Saturday, April 28, 2007

Weekly Stock Market Outlook

NASDAQ Outlook

On Friday, the NASDAQ Composite hit another new multi-year high of 2562.99 before coming back to close at 2557.21...a 2.75 point/+0.11% gain. For the week, we saw a 1.22% improvement, thanks to the 30.82 point move. However, though the week was clearly a winner, the momentum as well as the bullish volume tapered off over the last three sessions. On the other hand, that volume was still above average.

The bull/bear argument is still heated. Let's explore both sides of the fence.

What's bullish? Momentum. We just hit new multi-year highs, and the volume behind those highs was better than it had been in weeks. There's really no denying that the bulls have remained in charge. And as you know, 'the trend is your friend'.

What's bearish? For lack of a better way of saying it, being too bullish is bearish. We've now been overbought (stochastically) since late March....and the market hasn't been able to stay overbought that long since September of last year. And like we said above, the buying volume tapered off in the latter part of last week.

The bottom line, however, is that you can't fight the trend. All the same, here's what we're looking at to signal all this bearish potential is likely to be realized.....

Keep an eye on the stochastic chart (yes, we will for you). Once both of those lines cross back under 80, that may be the beginning of the end. Also - and just as importantly - watch for any closes under the 20 day line (blue) at 2502. However, note that even that sell signal has been a little shaky at best recently. Ideally, we'd like to say use the 50 day line (purple) as a bull/bear line in the sand - it's at 2453 right now. However, the NASDAQ would have to fall more than 100 points to get there....and we don't want to wait that long to take any bearish stance.

So, we may end up relying n the CBOE NASDAQ Volatility Index to make such a call. Unlike its S&P 500 brother, the VXN is close to support level around 14.80 again. Once we get a clear hint that it's trending higher again that may be the short-term beginning of the end for the market.

NASDAQ Chart

Click For Large Chart

S&P 500 Outlook

Friday's close of 1494.07 was 0.18 points under Thursday's close. However, on a weekly basis, the S*P 500 managed to gain 9.72 points, for a gain of 0.65%. Clearly the momentum is to the upside here...but perhaps by too much; we're waaaayyy overbought here as well.

As we've discussed a couple of times recently, the SPX is now dangerously above it's 200 day line (green) again. In fact, it's 8.3% above the long-term moving average. Just as a reminder of what happened the last time we got this far ahead of ourselves, you don't have to look any further back than February 28th. Though the over-extension alone wasn't the only contributing factor to the tumble, it certainly augmented the vulnerability.

One of the additional bearish arguments for the SPX is volume....or lack of, to be specific. Though the NASDAQ's bulls have come out in good numbers, the same can't be said about the S&P 500.

As with the NASDAQ, we can't really rely on the 10 or 20 day lines to act as a signal of any downside move....they just haven't been good signal lines lately. So instead, we're keeping watch over the VIX. Of course, at last look, the VIX was pointed lower, with plenty of room to move (from 12.45 back down to the support line around 9.60). In other words, the VIX says there's room for more market upside.

The point being, if the 10 or 20 day lines are succesfully retested as support, and the VIX isn't back at or near the mid-9 area, don't rule out any further bullishness....as unlikely as it may seem.

S&P 500 Chart

Click For Large Chart

Dow Jones Industrial Average Outlook

The Dow's new all-time high of 13,197 on Thursday was not topped on Friday - the DJIA only got up to 13,195 before settling in at 13,121. Still, that was a 15 point gain above Thursday's close....up 0.11%. For the week, the Dow Jones Industrial Average put up a 1.23% gain, adding 159 points to its score. Still bullish - still stunning.

There's no point in repeating anything we said above about the NASDAQ or the S&P 500 - pretty much everything we said above can be said of the Dow as well. There is, however, one additional item to examine that's unique to this chart....and perhaps troubling for the bulls.

The long-term resistance line that guided the Dow higher (though by acting as a ceiling) in the last quarter of last year (and January as well)? It's back.

Good news? Well, that's all a matter of perspective. We see it more as an 'end of the road' kind of thing. This line is plotted (dashed) on our chart today, currently resting at 13.171. If the resistance line fails to contain the Dow, then all we can say is that it's one uncanny breakout. However, if it holds the uptrend in place here, the bull's party may be over. That's not necessarily bearish, though it could be. A failure to move higher like it has been may leave traders uninterested, leading them to sell positions in what's already the traditionally weaker time of year.

Dow Jones Industrial Average Chart

Click For Large Chart

Have a great week!

Wednesday, April 25, 2007

Trade Selection

Today I will talk about the trade selection process. The solution really is simple, but too often overlooked. You have to have have some sort of methodology or system to find the best opportunities. It doesn't need to be a complicated system - it just needs to show positive results over time. In fact, the best trading systems are usually quite simple. Besides profitability, the only other thing your system needs is a means send you a signal, to let you know to place a trade. While this may sound like common sense, too many traders seem to forget these basics.

You must have an edge:

Ever notice that the market seems to zig just when it's completely obvious that it should zag? The market's direction typically defies conventional logic about half of the time. There's nothing wrong with using assumptions and logic to make market forecasts. However, you must absolutely concede to the fact that an assumption or a logical conclusion may be wrong. We're human, and as such, we're going to be swayed by fear and greed. That fear and greed, though, can warp our logic so much that we'll rationalize anything - even the wrong thing. When that happens, our logic becomes flawed and we become less profitable traders.

So how does one get around the problems that fear and greed can create? A trading system! Most readers may be assuming that by 'system', we're saying that you need a highly complicated piece of software that can test certain trade signals, and dozens of charts on your computer screen. These things are nice if you're a highly active investor, but you don't really need them. All you really need is a method that you know works for you. These may be moving average crossovers, momentum signals, or sector-based strength signals. It doesn't matter which one you use - you just have to become proficient at one of them and trade it consistently. In fact, one of the most famous trading systems is Bill O'Neil's "CANSLIM" method. You don't even need a computer to use that one, and it's a very passive method.

The point is, logic can be flawed, but a trading methodology can overcome flawed logic.

You must be able to receive a trade signal from your system:

If you only remember one thing today, remember this - most charts are ambiguous. It's especially critical that the pure technical traders understand this. These market technicians are completely reliant on chart data. This can be a problem, since at any given time, about 90 percent of charts are neither bullish nor bearish.

How many times have been looking for trades, and started to hunt just by looking at individual charts? You start with the symbols you know, then you go to the news to see if anything looks hot or cold to the media. After you look at twenty or thirty stocks, boredom and frustration set in, and you just start picking ones that look like they'll do. That's a mistake - you softened on your trade criteria and may have bought or sold a stock for a poor reason. You want to limit your trades to those 10 percent of stocks that are actually doing something. So how does one do this?

You have to have some method of receiving trade signals from your proven system. It's extremely inefficient to look for stocks that fit your criteria. Rather, you want these stocks to present themselves to you. This will not only save you time and frustration, but will provide you with opportunities you may have never seen on your own. There are many ways of getting the data, but the point is this - give yourself an efficient way to actually get the data you need. (continued below)

Bottom Line:

Systematic signals and signal scans go hand-in-hand. By taking fear and greed out of your selection process, you won't suffer from the problems of flawed logic. And by freeing up your time and focus spent on hunting for trades, you can focus on trade management.

Click the Trade Selection title link above to learn about creating successful trade plans.

Good day and good trading!

Tuesday, April 24, 2007

Socionomics

What is Socionomics?

An Interview with Robert Prechter, Executive Director of the Socionomics Institute.

Causality

Q: In a nutshell, what is socionomics all about?

RP: Socionomics is the study of social action that expresses social mood. Social mood arises endogenously from unconscious herding impulses inherited through evolution, and is patterned according to the Wave Principle.

Q: Endogenously, meaning that nothing impacts social mood?

RP: Right. No outside forces change the trends and patterns of social mood. This idea is counter-intuitive, but our studies demonstrate time and again that even the most dramatic news events do not change the dynamics of stock pricing, which is our measure of social mood. A positive mood motivates people to produce more, act peacefully with their neighbors, purchase uplifting entertainment, etc., and a negative mood motivates the opposite actions. So mood shapes economic, political and social trends. Most people think that social events cause the public's mood to change, but it's the other way around. This idea is the basis for what I call socionomics.

Q: How then can you explain the depressed mood after 9/11? It seemed the event put a gloom over everyone, which is contrary to what you're saying? Was that an aberration?

RP: On the contrary, it is exactly in accordance with socionomics. People had been getting gloomier for a full year and a half before the attack, not after. Six trading days after the attack, social mood improved non-stop for half a year to a far more optimistic level than it was at the time of the attack. The positive trend showed up in stock prices, consumer sentiment and measures of advisor and investor optimism. When the event occurred, people unconsciously latched onto it as an explanation for their waxing gloom. "Ah, there's a reason!" But if the attack really were the reason, then it should have occurred when optimism was strong and preceded a change toward pessimism. That's not what happened. All our studies show that mood trends, as revealed by the stock market, precede compatible social actions. So you can't use social actions to predict the stock market, but you can use the trends in the stock market to predict the character of social actions.

Q: Why then do people believe that social events impact social mood?

RP: Because people's brains naturally default to mechanics when they think about social events. Knowledge of mechanics has helped keep the species alive. We know that an object in motion will continue in motion unless acted upon by a force. So we duck when a rock is thrown at us and we swerve out of the way of a drunk driver who is drifting across the median. So people assume, with deep conviction, that any change in the stock market's direction must have been caused by some outside force. If they can't find one, they make one up. That's what the newspaper writers do every day after the market closes. But the stock market is not an object in motion, and outside forces are not required to change its trajectory. Unlike rocks, people have minds, and they can change them. In fact, they do change them, all the time, in accord with the impulse to herd. That is what moves markets. It's also what makes markets patterned. Herding is not rational, but neither is it random. It trends and reverses by its own dynamics.

Q: Are the effects of crowd psychology more pointed when we find ourselves in amore turbulent and critical era?

RP: Crowd psychology creates peaceful eras and turbulent eras. After the mood has trended positively for a longtime, peace reigns, as it did in the1920s, from the mid-'50s to the mid-'60s, and during the 1990s. After the mood has trended negatively for along time, turbulence reigns, as it did in the 1930s, the 1970s and since the peak in 2000. Social mood induces social actions, which express that mood. If you really want to get down to what I'm talking about, the eruption of scandals did not cause a negative social mood; a negative social mood caused the eruption of scandals. You say that notable social events follow, rather than precede, corresponding stock market waves (hence socionomics).

Q: Does the market cause changes in mass psychology or does mass psychology drive market prices?

RP: Mass psychology drives markets. But it also drives other things. A positive mood induces people to expand businesses, dress with flair, buy happy music, make peace with others and buy stocks. A negative mood induces people to contract businesses, dress conservatively, buy morose music, fight with others and sell stocks. So social mood moves not only the stock market but other measures of social action as well.

Q: Social mood, and therefore behavior, is always in flux. Change is constant.

RP: Absolutely. There's not such thing as social equilibrium. What we have is an unceasing dynamism. The thrilling thing about it is that it's dynamism at all scales. Dramatic moves lasting years or decades to the upside, equally or even more dramatic moves on the downside, over and over again. There's no such thing as equilibrium.

It's the buyers and sellers, it's the people who lend and borrow in the marketplace, it's the depositors and the bankers, all the people throughout society who are determining things like interest rates, how much economic production will occur, whether they'll be a recession or not, it's those summed decisions, which I believe emanate from shared moods that people have, that ultimately dictate all of those things.

See the list below for more examples of socionomics perspective of social causality.

Perception Versus Reality

Pattern – The Wave Principle

Q: So far we've established that social trends unfold of their own accord. Let's get back to the Wave Principle. Tell us more about fractals and waves.

RP: I think a lot of people are familiar with fractals these days, they became rather popular in the early eighties. A fractal is an object that is similarly shaped at different scales. Fractals permeate nature. Nature's fractals tend to be irregularly shaped, they don't come in circles, triangles and squares, they are irregular shapes such as clouds and trees and so on. They are self-similar at all scales.

Let's take a tree as an example. A branch will look very much like a whole tree. A twig off the branch will look very much like the branch and the whole tree. You have similarity at every scale although the branches are not similarly shaped they are quite irregular, you'd still recognize the tree because of that fractal pattern.

This brings us to waves, because in the mid 1930s until about the mid 1940s a man named Ralph Nelson Elliott began to investigate the price patterns in the stock market and other financial markets and he concluded what he was observing was a fractal. Of course, he didn't use that term, it hadn't been invented yet, but he drew out the patterns he was seeing and he said they linked together to form larger versions of the same patterns. So he was dealing with a fractal. Modern research has expanded on this quite a bit. The idea that the stock market is a fractal is no longer considered unusual; it's pretty much mainstream acceptance in academia.

The difference between Elliott and even modern researchers in the stock market is that he said, "It's not an irregular fractal, such a tree or a cloud formation, this is a very specific fractal, it's got specific patterns that make it up." Some researchers call it a quasi fractal. I call it a robust fractal because I think it's typical of nature's forms that involve growth, expansion and progress.

Pattern – Fibonacci Mathematics

Q: What is a Fibonacci progression?

RP: A Fibonacci progression is any progression in which two numbers are added to get the next and then those two later numbers are added again to get the next. The classic Fibonacci sequence, which was brought back to western civilization by Leonardo Fibonacci in the thirteenth century, starts with one. One added to nothing gives you another one, add that one to the first one you get two, one plus two gives you three, three plus two gives you five, eight, thirteen, twenty one, thirty four, fifty five, and so on.

What's interesting about this sequence, besides the fact that it shows up throughout nature, is that as the terms approach infinity the ratio between the two terms approaches an irrational ratio called phi. It's .618034 and of course it goes on forever. You can shorthand describe it as .62 or 62 percent. The interesting thing is that it's throughout nature. You find Fibonacci patterns in plants, in animals and throughout the human body as well.

Q: Tell us about Phi and human judgment.

RP: This is where the fractals, waves and Fibonacci begin to come together. The physiology of animals, including human beings, is full of phi or .62 relationships. Roger Penrose pointed out that the microtubules in our brains are arranged according to Fibonacci numbers. Our neurons electrical potential is not equal on both sides, one side is weighted by the Fibonacci ratio to the other. Even the fractal dimension of our neuronal system is 1.62. Throughout of bodies, everything related to thinking, the brain, the neuronal system, DNA and everything else, is extremely intertwined with Fibonacci relationships. Now, what does that mean? Does it have any effects? Do we think in Fibonacci terms? Some researchers have found that we do. A man named George Kelly back in 1955 presumed that people made judgments based on what he called bipolar constructs. Good is on one end, bad on the other end, happy is on one end, sad is on the other end and so on. He, like most of us, assumed that the midpoint for most people would be at the 50 / 50 point. If people felt neutral they would mean they fell right in between, 50 / 50. When he actually began doing his experiments, he found something really interesting. He found out that people's default was at 62 percent. In other words, a group of people who said they felt neutral would generally mark on a scale that they were 62 percent happy or 38 percent unhappy. Now we've had many psychologists in recent years that support that conclusion. So what they've concluded is that people default to the Fibonacci ratio for judgment when they have no real basis for judgment. In other words, this is some sort of central processor that the mind defaults to, it starts with Fibonacci.

What does that have to do with history, what has that got to do with human behavior in the aggregate? Here we come to what really got me interested in the first place on this whole topic. Robert Ray, back in the 1930s, charted bull markets and bear markets in stock and he found, even though he no idea what he was reporting, that bear markets tended to last about 62 percent of the time that bull markets did. They tended to retrace about 62 percent on average of what bull markets had performed on the upside.

So here we have people, in the aggregate, in a value neutral situation. When people argue what stocks are worth, they have no idea what they're worth, you could make a case on either side. So it's a sea of uncertainty and that's the time when people default to this Fibonacci judgment. When you add all this together, you come to the conclusion that Elliott's observation about the fractal and the stock market is correct because he found that the wave structure of that fractal is five waves in one direction, three in the other and when you iterate that and create a larger fractal you end up with the Fibonacci ratio and all of that is intertwined with general human thought. What's really interesting, of course, is the implications of this on human behavior.

Herding

Q: Part of the way our minds work is the herding instinct.

RP: Right. We can put what we just talked about together with the herding instinct and come up with what I call the engine of history.

Let's look at some of the recent research that people have done and discovered very interesting things about the way the human mind works. Dr. Paul McLean who is with the National Institute of Mental Health postulated essentially a three tiered brain. A primitive brain that developed through evolution, around the time of the reptiles, the limbic system which developed along with mammals which is the center of our emotions and then the neocortex which is a very late development that humans have, that's where we do our rational thinking.

It's a very interesting situation because we have a lot of things going on mentally that are unconscious, down in the limbic system. The limbic system is extremely powerful, it's faster than the neocortex, has higher amplitude and can override the neocortex, particularly in stressful situations and situations of uncertainty which is what we've been talking about in the stock market.

So here you have people who have impulses that were designed in a primitive way to allow them to survive, this is all mixed with their Fibonacci proclivities and you come up with something very fascinating. One of the things that McLean noted was that a lot of the primitive instincts like fleeing and fighting and so on are in this primitive area of our brains, or controlled by it, and one of those things is herding or flocking in lower animals. I think human beings have a good dollop of the herding impulse inside of them. Researchers have been showing this to be the case in many different areas. I think this is the reason that we have such a colorful human history. All through human history people are essential herding, they are looking to each other for emotional queues and sharing emotional states of mind what I call social mood. It fluctuates between polar opposites just like we were talking about in the individual mind. So people have a tendency toward the positive or the negative end of the social mood, not only as individuals, but in the aggregate.

So when the aggregate of society is feeling better, you tend to find that people do a lot of things the same each time. On of those things is buying stocks. So as mood improves people get a little more daring in their stock speculation, but a lot of other things are happening as well. They get more daring in their romantic relationships. People propose more often in bull markets. You find that people like happier pop music in bull markets. They go to see family fare movies like Disney cartoons in bull markets. A lot of effects come out of that positive mood. People are also more inclined to cooperate with each other and their neighbors. You find more peace treaties coming into being after a long uptrend and positive social mood.

The negative social mood has consequences also. When the trend is down people are more defensive, more self protective, they're selling stocks, they might be contracting their businesses so you end up with a recession or a depression. People like more depressing popular music and when they go to the theater instead of flocking to see that latest Disney cartoon they'd rather see horror movies.

So, in my opinion, this combination of fractal mental construct and the herding impulse which I believe follows that construct, essentially gives a mathematical shape to the ebb and flow of history and everything that society does.

Summary

Q: Social mood swings back and forth between opposites. This is the basis of your predictions, based on cycles.

RP: The important thing is to distinguish between cycles and waves. Cycles are regular things like the seasons. You know that every 365 days you'll rotate around the four seasons. Waves are very different. You don't know how large a tree will be when you plant the seed, you don't know how many branches it will have, but you know it will look like a tree. That's what we have in waves.

Under the wave principle there are all kinds of quantitative variations that you can have, but the form is always constant. And that form is a swing back and forth between opposites, toward optimism in the uptrend, toward pessimism in the downtrend, toward complacency in an uptrend and in a downtrend, fear and anger.

So you find these emotional states in society swinging back and forth at every degree which is why it's so complex, why society is so rich. And the ultimate result is human action. People take actions on these moods and those actions are what we read about in the newspaper every day and ultimately what we read about in the history books.

Q: Your work not only has ramifications for the future, but also puts history in a completely different light.

RP: Absolutely. Most people believe, for example, that our political leaders and our financial leaders such as the federal reserve are essentially making these grand decisions that move society from one direction to another, they pass laws that make us behave a certain way, and so on. Our work is showing that this is completely the wrong view of how society is motivated. In fact, the impetus or the motivation comes in completely the opposite direction. These patterns of social mood are completely internally motivated. People are getting clues from each other socially all the time and it's those moods that end up determining, for example, who are leaders will be.

Click the Socionomics title link above to learn more about low risk high reward trading with Fibonacci and Elliott Wave Principles.

Good day and good trading!

Monday, April 23, 2007

Exchange Traded Funds

During the 1990s there was an incredible flow of assets into the mutual fund market, as investors became acclimated to the period’s hottest investment vehicle that brought the benefits of professional money management to the “Main Street” investor.

Well, more than 10 years have passed, and now there’s a hot new investment that’s caught everyone’s fancy, as active asset management has become a more acceptable course. I’m speaking about exchange-traded funds, or ETFs.

An ETF share represents an ownership stake in a basket of stocks. These baskets can represent any number of entities, including a specific index (S&P 500 Index, Nasdaq 100), segment of the market (small caps, large growth stocks), sector (semiconductors, retail), or foreign country (Japan, China). Others represent holdings in bonds, gold, silver, or other commodities. The value of the ETF is tied directly to the value of the underlying securities.

While ETFs sound a lot like a mutual fund, there are a number of important differences. ETFs are bought and sold throughout the trading day just like stocks. Their price changes instantaneously, whereas mutual funds are priced at the end of the day. Also, because most ETFs mirror an index, they are passively managed and therefore have lower expense fees (no loads, either, like many mutual funds). They do incur a brokerage commission, however.

ETFs can be shorted, traded with a margin account, and many trade options. You can trade ETFs using market, limit, and stop-loss orders. Finally, there is no minimum for ETF purchases. (A similar class of shares called HOLDRs – which are often mistaken for ETFs - is different in that they trade only in round lots.) In short, ETFs offer the diversification advantages of mutual funds and the flexibility of stocks.

Investor interest in ETFs has grown for a number of reasons, primarily due to their diversification, low expenses, and offerings that track a number of sectors. These attractive options have been made available at a time when the independent investor, or what the business refers to as the “retail investor,” has found some comfort in navigating the market on their own to find above-average returns. This mindset is due to the availability of research and trading tools via the Internet and years of watching the professional managers of typical mutual funds fall short of expectations.

But could too much of this goodness be a bad thing for investors? Let’s reflect on the growth in the industry. As of December 2006, there were 357 ETFs available for trading. That’s triple the number of three years ago. In fact, 153 new ETFs were launched for trading last year. Compare that to 2003, when only six new ETFs launched.

One would think that more options for investors would be a good thing. But this growth comes with some caveats that every investor should know. The first is liquidity. We currently track the daily activity of more than 200 ETFs that regularly trade. An easy gauge of liquidity is a stock or ETF’s average daily volume (ADV). The average ADV of the ETFs we track is 2.9 million shares.

While this appears to be very robust activity, it is rather deceiving.

Let’s drill down to the individual ETF level. Only 38 (19 percent) listed ETFs sport an ADV of more than one million shares, while 44 percent trade fewer than 100,000 shares per day. (Again, this is of the ETFs we track.) To put this into perspective, the average S&P 500 stock has an ADV of 5.5 million. A little further down the liquidity chain, the average ADV of a Russell 2000 Index stock is 542,000 shares. Only 45 ETFs have an ADV of 542,000 or better.

Since lower liquidity typically translates into less favorable pricing, there is a very real risk that the ETF that you see as the perfect addition to your portfolio may be priced poorly. Buying a poorly priced share of anything (ETF, stock, option) means that you may end up at the mercy of an individual establishing the price rather than a robust market.

In addition to the liquidity issue, the ETF market’s increasing diluted landscape is also creating another potential risk - the loss of diversification. Like a mutual fund, ETFs offer diversification of one’s investment dollar. But many of the new breeds of ETFs that are hitting the market are taking an ultra-focused approach. It’s been called “ETF pollution.”

Take, for example, the HealthShares Cancer ETF (HHK), which focuses on companies that are involved in cancer treatments. While this fund currently invests in 22 stocks, it is hardly diversified. There’s little doubt that HHK will experience a lot of volatility based on company-specific risk. This potentially washes out the diversification benefit typically offered by ETFs.

The potential diversification dilution (can we call it ETF pollution dilution?) brought on by the continued release of these more exotic ETFs offers potential risks that investors may not be considering. As such, it’s just as important to consider the hidden risks of a particular ETF as it is to properly analyze the sector the ETF represents.

I like to wrap up these columns with a “So what?” finish, so here goes. The evolution of ETFs has provided investors with a terrific opportunity to build a portfolio geared to truly outperform the market in any market environment. The cost associated with this benefit is that you need to separate the wheat from the chaff in the ETF world along with doing your regular analysis of the underlying sector. Only by doing both will your portfolio achieve the alpha performance you seek.

I follow this process in my Sector Profit Alert trading service, which recommends only those ETFs that won’t have liquidity issues. There are plenty of alternatives to choose from, from both the long and short side, without having to resort to these “boutique” ETFs that are all the rage now. I stick to the basics to take advantage of the benefits that ETFs were originally intended to (and still do) offer.

Click the Exchange Traded Funds title link above to learn more about ETF's.

Sunday, April 22, 2007

Weekly Stock Market Outlook

NASDAQ Outlook

On Friday, the NASDAQ Composite added 21.04 points to its tally (+0.84%) to end the session at 2526.39. That translated into a weekly gain of 1.38%, or 34.45 points. Perhaps more importantly, Friday's high of 2532.24 was just a hair higher than February's peak of 2531.42. For our intents and purposes though, they're one and the same - the OTC has yet to actually hit 'new' highs.

We're going to devote most of the space this week to the S&P 500 and the Dow, but there are a couple of things to mention about the NASDAQ's chart.

First and foremost, unless 2532 is broken and stays broken, we'd have to say we can't justify getting overly bullish from here. If the rally is for real, we'll know in about6 points or so - we may as well wait for the next hurdle to be crossed.

Second, the NASDAQ's failure to lead this recent rally remains a red flag. Volume here has been weak as well...not what you'd expect when investor are feeling optimistic.

Yet we can't deny the momentum is still to the upside for the time being. We'd say keep a line on the 10 day line (red) at 2497 as the make-or-break level...and the 20 day line at 2475.

NASDAQ Chart

Click For Large Chart

S&P 500 Outlook

The bulls just couldn't get enough of the large caps on Friday, leaving the S&P 500 at 1484.35 thanks to a 0.92% (13.60 point) gain...the close was essentially the same as the high of 1484.75. Both were new multi-year marks. Can it be too good to be true? The picture is a bit mixed right now, but we're not ruling out the possibility that more of the same could be in store.

We discussed a few days ago how the SPX hasn't been that far above its 10 and 20 day average lines since the middle of last year. Well, that problem was quietly solved last week with a tepid Tuesday-through-Thursday, allowing the 10 and 20 day lines a chance to catch up. Hence, the concern is cancelled.

And, we also mentioned that being stochastically 'overbought' could weigh in on the market. However, having been overbought for about three weeks now, that worry is waning too,

What we're left with is upside momentum. Note that the S&P 500 has made its way back above a very long-term support line (dashed). In that light, the recent rally doesn't seem so unreasonable...it just makes March seem like a normal correction, and now we're back on track.

More than that, note how the moving averages are starting to show us a bullish divergence again after a consolidation in late March. Its' reminiscent of the consolidation we saw in June of last year - right before an unprecedented runup. So, we're not ruling anything out.

The trick will be in what happens once the market is really challenged If a couple of strong selloffs jump-start bigger problems, then the market's vulnerability will be exposed. If the bulls flight back and keep the index hoisted up at the moving averages lines then yeah, this market may indeed go higher.

In the meantime, patience is merited until we get that vital clue.

S&P 500 Chart

Click For Large Chart

Dow Jones Industrial Average Outlook

The Dow's high of 13,036 on Friday was a new all-time high, while the close at 12,962 was a new all-time high close. The feats followed a 1.19% rally, or 153 point gain. On a weekly basis, we saw a 2.78% gain for the Dow, as the index closed 350 points higher than the prior week's close. For the day and the week, the Doe led the charge. Yet, Friday's strength is actually a bearish concern most notable with the Dow.

We know we probably sounded more bullish than bearish in the above discussion. And, based on momentum, we mostly are bullish, However, the Dow's chart highlights the concern - and the type of concern - we currently have.

We already know the rally on Friday was huge. It was also the 15th day of the last 16 that we saw gains....very unusual indeed. To 'top' it all off, the volume was remarkably stronger behind Friday's buying than it had bee in weeks.

Too good to be true? That's the concern., We have to wonder if Friday was some sort of culminating blow-off top. Though not as extreme as the typical single-day blow off, we also have to consider the market has been doing almost nothing except buying for the last three weeks. Eventually, the buyers have to run out of money. We have to wonder if the 'last hurrah' for a while was just seen.

Just something to keep in your back pocket this week.

Dow Jones Industrial Average Chart

Click For Large Chart

Friday, April 20, 2007

USD Index

By Vadim Pokhlebkin of Elliottwave.com

While it's safe to say that the absolute majority of currency traders are trend followers, some are not. That group, likely a small minority, doesn’t like to run with the crowd – they like to run against it. They call themselves contrarians.

Contrarians are the salmon of the investment world: They are not looking for easy ways; they are upstream swimmers. And not just because they are the stubborn ones (although there is something to be said about that) – there is logic to this strategy.

Price of any market security, reckon contrarians, only goes up if traders are buying it. Conversely, price only falls if traders are selling. Once the majority has bought or sold, the price simply cannot move much more – and, in fact, is likely to reverse. When the majority has spoken, the minority takes the lead. So, paradoxically, the best time to buy is when everyone has sold, and the best time to sell is when everyone has loaded up.

You have to agree, this reasoning does make sense: in each case, you are betting against crowd psychology stretched to the point where it's about to snap back. Of course, the catch, as Bob Prechter once pointed out, is that "First we need a psychological extreme against which to go contrary."

If you've got the right data, finding such extremes is relatively easy: You just have to keep your eyes open. One measure of market psychology is the Daily Sentiment Index (DSI), which is constructed by polling traders to see whether the majority is bullish or bearish. And we believe that the recent DSI readings for the U.S. Dollar Index (DX) command attention.

As of Monday (April 16), the DX's DSI reading was at nine – the most pessimistic level since the May 2006 low. And you can see how closely the highs and lows in the DSI have correlated with the highs and lows in the DX over the past two years:

Click For Large Chart

Theoretically, a DSI reading at nine is a contrarian dream come true. However, a low DSI does not necessarily mean that the bottom is in for the DX. The psychology may be close to an extreme, but as one market veteran has observed recently, these days "markets run to greater extremes than they used to, relative to fundamentals,” making a contrarian's life more difficult.

A useful tool to combine with the Daily Sentiment Index is Elliott wave analysis. A contrarian method in itself, it looks at the market's internal structure to help you time the turnaround points. Based on wave patterns, on Tuesday evening (April 17) our own Currency Specialty Service warned to be careful about calling for the bottom in the Dollar Index: "The consolidation from 81.747 leaves the Index vulnerable to another dip to the downside."

When that bottom finally comes, it will have profound implications for the euro, pound, yen and other currencies that make up the Dollar Index. Forex traders live for opportunities like that.

Click the USD Index title link above to learn how Elliottwave has been programed into trading software that provides very high reward low risk trades. It's called MTPredictor. It has built in position sizing and trade management features that are unrivaled. It comes with a 30 day trial.

Good day and good trading.

Thursday, April 19, 2007

Newsletter Trading Systems

We are proud to be a Van Tharp educational affiliate. Van Tharp's book "Trade Your Way To Financial Freedom" book is a landmark trading book, and a must read just like "Market Wizards" was, which Tharp was one of those few top trader interviews of that famous book. Van Tharp trains traders to be a success in the markets, then takes the cream of the crop and gives them money to trade for him and his investors. Talk about quantum returns!

Newsletter as a Trading System - by Van K. Tharp, Ph.D.

If you buy a newsletter, you probably get a monthly trading recommendation. And that is usually a recommendation to buy an investment. The newsletter will also have its own stop rules (those that do have stops). As a result, the newsletter will generate a set of profit and loss statements which could be treated as R-multiples. In fact, if the newsletter does not give you initial stops, then you can probably simply use 25% of the entry price as the stop. Thus, I’d recommend risking 1% on that investment and having your total investment be 4% of your portfolio.

In the new edition of Trade Your Way to Financial Freedom, I did an analysis of nine newsletters, using four different models for how to evaluate them. The models included

1) the Win Rate (what percentage of the time does the newsletter make money).

2) the Expectancy… this is the average R-multiple of all of its trades. We actually had two of them with expectancies above 1R.

3) the Expectunity in two years … this means given the number of recommendations given, how much could you expect to make in terms of R in two years of recommendations. In other words, I calculated the number of recommendations given on average in two years and multiplied it time the expectancy.

And lastly,

4) I used my proprietary measure of success, the System Quality Number, which generally tells you how easy it would be to use position sizing to meet your objectives. The higher the system quality number the easier it is to use position sizing to meet your objectives.

While I don’t want to repeat what I said in that chapter here, I would like to point out that one of the newsletters evaluated cost $5000 each year. That’s right, you’d pay $5000 for a yearly subscription. And this newsletter consistently ranked worst in all of the categories, including having a negative expectancy and a negative system quality number.

What’s ironic is that after I did the analysis, the newsletters said that they would guarantee that you’d make a million dollars trading their recommendations in 2006-2007 or they give you a complete refund. The person who had this subscription tried three times in the prior year to get a refund and failed each time. The excuse was either our computers are down or you’d suddenly get disconnected or something else strange would happen.

Anyway, one conclusion that you can easily make from this study is that there is probably no correlation between the price of the newsletter and the quality of the newsletter. In fact, the best newsletters were relatively inexpensive.

One of the newsletters I analyzed was one called MicroCap Moonshots. It effectively recommended microcap newsletters that were trending. And overall the newsletter did not do very well and it is now closed down.

However, there were two phases of the newsletter. The first 38 trades were taken by the originator of the letter, Brian Hunt. For his 38 trades the newsletter had the third highest win rate, the second best expectunity, and the second best system quality number.

However, in March of 2005 the editor remarked that the market was enough to drive him to drink and suddenly another editor was making the recommendations. Lest you think that was good news, there were another 41 trades with the new editor. Those 41 trades had the worst expectancy of any of the newsletters (-0.3R), the second worst expectunity (also negative) and the worst system quality number of any of the newsletters.

And to me that says that the newsletter editor is a major factor in the performance of the newsletter. Imagine one newsletter went from being a star performer to one of the worst, just because the newsletter editor changed. And unfortunately, what was a good idea is now a defunct newsletter.

Click the "Newsletter Trading Systems" title link above to learn more about this incredible trading teacher, his training programs, and live worldwide seminars. Van Tharps teaching will turn you into winning and successfull trader in the long term. Thanks Van for your great education and awareness!

Have a good day, and continue to pray for the victims, their familes, and loved one's at Virginia Tech. God Bless all of us.

Wednesday, April 18, 2007

God Bless The Slain Virginia Tech Students

No financial post today after what happened in Blacksburg Virginia.

Instead I want to ask everyone to pray for the slain students, their families, friends, and loved one's.

My deepest condolences go out to the families and loved one's.

I also pray that more secure safeguards will be created and acted on in the future to prevent this from happening again.

May God Bless the Students.

Tuesday, April 17, 2007

Methods Of A Wall Street Master

There's lots of good trading books. One very good one that we recommend is 'Methods Of A Wall Street Master', as he talks in detail about some of the more subjective success factors needed in this business. Unfortunately we can't detail all of his wisdom, so we'll explain the ideas most important to us. Below are some of Vic's trading rules. Click the Methods of a Wall Street Master title link above to review the book.

Trade with the plan. Stick to it. Every rationale, target, stop, and scenario should be thought out before the trade is entered. As Vic says, "confusion is your biggest enemy". The biggest thing you need to consider is your intended timeframe for the trade. If you know how long you want to hold the trade, the goals, stops, and volatility allowances will be easier to establish. But the bottom line is, plan your trade before you enter it.

The Trend Is Your Friend - Trade With The Trend. It's great to catch a reversal, but it's even more difficult. At least when taking a position with the market rather than against it, you can get off on the right foot. It all may change the next day, but you'll have at least a day's worth of cushion/gain. Taking a contrary position and praying for a reversal rarely works out well enough to make it worth doing.

Let Profits Run. Cut Losses Short. The second one (cut losses short) is the tougher part of this rule. It involves admitting that you were wrong. But in trading, rare is the case where you will eventually be proven right after being proven wrong. It's just not worth trying. If you struggle to cut losses short, you can counter-act that psychological devastation by letting your profits run (once your target is hit), and then telling yourself that not only were you right, you were REALLY right, in that your target exit point was surpassed and you made a little more than originally planned. To do this, keep ratcheting up your stop-loss with each incremental gain above your original target.

Buy weakness and sell strength. If you're waiting till the very end of a rally to make your exits, you've waited too long - you and about a million of your best friends are all thinking the same thing. Rarely does the end of a rally announce itself, and it never happens slowly enough to actually do anything about it (until it's basically too late). The same is true for bearish trades. This may seem contrary to rule # 6, and maybe in some ways it is. But the more important point of both of these rules is to maintain a trading discipline. The pros do, and so should you.

Don't Trade Off Of 'Tips'. A tip is rarely more than opinion, and frequently a bad one at that. Even if the tip comes from a friend, don't take it. If you have a hard time with this, go back to rule # 2 - the trend is your friend. Burn this into your head! Unfortunately, in trading, a friend is not always a friend.

Never Trade If Your Success Depends On A Good Execution. If getting a fill that is not currently marketable is critical, you may want to go back to rule # 1 and make sure you're trading your plan. Great trade set-ups will always be great, even if you have to pay a little more to actually get into the trade. If you (or your broker) have to fight hard to get filled at a certain price, that's the market's way of telling you that this trade will not be an easy one to make profitable.

Victor Sperandeo's book 'Methods Of A Wall Street Master' is a great book for beginners as well as experienced traders. It also contains plenty of economic cycle explanations, market timing signals, and technical indicator tips.

Good day and good trading!

Sunday, April 15, 2007

Weekly Stock Market Outlook

NASDAQ Outlook

Friday's gain of 0.47% for the NASDAQ Composite matched that of the Dow. The composite gained 11.62% to end the week at 2491.94....which was 20.60 points ahead (+0.83%) of the prior Friday's close. The strong finish for the week suggests the bulls are going to remain vigilant here - as we roll into earnings season.

First and foremost, check out the position of the and 20 day moving average line (red and blue, respectively) in relation to the 50 and 100 day lines (purple and gray, respectively). We have a new bullish crossover. We could theoretically end the conversation right there.....despite never having made a typical full-sized dip, the prior uptrend seems to be back on track.

But, we do have something to add that supports the same bullish argument. Take a look at Thursday's bar. As of that point in time, this bullishness was still not a 'sure thing' (not that it ever is). Thursday morning when we were deep in the red, in fact, it looked anything but certain. The low of 2448.71 was back under the 10 day line, and pushing the support limits of the 20 and 50 day lines (as well as the 100 day line, which is a bit obscured on our chart).

Then, later on the day, a small miracle happened. The bulls turned what looked like was going to be a big loss for the day (as well as the week), and made it into a full recovery...and then some. On Friday, they kept at it, pushing the NASDAQ to a new high for the week (2491.94), as ell as a new high for the past six weeks.

It seems a bit unbelievable, doesn't it? Yet, the rewards aren't necessarily reaped by the traders who can apply the most logic most of the time. It's almost always better to respond to what the market is doing until you have a clear reason not to. As of right now, the trend is bullish.

Yet, being skeptical can also be prudent. We're entering into one of the softest (usually) times of year - particularly for the NASDAQ. Though it's a bit premature to predict, do note when and if the composite finally breaks under the conglomeration of its key moving averages. Right now, that 'zone' is between 2440 and 2450. If they do break as support - which is a distinct possibility - there aren't a lot of floors in place until you get to the 200 day line at 2324.

By the way, we still haven't seen any strong volume behind this buying. That remains our red flag.

NASDAQ Chart

Click For Large Chart

S&P 500 Commentary

The S&P 500's close of 1452.85 on Friday was the result of a 5.05 point gain (+0.35%). For the week, the average large cap stock moved higher by 0.63%, as the SPX rose 9.10 points. As a result, the bulls now have a much more impressive foundation to work with.

All the technicals we mentioned for the NASDAQ Composite? Insert them here for the SPX chart....short term lines are back above the long term lines. The only key difference here may be the support zone....it's a bit wider than the NASDAQ's. If the SPX falls under 1422 (the lowest portion of the 1422-to-1432 support zone), then we cold have trouble.

On the flipside, notice how close we are to making a new multi-year high. We peaked at 1461 in late February, only to run south again in a hurry a few days later. But, being persistent if nothing else, the bulls put their foot down and started forcing stocks higher again. Currently at 1452.85, we're less than 10 points away from new highs for this particular cyclical bull.

If we can break past that level with a couple of consecutively higher closes, then look out above....this market could come off the chain, perhaps repeating the kind of move we saw in the 2nd half of last year.

That, however, is a big 'if'.

Our biggest worry for the bulls - and our strongest support for the bears - is a potential double-tip around 1461. The market has a way of finding its way back to levels just barely strong enough to give a few folks a second chance at getting out at the same area they should have previously gotten out at. In this case, that is 1461. And then, after the window of opportunity opens just for a moment, it can shut again very quickly.

So, while we're impressed by the recent runup, we still strongly advise caution until we clear the 1461 hurdle.....if we even get a chance to.

In the meantime (and as something of a counter-argument), the VIX is back in it downward groove, closing at 12.20 last week. That was a three-week low. The lower Bollinger band line is at 11.38 and falling, which will allow some time and room for the market to creep higher until the VIX finds support. As always, we recommend using the VIX and the SPX chart in conjunction, as they both often hit their extremes (and reversal points) simultaneously.

S&P 500 Chart

Click For Large Chart

Dow Jones Industrial Average Commentary

On Friday, the Dow Jones Industrials gained 59 points to end the day at 12,612. That 0.47% gain left the blue chip index just 52 points above the previous week's close....a net of 0.41% for the five trading days. Along the way, a few more of the important buy signals were clinched.

Ditto for the Dow....literally. The line in the sand here is 12,431....the lowest points of the combined 10, 20, 50, and 100 day averages.

We've added a stochastic chart to the Dow's graph simply to illustrate how we're now into overbought territory. This could dampen the buying spirit, and is one of the primary reasons we're concerned the bulls may be at the end of the line. Of course, we were overbought for most of the second half of last year, and the Dow kept raging higher So....maybe it's nothing to worry about.

Dow Jones Industrial Average Chart

Click For Large Chart

Click the Weekly Stock Market Outlook title link above to learn how to perform technical analysis like this.

Have a great week investing and trading!

Friday, April 13, 2007

Trailing Stops

Questions are the answers & Readers are Leaders!

What is the recommended loss percentage in a trailing stop?

Answer: A specific type of exit methodology. A trailing stop is a stop-out level that changes every day, along with the price of a stock or index. The idea is to let a good trade 'ride' as long as things are going the right way, and scoot the stop level upward along with the stock.....just slighty below it, so as not to interfere with the natural ebb and flow of a chart. When things reverse, your trailing stop level should be close enough to the current price to get you out quickly if things turn sour...........but not so close that it might get you out of a trade too soon just due to a little volatility. The nice part about these kinds of stops is that they are often automated, if your broker will allow them.

The question specifically is asking how much loss should I tolerate from a high point (or peak) in a trade to a low point in the trade? Or to say it another way, how much of a percentage drawdown can I accept before I pull the plug on a trade?

To answer the question.....it depends. Some stocks are volatile and need a lot of wiggle room, where other stocks are consistent and should be played tight. Indexes can behave both ways. So the question really is how much room do you need to allow for your style of trading? We back-tested a variety of stocks and indexes, and the optimal trailing-stop percentage for us was anywhere from 4% to 12%. But is seems like the best overall results occurred when we used 6%. For an index, it was slightly less.

Did we just give away a proprietary secret? Nah - anybody with back-testing software could have done the same. Plus, getting the right trailing-stop is only one of numerous things that has to be 'just so' for system-based trading. However, we hope that little tip helps.

Click the Trailing Stops title link above to review trading strategy books on the subject.

Good day and good trading!

Thursday, April 12, 2007

Top 10 Trading Books

A reader asked me for my top 10 trading books. Here's my top 10.

#10 Encyclopedia of Chart Patterns - Thomas Bulkowski has created a comprehensive tome of all the indicators you need to know and much more. I use this book regularly to get up to speed on new ideas that I'm working on that have their roots in a popular technical indicator.

#9 Trade Your Way to Financial Freedom 1st Edition - Trading coach Van Tharp is a master at the probabilities of trading, and as a result Tharp's discussion on position sizing is a must-read.

#8 The New Market Wizards: Conversations with America's Top Traders NEW Edition - Jack Schwager wrote the original Market Wizards and has since followed it up with two more Wizards books. The benefit is learning how the best pros think, so you can model their success.

#7 Big Trends in Trading - I can't help that I think my book is good! But seriously, many tell me that what they like best is that the book is layered to be great for multiple readings. As you grow your trading knowledge, come back to this book and it will offer you new insights you had not been ready for previously. For a complete review, click here:
http://bigtrends.com/document.jsp?documentid=2056

#6 Trading To Win - Ari Kiev is a great psychological coach, and Kiev lays out a number of the psychology and money management issues that keep traders from reaching their goals.

#5 The Disciplined Trader: Developing Winning Attitudes - Mark Douglas breaks new ground into the heart, mind and soul of traders everywhere. Definitely one I try to re-read once per year. For a complete review click here: http://bigtrends.com/document.jsp?documentid=2226

#4 Technical Analysis of the Financial Markets - This was the first book on technical analysis I ever read, and I still consider it the first starting place for any of my analysts that I'm working with who need a good primer on technical analysis.

#3 How to Make Money in Stocks - William O'Neill foiunded Investors Business Daily and still espouses his CANSLIM principles to this day. While I am primarily a technical analyst, I agree with O'Neill that earnings growth is the primary fundamental factor to focus on to drive growth in aggressive stocks.

#2 Trading For A Living: Psychology, Trading Tactics, Money Management - Alexander Elder continues to be one of the most sought-after trading authors. This is due not only to his creative treatments of indicators like the Force Index, but also to his real-world application discussions.

and....

#1 Reminscences of a Stock Operator - Edwin Lefevre allegedly modeled this book over famous early 1900s speculator Jesse Livermore. It's amazing how nearly 1 century later, these issues in trading are universal and not solved.

Click the Top 10 Trading Books title link above to review the books. Readers are leaders!

Good day and good trading!

Wednesday, April 11, 2007

Stagflation

It’s the conundrum most economists can’t explain. Higher prices coupled with slower growth. Yet it’s something that haunted the U.S. economy during the late 70s. Is it possible that stagflation will show up again like an unwanted guest at the economic dinner party?

The economic numbers point to a resounding yes. And it’s happening due to five major reasons.

1. The falling dollar. We’ve got a dollar that keeps dropping in value. Sure this makes our airplanes, cars, and financial services cheaper for buyers in India, China, and elsewhere. But when it comes to the $2.2 trillion we import (according to the U.S. Census Bureau) from the rest of the world, prices just keep rising.

Since last year, the Chinese Yuan has appreciated more than seven percent versus the dollar. That makes Chinese goods seven percent more expensive. Sure, these Chinese manufacturers may not pass the higher price along quite yet, but eventually they will. And when they do, Wal-Mart, Target, and virtually any store that imports the $200+ billion worth of Chinese goods into the U.S. will have higher prices to pass on to Americans.

2. Worldwide inflation and money creation. It’s not just the U.S. that’s experiencing some higher-than-normal inflation. Russia and India have an inflation rate of more than seven percent. China’s used to be under two percent, but today it’s risen to nearly three percent. Brazil and Australia have inflation rates of just less than four percent. According to Bloomberg, Europe is also seeing increasing inflation risks.

This is due to increased money creation. As the world makes more money, everything becomes more expensive. And that makes imports into the U.S. more expensive as well.

3. Our food is turning into an energy source. Corn is being used in record amounts these days, and it’s not because Taco Bell sales are booming. The US is turning corn into ethanol. Since the start of this massive ethanol initiative, the price of corn (which is used in more food products than you can imagine) has more than doubled.

This price hike has made corn an extremely sexy crop for farmers to grow. So they’re growing corn instead of soybeans or wheat. This shortage of other crops is already taking its toll on the market with higher prices.

The proof is in the February Producer Price Inflation (PPI) report. Corn prices jumped more than 16 percent and soybean prices are up over 13 percent. These higher food prices were a big reason why the PPI came in twice as high as expected.

4. The crashing housing market. In 2006, the financial media was littered with stories of how the housing market crash was sapping the economy’s mojo. The sexiest of markets seemed to instantly turn dull and downright depressing. People who bought speculative land are now stuck with dirt they can’t sell. People who extracted money from their fancy new ATM called their home suddenly realized that they didn’t have any money left. This affected the main driver of our recent economic expansion - consumer spending.

And now things are getting even uglier.

Since 2006, more than 26 subprime mortgage lenders have gone bankrupt. According to the Mortgage Bankers Association, foreclosures hit a record and 13+ percent of subprime loans are in foreclosure. It’s estimated that more than 500,000 foreclosures will add even more inventory to a housing market that’s chock full of it. This is sure to depress prices even further and take a bigger chunk out of consumer spending.

5. A slowing economy with a healthy job market. The Empire State Index (which measures economic activity in the New York area) has fallen three out of the past four months. The Institute for Supply Management Index (which measures manufacturing activity) has fallen twice in four months. The Philly Fed Index (which measures economic activity in the Philadelphia area) fell last month.

The obvious pattern here is a slowdown in manufacturing. Considering that manufacturing makes up about ten percent of the overall economy, any slowdown there will definitely have an effect on the overall market.

Typically, the Federal Reserve would be inclined to lower interest rates. But jobs are growing. So long as jobs are growing and inflation is increasing, the Fed is less likely to lower rates to counteract a slowing manufacturing sector.

Now you can see why stagflation is closer to becoming a reality than ever before. We have a slowing economy amid building inflationary pressures. And as inflation keeps kicking, the Fed will be less inclined to lower interest rates to counteract the slowing economy. This will, of course, make the economy slow down even more.

In the past, the only way to really protect against this situation was to buy as much gold and silver as possible. Considering both of these precious metals are at short-term lows, this is a good time to get in at a great price.

Good day and good trading!

Tuesday, April 10, 2007

Analysis Paralysis

Do you ever feel overwhelmed by the sheer amount of information you have to process in your work day, or to be more specific, in the information you must process to determine your investment and trading decisions? As the pace of change continues to accelerate, and as market volatility perceptibly increases over time, I personally feel an internal nagging that I'm missing something. I'm not quite sure what it is, but I'm afraid I'm missing it - whatever "it" is. In my job guiding fellow investors and traders, I suppose for me it's the fear of missing the next big move in the markets. But I know that this fear is omnipresent, and decisions must be made with less than perfect information. My goal here today is to suggest some strategies to get back to the basic priorities that can help convert data into knowledge, while proactively cutting away the chaff that we cling to which really is just clouding our vision and focus.

It seems that the core problem is an increasing supply of information coming at us, without a defined set of filters to sort out the hidden nuggets of wisdom from the majority of data that serves to muddy up our thinking. The explosion of the Internet has put more data at our fingertips in a day than prior generations could access in a lifetime. But we must define the quality of the information we receive and not be consumed by the quantity.

Here are several core ideas for proactive strategies:

1) Preparation before entering a market in motion is critical. By doing your homework and creating a focus list of 5-7 names you will trade at a maximum (why do you think phone numbers are capped at seven digits?), you can come in to each trading day with a plan. While news may change during the trading day, I personally seek to let the market or stock reaction to news tell the tale of whether I should enter, hold or exit a position. By trading what you see in a stock's price action, this is the reality of whether buyers or sellers are winning the war, regardless of extraneous news. The last thing I want to do is come in unprepared and then be reacting to various news headlines without an understanding of the underlying structure of a stock or market.

2) What filters are effective at tightening your focus on the best or worst stocks? I have to give credit to Bill O'Neil at Investors Business Daily for two of the best filters: relative strength and volume filters. Relative strength gets the trader focused on the top longs and shorts to then apply other filters like volume to further narrow the focus on the most attractive situations. IBD shows you the top stocks according to their Relative Strength system, and this excellent paper also shows stocks breaking out on higher-than-average volume. In a database of roughly 2000 stocks I follow, if I focus on the top 1% of stocks for potential buys, that immediately narrows my buy list to 20 stocks.

3) Look past the traditional sources of market analysis to get a more focused view of outperformers and underperformers. For example, if I looked for every stochastics crossover each day, I would be faced with hundreds of stocks to sort through in my database. But if I instead search for stocks which are staying overbought over 80% or staying oversold under 20%, I get a more focused list of select situations where these stocks are trending longer and stronger, up or down, than most traders would expect.

4) Get organized. It's a fact that the more clutter you have around your workspace, the more stress you will feel from projects that are literally calling for your attention. This is called "subliminal screaming" and it will not help your trading focus. Get your open projects filed in order you will address them outside of the defined hours you will trade.

5) Boil down your indicators to truly value-added methods. If you're looking at both stochastics and the Relative Strength Index (RSI), you're really looking at the same overbought and oversold methods twice and should seek to eliminate one of the overlapping techniques. In contrast, volume indicators can add value to a traditional price-based indicator, since it offers a new piece of information to most price-following methods.

I suppose I could go on with other ideas to help you manage information overload, but then I'd be overloading you with too much information, right?! The bottom line is you should seek to boil down your indicators and sources of information to those that help you perform in a simple and effective fashion.

Good day and good trading!

Monday, April 09, 2007

Weekly Stock Market Outlook

NASDAQ Outlook

On Thursday, the NASDAQ Composite closed 12.65 points higher (+0.51%) to end the shortened week at 2471.34. That was 49.70 points higher than the prior week's close (+2.05%), which goes long way in getting the charts back to bullish again. Could it be simply the February 28th bearish gap acting as a vacuum? Or, is this upside effort a real indication that the market is already thinking optimistically again?

At the risk of oversimplifying things (including our forecast), look at the moving average lines....at least all of them except the 200 day line (green). The 10 and 20 day lines (red and blue) are on the verge of crossing above the 50 day (purple) and 100 day (grey) lines. Painfully simple, yes, but also a frequent indication of a new uptrend.

And, strict technicians will see that we have a new bullish MACD divergence (highlighted).

The one thing we haven't seen yet - that we'd like to see to really get into the bullish camp - is volume. Though volume has been positive, it's also been noticeably less than even average.

Like we said above, perhaps this effort is just going to be enough to close that February 27th gap at 2492.54. From here (only about 20 points away), we're willing to wait and see if we can actually stay above that level. If so, then it would be easier to justify any optimism. To get fully bullish, we need to see smooth sailing past the recent multi-year peak at 2531.42. Both of those levels are marked with red dashed lines.

NASDAQ Chart

Click For Large Image

S&P 500 Outlook

The S&P 500 ended the week at 1443.75. That was 4.40 points above (+0.31%) Wednesday's close, and 22.90 points (+1.61%) higher than the previous Friday's closing level. Though we still see a lot of vulnerability as we head into the 'soft' period of the year, the technical bullishness is starting to rematerialize on this chart.

Nearly everything we said about the NASDAQ Composite can also be said for the S&P 500, so we're not going to dwell on it here. Just recognize that all the short-term average lines are crossing above the longer-term lines, if they haven't already. Our view of the breakdown a little more than a month ago, and the subsequent recovery, is that the market took a breather. Now that it's 'reloaded', the steam can build again.

Yes, it wasn't an ideal correction, in the sense that it really wasn't as big as the 'normal' correction. That's likely to mean any subsequent rally won't be as big or prolonged as most. But, it is what it is.

As always, we're watching the VIX as much as the SPX's chart, though it basically says the same thing right now. After five straight lower closes, the VIX trend is to the downside - bullish as well. Moreover, Thursday's low of 12.69 is still more than 1.4 points higher than the already-falling lower Bollinger band line....the most likely place where the VIX would finally find a floor and reverse. The irony is, the more rapidly the VIX falls, the more rapidly that lower band drops....stretching out the likely pullback, and by extension stretching out the market's potential rally. We still think the long-term support line right at 10.0 could be a factor though.

We still have resistance pegged at the recent peak of 1461.55. However, if we extend out the long-term bullish zone (dashed) that guided the mild rally in the last quarter of last year, there's also a resistance line at 14989 - and it's rising. At its current rate of climb, it could be at 1495 before it's challenged.

S&P 500 Chart

Click For Large Image

Dow Jones Industrial Average Outlook

The Dow Jones Industrial Average went four for four last week....four straight days of gains, and it was actually six in a row if you go back to the previous week. Thursday's gain was good for 30 points, or +0.24%. On a weekly basis, we saw a rise of 206 points, or +1.67%. We also saw a quite-impressive recovery effort, putting the Dow back within striking distance of where it was before the late-February catastrophe.

It should come as no sunrise the same thoughts we had on the previous two charts also apply to the Dow's chart....short-term averages over longer-term averages - yadda yadda yadda.

The concern we see here though is evident in the stochastic lines - we're now back into 'overbought' status. True, being overbought hasn't always been problem the last several months, though it was a horrifying problem in late February. With both of those possibilities in view, we're not going to be overly-committed to either side of the market. However, it doesn't change the fact that the momentum is currently with the bulls.

Let's use the recent peak at 12,846 as the ceiling/resistance, for now.

Dow Jones Industrial Average Chart

Click For Large Image

Friday, April 06, 2007

Long-Term Secrets to Short-Term Trading

One of my favorite books is Larry Williams' book 'Long-Term Secrets to Short-Term Trading' . I think this book is a must-read for any trader, as it summarizes all of Larry's essential insights on what it takes to be great. Today we'll just touch on a few of those insights.

Insight #1: "Why do most traders lose most of the time? Markets can spin on a dime and most traders cannot." Even the best traders (or the best trading systems) are going to be frequently wrong. That doesn't negate the trader or the system - that's just part of trading. The challenge for traders is accepting that the trade signal was errant. In a case such as this, Williams' correctly points out that we've been trained to 'hang in there' and 'have faith in our initial insight', even if it's clearly the wrong course of action. That's just our ego needing to be right so badly that it will often ignore the exit signals that warn the trader of the impending problem. His analogy may help you work through this issue. He compares trading to robbing a bank. A bank robber may successfully break into a bank and start scooping up the money, but when the lookout guy warns the man in the safe that the cops are on the way, the robber drops the money and runs. If the robber were like too many traders, he might stay in the bank and hope the warning about cops being on the way was a false warning. As Williams says, "The instant you learn to trade reality, not wishes, you will break through the wall of fire to become a successful trader."

Insight #2: It's not the trade, it's the battle. Too many traders believe that their last trade is a reflection of just how good of a trader they are (but they are the only ones who feel that way about themselves). This boils down to one word - expectation. If you expect to win all the time, or even the vast majority of the time, you're setting yourself up for a lot of heartache. That frustration, though, is the very same force that will truly make your negative perception of yourself a reality. And even a good trade can be damaging if you let it warp your disciplined approach. The fact of the matter is that this is a game of odds, and should be played over a long period of time. Focus on the war - not the battle. (continued below)

Insight #3: The amount of (or lack of) evidence for a market move does not make the move any more or any less likely. All traders, but especially new traders, have one of two problems. They either buy too soon, or buy too late (and in reality, when it comes down to it, those are the ONLY two problems in trading). The first problem of buying too soon is a sign of not wanting to miss out of any of a move. Of course, if you jump in and the move never becomes a reality, the trade suffers. The second problem is the opposite - the trader wants to make sure the move is going to happen, so he or she will wait for all the right signals to verify that the move is for real. Of course by that time, most of the move is behind you. While it's easier said than done, one has to find a balance between those two extremes. In this case, the best teacher is experience.

Insight # 4: What's the difference between winning traders and losing traders? Well, first, there are a few similarities. Both are completely consumed by the idea of trading. The winners as well as losers have committed to doing this, and have no intention of 'going back'. This same black-and-white mentality was evident in their personal lives too. But what about the differences? Here's what Williams' observed:

The losing traders have unrealistic expectations about the kind of profits they can make, typically shooting too high. They also debate with themselves before taking a trade, and even dwell on a trade well after it's closed out. But the one big thing Williams' noticed about this group was that they paid little attention to money management (i.e. defense).

And the winners? This group has an intense focus on money management, and will voluntarily exit a trade if it's not moving - even if it's not losing money at that time! There is also very little internal dialogue about trade selection and trade management; this group just takes action instead of suffering analysis paralysis. Finally, the winning traders focused their attention on a small niche in the market or a few techniques, rather than trying to be able to do everything.

Hopefully the second description fits you a little better, but if the first one seems a little too familiar, you now at least know how to start getting past that barrier.

For more information about this and other trading tips, I recommend Larry Williams 'Long-Term Secrets to Short-Term Trading'. Cick the "Long-Term Secrets to Short-Term Trading" title link above to check out the book.

Good day and good trading!

Tuesday, April 03, 2007

Position Sizing

Position Sizing Is More Important Than You Think

By Van K. Tharp, Ph.D.

Position Sizing™ and your personal psychology are the two most important aspects of trading and they are probably the two most neglected topics. Chapter 14 of the second edition of Trade Your Way to Financial Freedom, is all about helping you understand the importance of position sizing.

Before we discuss this topic, let me give you some important background information. I tend to think of trading systems by the distribution of R-multiples that they generate. And the average R (or mean R) of the system’s R-multiple distribution is the expectancy of the system. It tells you what to expect from the average trade.

So let me give you a simple trading system, one that is probably much simpler than any you’d trade. Twenty percent of the trades are 10R winners and the rest of the trades are losers – 70% are 1R losers and the remaining 10% are 5R losers. Is this a good system? Well, if you want a lot of winners, then it certainly isn’t – it only has 20% winners. But if you look at the average R for the system it’s 0.8R. That means on the average, you’d make 0.8R per trade over many trades. Thus, when it’s phrased in terms of expectancy, it’s a winning system.

Let’s say that you made 80 trades with this system in a year. On the average you’d end up making 64R – which is excellent. If you allowed R to represent 1% of your equity (which is one way to do position sizing), then you’d be up about 64% at the end of the year.

I frequently play a marble game with this R-multiple distribution to teach people about trading. The R-multiple distribution is represented by marbles in a bag. The marbles are draw out one at a time and replaced. The audience is given 100,000 to play with and they all get the same trades.

So let’s say we do 30 trades, and they come out as shown in the table:
R-Multiples Draw In A Game
-1R -5R -1R
-1R -1R -1R
-1R -1R +10R
-5R -1R -1R
-1R -1R +10R
+10R -1R -1R
-1R -1R -1R
-1R -1R -5R
-1R -1R +10R
+10R -1R +10R
+8R -14R +30R

If you look at the bottom row, you see the total R-multiple distribution after each ten trades. After the first 10 we were up +8R, we then had 12 losers in a row and were down 14R after the next 10 trades. And finally we had a good run on the last 10 trades, with four winners, getting 30R for the ten trades. Over the 30 trades we were up 24R. And if you divide 24R by 20 trades is gives us a sample expectancy of 0.8R. Thus, our sample expectancy was exactly the same as the expectancy of the marble bag. That doesn’t happen often, but it does happen.

Now let’s say that you are playing the game and your only job is to decide how much to risk on each trade or how to position size the game. How much money do you think you’d make or lose? Well, in a typical game like this, 1/3 of the audience will go bankrupt (i.e., they won’t survive the first five losers or the streak of 12 losses in a row); another 1/3 of the audience will lose money; and the last third will typically have made a huge amount of money – sometimes over a million dollars. And in an audience of say 100 people, except for the 33 or so who are at zero, I’ll probably have 67 different equity levels.

That shows you the power of position sizing. Everyone in the audience got the same trades, those shown in the table. Thus, the only variable working was how much they bet or their position sizing. And through that one variable we had final equities than ranged from zero to over a million dollars. That’s how important position sizing is. And by the way, I’ve played this game hundreds of times, getting similar results each time.

Position sizing is that important and I’d suggest that you take a look at chapter 14 of my book because many people have told me that it turned their trading around, making them winners instead of losers. Next week, I’ll tell you a lot more about position sizing — how to do it and what its purpose is.

Click the Position Sizing title link above for Van Tharp's award winning book Trade Your Way To Financial Freedom.

Sunday, April 01, 2007

Weekly Stock Market Outlook

NASDAQ Outlook

The NASDAQ Composite was the only major index to pull out a gain on Friday, albeit a small one. The tech-heavy index closed 3.76 points higher, up 0.16%, to end the session at 2421.64. However, we still saw a loss for the week, as the composite closed 27.29 points under the prior week's close, or -1.11%. Is this the beginning of the next wave of selling?

In really simple terms, the NASDAQ seems trapped between the 10 and 20 day lines. As you'll read again below when we look at the S&P 500 chart in detail, that's something of mixed message, making it hard to say anything one way or another. So, we won't.

However, we will point out one thing - the NASDAQ's close under the 50 day line (purple) is not insignificant. It has been support in recent months, and an excellent indication of the beginning and end of intermediate-term trends. To see the SPX struggle to even test the waters above it, only to fall back under it three days after that, speaks volumes to us.

In the short run, a close under the 20 day line (blue) at 2400 cold be a short-term sell signal, while a close under the bottom made on March 14th, at 2331, could lead to longer-term bearishness.

On the flipside, a close or two back above the 50 day line at 2439 could inspire more buyers back to the table.

In the meantime, patience.

NASDAQ Chart
Click For Large Chart

S&P 500 Outlook

The S&P 500 couldn't hold onto Friday's gains, pulling back by 1.7 points (-0.12%) to end the day 1420.85. That was 15.25 points under the previous Friday's close, for a weekly loss of 1.06%. The week before last, it looked like a full-blown recovery was underway. Last week was a reminder that the market isn't exactly 'all clear'.

The bearish argument is simple....the slide back under the 50 day average (purple) and the 10 day line (red) is a short-term and intermediate-term sell signal.

The bullish argument is simply that the 20 day line (blue) acted as support on Friday, managing to keep the SPX well off its lows of the day by the time the closing bell rang.

Equally confounding is the VIX. For most of last week it was on the rise, as it was the latter part of two weeks ago. That should have been bearish for stocks, but wasn't. Yet, we also saw the VIX trade lower (lower range) and close lower on Friday....a hint that the momentum has shifted to the downside. That should be bullish for stocks, yet the market eased off a bit on Friday. Go figure.

So, as of right now, bit the market's momentum as well as the VIX's direction is a coin toss.

How do we play it? As usual, keep an eye on the moving averages.....the 20 and 50 day lines in particular. Crosses of them are usually the momentum signals we like to see.

As for the VIX, it could go either way, being right in the middle of its band lines. However, based on the last look at the VIX, we see downward momentum setting in...which has bullish implications. But still, we'd wait for a little more certainty.

S&P 500 Chart
Click For Large Chart

Dow Jones Industrial Average Outlook

The Dow Jones Industrial Average ended Friday higher by a mere 5.6 points, or 0.05%, to close out at 12354.35. For the week though, that still meant a loss of 126.66 points, or -1.01%., thanks to Tuesday's and Wednesday's big selloffs. As a result, the blue-chip index finds itself parked (again) back in that no-man's land.....not bullish, but not bearish.

Like all the indices, the Dow is trapped between the 50 and 20 day lines (purples and blue, respectively)....blah, blah, blah. Just read the comments above about the other two indices if you want to know what those implications are....a stalemate.

The only thing(s) we can add here are.....

1. There still hasn't been any real volume behind the recovery effort, leading us to think it's not a high quality recovery (i.e. may not be able to really produce one longevity or gains).

2. Those Fibonacci lines we talked about a couple of weeks ago? They're still on our radar. The first one that might come into play is the 38.2% retracement at 11,983. Theoretically it's supposed to be support, but if its not, the next likely landing spot would be the 61.8% retracement at 11,470. (There's a very small chance the 50% retracement line at 11,719 could be support, but that's not exactly a Fibonacci-based line.) A move all the way back to 11,470 would mean a 10.7% correction from the recent high, which is supposed to be the bare minimum pullback to qualify as a 'normal' correction.

The point is, we're still keeping an eye on the Fibonacci lines, as they may hold a lot of clues about where things could start and stop.

Dow Jones Industrial Average Chart
Click For Large Chart

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