Market Breadth Report

Not much time this morning to comment.

Important things to note: The Breadth Report closed its open short (which was profitable) at Friday’s close.

It will open a new long on today’s open based on the Raw Advancers and Decliners indicator.

How To Read the Breadth Report

Universe Screen: Applies to top three indicators. Does not apply to 52 week new highs and lows.

• The universe contains any stock trading on average more than 100,000 shares per day with a liquidity of  at least $1,000,000  per day, over the last 50 days.

1. Top most indicator is the measure of stocks in an uptrend (gray histogram) and the number of stocks trading above their 5 day simple moving averages (red line).

• Buy signal is generated for the open when the SPX is above its 200dsma and the red line crosses beneath 700.
• Sell signal is generated for the close when the red line crosses above 2500, or the trade is held for 25 days.
• Short signal is generated for the open when the SPX is trading beneath its 200dsma and the red line crosses above 2500.
• Cover signal is generated for the close when the red line crosses beneath 700, or the trade is held 25 days.
• Long trade lasts on average 24 days while short sell lasts on average 10 days.

2. The 2nd indicator is the Advance-Decline line (blue line) with a 50dsma plotted (gray line). My calculation is similar but not the same as Investopedia’s.

• Buy signal is generated for the next open when the SPX is above its 200dsma and the A-D line crosses beneath the 50 day average.
• Sell signal is generated for the close when the A-D line crosses back above the 50 day average.
• The average trade lasts about 15 days.

3. The 3rd indicator is the raw advancers and decliners, with the advancers being the green line and the decliners being the red line. There are also Bollinger Bands (purple) set 1 standard deviation beyond the 20 day average of decliners.

• Buy signal is generated for the next open after the decliners exceed the upper Bollinger Band.
• Sell signal is generated for the close when the decliners close beneath the lower Bollinger Band.
• The average trade lasts 5 days.

4. The bottom indicator is the measure of 52 week new highs new lows (histogram), with a 9dsma (yellow line) plotted over top.

• Buy signal is generated for the next open after the number of new lows exceeds the number of new highs.
• Sell signal is generated for the close when the number of new highs surpass the 9dsma.
• The average trade lasts 3 days.

Comments »

We’ve got some interesting things happening with the market technicals with the main concern being the breach of the 200 day simple moving average on the SPY. Similar breaches have occurred on other indices that I find worth monitoring, and so we’ll take a look at what this could mean. I will also link to some good quantitative research that will be applicable to our current environment.

The SPY chart above covers approximately 3 years. I know it is kind of busy, and even though I’m a minimalist when it comes to technical analysis, I included the lines because I think they are important.

First, look at the downtrending channel. I wrote many many months (a year?) ago that the steep drop on September/October 2008 was probably an over-reaction (note how the market breaks well beneath the channel). I have viewed the October 2009 breakout above the channel as a similar over-reaction. So the question is, will the SPY return to trade within this long-term downtrending channel? The answer to that likely depends on many things, but I like the simplicity of thinking this way: Are things really getting better with the economy?

The horizontal line marks support during the bull market period. Note that when this line failed, all hell broke loose in the October Armageddon trade. You may also want to note that the SPY was rejected at its April highs almost to the penny at this line. What does it mean? I’m not sure, but there is a certain symmetry that exists in nature, and in my opinion, this symmetry also exists in the markets.

A Closer Look:

The SPY chart above shows a little more than 1 year’s time. I wanted to include the March 2009 bottom as well as the Golden Cross that occurred in July 2009. I did extensive work testing the Golden Cross, which you may review here.

The most important consideration is the fact that the SPY is trading beneath the 200 day simple moving average, as is VTI and VEU. Basically, most of the world’s stocks are trading in bear market territory, once again. Take a second look at the first chart at what happened when SPY began trading decisively beneath this average. I believe that Friday’s rout was a decisive blow, on volume, and thus a serious rejection of the 200 day average.

So we see all these deteriorating technicals, and we wonder if they can really be used to make wise short and longer-term trading decisions. The answer is absolutely. There is some extremely reliable and valid quantitative research out there that should be used to guide traders and investors looking for help in the challenging environment we currently find ourselves to be in.

Some Quantitative Research Links

Mebane Faber has done some absolutely fantastic research (read it here: A Quantitative Approach to Tactical Asset Allocation) on using long-term moving averages to make investment decisions. His premier research uses the 10 Month Moving Average (which is very close to the 200 day moving average) as a timing signal applied to 5 asset classes: US Stocks, Foreign Stocks, US 10 Year Gov’t Bonds, Real Estate, and Commodities. Basically, when the end-of-the-month price closes beneath the 10 month moving average, you want to liquidate and sit in cash or cash equivalents. You want to be long each of these asset classes as long as their monthly closes are above the 10 month moving average.

Following this model, the only asset classes you would be long right now are Real Estate (and it is very close to triggering a sell) and US 10 Year Gov’t Bonds. Long story short: now is not the time to be long anything except for Gov’t Bonds, especially if you are an investor with a long time horizon.

Here is a link to Faber’s site with the charts of these asset classes and the 10 month moving average timing signal: Faber’s Timing Model.

But what about Mean Reversion? Surely, with SPY and other indices putting in the worst May in many years, we should buy for a bounce? Faber has posted some recent research that shows this may not be the case. The research shows that it may be better to wait a month after the bad month and then buy for a planned hold of ~2 months. Here is a link to this research: Mean Reversion or the Return of the Bear? Or, How About a July and August Rally?

The Good News

There are some indices, particularly the QQQQ and IWM which have managed to stay above the 200 day moving average, but they are very close to breaking beneath it. And that is about all the good news I have.

Summary

The technicals and research regarding application of these technicals to make trading and investment decisions all confirm that this is not a market to be blindly and largely long in. If you are adept at the art of shorting, this is the time to look on the short side. If you are not skilled at the art of short selling, this is a time to be largely in cash. If you want to attempt to get a jump on the longer-term moving averages, rather than waiting for price to re-take them, then I suggest following the breadth reports that are available on my blog as well as on Danny’s blog.

Comments »

I’ve noted before that when the market just goes up and up in a near straight line, the Power Dip System will have hard time outperforming. This is because the Power Dip needs some volatility. It needs some dips to buy and spikes to sell. That volatility came in May, and the Power Dip System was able to profit from it while the broader markets were punished.

Surprisingly, the fixed risk model of 1% risk and 10% stop outperformed the 3ATR position-sizing model which adapts to volatility. The 3ATR model started taking smaller positions as volatility ramped up during the flash-crash and the days after. Remember, with volatility position sizing, more volatility means smaller positions.

The 1% risk with 10% stop kept taking fixed-size positions meaning that its positions became larger relative to the volatility-based position-sizing. Simply put, larger positions mean larger profits (or losses), and so the 1% model outperformed. Even with 2% risk (double the 1%, duh), the ATR based model was taking smaller positions than the 1% risk model. Looking closely at the equity curves, this battle between fixed and volatility-based position-sizing was very close and so my analysis may be a tad over-simplified.

The question then becomes should we be switching between fixed and volatility-based position-sizing? In historical backtesting, the volatility-based position-sizing outperformed fixed position-sizing over almost 20 years. However, there may be a method developed that tells us when to consider switching. This may be as easy as using the ATR measures of SPY, and using volatility-based sizing when the market is not volatile and then switching to fixed-sizing when the market becomes volatile. Or maybe we use varying levels of volatility sizing based on the broader market volatility- switching between 1, 2, and 3 ATR sizing.

These are considerations that I think could make the Power Dip System even better and so I will be running tests over the next month or so.

1% Risk and 10% Stop

2% Risk and 10% Stop

2% Risk and 3ATR Position-sizing and Stop

Questions? Feel free to leave a comment or email me: woodshedder73 at gmail.

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Breadth contracts, matching price.

Summary:

Breadth is still very weak and all signs of improvement from last weak are quickly disappearing.

Closed and Opened Trades:

On Thursday’s close (May 27th), two long trades were closed, both losers. The trades were generated by the Number of Stocks Trading Above the 5 DMA indicator and the 52 Week New Highs and New Lows indicator. The system is still long 25% from the Advance Decline Line.

The opened trade was a short of SPY on Friday morning, May 28th. This was generated from the Number of Stocks Trading Above the 5 DMA indicator. Check the How to Read the Breadth Report for the specifics of how these signals were generated.

I will soon be updating all the tracking sheets for these indicators and will publish in an upcoming post.

How To Read the Breadth Report

Universe Screen: Applies to top three indicators. Does not apply to 52 week new highs and lows.

• The universe contains any stock trading on average more than 100,000 shares per day with a liquidity of  at least $1,000,000  per day, over the last 50 days.

1. Top most indicator is the measure of stocks in an uptrend (gray histogram) and the number of stocks trading above their 5 day simple moving averages (red line).

• Buy signal is generated for the open when the SPX is above its 200dsma and the red line crosses beneath 700.
• Sell signal is generated for the close when the red line crosses above 2500, or the trade is held for 25 days.
• Short signal is generated for the open when the SPX is trading beneath its 200dsma and the red line crosses above 2500.
• Cover signal is generated for the close when the red line crosses beneath 700, or the trade is held 25 days.
• Long trade lasts on average 24 days while short sell lasts on average 10 days.

2. The 2nd indicator is the Advance-Decline line (blue line) with a 50dsma plotted (gray line). My calculation is similar but not the same as Investopedia’s.

• Buy signal is generated for the next open when the SPX is above its 200dsma and the A-D line crosses beneath the 50 day average.
• Sell signal is generated for the close when the A-D line crosses back above the 50 day average.
• The average trade lasts about 15 days.

3. The 3rd indicator is the raw advancers and decliners, with the advancers being the green line and the decliners being the red line. There are also Bollinger Bands (purple) set 1 standard deviation beyond the 20 day average of decliners.

• Buy signal is generated for the next open after the decliners exceed the upper Bollinger Band.
• Sell signal is generated for the close when the decliners close beneath the lower Bollinger Band.
• The average trade lasts 5 days.

4. The bottom indicator is the measure of 52 week new highs new lows (histogram), with a 9dsma (yellow line) plotted over top.

• Buy signal is generated for the next open after the number of new lows exceeds the number of new highs.
• Sell signal is generated for the close when the number of new highs surpass the 9dsma.
• The average trade lasts 3 days.

Comments »

Breadth expanded ever-so-slightly, creating a tiny divergence from price.

Summary:

Breadth is still very weak but is showing some minor signs of improvement.

The top pane with the red line shows the number of stocks trading above their 5 day moving averages. You can see that while the market is doing a lot of up and down, this metric has been improving. This indicator must improve before its sister indicator, number of stocks in an uptrend (gray histogram), begins to improve. The number of stocks in an uptrend helps us determine when we get the green light to trade momentum.

Also on Wednesday, we saw a slight improvement in the number of advancing stocks.

Both of these improvements are in what I consider to be short-term breadth, but these measures must strengthen before it begins to show up in longer-term breadth measures.

Overall, breadth is still worse than it has been in one-year and there is not much to be excited about on the long side.

How To Read the Breadth Report

Universe Screen: Applies to top three indicators. Does not apply to 52 week new highs and lows.

• The universe contains any stock trading on average more than 100,000 shares per day with a liquidity of  at least $1,000,000  per day, over the last 50 days.

1. Top most indicator is the measure of stocks in an uptrend (gray histogram) and the number of stocks trading above their 5 day simple moving averages (red line).

• Buy signal is generated for the open when the SPX is above its 200dsma and the red line crosses beneath 700.
• Sell signal is generated for the close when the red line crosses above 2500, or the trade is held for 25 days.
• Short signal is generated for the open when the SPX is trading beneath its 200dsma and the red line crosses above 2500.
• Cover signal is generated for the close when the red line crosses beneath 700, or the trade is held 25 days.
• Long trade lasts on average 24 days while short sell lasts on average 10 days.

2. The 2nd indicator is the Advance-Decline line (blue line) with a 50dsma plotted (gray line). My calculation is similar but not the same as Investopedia’s.

• Buy signal is generated for the next open when the SPX is above its 200dsma and the A-D line crosses beneath the 50 day average.
• Sell signal is generated for the close when the A-D line crosses back above the 50 day average.
• The average trade lasts about 15 days.

3. The 3rd indicator is the raw advancers and decliners, with the advancers being the green line and the decliners being the red line. There are also Bollinger Bands (purple) set 1 standard deviation beyond the 20 day average of decliners.

• Buy signal is generated for the next open after the decliners exceed the upper Bollinger Band.
• Sell signal is generated for the close when the decliners close beneath the lower Bollinger Band.
• The average trade lasts 5 days.

4. The bottom indicator is the measure of 52 week new highs new lows (histogram), with a 9dsma (yellow line) plotted over top.

• Buy signal is generated for the next open after the number of new lows exceeds the number of new highs.
• Sell signal is generated for the close when the number of new highs surpass the 9dsma.
• The average trade lasts 3 days.

Comments »

Breadth contracted slightly with price.

Summary:

Breadth is still very weak and it appears that we may have seen an unsuccessful attempt to regain the 200 day moving average. On Friday’s bounce day, it is evident that other than the Raw Advancers and Decliners indicator, breadth was not significantly positive. In fact, breadth barely moved.

While I have not completely written off another attempt over the next few days or a week to regain the 200 day, things are looking pretty grim with S&P500 futures down -2.85% as I write. I don’t know whether this will be a prolonged correction or whether we are seeing the beginning of another 20% slide, but as long as breadth stays negative, both are possible. I have to say that the market feels like any move will come swiftly and severely rather than slowly and methodically.

Closed Trade:

The open trade from the Raw Advancers and Decliners indicator was closed at Friday’s close. It was of course a loser. I will update the spreadsheet to reflect this trade in an upcoming post. The system is unfortunately 75% long, but with the [[SPY]] trading beneath the 200 day, once these trades are closed, the number of long signals will be scaled back significantly.

How To Read the Breadth Report

Universe Screen: Applies to top three indicators. Does not apply to 52 week new highs and lows.

• The universe contains any stock trading on average more than 100,000 shares per day with a liquidity of  at least $1,000,000  per day, over the last 50 days.

1. Top most indicator is the measure of stocks in an uptrend (gray histogram) and the number of stocks trading above their 5 day simple moving averages (red line).

• Buy signal is generated for the open when the SPX is above its 200dsma and the red line crosses beneath 700.
• Sell signal is generated for the close when the red line crosses above 2500, or the trade is held for 25 days.
• Short signal is generated for the open when the SPX is trading beneath its 200dsma and the red line crosses above 2500.
• Cover signal is generated for the close when the red line crosses beneath 700, or the trade is held 25 days.
• Long trade lasts on average 24 days while short sell lasts on average 10 days.

2. The 2nd indicator is the Advance-Decline line (blue line) with a 50dsma plotted (gray line). My calculation is similar but not the same as Investopedia’s.

• Buy signal is generated for the next open when the SPX is above its 200dsma and the A-D line crosses beneath the 50 day average.
• Sell signal is generated for the close when the A-D line crosses back above the 50 day average.
• The average trade lasts about 15 days.

3. The 3rd indicator is the raw advancers and decliners, with the advancers being the green line and the decliners being the red line. There are also Bollinger Bands (purple) set 1 standard deviation beyond the 20 day average of decliners.

• Buy signal is generated for the next open after the decliners exceed the upper Bollinger Band.
• Sell signal is generated for the close when the decliners close beneath the lower Bollinger Band.
• The average trade lasts 5 days.

4. The bottom indicator is the measure of 52 week new highs new lows (histogram), with a 9dsma (yellow line) plotted over top.

• Buy signal is generated for the next open after the number of new lows exceeds the number of new highs.
• Sell signal is generated for the close when the number of new highs surpass the 9dsma.
• The average trade lasts 3 days.

Comments »

I’ve backtested the historical performance of the Power Dip System since its November 18th, 2009, inception. This backtest assumes that you were able to receive the actual opening and closing prices provided by the exchanges. Sometimes you do; sometimes you get a better price; sometimes you get a worse price. My opinion is that over time you end up receiving positive slippage. My personal account has performed slightly better than the historical backtested performance but there have been times when I have missed trades, taken a week off, and made mistakes.

I have posted two different models- the 1% Risk and 10% Stop model which I use as the baseline and the 2% Risk and 3ATR Position Sizing and Stop model which is my current favorite (and the model that I am currently trading).

The system ranks the picks and takes the top-ranked picks until it runs out of cash. This means that there are often picks that it does not take as there is no cash left. Backtesting has shown that the lower-ranked picks do not perform as well as the higher-ranked picks, but over the time tested, it appears that the lower-ranked picks may have been performing better. We can see this might be true by examining the Power Dip performance metrics in the right side-bar of the blog where we see the average trade of all trades (even the ones we might not have had room for in the portfolio) is higher than our backtested results (where only the highest ranked trades were taken).

Keep in mind that the tracked performance metrics in the right sidebar do not include the .01/share commissions which are included in the backtest. The performance metrics in the right sidebar do not include the use of any stops, only the raw exit signal is used to close the trade. Despite some of the larger losses that you may see from time to time in the sidebar, not using stops is actually superior to using them; however, I do not advocate trading the system without stops and so all backtests include the use of stops.

1% Risk 10% Stop Model: Net Profit 7.86%, Compound Annual Rate of 16.18%

Equity Curve

Drawdown Profile

2% Risk 3ATR PositionSizing / Stop Model: Net Profit 7.68%, Compound Annual Rate of 15.80%

Equity Curve

Drawdown Profile

SPY Performance from November 18th to May 21st: -1.93% Net Profit

Questions or Comments?

I have tried to address some of the questions that have been asked over the last few weeks. The system is very simple to use, but I realize that I am very familiar with it and many readers or not. Please feel free to ask any other questions about this report or the system itself in the comments section, or you can send me an email at woodshedder73 at gmail.

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