5-25-12 Weekend Report

[Mike]

I have been working on various projects waiting for the market to signal a new advance.
Given the last post I made about the market breaking above decade long secular resistance my expectations have been muted. I have to maintain the thought however that we live in a QE environment and anything can happen. My expectatons are that without QE we may have seen a post-2009 high and be in the early stages of a cyclical bear market.

Tuesday will be a day-6 count in a possible advance. We are looking for a rise in the NASDAQ, S&P500 or NYSE Composite of 1.25% or greater on volume higher than the day before to signal a new confirmed rally. Another possibility is an undercut of the last low (2774.45 on NASDAQ) to start the counting process all over again. A factor I watch is IBD6000 percent of stocks with an E distribution rating (heavy distribution). We are sitting at 18.6% a bit high for successful rallies in the past. There seems to be an optimum level of blood in the streets for successful rallies to launch from 7.4% to 16%. In history going back to late 1994 there have been 80 follow through days. Only one successful (tradeable) rally occured in the month of June and zero in the month of July. Very few leading stocks have set up long enough in basing structures to be considered ready to breakout and move up out of a sound base. So except for what is in the next paragraph I am in mode of shorting rallies that appear to stall at logical resistance levels.

I read in a McClellan report about commercial traders having moved to very serious net short positions in the US dollar and T-Bonds. I guess this could indicate a possible topping process in these instruments, the dollar and bond markets have been sucking money out of the equity and precious metals markets. Commercial traders have gone to the biggest net long position on the Swiss franc since 2007 also. A dollar and bond top might free up money to move back into equities...

[slgerritz]

I have been working on various projects waiting for the market to signal a new advance.
Given the last post I made about the market breaking above decade long secular resistance my expectations have been muted. I have to maintain the thought however that we live in a QE environment and anything can happen. My expectatons are that without QE we may have seen a post-2009 high and be in the early stages of a cyclical bear market.

Tuesday will be a day-6 count in a possible advance. We are looking for a rise in the NASDAQ, S&P500 or NYSE Composite of 1.25% or greater on volume higher than the day before to signal a new confirmed rally. Another possibility is an undercut of the last low (2774.45 on NASDAQ) to start the counting process all over again. A factor I watch is IBD6000 percent of stocks with an E distribution rating (heavy distribution). We are sitting at 18.6% a bit high for successful rallies in the past. There seems to be an optimum level of blood in the streets for successful rallies to launch from 7.4% to 16%. In history going back to late 1994 there have been 80 follow through days. Only one successful (tradeable) rally occured in the month of June and zero in the month of July. Very few leading stocks have set up long enough in basing structures to be considered ready to breakout and move up out of a sound base. So except for what is in the next paragraph I am in mode of shorting rallies that appear to stall at logical resistance levels.

I read in a McClellan report about commercial traders having moved to very serious net short positions in the US dollar and T-Bonds. I guess this could indicate a possible topping process in these instruments, the dollar and bond markets have been sucking money out of the equity and precious metals markets. Commercial traders have gone to the biggest net long position on the Swiss franc since 2007 also. A dollar and bond top might free up money to move back into equities...

Hi Jerry,

In your forum post you said that leading stocks have not set up long enough basing structures to be ready for breakouts. What does a typical basing structure look like and how long does it take to set up for a potentially successful breakout? What is the buy point?

Stephen

[Mike]

Hi Jerry,

In your forum post you said that leading stocks have not set up long enough basing structures to be ready for breakouts. What does a typical basing structure look like and how long does it take to set up for a potentially successful breakout? What is the buy point?

Stephen

Stephen,

The most common cup and handle and double bottom bases require 7 weeks to form. These bases are counted on a weekly chart starting with the first down week after a closing high.

CRUS and PCLN for example have four weeks in their consolidations so far and neither have an identifiable pattern yet. An example of a 7-week cup and handle is CMG starting 11/4/2011 (the first down week). CMG also shows a 10-weeek cup and handle starting on 6/25/2010. The buy points are ten cents above the highest point in the handle, 341.38 in the first example above and 154.53 in the second example. My charting package labels the week with the week ending date, some use Monday dates so if you look at these examples you should adjust the dates to match.

Stock prices are driven primarily by institutions. It takes them a while (weeks-months) to establish a position because of their large position sizes. Once established they will tend to trade a portion of the position on the way up taking partial profits and then redeploying back in. Typically a stock will move up 20-25% and they will begin taking profits. This causes a stock to consolidate or base. A normal pull back is 10-30% and lasts 7 weeks or longer. Somewhere along the bottom the stock price will stabilize as the institutions begin moving back in or new institutions begin taking a position. The base will form a right side and move up to near the old high. If this shape is a "U" shaped a cup has formed. Quite typically a stock will pull back for a week or more near the old high shaking out weak holders. This is the handle area of the pattern. Once weak holders are depleated the price begins an assent and breaks above resistance in the handle. Since no resistance remains the price can resume its advance and move up another 20-25% or more and begin the process all over again. By the time a stock has gone through 3,4 or more of these cycles the stock has become too obvious and everyone that wants to get in is in leaving few buyers to continue the advance and the stock may be ready to top. Some unusually strong stocks can go on for 5 or 6 basing structures before they top, sometimes spectacularly in a climax run where the last reluctant people who missed the move buy in and drive the price up 25-50% or more in a couple of weeks. Stocks that break out early, not spending the requisite time in their consolidations tend to not flush out weak holders and the breakouts become failure prone.

The reason for the long winded answer above is that many-many of the leading stocks have already formed late-stage bases which is an indication that is not good for a fresh advance. What resets the base count requires a bear market or in an individual stock for the price to undercut the low price of the last base formed. I haven't seen this happening on leading stocks yet.

IBD methods look for a move up in a major index of 1.25% or more on day 4 or later in a potential rally with volume higher than the day before to declare a new confirmed market rally. The rest of the picuture however must be confirmed by the action of leading stocks breaking out and moving up above sound basing structures. It is this latter picture that needs a little more time sideways and perhaps some more downward action to reset bases before we are set up for a tradable rally that can last months...

[slgerritz]

Many thanks Mike. I really appreciate your indepth responses to my questions. I always find your insights and comments to be most valuable.

Stephen