The Week Ahead Highlights from May 2012

 Notes for the week of May 28, 2012

During your holiday weekend, are you trying to fit in time on your normal weekend activity of investigating possible trades for the coming week? May I suggest something? Go back to your family, friends, and frolicking. Take the week off from trading.

Until recently everything said and written about Greece was focused on reassuring everyone that Greece will of course stay in the euro zone, and it is just a matter of working out a solution. Suddenly last week the talk changed to mentioning the possibility of Greece exiting from the euro zone. Months of straight denial, then a "it may not be that bad" slant on comments.

When looking back at some major negative events, ever notice how denials that it would happen become almost deafening just before the event happened, the failure of Lehman or the devaluation of a currency for example? Then right at the last minute the talk suddenly changed to "this may not have a big effect", as if they were preparing you for the event (and distracting you so you will forget they were telling you it wouldn't happen).

Before Tuesday's open, be sure to ask yourself how much exposure you will feel comfortable with if Greece suddenly leaves the euro zone or a major European bank fails (as I'm writing this on Monday morning, Marketwatch.com has the headline "Spain weighs Bankia fallout").

Postulating aside, it's time to comment on index/ETF-related things. The NASDAQ, Dow, S&P 500, and the Russell 2000 have all pulled back near, or to, their 200-day moving averages. Their 50-day moving averages have started to curve downwards. If they start closing below their 200 MA's, especially on increased volume, you should not be long the market. Many institutions will view this as a major sell signal.

The S&P 500 has rather regular short-term cycle lows, averaging about one month apart. In fact, the average down-move for the S&P 500 lasts about 13 days. The most recent pullback by the S&P 500 was exactly 13 days:

chart courtesy of Worden − www.Worden.com

The S&P nearly touched its 200-day MA this past week, then began moving upwards (slightly). It is quite possible this may end up being another cycle low.

Could the market stage a reversal at this point and rebound strongly? Anything is possible, so the answer is yes. Should you enter a long-side trade because you can structure a good reward-to-risk trade by using a tight stop just below the 200 MA?

If you have ever traded 'soft' commodities (things that grow vs. mined), experiencing an opening gap followed by a quick limit-down move will introduce fear into every trade evaluation you do in the future. This is less likely to happen in the equity markets, but as the 2010 'flash crash' showed, anything is possible. That well-designed high reward-to-risk trade can go out the window within 30 milliseconds of market open if a major negative news story hits the wires outside of market hours.

If the market does bounce, there may not be much upside unless significantly positive news starts coming out. I expect the S&P's falling 50-day MA, currently at 1375, will provide short-term resistance (if you are curious, the average S&P 500 up-move lasts about 15 days).

The bigger concern I have is the number of big-name stocks that have poor-looking daily and weekly charts. Especially noticeable on the NASDAQ Composite is the number of days of above average volume on down-close days, starting back in February, well before the high was set in late March:

chart courtesy of Worden − www.Worden.com

As I've covered in recent weeks there is little seasonal bias this time of year. The seasonal charts on most major indexes and ETFs show no significant gain or loss over the next several weeks. We will have some good seasonal trades coming up soon, but right now, you won't have any seasonal biases in the major markets to work for or against you.

A couple of ETF seasonals did catch my attention - IYC, the Consumer Services ETF, and XLF, the Financial Sector ETF. Over the next four weeks, IYC has fallen an average 3.0% with losses in 9 out of 11 years (82%). I investigated the top holdings in IYC. Wal-Mart (WMT), the top holding of IYC, has moved up strongly in the past 7 days, setting a high not seen since January, 2000. WMT's seasonal chart actually has a positive bias over the next several weeks.

Next on the holdings list, MCD, showed a virtually sideways seasonal. HD, DIS, AMZN, and so on, also showed generally sideways seasonals. I therefore looked at IYC's lifespan. IYC has been in existence for only 11 years. Most of the top holdings of IYC have been around for many more years, and perhaps if the seasonals focused on just their most recent 11 years, a different story would appear.

Sure enough, Home Depot (HD)'s most recent 11 years showed losses in 10 of those years. I moved on to Disney (DIS). DIS showed losses in 9 out of the last 11 years. AMZN had losses in 7 out of 11 years. Comcast (CMCSA) was ok, but number 7 on the holdings list, CVS, had losses in 7 out of the 11 years.

It is interesting that most of these big name consumer stocks have displayed losses over the next 3 to 4 weeks in the majority of the years since 2000, in contrast to their track records prior to that.

I also mentioned XLF, the Financial Select Sector SPDR. Over the next 4 weeks, XLF has lost an average 3.3%, with losses in 11 out of its 13 years (85%). XLF's biggest holding, Wells Fargo (WFC), has an overall track record of losses in 16 out of its 28 years (57%). But focusing on the most recent 12 years, it had losses in 10 of those years (83%). Being long major consumer and financial stocks over the next several weeks will not be a higher probability trade.

I'll look for the most interesting stock with a strong negative seasonal to focus on in Stock Talk, just in case the markets don't hold at their 200 day MA's.

On a closing note, I noticed a number of major stocks showing average volume having fallen off significantly over the past few years, even as most of them were setting new highs. For example, Home Depot's average weekly volume has fallen from a high of 108 million shares in June 2009 to this week's average of 56.7 million, nearly half.

Costco is worse. COST's average weekly volume has steadily fallen from a high of 31.7 in May 2009 to just under 12 million. You have to go back to the early 2000's to find average weekly volume that low. MCD, GS, WMT, even AAPL, same story.

This is not a falloff of volume during the most recent pullback. This is a steady multi-year decline of market activity. As activity and price competition decline, some option strategies that work best with tight Bid/Ask spreads and active daily/weekly movements of the underlying may not work as well, or be as profitable, as in the past. The markets change. Good traders look for indications of change and make plans on adapting to the new environment.

 Notes for the week of May 21, 2012

As you may have noticed, the Dow Jones Industrial Average and the DIA have broken below their well-defined trading ranges. The S&P 500 has set a much lower low and the NASDAQ has finally violated the oft-mentioned "hasn't closed below 2900 so far...".

The wide variety of projections on where this down-thrust may end make for interesting reading. But this down-trend has gone too far, too fast, to make new bearish positions worth considering, and you don't want to risk your trading account balance trying to time a turnaround.

Nearly all of the major indexes and ETFs we follow are showing weak downward seasonals over the next couple of months. For example OIH, the Oil Services HOLDRs, has fallen an average 1.8% over the next 7 weeks with losses in 6 out of the 11 years (55%), -4.3% over the next 13 weeks with losses in 8 out of the 11 years (73%), and -6.1% over the next 20 weeks with losses in 6 out of 11 years (55%). These numbers do not represent a strong seasonal, so no prudent trader would initiate shorts or time-sensitive bearish option trades just on the seasonal. But for those of us who look for tailwinds to our trades, and try to avoid headwinds, we will avoid taking bullishly-oriented trades against the negative seasonal bias.

There is a good chance for a strong bounce in the next week or two. If that happened, I would expect another strong down-move sometime after that. What we need to see to believe this is a good time to enter new bullishly-oriented positions is not only a bit of consolidation/base building, but also a consistent increase in news beneficial to business. That, along with the positive seasonal biases that will come into effect in the fall, could produce a grand alignment of the planets situation for strong profits for short-term traders, the type of environment where active traders can make most of their profits for the year within a short time span.

 Notes for the week of May 14, 2012

The DJIA has fallen back to the bottom of its recent trading range. It has been about a month since it was last down in this area. While you won't see a clear-from-thirty-feet-away cycle low formed every month, well-defined lows, approximately one month apart, are typically seen in the major indexes. Focusing on just the DJIA (or DIA) chart, it is reasonable to expect a turnaround within the next few days with a movement back up towards the top of the trading range being the most likely result.

However, the S&P 500 was setting higher highs and higher lows, but has started setting lower highs and lower lows:

If the economy was strengthening, one stock sector that should be showing strength would be Materials, comprising companies in the chemical, mining, and building/construction areas. As inventories start being rebuilt, as increasing faith in being able to sell homes leads builders to start new homes 'on spec', as more goods are sold and transported, a sector ETF like XLB should offer trading possibilities. But alas, XLB seems to be within a down-trending channel, and the best long trade we could hope for would be merely a play to the top of the channel:

The energy and financials look worse than that. The seasonal charts on most major indexes and sector ETFs have no bias, or a slight downward bias for the next few months, so that will not be a factor.

Income trades such as credit spreads are worth investigating at this time. Within a few days I will be posting a new article on the MarketTamer.com blog. It will be a detailed analysis of how to increase probabilities on a Bull Put credit spread. The same approach could be used to analyze Bear Call credit spreads, which will be worth considering if the market moves upwards on declining volume over the next week or two.

 Notes for the week of May 7, 2012

Last week I pointed to the market's recent turnaround and the 2-day island reversal that was especially apparent on the NASDAQ. However, I expressed a bit of skepticism. Friday's action, which again took the NASDAQ well below its 50-day MA, setting a lower low with most above-average volume days since February being on down-close days, certainly reinforced my opinion:

chart courtesy of Worden − www.Worden.com

As if on cue, DIA turned right around and began dropping as soon as it touched its trading range resistance level:

chart courtesy of Worden − www.Worden.com

As I've mentioned several times in recent weeks, this is the time of year that the seasonals of most of the major indexes and ETFs display a virtually sideways, or slightly downward, bias. This means historically, there is no average gain or loss in the various markets over the next several weeks. That doesn't mean this isn't a good time to trade. See my article Sell in May?

Many big-name stocks have poor looking daily charts. There are also many big-name stocks in holding patterns and trading ranges. Some even show good bullish patterns, refusing to play along with the recent pessimism (we're still in earnings season, and positive surprises have helped certain stocks).

There is always the chance a 'Black Swan' event can come along, one of those 'once in a hundred years' events that seem to happen every couple of years now. But you can't plan on those. You just have to professionally plan and manage the trades you are in.

This can be a better-than-usual time for using non-directional trades, such as Iron Condors, where you make maximum profit if the stock/ETF stays within a range. Calendar trades can work well, if properly managed. If you don't have much experience with advanced option strategies, there are several good options training and/or mentoring services out there, usually run by the well-known names in options trading. Investigate MarketTamer, OptionsAnimal, and Dan Sheridan. Also, Larry McMillan, who wrote the option trader's bible, "Options as a Strategic Investment", offers mentoring (OptionStrategist). (Disclosure: At this time, StockQuirks provides occasional articles for the MarketTamer blog, but receives no compensation or any other benefit.)

If you sign up for training or mentoring, paper-trade the strategies they teach for months before starting actual trading. StockQuirks.com will help you learn how to implement their strategies with even greater chances of success.