previous high of $10 to $9 - which has almost been reached now.

Elan is a British biotech stock that has just zoomed out of a flatish, four month long base. As you can see, it is showing remarkable relative strength in the face of the general market action:

But even so, I would only go long ELN within a short time frame (days rather than weeks or months) since it is notoriously volatile. As well, there is a massive amount of overhead resistance if you zoom out to a longer time frame.

It bears watching to see if it continues to show strength, especially this week, as the general indices may reverse to revisit recent lows. In that case, it would be a fantastic candidate for a swing trade long.