Trading Range Bounce Under Way
On
Tuesday we got a decent follow-through day up (up 1% or more on volume higher
than the previous day and volume above the 50-day average) in the Dow, the S&P
and the Nasdaq. Finally, an
announcement of a rally of major bull-market support! With this technical evidence, we can at least say that the trading-range
bias has now shifted from down to up. Whether
this is the start of a new rally to all-time highs we cannot yet say. Technical evidence is not yet strong enough that this looks like a
shoe-in. Our long-time outlook that
major support would hold up to an October decline and then a seasonal rally
would begin still seems on target. But
if the October lows fail in all the major averages, or even just in the Nasdaq,
watch out below.
Investors will
recall that we guessed well at the May lows that the rally would not lead to new
highs. And we guessed well that the
October decline would both develop and not lead to new bear market lows. Our best guess now is that we’re still in a trading range, but that a
decent and catchable rally will develop from these lows. New highs are possible, but we would await further technical evidence
before making that our best odds guess. There
is still an economic slowdown taking place. But if bonds can lead stocks
in another new leg up, our bias would
shift toward expecting a belabored move to new highs. So keep all eyes on bonds now.
Needless
to say, the 3000 Naz, the 1300 S&P and the 9700 Dow levels remain critical
support to be watched like a hawk. In
the absence of another follow-through day up and with technical evidence showing
dominance, but not overwhelming dominance, in breadth, we’ll stick with our
cautious stance of taking only two trades in either direction. But we’re watching the markets closely with a bias toward releasing our
caution toward longs if we can get some clearly strong action next week.
Let’s
look at some numbers from the week. New
Highs vs. New Lows on our RS/EPS lists were
20/23, 28/29, 44/14, 44/6
and 17/4. This shows dominance on the long side, but neither side had
20-plus each day. There were roughly 20 breakouts on the upside with 2 breakdowns on the downside of four-week-plus consolidations on our RS/EPS
lists. There was only one valid breakout during the week, Downey Financial
(
DSL |
Quote |
Chart |
News |
PowerRating),
but there were also some upside breakouts very close to meeting our criteria —
MGIC Investment
(
MTG |
Quote |
Chart |
News |
PowerRating) and Labranche & Company
(
LAB |
Quote |
Chart |
News |
PowerRating). We also got
stopped out of our long, Key Production
(
KP |
Quote |
Chart |
News |
PowerRating), on a trailing stop with
miniscule profits, and we got stopped out of Corus Group
(
CGA |
Quote |
Chart |
News |
PowerRating) on the short
side with strong profits. There were no valid breakdowns of stocks meeting our
downfuel criteria on the week. Thus, upfuel breakouts are improving, but neither
long opportunities nor short opportunities are developing in abundance, hence
our maintenance of a cautious stance.
Our
overall allocation remains quite low. We
are now around 16% long (including open profits) and 15% short for aggressive
accounts using leverage (8% long and 8% short for unleveraged, more
conservative accounts). Last week
our longs were flat on the week, while our shorts rose an average of 5.3% (and with
20% starting allocation, this subtracted 1% from our overall portfolio), giving our overall
portfolio a loss of about 1% on the week and leaving us with around a 77.6%
gain on the year (5.8% below 83.4% equity highs) on a 12% maximum drawdown so
far. Conservative investors not using leverage show about half these gains and
drawdowns. Our three steps forward, 2.5
steps back snail-slow gains with
relatively low volatility in our total account continue, but we have managed to
keep our gains and avoid both the bloodshed and volatility many other strategies have
shown here, which is actually even more important
than cleaning up from the big moves up. (Offense sells tickets, but defense wins
Super Bowls.)
For
those not familiar with our long/short strategies, we suggest you review my
10-week trading course on TradingMarkets.com, as well as in my book The Hedge
Fund Edge and course “The Science of Trading”.
Basically, we have rigorous criteria for potential long stocks that we
call “up fuel,” as well as rigorous criteria for potential short
stocks that we call “down fuel.” Each day we review the list of new highs on our “Top RS and EPS New
High list” published on TradingMarkets.com for breakouts of four-week-or-longer
flags, or of valid cup-and-handles of more than four weeks.
Buy trades are taken only on valid breakouts of stocks that also meet our
upfuel criteria. Shorts are similarly
taken only in stocks meeting our downfuel criteria that have valid breakdowns of
four-plus-week flags or cup-and-handles on the downside.
We continue to buy new signals and sell short new short signals until our
portfolio is 100% long and 100% short (less aggressive investors could stop at
50% long and 50% short). In early March,
we took half-profits on nearly all positions and lightened up considerably as a
sea change in the new economy/old economy theme appeared to be upon us.
We’ve been effectively defensive ever since, and continue to be.
Upside
breakouts meeting upfuel criteria (and still open positions) so far this year
are: Key Production
(
KP |
Quote |
Chart |
News |
PowerRating) @21 — out on
22 ops;
Mid-Atlantic Medical Services
(
MME |
Quote |
Chart |
News |
PowerRating) @16.56 w/15.25 ops; and this last week we had
one valid pattern breakout up in
stocks meeting our upfuel criteria (see 10-week trading course): Downey
Financial
(
DSL |
Quote |
Chart |
News |
PowerRating) @45.25 w/41 ops. The average gain in these stocks from
breakout points of entry to Wednesday’s close is 64%, substantially
outperforming the NASDAQ, DOW and S&P for the year to date. Continue to
watch our NH list and buy flags or cup-and-handle breakouts in NH’s meeting our
upfuel criteria — but continue to add just two per week.
On
the downside, this year we’ve had breakdowns from flags (one can use a down
cup-and-handle here as well) in stocks meeting our downfuel criteria (and still
open positions) in: Corus
Group
(
CGA |
Quote |
Chart |
News |
PowerRating) @11.88 — out on 8.25 ops; Barrick
Gold
(
ABX |
Quote |
Chart |
News |
PowerRating) @14.44 w/15 ops; and Global Crossing
(
GBLX |
Quote |
Chart |
News |
PowerRating) @21.44 w/25.5
ops; and
this last week, we had no valid pattern breakdowns in stocks meeting our downfuel
criteria (see 10-week trading course). These shorts are down over 56% from breakdown levels on average
so far this year (before current prices or exits). Continue to watch our
NL list daily and to short any stock meeting our downfuel criteria (see 10-week
trading course) breaking down out of a downward flag or down cup-and-handle.
Here, too, remain cautious by only adding two shorts in a week. As we had been
commenting, we got stopped out via trailing stops on much of our portfolio here
in these last two weeks. Note that most of these stop-outs are on trailing stops
with profits locked in. Our trailing stops being hit thus allows us to book
profits and prepare for the rally.
We
still need to hold critical support. We
may get an upward-biased trading range — and we may get a schizo market with the
Naz in trouble, while the broad market holds up. A rally is likely to develop here, however. But until we get more
long-side opportunities or an upward-biased breadth,
don’t get wildly excited. We still
need for support to hold, another one or more good follow-through days, and a
couple of weeks of abundant breakouts that meet our upfuel criteria to release our
cautious stance toward longs. Remember
to let market action be your guide. Only
when our opportunities grow to become abundant will we be able to get more
excited about moving our long allocation or short allocation up to more
aggressive levels. Let’s stick
religiously with our strategy, and let it tell us how aggressively or defensively
to allocate and to what vehicles on what side of the market, since the strategy
is doing so well in this market environment.
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