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Sunday Thoughts for July 20th 2008

From Investopedia:

BEAR MARKET

A market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment to be self-sustaining. As investors anticipate losses in a bear market, selling continues, which then creates further pessimism. Although figures can vary, for many a downturn of 20% or more in multiple broad market indexes, such as the Dow Jones Industrial Average (DJIA) or Standard & Poor’s 500 Index (S&P 500), over at least a two-month period, is considered an entry into a bear market..

BULL MARKET

A financial market of a group of securities in which prices are rising or are expected to rise. The term "bull market" is most often used to refer to the stock market, but can be applied to anything that is traded, such as bonds, currencies and commodities.

Bull markets are characterized by optimism, investor confidence and expectations that strong results will continue. It’s difficult to predict consistently when the trends in the market will change. Part of the difficulty is that psychological effects and speculation may sometimes play a large role in the markets.

The use of "bull" and "bear" to describe markets comes from the way the animals attack their opponents. A bull thrusts its horns up into the air while a bear swipes its paws down. These actions are metaphors for the movement of a market. If the trend is up, it’s a bull market. If the trend is down, it’s a bear market.

The criteria used for making a claim of a bull or bear market varies greatly between technical analysts and fundamental analysts. Even within each side their are differing opinions of what the guidelines are. One thing that has never changed throughout time is the battle between the two types of analysts.

Back in November 2007 we said that we were heading into a bear market. For us, it was mostly based on a technical analysis methodology but we were also using fundamental analysis of economic trends to add clarity to our view. Economic conditions, when viewed as trends showed us (and still do) that the fundamentals of the economy would deteriorate further and the charts were beginning to give us the warning signs that a long bear market would be upon us.

In the stock market nothing goes in one direction in a straight line. In a bear market there will always be periods where the declines stop and a rise begins. For each respite in the down ward selling the talk always turns to "is this it?, "Is this the bottom?", or "time to load the boat". In a bear market whenever there is an upward price rally we call it a "bear market rally". Meaning it is a rally within a bear market. The most important thing for traders and investors is to never fight the primary trend. As Jesse Livermore often said "Don’t fight the Trend".

In other words, if the primary trend of the market is down, then the smartest trades are those that are profitable to the downside. Wait for resistance levels to be reached on each rally attempt and short them. As long as the primary trend in the broad indices is down, then so to should ones trading game plan. Day traders can pick up some juicy plays on the long side in a bear market rally, but a majority of the professionals who trade day after day will adhere to the primary trend. Bear market means holding long positions for anything more than a few days becomes VERY risky. Where the primary trend of the market is bullish the opposite becomes true which is holding shorts for anything more than a few days becomes risky.

There are multiple methods to determine bear or bull market. One of the oldest is the Dow Theory developed by Charles Dow in the early part of the 1900’s. Dow theory is simply the trends of both the Dow Industrials and the Dow Transport indices. For a bear market to be claimed both indices must decline and establish lower lows. In reverse, for a Dow theory bull signal both indices must establish higher lows and exceed the previous sell signal points. But, both indices have to meet the criteria for the signal to be valid. If only one of the two indices advances while the other does not then that is not a bull signal. At this time we remain in a Dow theory ’sell signal’

Other methods used are moving averages. On multi year charts the interaction between two moving averages can provide insight into the markets trend. For example, on a multi year weekly chart you can plot the 20 week and 80 week moving averages and when the two cross it signals a potential trend change.

 

 

 

 

 

 

 

 

 

Multi Year Weekly Chart with 20 and 80 week moving averages plotted. Cross over points are highlighted.

 

Another method is to simply know where the primary trend is in any market direction. And the break of that primary trend line is a technical indication of a possible trend change. In the chart below you can see that the primary trend remains slanted downward. As Jesse Livermore would say here "It’s a bear market you know".

 

 

 

 

 

 

 

 

Primary Bear Market Trend Line

 

Anyone who adjusts their trading system based on a ‘perceived bottom’ is someone who takes high risks. Those who seek the absolute greatest returns and want it "now" are those who will bet heavily on any short term market change. "Hoping" to be getting in at the bottom is not a sound investment strategy. Confirmation is key to any trading plan. A trend is in effect until it is broken.

One issue that is concerning regarding the S&P 500 Index is the double top.

 

 

 

 

 

 

 

S&P 500 showing double top pattern

 

For the S&P 500 to be truly in a new bull market the index needs to break above the double top line and move into new highs territory.

I received an email asking how I trade and what I look at on my trading screens. For a trader it is always important to keep an eye on the past while you make your trades. For example, the image below is a typical trading window I use when I am watching for a trade to present itself. For swing traders and day traders you must always know where trends and support/resistance levels are on longer term charts when you decide to make a trade while watching the short term intra day charts. For me I always watch the weekly, daily, and the 5 minute chart of the same stock. I will often change the daily chart to a 60 minute view to gain another perspective before I make my decision. On another monitor I keep the primary indices and the major sector charts. If your deciding to trade Oracle (ORCL) for example as a short on a trend line failure but the Nasdaq index is breaking upwards out of a trend then your chances of a successful trade are reduced. Always keep an eye on the big picture.

I run four 22" monitors for my trading platform. But remember I am monitoring many more things so that we can keep you up to date on our views of the market. Most traders should be fine with two monitors in order to make life easier. Trying to keep everything all confined to one monitor could be a bit much.

 

 

 

A little hard to see as I had to shrink the image to fit the blog, but you get the idea. This example is my typical trading setup for stocks. It includes the Weekly, Daily, and intra day 5 minute charts, plus level 2 data.

 

Earnings season gets cooking this week with many companies slated to issue this week. On tap for tomorrow:

Before the Open: ALDN, AME, ASTE, BAC, CACH, CRNT, DSL, GBE, HAS, HIFN, RX, MRK, NVR, PETS, RPM, SAY, SGP, UB, WFT.

After the Close: ALB, AMLN, AAPL, ARTC, BSX, CNI, CX, EXP, EFX, RE, FNB, FWRD, HPC, HXL, LNCR, LOGI, MSPD, MHK, OMCL, OMI, PKG, PGI, QLGC, RGA, SNDK, SFG, STLD, TXN, VRTX, VLTR, WGOV, ZRAN.

(Note: American Express (AXP) should be be reporting tomorrow as well after market close, there has been some conflicting data on their earnings date)