When the markets consolidate, many traders lose focus. Some lose sight of this fact and continue to trade as though nothing has changed. The end result is, more losing trades than winning, for those traders not using a strategy. We are currently consolidating, so we need to approach the markets differently.
Considering the state of the markets, it is important to understand how we’ve changed in the past few weeks. We have been taking smaller positions, on fewer trades and have recently been trading more “weekly” income trades. When the trend resumes, if its bullish, we can increase or size, number of positions and add more long term “income trades.” Additionally, we have not added to long equity exposure in our 401(k).
Are we about to rollover?
Let’s examine the context in our current market environment.
Nasdaq gained 18.32% since the November nadir. It has since closed at the ascending 50ma, giving back 2.33%, as of Friday. That’s not bad, all things considered. Still, the market has literally gone nowhere, since Valentines Day. The market is consolidating the November gains.
We should push higher, however we need to see the clues first. We don’t need to act hastily and put money to work before a new trend emerges.
The chart above illustrates the Ichimoku Kinko Hyo trading system. This method is used for trend following. Since we currently have no trend, we can only look to it to measure support.
Where is support?
The two lines near price are, tenkan-sen and kujun-sen. These two are similar to traditional moving averages. Where differences occur, can be better explained in video format. Click the link.
“One glance” is the literal translation of Ichimoku. As we can clearly see, price is fading back to kumo (the cloud) and should provide support.
Are we about to bounce?
Ichimoku doesn’t tell us if we will bounce, so we look to our second method for answering that question.
Let’s analyze the Aroon Indicator. This method uses time relative to price, exactly the opposite of typical momentum oscillators.
A short explanation and example will help us interpret the Aroon chart.
A surge above 100 in November was very clear, as Aroon told us to anticipate a new trend was emerging.
There are three stages to an emerging trend signal. First, the Aroon lines will cross. Second, the Aroon lines will cross above or move below 50. Third, one of the Aroon lines will reach 100. All three occurred in November, to signal a new bullish trend. When the green line stayed above 70, it confirmed the trend was strong.
What about now?
If you’re bearish, the second part of our answer will be confirmed if 1) the red line pushes back above 100 this week and 2) the green line crosses down, followed by 3) a cross below the 50 line.
If you’re bullish, we need to see the opposite. 1) the red line will continue to drop below 50 this week and 2) the green line will remain above 70.
Having read this post, you’re probably thinking, so what do I do now? The simple answer is what I’ve been saying over the past couple of weeks. Smaller positions, fewer trades, cut losses fast and wait for direction.
If you are trading in a 401(k) or IRA, odds favor a fade of the extremes presented in the VIX:VXV ratio last week. To put it another way, risk is higher now, so trade smaller and cut losses quickly. If the hook seen in VIX:VXV Friday continues lower, that’s bullish. Look for a bounce.
Here is a caveat. The news this weekend could produce more anxiety, where institutions get nervous and VIX:VXV spikes higher as a result.
Lot’s of moving parts, translates into “trade smaller, trade fewer.” Reduce your risk.
In summary, we highlight a few points to understand.
First, we will not “add” to existing positions until we see evidence that the November trend is resuming. That means, Aaron “Up” (green line) will remain elevated. Aaron “Down” red line will drop. Anything other than this scenario means we have to reassess and reanalyze.
Second, if VIX:VXV fades and the bond stock ratio continues to drop, “The Big Picture” is more bullish than bearish, albeit with weighted volatility. Then remember to watch Junk bonds and High Yield for direction. Should they continue higher we will remain bullish. Crude should bounce as well.
Third, If any of these move in the opposite direction, we expect to see price, Ichimoku and Aroon all say the same thing.
In summary. We are at a decision point. What institutions do next will determine the short term.
Study the IBD50. Many of these stocks look like distribution after hands gains. Six look bullish, BIVV, DY, ELLI, MOMO, and PRAH. In contrast, PCLN could see more downside if airlines see more fallout over the UAL debacle. It looks suspiciously bearish. The rest of the IBD50 this week look more bearish than bullish. Thats a problem.
Happy Tax Weekend.
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