Calling a Market Top

This post will set out to determine if we are currently forming a market top by identifying current warning signals and by using past examples, most notably the 2007-2008 market.

Calling an exact market top or bottom is fairly difficult and not a task that I aim to succeed at. However, I pride myself on gathering warning signs of a major change in trend whether it is a market top or market bottom. Major tops and bottoms don’t happen overnight and typically take months to materialize. And this is good for the longer term investor – it gives us time to make moves and protect capital.

Mr. Market, as some call it, will give the astute investor plenty of warnings as a major change in trend starts to occur, especially at a market top. The market will likely offer head-fakes along the way and this is all well and good provided you maintain your sell stops and follow rules. It can be frustrating to sell prematurely and possibly buy back-in at higher levels than where you previously sold but that is par for the course: simple money and risk management.

Let’s take a look at 2007-2008.

The market was in a prolonged up-trend from 2005 into much of 2007. The DJIA peaked in July 2007 before dropping quickly to end the summer. It briefly violated the 30-week MA but more importantly, the number of New Lows spiked dramatically, to levels not visited in years (this was a red flag). The NH-NL Diff 10d MA and 30d MA both went negative (July 26th and August 1st, respectively). It was the first time the 10d and 30d Diff had been negative since the previous summer but daily readings were much more dramatic this time around, reaching 500-1,132 new lows. The 1,132 New Lows registered on Thursday, August 16, 2007 was more than Black Monday (10/19/87 when 1,068 were logged – fewer issues on index of course). This was just the first red flag but not an immediate sell signal (watch positions closely, maybe raise some cash to be safe).

2014_10-23_NHNL_Diff_NYSE_2007-08

Following the August lows, the DJIA went on to make new highs in October 2007 and then quickly reversed with another batch of New Lows . The second red flag was the fact that New Highs did not exceed previous levels as the DJIA made a new high, a divergence which is telling. Further confirming this second red flag was the fact that the market once again crashed below the 30-wk MA (November 2007). Please note that the initial red flags span from July to November (4 months = “time”).

The third red flag occurred when the market attempted to re-take the 30-week moving average in December 2007 but failed, as New Highs dipped dramatically and New Lows started to creep back up. By January, the NYSE registered another 1,000+ reading (1,114 on Tuesday, January 2, 2008). By this time, the market had dropped more than 2,000 points or more than 15%. Many individual stocks had dropped much more. Sell stops should have been followed and long term investors should have been accumulating cash by this time. Take profits and cut losses when multiple red flags appear (you can always get back in if the correction doesn’t confirm)!

The fourth and final major red flag occurred after the market rallied in the spring of 2008 yet the DJIA could not overtake the 30-wk MA in April and May. Following this failure, the fear and bad news related to the housing and banking crisis were starting to spiral and New Lows confirmed the damage by reaching the greatest levels ever witnessed on the NYSE, culminating with NL’s surpassing 2,000 on two separate occasions, nearly touching 3,000 on Friday, October 10, 2008 at 2,901. The NH-NL diff 10d and 30d MA went negative on Tuesday, June 10, 2008 and Friday, June 20, 2008 respectively. The NH-NL Diff 30d MA did not turn back to positive territory until Wednesday, April 29, 2009 (essentially as a new up-trend was confirming). The market was still trading above 12,000 in June 2008 so any stragglers could have sold, even at a decent loss at this level. If not, that investor rode the market down to the 6,000’s by October 2008, or another 50% loss (remember, it takes a 100% gain to break even after a 50% loss).

Now, before I am called a Monday morning quarterback, visit these blog posts that I made in late 2007 and early 2008, well before the ultimate crash (the Cramer Post lists additional links from 2007):

01/24/2008: Cramer YELLED Buy, I wrote Sell

10/12/2007: Distribution Day

10/20/2007: Second Major Distribution Day

For a detailed look at the monthly New High and New Low data in 2008 and early 2009, please visit this blog post (some excellent and original analysis here):

Identify Market Tops and Bottoms by Doing this, Guaranteed!

Now let’s take a look at 2014!

The first red flag has been materializing over the course of the entire year: fewer New Highs as the DJIA makes all-time new highs: a divergence that’s telling (remember this from 2007).

The second red flag is the increase in recent New Lows, reaching levels not seen since October 2011 (which was the most substantial correction since the bottom in 2009). Furthermore, the NH-NL Diff 10d MA and 30d MA went negative on September 22nd and October 6th respectively. As of this blog post, the NH-NL Diff 30d MA has been negative for 14 consecutive days and will remain negative for at least another week, based on the figures dropping off and being added to the calculation. It will become the longest consecutive stretch since the correction in 2011 (which lasted 71 days). The 2008-2009 negative stretch lasted 215 trading days (June to April).

2014_10-23_NHNL_Diff_NYSE_2012-14_2

The third red flag and it’s early, is the fact that the DJIA has violated the 30 and 40 week moving averages. The market is allowed to do this during normal corrections but it becomes a red flag when the NH-NL diff is negative with increasing New Lows (which is the case in October 2014).

As of this week (October 23, 2014), New Highs are increasing and New Lows are decreasing but that is normal action as buyers and sellers fight to control the trend. This action is similar to October of 2007 (383 New Highs were registered on Thursday, October 11, 2007). Individual days will swing from time to time so it’s most important to step back and focus on the macro trends that are building.

There you have it: several red flags have been logged here in October 2014 so the caution flag has been raised. Just as in 2007, I can’t confirm a new major change in trend will take place but I can tell you to be prepared and watch for additional red flags and respect sell stops. Remember, you can always buy back in if a steeper correction does not confirm. What you cannot do is make up for a large loss if the market starts to free-fall.

As identified in 2007-2008, these changes in trend take time so we can be diligent in making decisions but we cannot lose sight that the market has given us a warning. Until told otherwise, this market is suspect so I am in the business of raising cash levels. I am not completely out of the market but I have tightened stops and raised cash. Cash is a position and I know I can always jump back in with both feet if an up-trend continues. I’m just managing risk!

Stock Screens & Scans for Traders & Investors

As a part time trader & investor, I strictly use end of day data for my screens and scans as I don’t have the luxury of watching the tape all day long (nor do I want to). With that said, I do receive text alerts if a buy signal is made or if a sell signal has been violated. Using my smart phone or tablet, I can and do trade during business hours (when absolutely necessary) but it’s not imperative.

I encourage investors and traders in all time frames to evaluate stocks for investment using both fundamental and technical analysis. A day trader and even a swing trader can get away with avoiding fundamental analysis but I highly recommend both methods of analysis for intermediate and longer term trend traders and investors. Both tools are equally important in making serious decisions with your hard earned CASH!

Let’s start with a list of the key fundamentals that I require to be filtered within my mechanical screeners (please note that you should use your screener of choice):

Simple Fundamental Screener Criteria:
The criteria listed in this section can be used together or arranged in a variety of ways to generate multiple screens containing all possible opportunities. Get a feel for specific screens and determine which are the most successful during certain market conditions.

Most Important Fundamentals:

  • Increasing Earnings (current, past: quarterly, yearly and future estimates)
  • Increasing Sales (current, past: quarterly, yearly and future estimates)
  • Increasing Net Income (current, past: quarterly, yearly)
  • Increasing Institutional Sponsorship
  • Increasing and strong Relative Strength ratings vs. general market

Most Important Price Data:

  • Stocks making New Highs
  • Stocks within 15% of New Highs
  • Stocks trading slightly above or within 5% of the 50-d ma
  • Stocks within 10% of the 200-day moving average (in weaker markets)

Less Important Metrics:

  • Increasing Return on Equity (ROE)
  • Price / Earnings Growth (PEG) – less than 1 is preferable
  • Accumulation/Distribution ratio (up days vs. down days)
  • Up / Down Volume over past several months

Fundamental screeners will scan thousands of stocks narrowing down the universe to a couple dozen to a few hundred each night or weekend. The more bullish the market, the larger the list of stocks will be and vice versa for weak markets. From here, the savvy investor turns to technical analysis to identify “when” and “where” to place a new position for the ideal risk-to-reward ratio.

General Market Metrics & Technical Analysis:

  • Determine if overall market is in a specific trend (up, down or sideways). Use multiple moving averages to quickly determine the trend.
  • Evaluate sister stocks or stocks within the same industry group (strength travels in groups so the probability of success rises when buying into a strong industry).
  • Study the one year weekly chart (preferably candlesticks)
  • Study the six month daily chart (preferably candlesticks)
  • Look for increasing accumulation days (stock up on above average volume)
  • Evaluate the Point & Figure chart for clean support and resistance levels
  • Look for basic chart patterns such as flat bases, cup bases, saucer bases, triangle breakouts, obvious trends along a moving average, etc…
  • Properly forming bases
  • Pivot points
  • Breakout areas
  • Extended stocks
  • Stocks pulling back to key support lines
  • Favorable risk-to-reward setups
  • Check volume action when bases are formed

Market Breadth – Using Screens
It is extremely important to pay attention to the quantity of stocks making your screeners from time to time. The length of the list alone will tell you how healthy or how weak the market currently is, without even checking another factor.

For example, a standard screen of mine searching quality stocks making new highs should be full of candidates during a fresh up-trending market. The list should be full of candidates as long as the trend continues. As soon as this list starts to thin out on a daily and weekly basis, become cautious that the breadth is weakening.

Example of my most successful screens:
When scanning these screens, I will view the stocks in descending order starting with the day’s largest price percentage change and occasionally starting with the day’s largest volume change versus 50-day average.

1. Quality Stocks that are trading within 15% of 52-week Highs

  • Current price is within 15% of the 52-Week High
  • Earnings increasing qtr-over-qtr and year-over-year
  • Relative Price Strength greater than 80% of the general market
  • Current 50-Day Average Volume is at least 100k shares per day
  • % Increase in Volume (Current Day) vs. 50-Day Average Volume: Volume 50% larger than the 50-d average

2. Quality Stocks making New 52-week Highs:

  • Current price is trading at a new 52-Week High
  • Earnings increasing qtr-over-qtr and year-over-year
  • Relative Price Strength greater than 80% of the general market
  • Current 50-Day Average Volume is at least 100k shares per day
  • % Increase in Volume (Current Day) vs. 50-Day Average Volume: Volume 15% larger than the 50-d average

3. Institutional Sponsorship Increasing

  • % of the number of Institutions for Current Quarter vs. Prior Quarter have increased by 10%
  • % of the number of shares owned by Institutions for Current Quarter vs. Prior Quarter have increased by 5%
  • Earnings increasing qtr-over-qtr and year-over-year
  • Relative Price Strength greater than 50% of the general market
  • Current 50-Day Average Volume is at least 100k shares per day

4. Quality Stocks with a new IPO’s within the past two Years

  • Current price is greater than or equal to $10 per share
  • Earnings increasing qtr-over-qtr and year-over-year
  • Relative Price Strength greater than 80% of the general market
  • Market Capitalization is greater than or equal to $100M
  • Current 50-Day Average Volume is at least 50k shares per day
  • % Increase in Volume (Current Day) vs. 50-Day Average Volume: Volume 50% larger than the 50-d average
  • IPO Date within past 5 years (sometimes use 3 years)

Although I run these screens at least once per week, one or two will come into favor while others fall out of favor depending on the market environment or situation. Over time, the strength and weakness of certain screens will also give you a hint as to what the overall market is doing (another breadth signal).

For example, a screen that locates quality stocks making new 52-weeks highs is best used when a market is forming a new up-trend and the overall movement is still fairly fresh. This screen is less important near the end of a strong up-trend because at this point, many of the stocks making new highs are exhausted. The trader will see more failed breakout attempts, reversals and late stage bases so the odds are no longer in favor of this screen.

In strong up-trending markets, one cannot expect to buy every stock that makes the screens so it comes down to developing a risk-to-reward calculation to grab shares in the equities that show the greatest upside.

Lastly, it’s important to understand that no investor is perfect and losses are part of the game when it comes to investing and trading. Most traders will have as many winners as they do losers (using successful screeners) so having sell rules is critical for sustainable success. Learn to cut losses short while letting winners run, no questions asked.

By cutting losses, you account will not blow-up and you will be around to trade another day, especially when your screens are screaming buy!

Identify Market Tops and Bottoms by Doing this, Guaranteed!

Can major market tops and bottoms be identified with accuracy? Yes, they can! And I will present data that will argue that identifying “major” market bottoms is easier than any other change in market direction. Market tops can also be identified but it’s a bit more difficult than bottoms.

No one can guarantee an “exact top or bottom” but this data will pinpoint an overall change in trend. There’s plenty of time to get out of the market before a devastating fall and even more time to jump on a new up-trend after a bottom.

To support my findings, I will use extensive New High and New Low (NH-NL) data extracted from the NYSE in 2008 and 2009. This data phenomenon is not exclusive to the market bottom of 2009 as studies will show the exact, yes exact, same results can be extracted from every other major market bottom stretching back as far as the NH-NL data is available.

New High – New Low data is historically the most accurate indicator for identifying a major change in trend by highlighting extreme readings and the change in underlying market breadth.

The images contained in this article will identify the following data points:

  1. NYSE New Highs: The number of stocks making New Highs on a specific date
  2. NYSE New Lows: The number of stocks making New Lows on a specific date
  3. New High –New Low Differential: This is simply the number of stocks making new highs minus the number of stocks making new lows.
  4. NH-NL 10d Diff: This is a simple 10-day moving average representing the number of stocks making new highs minus the number of stocks making new lows.
  5. NH-NL 30d Diff: This is a simple 30-day moving average representing the number of stocks making new highs minus the number of stocks making new lows.
  6. NH-NL % Ratio: To calculate the percentage correctly, use this formula: (New Highs – New Lows) / (New Highs + New Lows) * 100 = X%
  7. NH-NL % Ratio 10d Ave: This is a simple 10-day moving average representing the percentages listed in the column terms #6 in this list

I follow the progress of stocks making new highs and new lows on the NASDAQ and NYSE and pay specific attention to turning points in the differentials and ratios. I am particularly interested in the extreme highs and lows of the readings, especially after a long trend, as they start to drop hints of an impending change of trend (positive to negative and negative to positive).

The image below shows that New Lows had dominated the market for nearly 18 months when extreme readings started to appear in October 2008. In fact, the readings in October 2008 were the most extreme that my NYSE NH-NL data contains which goes back to the early 1980’s.

010509_NHNL_wkly_18months

October 2008 NH-NL Readings for NYSE:
2008_10 - October

As the second image shows, the daily New Low readings were well above 1,000 with a peak of 2,901 on Friday, October 10, 2008. The market was screaming exhaustion as the selling pressure of the past 18 months was hitting its max. All other readings were in extreme territory including the basic NH-NL differential, the 10d & 30d differentials and the % ratio. The extreme readings continued through the end of November 2008 when they final subsided in December but remained negative.

November 2008 NH-NL Readings for NYSE:
2008_11 - November

December 2008 NH-NL Readings for NYSE:
2008_12 - December

Heading into early 2009, “blood was running in the streets” as Baron Rothschild once declared and most investors had been knocked to their knees while two of the most prestigious investment banking firms in America disappeared. The greatest value investors of all time state that the best time to buy is when this type of extreme environment occurs. The problem with that statement is that it’s based purely on fundamentals and I just can’t blindly jump-in and grab shares without some form of technical guidance. Think about that for a second, blood had been running in the street for the duration of 2008 so I suspect that many value investors were buying and saw more pain before the market decided to turn. Buyers in early to mid 2008 had to endure quite a ride before the market turned up in the spring of 2009. I prefer to catch a trend on the up-swing, not the bottom; besides, pinpointing the exact bottom is virtually impossible.

January 2009 NH-NL Readings for NYSE:
2009_01 - January

Bernard Baruch was quoted as saying: “Don’t try to buy at the bottom and sell at the top. This can’t be done–except by liars.”

January 2009 was much like December 2008 as the market remained negative. Then in February 2009, the market dropped again as the NH-NL readings started to head back towards more extreme levels. However, they didn’t reach the levels of October 2008 so this signified a “higher low” for the readings, a second clue that the market may be looking to reverse direction.

February 2009 NH-NL Readings for NYSE:
2009_02 - February

NH-NL Readings making higher lows for NYSE:
040609_NH_NL_trend change

March 2009 was the turning point. The extreme readings subsided (light red and dark red readings on my graphics) and the FIRST positive reading was registered since May 2008 (represented by “blue figures” on my graphics). On March 26, 2008, the NYSE logged a reading of 10 New Highs and 0 New lows, the first time a “0” New Low reading was logged since February 27, 2004. By contrast, the NYSE logged 11 additional days with “0” New Lows in 2009 and 20 days with “1” New Low for that same year. The year 2008 had one day with “1” New Low and the years 2005, 2006 and 2007 had zero days with “1” New Low. Amazing stats!

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2013 Stock Market Outlook: Buying in a Low Risk Environment

President Barack Obama has been reelected as the President of The United States of America and many investors remain concerned that they don’t know what to expect in the years ahead. None of us have a crystal ball but we can always fall back on reliable charts, indicators and historical analysis to help give us an edge.

Historically speaking, November, December and January are the year’s best three-month span in terms of overall percentage performance for the S&P 500 (data from 1950 through today). Similarly, the NASDAQ is historically best from November through January with an extended positive trend running through to June (data from 1971 through today). The Stock Trader’s Almanac states that the year-end strength comes from corporate and private pension funds.

There are a couple of things to consider before backing up the truck and investing in stocks.
1. Understanding the general economic environment & fiscal policy
2. Understanding technical analysis of the markets to anticipate low risk environments

It is very important to understand that fiscal policy, the taxing and spending power of the Federal Government, may be the most powerful influence affecting the nation’s and many times the world’s economies. Now, Bernanke and The Federal Reserve do not have the power and mechanisms to control movements in money with accuracy over the short term but they often tip their hand and lend a clue for long term performance.

In addition to The Fed, unique cycles occur within markets, such as the 4-year presidential cycle and we know by studying the markets that recessions typically occur in years between presidential elections. With the 2012 election behind us, we will now be headed into that territory; however, we also saw what took place during President Bill Clinton’s second term (boom). So use history as a gauge with relation to what’s happening today and not a full-fledged prediction tool. Macro cycles clearly exist so I suggest you become familiar with their tipping points and seek action when opportunity becomes favorable (I will highlight some techniques below).

Although the Federal Reserve has enacted a policy of near free credit, the private business sector in the United States is deleveraging. It has been argued that the business sector has been accumulating large surpluses of cash reserves since the meltdown of 2008-09. One can argue that this deleveraging is responsible for the poor economic activity over the past several years. American businesses and individuals to some extent are more concerned about repaying their debts than discretionary spending. This is the main reason why The Fed’s generous monetary policies have been mostly ineffective.

Some analysts have suggested that the deleveraging (debt reduction) may continue for another 4-5 years which would extend the length of Obama’s entire second term. If that is the case, interest rates should remain low and prove that additional stimulus will provide little to no spark to an already sluggish economy. I don’t know how unemployment will turn out but it benefits us all if these figures improve so consumer spending can edge higher thus creating further job opportunities.

Will we face a period of hyperinflation or complete deflation? I don’t know and I can’t lead my life based on “possible doomsday scenarios”.

One may believe that I am tilting to the bearish side on the macro perspective of the market but that is not the case because there are two sides to investing: Fundamentals and Technicals. Up-trends and down-trends will form in the market regardless of marco bear and bull cycles. So, I will keep investing in strong American companies via the stock market regardless of any pending “fiscal cliffs”. As far as the fiscal cliff is concerned, I’d like to believe that Washington will figure something out, at least in the near term (next several years). It behooves us all.

Moving on, investors should know approximately when to expect opportunities to buy stocks at relatively low risk by using technical analysis to recognize these opportunities. The fundamentals usually point us towards “what” while the technicals usually tell us “when”. In buying young, innovative and profitable American companies, I am looking at holding their shares from anywhere between 6 and 36 months. Ideally, the average position will last from 6-18 months as I am not in the business of trading or flipping for a quick profit. I have a full time career so short term focus on the market is kept to a minimum these days.

As highlighted in the past (on this blog), we must look towards a few simple charts that will give all investors a fantastic risk vs. reward setup/ signal. By following these simple charts, any investor should be able to consistently outperform the market (buy when the market is deeply depressed and sell when it becomes over-bought). Please keep in mind that these signals are for longer term investors as they only appear once every year or so.

The three charts represent the following:

1. The % of stocks above the 200-day moving average for the NASDAQ
2. The % of stocks above the 50-day moving average for the S&P 500.
3. The % of stocks above the 50-day moving average for the NASDAQ

I consider this first chart the most powerful of the three (because of the sheer magnitude of the weakness or strength charted among individual securities) for gauging the overall risk level for accumulating shares in the market. The chart highlights the NASDAQ percent of stocks above the 200-day moving average. It is a rare occurrence when only 5%-15% of all stocks are trading above their 200-day moving average on one or more of the majors indices. Think about that for a moment, the idea of having 85%+ of all stocks trading below their respective 200-day moving average. This level of depression shows that the market is likely close to a bottom and is providing a nice risk-to-reward accumulating opportunity.

The levels reached in late 2008 and 2009 were near historical lows and provided one of the best opportunities to accumulate shares in recent memory. In fact, the percentage of stocks trading above their respective 200-day moving averages (on the NASDAQ) in late 2002-2003 only fell as low as 12.29%. As you can see on this chart, the levels reached in 2008 and 2009 went as low as 5.23%. In other words, nearly 95% of all NASDAQ stocks were below their 200-day moving averages. If that doesn’t scream buy, I don’t know what does.

By using the second chart, we are looking for the S&P 500 percent of stocks above the 50-day moving average to cross below the “20%” oversold level. Historically, this is a level that signals a lower risk environment to commence accumulating shares in leading stocks. Please note that oversold levels for the general market can last for a period of several months so please be patient with your buys. Investors do not have to buy as soon as this level is breached and the summer of 2011 serves as a nice example.

Similar to the second chart, the NASDAQ percent of stocks above the 50-day moving average also triggers a nice risk-to-reward environment for accumulating shares. The investor would be wise to start accumulating shares when the percentage of stocks drops below the “10%” oversold level. Late 2008 through early 2009 and the summer of 2011 serve as the most recent examples.

With the above in mind, continue to monitor these charts and have the courage to buy when “blood is running in the street”. Investors must have the courage and intelligence to buy when markets are beaten down and individual securities are collectively trading near lows. A completely separate post would be required to discuss “which stocks” to buy at these depressed levels but a quick rule of thumb is to focus on the market leaders, ones showing strong relative strength and earnings growth.

Looking at the current readings on all three of these charts, I can confidently venture to say that we are not in the prime low risk accumulation phase of the market. We appear to be heading in that direction but we are nowhere near a major bottom. Keep an eye on fiscal policy, economic indicators such as unemployment, consumer spending and the three charts above. By doing this, every investor should be prepared to accumulate shares in a favorable, low risk environment.

Corrections Take Time, Be Patient

As I surf the twitter and blog world tonight, I see an unusual number of people claiming a market bottom based on “historical readings” among many of the secondary indicators.

Several of my indicators are also starting to enter those same levels but what many are failing to realize is that the market can take several months to complete a full correction and reach a bottom.

See below for the most recent two year chart with individual corrections for both of the recent bottoms in 2010 and 2011 (highlighted below the 20% figure).

As you can see in 2011, the secondary indicator started to flash “bottom” signals in June but the market didn’t complete its volatile correction until September.

In the summer of 2010, the secondary indicator started to flash “bottom” signals in May but the market didn’t complete its correction until July, two full months of up-and-down action.

The lesson: 2012’s secondary indicators started to FLASH a market bottom last Friday, for the FIRST time. Based on past corrections (going back a decade), this will only be the start of a volatile period of up-and-down action that could last several months (the swings can be greater than 10%). Be Patient!