Forewarned is Forearmed: "Traders' Remorse" and the "Inflation Trade"

"Traders' Remorse" is a term I've used several times recently but don't think I ever fully explained or demonstrated it before. Given what I see evolving among stocks of the old "inflation trade" and what I believe the S&P 500 Index will do soon after it crosses above the neckline of the inverted head+shoulder that goes back to October, 2008, it seems apropos to do so now. Moreover, some believe that the conclusion of the "traders' remorse" correction is actually the best time to initiate a purchase.

Quoting an excellent description from MetaQuotes Software:

"After a support/resistance level has been broken through, it is common for traders to ask themselves to what extent new prices represent the facts. For example, after a breakout above/(below) a resistance/(support) level, buyers/(sellers) may question the validity of the new price and may decide to sell/(buy). This creates a phenomenon that is referred to as "traders’ remorse": prices return to a resistance/(support) level following a price break through.

Price action following this remorseful period is crucial:

• either the consensus of expectations will be that the new price is not warranted, in which case prices will move back to their previous level, classic "bull or bear traps" (or false breakouts) where or
• investors expectations may change causing the new price to be accepted, in which case prices will continue to move in the direction of the break through.

A good way to quantify expectations following a breakout is with the volume associated with the price breakout.

• If prices break through the support/resistance level with a large increase in volume and the traders’ remorse period is on relatively low volume, it implies that the new expectations will rule (a minority of investors are remorseful) or
• Conversely, if the breakout is on moderate volume and the "remorseful" period is on increased volume, it implies that very few investor expectations have changed and a return to the original expectations (i.e., original prices) is warranted."

Remember when everyone was talking about the emerging world economies generating new demand on all commodities pushing those stocks up dramatically? What happened then was that everyone started second guessing the assumptions and prices started to falter.

Individual stocks will act differently producing a wide range of chart patterns-but each is a valid example of "traders' remorse". Stocks may form an "inverted saucer", a horizontal channel, a symmetrical triangle, a descending flag. Name it, you'll see it; but they all mean the same thing:

• AKS (AK Steel)
• MTL (Mechel Steel)
• ANR(Alpha Natural Resources)
• STP (Suntech)
• PAL (N.A. Palladium)
• ATI (Allegheny Tech)
• BUCY (Bucyrus)

I look at hundreds of charts daily and could find many more (most of these are from the Spreadsheet list of ). If you're in a stock that experiences traders' remorse, don't panic; if you're not in one of these stocks, remember it's the best time to get in.

"That's All Folks"

Wow, what an opening this morning. Fifteen minutes into trading and the S&P is up 1.54%. As far as the head-and-shoulders top everyone was talking about last week, well, as Porky Pig used to say "That's all folks!"

The neckline for my long-term inverted head-and-shoulder (see "Market Future is in Eyes of the Beholder") at 950 is only 3.2% higher than the current 920. I thought we'd cross above around Labor Day but it could be earlier. On this score, however, I've willing to be proven wrong.

This is getting exciting. Stay tuned. (I hope I'm not going way out on a limb, that it's not wishful thinking and that the market won't disappoint again.)

Following the Herd to New Heights

Here are two quotes, guiding lights, that if you copy them down and post them over the monitor of your computer or trading station will never fail you:

1. "50% of a stock’s price movement can be attributed to the overall movement in the market, 30% to the movement in its sector and only 20% on its own". The saying comes from a dissertation paper written in the 1960's by a graduate student at the University of Chicago, Benjamin F. King. I came across it early last year, just as the Bear Market was starting and quoted it several times last year throughout the year. Adhering to it's message enabled me (us) to avoid getting sucked into the market is it metamorphosed into the worst Crash in 70 years.
2. "Buy high, sell higher." This principal applies to stocks making new highs and works better in some markets than others. As I've written frequently here before, I think the market's on the verge of transition from Accumulation phase to the Mark-up phase of a typlical life cycle. It's in early stages of the Accumulation phase, when the market is clearly in an upward trend, that this stock selection technique works best.

I make no attempt to hide the fact that I'm basically a momentum trader/investor. I like to buy stocks where the herd's already begun moving the stock up rather than hope for a big score by buying a stock that's at the bottom of its trading range and may, or may not, turn back up. If the market does come through with completing the formation of my long-term inverted head-and-shoulders pattern, then this is the perfect time to start running with the herd by buying stocks that are moving to new highs.

I haven't updated these market report card statistics for a few weeks (click image to enlarge):

I've selected 5 prior periods when the S&P 500 was at approximately the same as today's close. While the most sensitive crossover (the 90-day) has deteriorated (today 68.74% of stocks having crossed over down from 86% on June 5), the number of stocks with Golden Crosses and Bull Crosses has continued to grow.

I've added 5 new pieces of information at the top half of the table: the number of stocks hitting 1, 2, 3, 4, or 5 year new highs. New highs, especially those approaching all-time new high status, are a fertile ground for finding stocks with real momentum, especially when in sync with the market's upward momentum. Note: Stocks that recently started trading (4 years or less) become especially strong momentum stocks [a prime source for stocks on IBD's 100 or New America lists]. However, a 3 year-old stock making new highs will only be on the 1, 2 and 3 year list - not the 4 or 5 year new high lists.

Take, for example, the following:

• SNX (Synnex): In all likelihood, the stock may suffer traders' remorse and soon consolidate, retreating back to the 24-26 area but, after that, with a strong market tailwind could shoot up to new heights.
• RDEA (Ardea Biosciences)Another relatively new IPO that's forging new high ground territory. It, too, may soon consolidate in a traders' remorse consolidation but soon afterward could be propelled to much higher levels.
• LL (Lumber Liquidators)LL has made a new 12-month high and is within a hairs breadth of a new all-time (albeit 2-year) new high. LL also has an excellent volume accumulation pattern.
• CTB (Cooper Tire):Not only has CTB made a new 12-month high, it has also completed a near perfect inverted head-and-shoulder pattern (mirroring what I hope will happen at the overall market level as reflected in the S&P 500).

I'll post a Google spreadsheet listing them when the new high lists begin to generate some week-to-week consistency.

Market Future is in Eyes of the Beholder

I confess, chart reading is somewhat of an art form, something that improves with practice. Chart patterns are clearly in the eyes of the beholders. Take 5 chartists, stick the same chart in from of them and you'll probably get 5 different responses. The criticism isn't as much about delineating and defining the patterns carved out in the price movement of stocks or indexes, as it is about the interpretation of what those familiar patterns portend for the future. And perhaps it's not even so much the interpretations as it is in how precisely the conclusion is articulated and communicated.

That's what drives most fundamental analysts crazy and why they place technical analysis on a par with astrology or tarot car reading. Take for example all the discussion over the past couple of weeks about the head and shoulders pattern seen in the action of the S&P 500 since May:

We're all familiar with it by now. It seems so obvious: the head and shoulders formation portends a decline of around 8% from current levels to approximately 820. The Bears point to this chart as reflective of the cascade of bad economic and financial news that continues piling up here and around the world. One look at the headlines (see RealClearMarkets.com) about an impending commercial real estate meltdown, the new taxes for healthcare reform or energy usage looming or the budget crises in state and local governments and you're sure this head and shoulders might be the last you'll ever see again.

But here's a view that you probably haven't seen before:

When it served their purposes, the Bears trotted out one of their favorite patterns, the rising wedge. Towards the end of 2008, before we knew there would be a March meltdown, much was written, correctly I should add, about another leg down after the Lehman bankruptcy in September followed by talk of the auto industry collapse that would carry the market to the the mid-400's on the S&P and 4000's on the Dow (I'm not sure I have the numbers correct but it was a pretty scary time).

When the market rallied off a "bottom" in March, most were calling it a suckers' rally, a bear trap. The Bears pencilled in a second rising wedge portending another final decline to their ultimate and illusive goal of Dow 4000 (see MarketWatch video of Peter Eliades predicting 4000). And the Fundamentalists call technical analysis reading tea leaves?

But something happened in April and May. There was all the "green shoots" talk, the market firmed and the decline to 4000 was averted - or delayed. If you look at the most recent period you'll see I drew in a bullish flag, a downward-sloping channel cutting across the previous uptrend. The flag straddles the 200-day moving average indicating an unwillingness for the market to give up that easily on having crossed above that indicator. I don't believe I've seen anybody else picking this up yet but they will if the head-and-shoulder above fails to deliver the anticipated decline.

And then there's my favorite, the longer term inverted head and should pattern that stretches back to those awful days last winter:

This is the one the bulls like. It clearly supports the notion that most of the bad news has already been priced into the market, the rate of decline has moderated, comparisons against prior year are improving and that the effects of the economic stimulus package (a.k.a., massive government deficit spending) will start showing up even though there's a lot of debate on the need for a follow-up, second package (because the first one was poorly designed and isn't working).

The Pause the Refreshes , a/k/a Traders' Remorse

The bears continue to try scaring you into thinking that we've seen the best we're going to see this year and it's going to be all down hill from here, back to the low 800's or even 700's (the bear market bottom) on the S&P.

What these perennial pessimists fail to understand is that all markets, whether trending higher or lower, periodically need to pause, catch their breath, marshal their strength before continuing in the direction they were determined to head in the first place.

O.K., the S&P 500 Index has retreated nearly 7% from the 946 peak on June 12 but this is exactly what we were all calling for since early May, the 6th to be exact. Actually, we reiterated the view on June 23 by specifying a decline to 800-810 by Labor Day. So the past couple of weeks has been uncomfortable and cost some money, but so far it's just about as expected.

As I see it, the market's correction so far is too tame to signal the end of the world - again. In fact, the Index along with many stocks are showing typical signs of fatigue, not collapse. They are either hugging a resistance trendline, bouncing up against a longer-term moving averages or demonstrating a typical case of traders' remorse by giving up the breakout move and returning to resistance (nee support) trendlines. Here are several examples:

• XLF (Financial Sector ETF) - hugging the 200-DMA as it forms the right shoulder of an inverted H&S pattern, gathering strength to break above the neckline:
• NS (Nustar Energy) - after forming a inverted head & shoulder bottom and successfully crossing over the neckline, stock is now retreating in typical traders' remorse fashion back to neckline to test its support.
• VSEA (Varian Semiconductor Equip) - After successfully crossing above neckline of double bottom, stock is hugging the bottom of 300-day MA in the form of a symmetrical triangle.

These stocks are only examples and I could have selected many others; as I peruse hundreds of stock charts every day, a large percentage of them look similar. Rather than being dismayed, I'm excited that the long-awaited correction has arrived. As the final hurdle to a full-fledged bull market, the 300-day moving average, comes within striking distance, some missed opportunities will be brought back into line. Hopefully, sometime around Labor Day, the market will finally issue an all-clear, all-in signal.

But Which Semiconductor Stocks?

When the market's trend turns back up again, which industry group will lead? Well, if you read or hear many of the "talking heads", the near unanimous, uproarious answer seems to center on tech and, more specifically, the semiconductor industry.

Most of us who've been in the market for a while know that the industry's performance has been anything by lackluster since the Tech Bubble Crash of 2000-2003. For example, INTC (Intel), one of the icon of that period, is still just 25% of its value nine years ago; the same for TXN (Texas Instruments; BRCM (Broadcom) is only 14% of its value then.

With each recovery since - in 2003 and 2005 and, now, 2009 - the hope lands again on the semiconductor industry. But how has the sector recently performed history. One way to measure their performance is to look at the industries' ranking among the 197 IBD Industry Groups:

• Semiconductor-Equipment
• Semiconductor-Manufacturing
• Semiconductor-Equipment

What these graphs show the performance of the three industries relative all the others. What you see is that the groups remained at the top for only a few months before other groups started displacing them in their top ranking. But if you were to look at the charts of individual stocks, you'd see that most have much repair work left. There are over 170 stocks in the three groups combined. So which look most likely to deliver extended moves and significant percentage appreciation. There's many to pick from but here are a few that I'd take a flier on:

• VSEA (Varian Semi)
• LRCX (Lam Research)
• FORM (Formfactor)
• ASMI (ASM International)
• NVDA (NVDIA)
• ASML (ASML)
• TRID (Trident)
• DSPG (Dsp Group)
• MU (Micron)

Only my humble opinion but these are the stocks I'm going to be focusing on when the next upleg begins.

Aiming for Dividends + Appreciation with REITs and Pipelines

Hope everyone had a wonderful 4th of July weekend holiday. I know we did because it was probably the first weekend without rain in about 3 months and, this morning, the sun's shinning, the sky's blue .... how bad could life be?

And then, of course, there's the stock market. The correction everyone expected back in May and early June (see "Is it déjà vu or something new") seems to have finally arrived:

"We're now stuck with the toughest question in stock market investing/trading - when should you sell? Accepting the proposition of a 10% market correction to around 800-810, what should we do with stocks we now own?.....More importantly, the question you should ask yourself is whether there are strong, compelling reasons to not sell a stock......

As a general rule, I would say that market direction and momentum rules; if the market is starting to trend down, you should sell nearly everything.... Because you think it's a good company, pays a good dividend, you already own it and believe it will come back or because Cramer just mentioned it on his show are not good enough reasons to continue holding a stock......

I know this sounds extremely conservative, some might even call it pessimistic. But I'm actually quite optimistic. I, like many others, have been waiting on the sidelines and are anxious to jump in with both feet. There are reports of huge amounts in money market accounts waiting for just that opportunity."

Those who claim to see an emerging right shoulder to a h-and-s top and those who see it in an inverted h-and-s bottom (see "Half-Full or Half-Empty Views: A Head and Shoulder Market Top?") are both going to be right. It'll be a long, trying summer fending off the shouts of the bears claiming vindication in their warnings back in April of a "suckers' rally. Also, the naysayers will harkening back to the notion that the economy is following the 1930's Depression-style market pattern.

What most gives me agita are claims that the end to the era of living off of asset price appreciation has arrived. No more counting on your house appreciation for retirement, no more for selling hand-me-downs and junk on eBay for exorbitant prices and .... here comes the bad news ..... no more 15-20% per year appreciation in your portfolio. Just look at the volatility in prices for individual stocks in the July-March period vs. the volatility for those same stocks since March. The left shoulder of the inverted head-and-shoulders last November might have been 25% (from 980 to 750) but I'll bet that the right shoulder will be between 10-15% due merely because of less volatility.

So what's the strategy? Adding dividends to the total return calculation. While I, for one, would rather catch a stock's 10-20% move up than collect $.25 in quarterly dividends off a $40 stock, having both dividend and price appreciation is like having your cake and eating it too (beating the birthday theme to death). So begins the quest for high dividends with price appreciation potential.

And what better place to begin the search than with REITs, natural gas pipelines and utilities. Many of these stocks have been beaten down in this Crash so their dividend yields are quite good; if the economy does show any signs of bottoming out, then the risk of dividend cuts at this late stage in the recession should also be reduced. Up the upside, many of the stocks are in the late stages forming excellent reversal patterns similar to the patterns of stocks included on the spreadsheet lists posted here earlier (like the stocks with bullish perfect moving average alignments). A spreadsheet list of 37 candidates (including dividend yield and volatility as indicated by Telechart) is available by clicking here. Examples include:

• REITs
  • SUI (Sun Communities)
  • NLY (Annaly Cap Mortgage)
  • MFA (MFA Financial)
• Pipelines
  • BWP (Broadwalk Pipeline)
  • MMLP (Martin Midstream Partners)
  • TPP (Teppco Partners)

Life might get less exciting but, just perhaps, we'll wind up at the same bottom line.

Four Candles on the Birthday Cake

Can't believe it but this blog has aged another year; we're now 4 years old. Over the past year, I've added 210 posts; since the beginning, four years age, the number is around 500 (I started deleting the first year's posts last year). In case you're interested, you can see all this years posts, including the number of comments and their tags by clicking here and all of them can be accessed through the archive which is under the Google search box on the right.

It's been an exciting year to say the least. I most proud of the fact that I warned you all through the year to stay heavily in cash with such posts as:

• 7/20/2008: The Dow at 7,200?
• 9/12/2008: When Will Market Predictability Return
• 10/6/2008: Final Leg Down Begins
• 10/24/2008: Lessons From Past Crashes and Recoveries Out of Them

But I alerted you to the approaching bottom and offered some strategies for playing it while still staying safe:

• 11/15/2008: Those "Perpetual, In-the-Money Call Options"
• 11/26/2008: Golden Cross and OBV: An Update
• 12/14/2008: What Does 2009 Look Like From This Vantage Point
• 2/8/2009: More Stocks with Basing Chart Patterns
• 3/19/2009: The Debate is Settled: The Market Has Hit Bottom
• 4/17/2009: The Next Industrial Revolution
• 5/9/2009: Comparing Market Crash Bottoms: 1975, 2003 and 2009
• 5/20/2009: U.S. Stocks: The World's Laggards

I've had fun tweaking Cramer about his ridicule of charting through some of his lamest calls. I admit to have a couple of misses too but you'll have to find them on the list yourselves .... I'm not going to list them here. The most fun has been in being able to expound on my view of how I chart so that you can do it yourself.

Heard Bill Gross of Pimco saying this morning that people have seen the end of living off of the rise in the value of their assets; I hope he's merely "selling his own book" as they say because dividends trying to live off dividends is tough and boring. Being an optomist, my view is we'll survive an otherwise uneventful summer together and come out the other end, around Labor Day with renewed confidence, the completion of the inverted head-and-shoulder reversal pattern of this market bottom and the long awaited break above its neckline.

In the meantime, thank you for reading, your questions and comments and your support. Let's all make money together.

Half-Full or Half-Empty Views: A Head and Shoulder Market Top?

A regular reader and friend of this blog asked "...is a head and shoulders top forming in SPY?" It's a relevant and important question for two reasons: it addresses the market's future direction and it focuses on chart reading techniques. Not being one for short, quick, direct answers, I'm going to take the opportunity of having been asked it, if you'll indulge me, to get on my soapbox and expound a bit.

This is a glass-half-full or glass-half-empty sort of discussion. I've read elsewhere from other bloggers (DistressedVolatility, BullzandBearz) that based on their view the market is forming a head-and-shoulder reversal top pattern:

The right shoulder of this pattern hasn't yet been fully formed but those who talk of a head-and-shoulder top say so because of the need for a correction/consolidation of the 35% increase from March 9 (remember, long ago, in days of yore, a 35% increase over two years rather than two months, would have been considered a fabulous and rare bull market).

Perhaps they're right and, if so, traditional chart reading dictates that the neckline represents the midpoint between the top of the head and the bottom of the correction move (or a bottom of 892/944 x 892 = 843). Hence the often quoted number of 850 as the target of a downside move (a number also thrown out, coincidentally, by those who measure Fibonacci lines).

On the other hand, I'm a longer-term trend trader. Rather than seeing something negative in the above chart, I see something quite the opposite. If it comes about, I see the move down as the right shoulder of another head-and-shoulder pattern, one that's inverse (upside down):

Of course, I'm partial to my interpretation because I have more opportunities to be correct. There's no clear-cut requirement is for a right shoulder. The preference, of course, is to have it match in time and scale the left shoulder. But (and this is what it now looks to me like) it can turn out to be shorter and shallower due to the strength of the market driven by the sidelines money waiting to be invested.

I'm also partial to mine because it's within a context of market momentum as measured by moving averages (and as you know, I use four). An 850 target is possible over the summer until around Labor Day and market momentum (the 180- and 90-day moving averages) would remain in tact and not violated.

One chart, two views. One sees a lack of direction and sideways movement since the beginning of May, the other sees a lack of direction and sideways movement since last October. And I'm sure each of you could see a host of other possible future outcomes. But that's what makes the market so challenging ..... and fun (when it stops being fun, like last year, I stop playing, take my marbles and go home).

What strategy conforms to the longer-term view? Because the market is still risky in the short run so it's to continue sitting on the sidelines, waiting for the market's next phase to begin (when it crosses above my neckline). When that happens, it will be time to jump in with both feet and not be overly concerned about world coming to an end.

Panning for Nuggets

Most don't understand that perhaps the best use for technical analysis (charts) isn't to predict; I believe the best tool for charts is enhancing timing. Charts don't necessarily tell you which direction a stock or an Index will move or where it will be in six months. But what charts do is to help you to see and understand when a stock or an Index has gained sufficient momentum to initiate a significant directional move.

So we're sitting around these days while the Market trys to figure out which direction it wants to go. Since early May, most have been waiting for a correction to begin after the 35% move up from the March lows. But each time the Market retreated, buying volume entered as support. The S&P 500 is still above the traditional 200-day moving average. But more significantly, its ability to hold its ground has allowed the 180-day moving average to start to turn up along with the 60- and 90-day moving averages.

About the best thing to do these days is to go prospecting. It's been about a month since reporting to you my metrics of the market's internal health. These statistics concern the number and extent of stocks developing upward momentum as measured by a number of moving averages of their prices.

I began monitoring these metrics in January (click here) as we followed the Market's improving health. This week, I'm adding two new metrics - stocks making new covering the past 200 days (approximately the past year) and the number of stocks making high highs covering the past 1000 days (approximately the past 4 years-one reason the number is lower is that stocks that began trading within the last 4 years are excluded since they don't have a 1000-day moving average). Until a couple of weeks ago, almost no stocks had advanced enough to register a new high. The statistics are (as always, click to enlarge):

Why are these metrics important? Because one school of thought about momentum trading is that the key to making money in the market is to "buy high and sell higher" rather than to "buy low and sell high". This strategy is especially powerful when the market is in the Mark-up Phase of its life cycle (see October 17) and I believe we're at the cusp of transitioning from the Accumulation to the Mark-up Phases. It will be interesting to see if these numbers grow.

I consider stocks making new highs to be in the vanguard. Each criteria is increasingly more difficult to meet: 12-month new high, 4-year new high, bullishly aligned moving averages. They're stocks that are leading the rest of the 6000 or so stocks to virgin new high territory. They are in the envious position of having few owners that show losses from in their positions. But which are these leading stocks? I've created a spreadsheet as of last Friday's close (click here) listing these stocks and indicating which of the criteria they met (along with noting the 36 that are in IBD's 100 leading stocks).

One example is PALM one of the few stocks that has had a bullish cross since April along with registering yearly new highs; it recently notched a 4 year new high:

There's no way to tell if Palm's seven-fold appreciation will continue and, if so, how far momentum will carry it (traditional technical analysis indicates the trendline represents the half-way mark, after a buyers remorse correction back to test the trendline as support).

I wish I had spotted PALM back in April; heavens knows there was enough conversation concerning its new PRE phone. I missed it but that's the beauty of the market: there's always another nugget out there to find, it's just knowing where to look and how to spot them. Could it be SPPI, VIT, SNTS, LZR, CKSW, FRPT or LCI. I hope this list will be a way for you to begin.