Monthly Archives: July 2020

Reverse Engineering Chart Patterns – Prevent Weekend Chart Hypnosis

It’s Sunday morning. Do you sit in front of your computer, coffee cup in hand, and look for stock trading candidates? Maybe, you input technical conditions into a scan engine. Then it spits out a bunch of stocks with oscillators entering or leaving overbought or oversold zones, or with classic MacD crossovers either bullish or bearish. Perhaps the scan engine suggests candidates flirting with a Fibonacci level or Fibonacci time frame, or Fibonacci arc or Fibonacci angle, there are any manner of Fibonacci ingredients, and there are any manner of general technical conditions to screen for. Many of them work. Often these scans reveal some very good trading material. Sometimes they don’t and that’s all part of the trading game.

My main objection to scanning via indicator or oscillators is that the people who use them often have no understanding of how they are constructed. For instance, the data used in the Relative Strength Index, is similar to the data used to compute the Stochastic indicator. “Technicians” have to be careful then not to use a like indicator to confirm another like indicator. This problem is called multicollinearity. It’s comparing apples to apples by using similar input data.

Back in the days before computer charting, I had to update weekly charts sent by mail. I would simply draw a new daily candle as the trading week progressed. But, if you chose to, you could also update the technical indicators, like the MacD and the RSI, which were included on the charts. This involved following the formula for the indicator and doing the math. One positive result was that you became familiar with the information that went into the construction of the indicator or oscillator. This helped avoid the danger of multicollinearity and it gave me a better understanding of technical indicators and oscillators. Today there are so many or more accurately too many, indicators that can be attached to your computer charts. Again, “technicians” (I am using this word lightly) fill their charts with studies and they have no idea what those studies represent. To them it’s this simple: a moving line crossed over or under a particular horizontal line, and that is either a good or bad thing for the stock. If you don’t know what input produces the output of your indicators you are not a technician. But, I digress.

Reverse engineering a chart is the opposite of imputing data into a scan engine to find a trading candidate. It involves first identifying a stock chart that provided a profitable trade in the recent past. Then disassembling the chart by looking at the technical conditions just prior to the initiation of the trade. This includes not just the indicators and oscillators, but any candle patterns and volume levels, all using multiple time frame analysis. Basically, you’re looking at a chart that represents a previous profitable trade and you’re trying to identify the early technical particulars that made it a winner. Breaking it down and deconstructing the conditions just prior to the initiation of the trade.

Often traders just move on if they miss a winning trade. They immediately start scanning and scrolling for another opportunity. But reverse engineering, even a missed trade, is an opportunity to gain more trading insight. Take, for instance, a chart that has a clear stair-step pattern of higher highs and higher lows. It may be too late to enter that trade but you can go back to where the trend began, and notice the technical conditions that presaged the start of the pattern. The same applies, of course, to bearish trend reversals. What happened to momentum and money flow ahead of the reversal?

Reverse engineering is a simple and unique way to analyze a stock chart, and it can prevent weekend chart list highway-like hypnosis. Always use your time productively. Don’t just blindly scroll through reams of charts. Pick prime candidates and analyze them thoroughly and in a unique way. It keeps you sharp and on the lookout for new trading ideas.

Six Stocks With Large Short Interest + Good Charts = Potential Covering Rallies

Here are six stocks with solid chart patterns, improving price momentum and money flow and they have large outstanding short positions. The implication is that if there are bullish chart pattern breakouts, the shorts will be forced to cover their positions. This would initiate short covering rallies in the stocks.

Remember though, often times the shorts are correct in the longer term. So, if you trade this kind of strategy, keep time frames short, and take quick profits or quick losses.

The DOW – Bullish Breakout From a Moving Average Squeeze And There Is Plenty Of Upside

The Dow Jones Industrial Average ($DJIA) dropped below its 200 day moving average in early June. It’s been trading just below the horizontally trending 200 day average and more recently above a rising 50 day average. Over time this the area between the two averages compressed along with the Dow’s average true range and Bollinger bandwidth.

A period of price compression is often followed by a volatile resolution. This means that the Dow would be expected to make either a volatile breakout or breakdown. The Dow futures this morning suggest that it will be the former as they project a 500 point jump at the open.

A positive DOW breakout was being forecast by two technical indicators. The Relative Strength Index has been tracking above its center line and is now above the 21 day moving average of the indicator. This reading represents positive price momentum. The Money Flow Index, a RSI measure of money flow, has crossed above both its center line and signal average.

The Dow’s upside targets are highlighted on the below chart.

The first upside target is the 27,000 level which would close the island gap that formed in early June. This close should be accomplished at the open of trading today. The second target is the June high an additional 500 points higher from the gap close. This shouldn’t be a high hurdle for a market with the current level of positive momentum. The third upside objective is a small open gap around 29,000. If that gap is filled then the magnetic effect of new all-time highs would likely levitate the DOW above the 29,568 level.

This is a lot of DOW speculation but it seems, at least at this point in time, that the only thing that could alter this positive scenario is negative news on the virus. But if investor sentiment is like a scale, then the negative virus news is currently being balanced out by the vaccine news. Hopefully, the vaccine news will begin to tilt the scale in the healthy and bullish direction.

The Volatility Index And The Anomaly At The 26 Level – “The line must drawn here! No further!”

The market got a scare in the last two hours of trading on Monday. There was a sharp drop in equity prices on news that some businesses in California were being closed again and of renewed US/China tensions in the East China sea. The broader market dropped sharply and the Volatility Index jumped closing the session with a nearly 18% gain. This correlation is normal: as investor fear levels rise stock prices fall and the Volatility Index moves higher. But here’s a interesting anomaly that can been seen on Monday’s 10 minute VIX chart.

Earlier in the Monday session when the DJIA had been up over 500 points the VIX was also slightly higher on the day. Note the first hours of trading that are framed in green. The DJIA goes into rally mode and the VIX also moves higher, of course on a more shallow trajectory. The correlation indicator during this intra-day period shows a high degree of correlation. In the last two hours of trading when the DOW started to go into a waterfall decline the VIX rallied sharply. The correlation between the two readjusted and realigned into a normal inverse correlation.

Anomalies like this have occurred this month because of the formation of the strong zone of support that we have been highlighting on the VIX daily chart, between the 26.50 to 25 levels. When the VIX returns to that area it is more likely to bounce than to break through. This thesis has been confirmed a number of times going back to June. At this point, it looks like the only event that will take the VIX down through the support zone is some very positive news on the virus. I’m all for that. But what has been holding the Volatility Index above the support zone despite the higher equity prices?

It’s fear. It looks like traders have their speculative limit and they see the VIX at a certain level as a good level to buy puts. More profits equals more puts. Apparently that has been the case since the beginning of June. The chart below is the 10 day average of the CBOE put/call ratio. It shows the monthly increase in put buying. For those that trade the $VIX or the VXX, rebounds off the 26.50/25 area have been profitable. While for traders booking big equity gains, hedging those positions is a good idea.

In the immortal words of Jean-Luc Picard, “The line must drawn here! No further!”

Have Interest Rates Bottomed? – Is It Time To Buy The TBT?

Interest rates have been moving lower and for a long time. If you were on a fixed income like a pension during this period you’re a happy person. The low interest rate environment produced little or no inflation. This preserved the buying power of your income over time. If, on the other hand, you bought government bonds to supplement retirement income over the last ten years, it has been a different story. The yield structure you might have anticipated in your retirement years collapsed. You had two options: go back to work or go out on the risk curve to get more return, specifically buy stocks.

While a steady income is a comfort for retirees, reaching out on the risk curve actually payed off. The increased demand for return caused stock prices to move higher. The blue chip risk-reach produced both return and capital growth. This dynamic was the result of the Federal Reserve policy of lower short term interest rates.

But stock prices can’t go up forever, at some point valuation will matter. Likewise, interest rates cannot go lower forever. In fact there is little room for rate decreases and any future decreases would likely have a minimal effect on the stock market. So what if interest rates start to rise? Is there a way to profit from a rising interest rate scenario?

The ProShares UltraShort 20+ Year Treasury ETF (TBT) is an inverse exchange traded fund, and provides 2X inverse exposure to bond maturities greater than 20 years. It is a levered bet on rising interest rates. The TBT goes up when bond yields go up and interest rates rise. Take a look at the weekly 10 year chart of the TBT. Not pretty. It has headed lower along with the historic decline in interest rates. A positive correlation.

Now here is a six month daily chart of the TBT. This has some positive technical potential.

The TBT looks like it may be putting in a base or more boldly stated – a bottom. Over its ten year period of decline there have been many times when the TBT looked like it was building a base. But this time is a little different in the contextual of interest rates having basically reached their lower bound. Additionally, the lateral action on the daily TBT chart over the last four months has established a zone of support in the 15 to 14.50 area. In last Friday’s trading the TBT opened on that support and closed near the high of the session. This created a short-term bullish candle.

At this point in time, the chart suggests several possible outcomes. The first is that a triple bottom has been made and the TBT along with interest rates will begin to move higher. (My anecdotal observation over the years is that when rates rise they accelerate quickly.) Higher rates correlate to gains in the TBT. But another possible outcome is that rates remain near current levels and move horizontally, bumping along the support area. This second scenario is less positive for the TBT. Of course, there the third possible outcome that interest rates move to zero and the 15-14.50 support area is taken out. This outcome would be a clear negative for the TBT.

My opinion is that the lows for the TBT are in, based on the charts and the level of short term interest rates. It is not likely that the Federal Reserve will allow short term rates to move to zero, and they will do what they can to keep longer term rates from reaching that lower bound. So, the TBT at current levels seems a good risk/reward trade. Support is clearly delineated and if my hypothesis is wrong, a confirmed move below the 15-14.50 area provides a nearby exit point.

“There is no S&P 500 index anymore.” Here’s Why.

“Chart Master” Carter Worth checks out the concentration of capital issue in the S&P 500 index. This overweighting problem is why, when traders finally try to rebalance out of the tech high-flyers (that could happen) the whole market will suffer.

The DOW : Monday’s Focus Was On Breaking Through Resistance – On Tuesday The Focus Is On Holding Support

Yesterday we took a look at the Dow Jones Industrial Average chart. The primary focus was on the trend line resistance level situated in the 26,426 area which is being reinforced by the horizontally tracking 200 day moving average. A strong open suggested that the Dow was set to break above resistance and potentially move up to close the island gap. See the post here.

But the follow up to the open on Monday was flat and only accelerated a bit at the close. The resistance line held. Today’s open will be lower and we will see if there is downside follow through during the session or the move fades. In any case, it would be prudent to do the exact opposite of what we did on Monday morning, that is take a look at areas of support on the indices.

The chart shows the Dow Jones Average with the island still floating unattached above horizontal resistance. As we said that resistance was tested on Monday but held. Back down in the 25,000 level is a confluence of support. It consists of two intersecting trend lines and the 50 day moving average. It is a long way back down to that area but it is good to know its there.

On the S&P 500 chart, the similar support area includes multiple trend line support, the 50 day moving average and the 200 day moving average. If the index were to revisit that area, a bounce might be in the cards.

Powerful Market Open Today Propels the Indices To Important Technical Levels On The Charts

Resistance on the Dow Jones Industrial Average daily chart for the last month has been defined by the 200 day moving average, currently situated at 26,254 level. It should be tested right at the open this morning. If this resistance is broken the assumption would be that the next upside target would be closing the island gap created earlier in June. That would be a major step in initiating a credible run at new highs.

The Volatility Index weakened for most of the month of June. Last week the 200 day moving average was tested. That average has been running along with a horizontal support line. Together they compromise a double level of support situated along the 26-25 level. That area will come under heavy pressure at the open today. The collapse of volatility is an all-clear sign for the bulls.

The NASDAQ Composite chart is a thing of beauty. It continues its lower left to upper right climb (remember that one, I miss Gartman) within its upper Bollinger Band range. The only negative about this chart is its relative performance to the broader market, in this case the S&P 500 index. It’s too good. The NASDAQ is outperforming the S&P 500 by about 12.5%. These gains are powered by the tech heavy weighting in the Composite Index. The negative implication is that, at some point in time, NASDAQ performance will revert to the S&P mean and come in.

Regression to a mean is likely over time and looks obvious in retrospect on the chart. It is just hard to time or more correctly impossible to time. That is why traders respect the trend.

So, how will the trading landscape present itself today and later into the week? The futures are telling us the week will begin with a bang, that’s the easy part. But will the move gain traction or whimper out? and will volatility continue to contract? I don’t know. If you are comfortably invested my suggestion is to continue to ride the trend and look for levels to tighten trailing stops. If you are less invested that you want to be, don’t use this strength to add more exposure. There will be pullbacks and opportunities to add incrementally. Be patient.