Bank Action And The Market

The one sector that held up very well Thursday was the Banking Index (BKX). Yesterday I showed a study that suggested a bullish bias following a negative SPX day where the SOX thrives. Below is a similar test using the BKX instead of the SOX:

(click to enlarge)

This study would have triggered both on Wednesday and Thursday. Instances are too few here to draw any solid conclusions. It does appear worthwhile to keep an eye on the BKX as well as the SOX, though. Interesting about this study is that there were two occurrences in 2008. They were on 1/22/08 and 10/10/08. Both near notable market lows.

Edit: Citigroup is trying its best to ruin these results as I type this. Expect the banks to remain front and center. Looks like we'll have another action filled day.

SOX Gives Intermediate-Term Bullish Market Indication

A positive intermediate-term sign Wednesday was the fact that the Semiconductor Index (SOX) rose even as the S&P and Nasdaq suffered 1% declines. I first showed the below study on the blog last August. I’ve updated the stats to run up until the present.

(click to enlarge)


These are solidly bullish results with the winning percentage, the profit factor, and the average trade all posting strong numbers throughout the test period.

Not shown above is that over the next week the S&P has posted a close higher than the trigger day close 89% of the time. If you look out 12 days there has been at least 1 close higher than the trigger day in 42 of 43 instances (98%). The only loser came after the 7/21/98 signal. This has been a solidly bullish intermediate-term signal.

VXO Collapse May Indicate A Brief Pullback Is Likely

The VXO fell over 15% on Tuesday – a fairly rare occurrence, especially when the S&P 500 is moving off a 50-day low. Below I took a look at how the S&P has performed following such instances:




Notable above is that only 1 of 10 instances saw the S&P rise the next day. Not shown in the chart is that the lone day 1 winner closed lower than the entry on day 3 – meaning there was a short-term pullback in every case. Instances are a bit low in this study but notable and quite suggestive nonetheless.

Another Study Suggesting A Short-term Bounce

Monday marked the 5th day in a row that the S&P 500 closed below its lower Bollinger Band (20 period, 2 std dev). Looking back to 1960 I found only 23 other occurrences. Of those, 22 managed to close higher than the trigger-day close at some point in the next 3 days.

Unfortunately, as you can see from the table below, the edge has been very short-term:

As this selloff has worsened more and more evidence is suggesting a bounce is well overdue. To this point, though, the bounce has evaded us. I expect it shouldn’t be too much longer until we see it.

CBI Hits 7 For 1st Time Since November

I haven’t mentioned the Capitualtive Breadth Indicator (CBI) for a while. For those unfamiliar it is a proprietary method of measuring the amount of capitulation evident in the market. You may read the intro post here or the entire series here. Since the November lows it has been pretty much dormant except for a quick blip in January. It began to move up last week and at Friday’s close it hit 7. Long-time readers will recall that this is a level where I feel a decent bullish edge exists. Below is a chart of the CBI from the Quantifiable Edges members section.

(click to enlarge)




In the past I’ve demonstrated that it can be used as a market timing tool for swing trades. One “system” I’ve shown here on the blog is to purchase the S&P 500 when the CBI hits a certain level (7 being one of them) and then sell the S&P when it returns back to 3 or below.

Below is an updated performance report of the above “system” covering 1995-present.






I'll keep readers informed of significant changes in the CBI over the next several days until it returns to neutral.

Short-Term Oversold At An Intermediate-term Low Provides Bullish Edge

Short-term oversold at intermediate-term lows can be a powerful combination. Let’s look at the current situation. The 2-day RSI of the SPX closed basically right at 2. The SPX also closed at a 50-day low. Below is a test that shows how this combination has performed since 1985.

We see here a strong inclination for an almost immediate bounce. The edge is very short-term though as it begins to dissipate after just 2 days. Not seen in the table above is that an astonishing 30 of 31 instances closed higher than the entry price at some point over the following four days. The only failure was on March 25, 1994.

Mild Selloff After Sharp Drop Sets Up S&P For A Bounce

In the past I’ve found that weak bounces after strong selloffs have had bearish short-term implications. Wednesday’s action just missed the weak bounce as the S&P finished marginally lower. So tonight I looked at S&P performance following a sharp drop and then a marginally lower day. Below I show the 5-day return across a spectrum of possible % declines between 0 and X%.

(click to enlarge)

Rather than the bearish results found when the market undergoes a weak bounce, we see here that limited additional selling carries a bullish expectation over the following week. The edge remains fairly consistent regardless the level of decline between 0% and 1%.

Observations On NYSE Issuers 1929 - 2008

A reader pointed me to the data I needed to produce a graph going back to 1929 showing the total issuers on the NYSE. The data is annual and can be located on the NYSE’s website using the following link:

http://www.nyxdata.com/nysedata/NYSE/FactsFigures/tabid/115/Default.aspx

(click to enlarge)

A little difficult to see is that the total issuers peaked in 1930 and declined until 1934. The market bottomed in 1932. The next true bull market didn’t emerge until 1942 though. (The 1942 Dow low was at 1933 levels.) Issuers crept higher for 8 years before the next great bull market environment emerged in 1942. When that bull market emerged the pace of increase in new issuers did also – confirming the rapid economic expansion.

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*Note that the breakout of U.S. / Non-U.S. was not available until 1956.

NYSE Total Issues Contracting

One number that has been hitting low levels lately is the number of issues traded on the NYSE. The chart below goes back to 1970, which is as far back as my database goes. During the difficult economic environment during the 70’s the total issues crept higher without much in the way of sharp rises or falls. Following the crash of ’87 the total issues only suffered a mild setback. The 90's saw a rapid expansion in total issues. The 2000-2003 bear market saw a sizable contraction. In the last year there has been another fairly sharp contraction. With increased bankruptcies, floundering stock prices, and a dormant IPO market this number may continue to contract. A true economic expansion that could be accompanied by a multi-year bull market would likely see the IPO market revived and the NYSE total issues expand as well. I’d be wary of the sustainability of a bull market that saw continued contraction in the total issues traded on the NYSE.

(click to enlarge)


P.S. It would be interesting to see how this chart would look in the 30’s and 40’s. I haven’t been able to locate that data yet. Should any blog readers know a resource I’d be happy to link to it.

Stops Part 2 - When To Use Them

It’s been a couple of weeks since I wrote “Stops – When Not to Use Them”. In that post I suggested that using stops when trading mean-reversion systems hurts performance in the long run. There were many good comments left after that post which I will address in the next post on this subject. Today, though, I’m long overdue to tell you when I think stops ARE appropriate.

While stops do not work well for overbought/oversold trading, they DO work well with breakouts or trend following systems. Traders that buy on a pattern breakout do so because their analysis indicates a trend could emerge in the stock or security they are trading. A reversal back into the base or below it would invalidate the pattern from a technician’s standpoint. Therefore in such cases I believe a stop is completely appropriate. Once the pattern “fails” you should no longer be in the trade. Of course some people may want to give a little extra leeway rather than putting a stop right at a support point, but even so, there is a point where the breakout simply didn’t take.

For my own breakout trading I tend to use very tight stops. I also tend to show little patience for a trade to work once I enter it. Most successful breakouts have a tendency to work right away, and when the market environment is conducive to breakouts there’s just no point in sitting around with dead wood. I’d rather exit with a small profit or loss and try the next one.

The edge in breakout or trend trading is not in the winning percentage. It’s in the risk/reward. A big winner can gain several hundred percent if it goes on a tear. That makes up for an awful lot of scratches and small losses. As an example in 2003 I did a lot of breakout trading. Cup & Handles, Flat Bases, High Tight Flags, Double Bottoms, etc. – all based primarily on daily bars. It was a tremendous year for trading breakouts because the ones that took caught fire rather quickly. It was also one of my best market years. Yet at the end of the year I went back and tallied the percentage of breakout trades I took that “worked”. In other words, they did better than a very small gain or scratch. My success rate? A little under 15%. And it was a great year. Why? Tiny losses and massive gains.

Everyone’s style is different and someone with more patience would likely have had a better win rate, but the win rate wasn’t important. What was important was controlling the losses, and one way to do that was through the use of stops.

For more discussion on using stops check out some older posts from:

Afraid To Trade

IBD Index

Also, for some (much) older discussion on trailing stops you can check out my “Double Support Trailing Stop” concept.

To be continued…

The Importance Of Positioning In Analysis

So what typically occurs after strong selloffs like we saw Tuesday? When considering the potential influence an individual bar may have on future bars it is important to consider the positioning of the bar we are studying. A sharp selloff coming when the market is extended up has a whole different meaning than a sharp selloff when the market is extended down. Let’s first look at the current situation to see what I’m talking about.

Here we see the sharp 1-day selloff has typically led to a muted bounce that then rolls over to make new lows. Instances are a little low. When I loosened them to a 2% drop I saw the same pattern.

But what if the market was at a 5-day low instead of a 5-day high? Results in that case would be much different:

Here we see a sharp initial bounce that is followed by more upside. In this case the sharp selloff is possibly exhaustive. That's not the case when coming off a top. The expectation turns from negative to positive based on where the sharp selloff is occurring. So remember, when considering the meaning of a bar or pattern or of bars it is also important to consider the positioning.

Overbought Nasdaq With Low Spxy Reading Suggests Downside

We’ve seen numerous times how low Spyx readings typically lead to weakness or at least underperformance over the next few days. Both the S&P and the Nasdaq posted low readings on Monday. I decided to look at the situations where an extremely low reading came in an extremely overbought market as we’re seeing currently with the Nasdaq. This first test uses a Spyx level of 20 or below:

(click to enlarge)


A short-term bearish edge is apparent based on the above. Not shown but also notable is that 85% of all instances closed lower than the close of the trigger day at some point in the next 3 sessions.

The actual Nasdaq Spyx reading Monday was about 5. Lowering the Spyx requirement from 20 to 10 produced the following results:

(click to enlarge)


Instances here are a bit low but it appears the edge is even more pronounced with the extremely low Spyx reading.

A chart with the current S&P 500 Spyx reading is updated on the home page each night.

Some Thoughts On Bear-Only Edges

One study I looked at this weekend was how the market reacted following times when the SPY gapped higher, never traded down to the previous day’s close, and closed above its open as it did on Friday. Friday was a bit of a borderline example since the gap was small and it came within 1 cent of filling the overnight gap, but the results were interesting nonetheless. Rather than use a results table as I normally do I decided to show an equity curve of this study. The equity curve assumes a 5-day exit. It may be a bit difficult to read the dates below. The test was run from the SPY inception in 1993 though 2/6/09.

What I see is an incredibly strong and consistent tendency to reverse and trade lower has been evident since the bear market began in late 2007. This tendency did not exist prior to that. It is worth taking note of such test results for a couple of reasons: 1) To understand how the market is reacting to such setups currently (or in the recent past). By knowing what the market current tendency is you can position yourself to take advantage of it. 2) To consider possible implications if these kind of setups stop preceding strong negative market reactions. The bear market reaction has been extremely negative. If negative reactions to this or other similar bear-only studies stop occurring it could signal a shift in market dynamics and a possible rally.

Further Detail On The Recent Spyx Study

A commenter, Frank, on the recent Spyx study questioned how the setup has worked more recently as opposed to over the entire period from 1995-present.

Below is a short excerpt from Tuesday night’s Subscriber Letter which addresses Frank’s concern and provides more detail on the setup. It’s fairly common that I include additional information on studies in the Subscriber Letter, and this was one of those instances. As a refresher, the setup involved a 1.25% rise in the S&P 500 and a close below 25 for the Quantifiable Edges Spyx reading.

This setup has been especially bearish during the current bear market. Below are all instances since October 2007 along with their 4-day returns:



Ten for ten to the downside in this case.

Subscriber Letter Trade Results For January

Like December, January was a bit slow for trade ideas. A big reason for this was that there were no Catapult trade ideas that filled. There were several that triggered on 1/20 but the gap up on 1/21 kept them from receiving fills.

I only tracked 2 “system” trades in the Subscriber Letter during January. Subscribers that may trade more aggressively than me can find additional setups almost every night in S&P 500 stocks as well as ETF’s by checking the “System Triggers” page in the members section of the website.

The “Index” trades are typically SPY and QQQQ trades based on the short-term market outlook section of the Letter. The outlook is based on edges identified in my market studies. One tool I use to quantify the different studies is the Aggregator.

Now for the usual caveats and explanations before unveiling the results.


I don’t suggest position sizes. The primary reason for this is I’m not acting as a financial advisor. I don’t feel it is appropriate to suggest allocation sizes without understanding someone’s financial situation and risk tolerance. Even for my own trading I run different portfolios with different levels of aggressiveness. For instance, my most aggressive portfolio is my IRA. Here I may use options to sometimes get 400-500% leveraged. Other portfolios on the other hand normally take much more conservative stances and some rarely reach or exceed 100% exposure.


Since I don’t suggest position sizes this is should not be considered a performance report, but rather a trade idea scorecard. Therefore, no matter how objective I try to be the reporting of the results is always going to be skewed depending on how you approach the trades. For instance, I always recommend scaling into the Catapult positions in 3 parts, whereas the “System” trades (whatever system I unveil other than Catapult) are normally one entry. The “Index” trades I normally recommend scaling into as well. For my own trading I trade much larger size with the index trades than any of the individuals. I also control my exposure by limiting the total amount invested per day. As I mentioned, this will vary depending on the account I’m trading. My most aggressive account I may put in up to 100%/day and get heavily leveraged using options. A more conservative account may max out at 15%-20% per day.

It’s unlikely anyone would have taken all of the trades with equal amounts, so personal results would vary greatly depending on the trader’s approach. All that aside, below are January’s results (click to enlarge):





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January Barometer

The January barometer is a well known study that is often referred to. It states that “as goes January, so goes the year”. In other words, if January closes down, there is a good chance the entire year will close down. Of course the bear case has a head start. I decided to eliminate that head start and look at performance from the end of January forward. Below performance is shown from the end of January to the end of the year. I used the Dow Jones Industrial Average from 1920 – today. Dividends are not taken into account.

(click table to enlarge)

What strikes me here is that wins and losses are almost dead even – for all 11 time frames. When considering your trading approach from now through the end of the year I wouldn’t worry too much about January’s performance.

Low Volume Spyx Reading On Strong Up Day Historically Bearish

The Quantifiable Edges Volume Spyx indicator came in at a very low 15 reading on Tuesday. In general, very low readings have been bearish while very high readings have been bullish. (For those who are new to the volume Spyx indicator, click here for the introductory post on it.) Below is a study showing returns following all instances where the S&P rose at least 1.25% and the Spyx finished below 25.

(click on table to enlarge)


Most of the bearish tendency plays out within the first 4 days. As a baseline, over the same period the average 4-day return of the S&P 500 following a 1.25% gain with a Spyx reading ABOVE 25 is almost dead even at -$0.13. This is substantially higher than the average -$840.66 decline shown in the study.

An S&P chart with the volume Spyx indicator is updated each night on the Quantifiable Edges Home Page.

2% Gaps Down Revisited

SPY is nearing a 2% gap down this morning. I performed a study back in October which looked at the tendency of the SPY to close above its gap opening at some point in the next few days after such a large gap down. Below I have updated that table with the 7 additional instances that have since occurred. The edge remains squarely bullish.

(click table to enlarge)