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Market Wrap

Pre-Holiday Day to End a Pre-Opex Week

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We've had some slow days before but this was also a slow week. Other than the occasional buy program spike and an occasional bout of selling, this week was much of the same--boring sideways consolidation. The DOW ended the week up +13 points, the S&P 500 was down -6 points (equivalent to DOW 60 points so you can see where the relative strength was this week) and the COMP ended the week down -12 points. Each day it seemed there was a different stock selected out of the DOW to be blessed with buying and it doesn't take much more than that to keep the DOW levitated. Keep the DOW up and the retail crowd stays happy since that's what gets reported in the news. Keep the retail crowd happy and buying and the Boyz can continue to distribute their stock to them. I hope you're not taking that stock from them--you should be following their example and using rallies to lighten up your exposure to the market right now.

By the way, for those of you looking for the conclusion to what I started on Monday, the rest of the trading rules have been placed at the end of this Wrap.

We've got opex week ahead of us next week and anything goes during this coming week. The equity market is dancing on some critical support areas and can't tolerate much more of a pullback without sounding the dive horn which would signal batten down the hatches 'cause we're goin' down. As I'll show in some of the charts, we could still get another leg higher to finish the bull market rally and in fact I'd like to see it so that it would give a little cleaner count to the wave pattern. But it's certainly not necessary and I consider the risk to be clearly on the bulls' side. As I see it any more upside potential is very limited and simply not worth chasing. But without some better sell signals, such as breaking important support levels, it's a tad early to be thinking of shorting the market. It's one of those times where it's good to be in cash as we wait further signals. Think of yourself as a special forces guy hiding in the bushes while watching the market through a high-powered night vision scope. You know what your plan is but you're waiting for the signal to attack. In the meantime you're sitting very quietly. OK, too many action movies for me, moving on.


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It was a busy day for economic reports but in the end they didn't mean much of anything to the market. That's the surprising thing actually--we're getting lots of signs, if you look carefully, that the economy is not as robust as people would like to believe. We're in lala land and the market has turned a blind eye towards the danger. Even the geopolitical risks are having no impact on the psyche of the market. But when it does, it will probably register quickly. Certainly that's the way I read the tea leaves in the price patterns at the highs now.

At any rate, we got the new unemployment numbers which unexpectedly rose by 12K to 313K (actually up 14K from the previously reported 299K). This is the level of claims in the past month. The 4-week average for initial claims fell by 1,500 to 307,500. Continuing claims rose by 29K to 2.50M and its 4-week average fell 7,750 to a 5-year low of 2.43M. This number had peaked at 3.75M in May 2003, 2 months after the market found a low in March 2003. I suspect we'll see the same thing happen in reverse again.

We received the data on import prices which declined -0.4% in March. Many credit this for helping contain inflation in the U.S. This decline follows a -0.5% decline in February. Excluding oil, which dropped -0.7% in March (that'll change for April) imported prices fell -0.3% following a -0.6% drop in February. Export prices were up +0.2% which is good combination to have--pay less for imports and receive more for exports. As was reported yesterday, the U.S. trade deficit was down -4.1%.

The Retail Sales numbers for March showed a rebound from February's poor numbers--up +0.6% even after an upwardly revised number for February. The previously reported -1.4% for February was revised to -0.8%. Auto and auto parts sales were up +1.6% so outside the auto sector the retail sales increase was +0.4% which is still respectable.

U.S. business inventories were unchanged in February while sales dropped -0.6%. It was the largest drop in sales since a -1.5% drop in April 2003. The inventory-to-sales ratio rose to 1.26 from a record low 1.25 in January. Economists had expected inventories to rise +0.4%.

The Michigan Sentiment (preliminary) hit expectations at 89.2, up slightly from 88.9 in March. This made for the 3rd straight increase in sentiment. As long as the consumer is feeling confident enough in their present situation we'll see the purchasing continue which of course is important to our economic growth. The current conditions index rose to 1111.1 in April from 109.1 in March. It's the future expectations component that hasn't been doing as well lately and April's number fell to 75.1 from 76.0 in March. If conditions stay OK, the current conditions component tells us what the consumer is feeling today. And as we know, when we look at the overall savings rate (negative), we know consumers are living for today.

The problem for our near future, as far as how will have an impact on our markets, is that the numbers are not keeping up with current consumer confidence. In other words I'm thinking many consumers have their heads in the sand. They're concerned about the future but not doing much about it yet. They're in denial about their current situation and continuing to spend like there's no tomorrow. The record debt levels, bankruptcy rates and rising interest rates are not a good combination. I've discussed this before so I won't repeat a lot of it but when we, collectively, are faced with rising costs (energy, housing, food, etc.) and reduced earnings (new jobs replacing lost ones are lower paying service jobs) we all know that sooner or later something has to give.

Real earnings have been dropping for the past 8 years but we've gone into more debt or financed our purchases through the equity gained in the stock market or our houses. The stock market hasn't gone anywhere for more than 2 years (and in some cases still well below the 2000 highs) and home values will level off at best. Kiss the money tree in the backyard goodbye. When the expectations index becomes the current conditions index, we will have already seen the result in the stock market and that's why we watch these numbers. When we see waning momentum in the market at new highs (bearish divergences), deteriorating internals (such as the increasing number of new lows vs. new highs) and these program buying spikes that have no follow through, you can guess what's happening--the Boyz have been unloading their inventory on rallies. Are you doing the same?

As we look at the charts the question in my mind is whether or not we've got another rally leg ahead of us in the next couple of week or so or if instead we've seen the high. On to the charts.

DOW chart, Daily

The DOW, particularly with its relative strength this past week, looks the most bullish as far as supporting the idea for a continuation of the rally. Support at its 50-dma and October uptrend line is holding and the price pattern would look best with another new high. Therefore, as long as the recent lows hold I'd say this is pointing us higher. It's possible, as I look at the short term charts, that we'll see a dip early in the week to finish the pullback. I could see the DOW pulling back to something just above 11K (11040 is a potential Fib target where we'd have two equal legs down from its high) but it would have to be a quick drop down to tag the level and then a quick reversal so that it would only look like an under-throw of support. Watch for that possibility.

SPX chart, Daily

SPX gives me the impression it's only at the beginning of its break down. So between the DOW and SPX I've got a different impression and it has to do with the relative strength displayed over this past week. The SPX is consolidating on top of its 50-dma but unable to break free and rally. The previously broken October uptrend line, currently at 1295 (which is also the level of its break down from its most recent congestion), hasn't even been tested from underneath yet. MACD has moved into negative territory. If this lets go of its 50-dma at 1288 and can't recapture it, it could be bombs away down to its 200-dma at 1248. Interestingly, for those of who were playing with the Gann Wheel as I reviewed it last week, 1242 is 180 degrees from 1314, the high made last week.

Nasdaq chart, Daily

The COMP looks even more bullish than the DOW. So do 2 out of 3 make the case for a short term bullish outcome here? Could be. The 50-dma and October uptrend line at 2296 haven't even been tested yet so by this measure the COMP looks bullish. The trouble I have with the techs is that the leadership doesn't look so good and without the generals can the techs make it very far? They might but then they'll probably got shot along the way so I'd be careful.

QQQQ chart, 240-min

First impression from this chart is that support held and now we should see a bounce back up in its up-channel. That may be good for a little more lift but the problem I have with this index is that the current bounce looks very corrective--much more like a bear flag than something more bullish. I'm thinking short the rallies on this one.

SOX index, Daily chart

Short the rallies on this one too. A failure to recapture its 50-dma is a bearish sign. The choppy overlapping highs and lows in its bounces tells you to not trust the upside. While it could always bounce higher, it looks like corrective price action against the declines. Therefore when buying momentum appears to be waning, pick on your favorite (weakest) component to short or select bearish plays on SMH. I would not want to be long the semis.

I came across an article (thanks to Joe for pointing it out to me) in Trader Daily (a part of Trader Monthly publication) that discusses the top traders in the market. The 15 top Wall Street traders were all from the mega banks that I discussed a few weeks ago (the ones with trading teams who use a "proprietary trading system" and who have been able to reduce their risk in the market). Today saw the usual program buying spikes that went nowhere and now whenever I see them I think about these trading teams in the mega banks doing their thing and jerking the market around to their benefit. Some day they'll pay dearly when they become so arrogant to think they control the market and get a few nasty surprises when the market overwhelms them. Happens to them all. But for now we have to be careful around these program spikes.

At any rate, the top trader on the list, Mark McGoldrick (should be Goldbrick), works for Goldman Sachs and made GS over $2B (that's with a B) in 2005. For his efforts GS paid him roughly $40-50M. GS was not at all happy with this article coming out and has instructed their traders not to talk with reporters. The other big winners were traders with UBS, Lehman Brothers, Deutsche Bank, Morgan Stanley and Merrill Lynch. Interestingly enough (and of course not at all surprising) these 6 banks just mentioned were the primary banks responsible for the bulk of the program trading in the market. I'm telling you, something smells in the state of Denmark here.

BKX banking index, Daily chart

If the DOW or COMP looks bullish and SPX looks bearish, the banks are right down the middle. They're barely holding on to support but for the time being I'm giving them the benefit of the doubt and think they'll hold support and give us another leg up to finish their rally. However, if they close below the 50-dma at 369.50, we'll probably see the 200-dma get tagged next.

U.S. Home Construction Index chart, DJUSHB, Daily

The housing index has broken down from its small corrective bounce and looks like it will at least test its uptrend line from March 2003. This is obviously an important trend line and should be good for another bounce. The inability to hold the 50-dma after recapturing it is a bearish sign. I wonder sometimes whether we'll see this index bounce around inside its sideways triangle for a while before it makes a bigger move (down is what I'm guessing). This index is taking a long time to correct which obviously chews up time premium on any long put positions. Bear call spreads is a good way to play these stocks. If and when we get the break below 830 then it'll be time to get more aggressive on the short side. Until then be careful with option plays.

Oil chart, May contract, Daily

Between the geopolitical risks and the new ETF (USO), which could be creating some additional demand, the price of oil has been slowly working its way back up towards its hold high. By this consolidation pattern that I believe is playing out (ascending triangle with risking bottom and flat top), we should get another multi-week pullback before rallying out of it. If we who will be doing a lot of driving this summer are lucky, that pullback will take us well into the summer but it'll probably bottom before summer starts and be making new highs as peak driving hits.

Oil Index chart, Daily

I'll continue to urge caution in all stocks, including oil stocks, but I'll also continue to show a path I think oil stocks could follow if they follow the same path as oil. We should be due a multi-week pullback that then sets up a rally to new highs. Support, assuming we see a drop back down, should be its uptrend line and 200-dma.

Transportation Index chart, Daily

Ideally we'll see one more push to a new high in this index before it's all done. It's possible it finished at its last high, having missed its Fib target by only 11 points but from a wave count standpoint it could use one more new high. Right now the TRAN broke below its uptrend line from March and dropped below its previous high, both of which tell me to be heads up for a potential high having been made. Price bounced back up and found resistance at the broken March uptrend line (at 4650) so if that continues to act as resistance, the next test is just below at its October uptrend line at 4575. And then the 50-dma just below that so there's layered support before this one can be declared finit.

There can't be any discussions of the US dollar without recognizing its value as the world's reserve currency. It's what gives us the ability to print as much of it as we want (and you can bet we'll defend against any threats to the dollar). We've become beholden to foreign countries and their ability to buy our debt. China alone held $854B in reserves at the end of February, the highest of any country in the world. If I were John Snow, I'd make nice with the Chinese. If they decide to unload their dollars and diversify into euros I'm thinking our financial system might take a small hit, especially since it could create panic among the other dollar holders.

U.S. Dollar chart, Daily

So far the dollar is hiding its intentions very well as it continues to consolidate more and more tightly in its sideways triangle pattern. I'm thinking the break will create a fast move so continue to keep your eye on this. It will clearly have an impact on commodities and bonds and it will ripple through all financial systems.

Gold chart, April contract, Daily

Gold looks like it's pooping out. Silver is in its parabolic spike and when I look at that chart I want to cover my head. That one won't be a soft landing. But gold appears to just running out of steam here. The last two weeks have seen price chop its way higher and this is the sign of an ending pattern (in fact is forming an ascending wedge for an ending diagonal 5th wave). I have a Fib projection on the chart at 607.83 which is where the extended 5th wave will equal 162% of the 1st wave. This is very common in commodities (extended 5th waves) and therefore watch this level carefully if you like a short trading opportunity in gold). And if you're brave, keep an eye on silver and try to grab a short in that one if it looks to be breaking down. That one should give a nice ride on the southbound train when it breaks.

Results of today's economic reports and tomorrow's reports include the following:

What happens if an economic report comes out and there's no one there to hear it? Did it really get issued? If we don't pay attention to the news tomorrow, we'll never know. Supposedly the Capacity Utilization and Industrial Production numbers are coming out tomorrow but I'm not sure if that's true or if someone forgot tomorrow is an exchange holiday. At any rate, if they do come out my guess is that they will have no impact on the market (wink).

As briefly mentioned in the beginning, market breadth has been deteriorating and today was no exception. While price was marginally in the green today a look under the hood says we're about to split some water hoses and throw a few belts off their pulleys. New 52-week lows handily beat new highs 237 to 195. We've seen the new highs-new lows curve start to tip over for the first time since last October. The advance-decline line has been diverging against new price highs for quite a while now. These are not necessarily tradeable indicators but they're a heads up that the strength is not there so again be careful if trading on the long side of this market. That is the current trend, and as discussed in the rules below you certainly want to trade with the trend. But you also want to know when to pull your stops up tight and get a little less aggressive in any new positions.

On Monday I had started a discussion of trading rules that I got from Dennis Gartman's "Rules of Trading" and I highly recommend copying and pasting the first 5 rules I went over on Monday and then the other 8 rules below. We spend hours developing and back testing trading systems, explore and test a myriad of trading tools, read and research reams of analytical and fundamental data about the market and then when we finally trade we often forget very fundamental trading rules. Violate these rules and you will likely bust your account sooner or later. Follow these rules and manage your risk and account properly and it really won't matter which trading system you use.

For a quick review, the first 5 trading rules are:
#1 -- Never ever add to a losing position
#2 -- See rule #1
#3 -- Learn to trade comfortably in both directions without bias or preference
#4 -- Do not hold on to a losing position--it will cost you both mental as well as trading capital.
#5 -- Go where the strength is--the trend is your friend and you should trade with it (buy high and sell higher, sell low and buy lower).

Sell markets that show the greatest weakness; buy markets that show the greatest strength.

This is an extension of rule #5. Look over the various sectors to identify the strongest and weakest ones. If you want to be long the market, buy the strongest sector. Identify the strongest stocks within that sector and buy that stock. Do the opposite if you want to be short the market. If you're long and you have a stock/sector that's not keeping up with the others, sell it and put that money to better use in stronger stocks/sectors. Do not develop an attachment to any of your holdings no matter how good it was to you in the past. Most traders do the opposite--they sell their strong stocks and put the money to work in their weaker stocks doing themselves double damage.

In a Bull Market we can only be long or neutral; in a bear market we can only be bearish or neutral.

The trouble of course is if you look at just 2004-2005 you have to wonder whether we've been in a bull, bear or flat market. So obviously your time frame matters for this rule. If you're a day trader you obviously don't care what kind of market we're in. But regardless, the point with this rule is that you want to find the primary trend. As Jesse Livermore would say, find the path of least resistance and trade in that direction. If you identify an up trend, trade long, let it correct and then get long or add to your long position. Trading against the trend will almost always be more difficult and choppy. When you fight the trend you consume precious mental capital if not trading capital. Losing mental capital then causes you to make more errors in judgment. When you're nervous about what the market is doing, flat is the best position as it's the only position from which you can think straight.

"Markets can remain illogical far longer than you or I can remain solvent."

Lord Keynes is the person credited for first saying this and I think it's truer today than in his time. If you fight this rule it means you're violating some of the other rules, such as holding a losing position or adding to a losing position or failing to identify the trend and trading with it. The markets are driven by human emotions and not by funnymentals. And this brings us to the next rule:

Rule #9
Understanding psychology is more important than understanding economics.

This happens to be one of my favorite ones and the reason I like to use EW analysis in the market--EW is based on the swings in human emotions and can accurately predict its next swing based on the current pattern. Without an understanding of human psychology the more trouble you will have following the market and you will likely find yourself fighting the market more often. Trying to understand this component is why we look at such things as trader sentiment, consumer sentiment, bullish vs. bearish opinions and put/call ratios. The moment you trade the market by what it should do vs. what it is doing is the moment you will lose money. The market tends to swing too far to the extremes and logic will tell you you're crazy to trade in that direction but logic will often get you into trouble. Don't argue with the market; make money from it instead.

The hard trade is the right trade.

This is a corollary to rule #9 because it has to do with human psychology. If it's easy to sell, don't: if it's easy to buy, don't. If it feels easy to make the trade, so too does it feel that way for everyone else and it will probably be the wrong trade. Trading in the same direction with the masses is more comfortable but often wrong. It's hard to pull the trigger when it feels like the worst trade you could make. Just be careful you're not fighting rule #8 in the process.

RULE #10
Trading runs in cycles; some are good, some are bad, and there is nothing we can do about it other than accept it and act accordingly.

This is hard for many to understand, unless you're a trader. Those of us who trade for a living know that there are times when every trade, no matter how foolish, is profitable and we feel invincible. Conversely, there are times that no matter what we do--no matter how great the setup was; no matter how insightful our analysis was--our trades will be losers and we'll feel like miserable failures, that we've lost our touch. Therefore, when things are going well, trade often, trade larger, and try to maximize those times when everything seems to be working in your favor. But when your trading turns south on you, trade infrequently, trade smaller, and continue to get steadily smaller until the you start getting steady base hits again. The latter usually happens when we begin following the rules of trading again. Funny how that happens...

RULE #11
To trade/invest successfully, think like a fundamentalist; trade like a technician.

It is obviously important for us to understand the economic fundamentals behind why the market might move in one direction vs. the other but as traders we must understand the technicals behind the current move. If we can get the two in synch, all the better for our trading. If we're trading technicals counter to the fundamentals we should be aware and be heads up for the winds to change. Trading against the fundamentals is one of those times rule #8 prevails. But when you can get in synch that's the time when you want to trade with the market and to do so aggressively.

RULE #12
Keep your technical systems simple.

Many very bright people have developed super sophisticated trading systems. You can't visit a trading site without reading about why you should spend $3000 and up for a trading system guaranteed to win you money. Guess what--nearly everyone comes back to the basics of oscillators, moving averages and trend lines. The KISS principle applies here so save yourself a lot of money and angst and use what works. Simple systems and these trading rules will make you money, pure and simple. The battle-tested and successful traders attribute their success to their knowledge gained over the years that complexity is the home of the young and untested.

RULE #13
Do more of that which is working and do less of that which is not.

This is the rule that sums up the rest and is a simple rule in writing but a difficult one to act upon. But by working on these rules and making them the core of your trading plan you will find success. Adding to a winning trade while cutting back on losing trades is the big one--focus on it above all else and you will do well. And interestingly this concept works in your life outside of trading as well.

I hope everyone has a great long weekend and enjoys time with family and friends. Be safe and we'll see you fresh-eyed and bushy-tailed for a new week, opex no less.

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