Trader’s Narrative

Continuing to look at the energy sector, here is another chart that shows some interesting technical characteristics:

A shallow angle of ascent provides for an uptrend’s longevity. But as it ramps higher at a steeper and steeper slope, then the trend is either about to end or reverse.

You can see in the case of S&P Oil & Gas Exploration SPDR (XOP) ETF that the uptrend has changed slope three times. Each time becoming steeper. According to traditional technical analysis this is a sign of exhaustion. No trend can sustain itself for much longer once it has intensified three times.

Another important element is the formation of a shooting star candlestick formation on the weekly chart. This is another sign of impending trend exhaustion. It is significant only after an uptrend. You can find others on the chart, for example the first week of November 2007.

Think of shooting stars as inverted hammer candlesticks. Just as hammers are bullish when they occur after a downtrend, so are shooting stars bearish after an uptrend.

Let’s take a look back at my previous commentary on Canadian REITs’ oversold condition on June 27th, 2007. Yup, it is report card time!

Unlike many other trading bloggers who let previous calls drift into the ether I like to keep myself honest by reviewing past calls and analysis. Both to be transparent and to give myself and others another chance to learn (from my mistakes).

…we could be seeing a major trend change with REITs. But even so, they aren’t going to go straight down. I think this technical oversold picture in the short term is still actionable.

So how did I do?
My thesis was that it was yet another correction within a long term uptrend. I was right about an “actionable” short term oversold condition because we did see REITs bounce into July. However, the index failed to ricochet off its 200 day moving average as it had so many times before. So I was wrong in the sense of not seeing a trend shift taking place right under my nose.

Thinking back, I don’t think I did anything necessarily wrong. I prefer to be proven wrong by price action than trying to simply ‘guess’. I think it is always wiser to continue to do what has worked, until it proves you wrong. As long as you are practicing smart money management you’ll be ahead.

Weinstein’s Stage Analysis
If you’re not familiar with Stan Weinstein, what are you doing still reading this? Go and buy his classic book on technical analysis (on your left). Then you’ll have a great grasp of basic TA and understand what follows.

According to Weinstein, stocks follow 4 stages. From his definition, last summer the Canadian REIT sector had all the indications of Stage 3 - topping. It is now in Stage 4 - decline. Simple to see that in the chart: lower highs and lower lows.

As well, in mid-July 2007, the Canadian REIT index’s 200 day moving average plateaued. No surprise really since the index had been going downhill since late February 2007 (red arrow).

It isn’t just coincidence that since that same point in time, the Canadian REIT index has been trading consistently below its long term moving average. Something that it hasn’t done in years. This definitely denotes a major shift in REITs.

Way before they actually did, I correctly surmised that the Fed was going to have to start cutting rates. But my misstep was in not realizing that there were greater forces at play. So much so that a major campaign of tax cuts has not been able to withstand the tsunami of the credit crisis.

On a positive note, the index seems to have found footing recently along with the rest of the market, lifting off from a double bottom formation. If it continues to rise, its next challenge will be meeting the long term moving average from below as it is hurtling down towards it.

I find myself unable to resist the temptation of picking up some Charter REIT (CRH.un); a tiny real estate investment trust that has a 15% yield. Other than that I’m just going to hang on to my long term holdings.

Lesson learned:
When Sam Zell sells, real estate has peaked.

The US market isn’t the only one getting whacked. Almost all the international markets have swooned in unison, thanks to an ever intertwining global financial market.

The Canadian market has been most recently driven by the natural resource sector: the mining (gold, uranium, etc) and energy sectors (oil and natural gas) especially.

According to Lowry’s research, when the percentage of stocks trading above their 10 day moving average is below 10%, the market reaches not only a short term bounce but also a lasting intermediate to long term bottom. It has only failed once! To see a graph of this indicator from 1990 onwards, click the above link.

On March 5th 2007, the US market had less than 4% of stocks trading above their 10 day moving average. You all know how that turned out. Last week, in the Canadian market, we saw less than 9% of stocks trading above their 10 day moving average.

While there is no law that says that this indicator can’t go lower (even to zero), past behaviour would argue that we are seeing an opportunity here for an inflection point.

Click to Enlarge Graph

Graph from Stephen Whiteside’s uptrend.com

Sometimes it helps to understand the markets by peeling back the price layer and peeking at the internals like advance decline numbers. I mentioned before that extremes of advance decline usually point out the start of a trend.

Last week we saw back to back extreme days in this metric. On Thursday, May 10th 2007, we had the AD line fall to -1731 (close to maximum lows ~ -1750). And the next day, on Friday, May 11th 2007, it rose to +1200 (not that close to maximum highs ~ +1400). This is quite unusual.

This back to back up and down wasn’t at all as extreme as the late February to early March bottom but it still was noteworthy. The last time we had this magnitude of up and down advance decline numbers was in late November of last year.

On November 27th 2006, the Nasdaq advance decline shows an extreme -1920 reading. Then just two days later, on November 29th 2006, it flipped to the other side with a +1101 reading. As you can see on the graph below, this was followed by a continuation of the uptrend: