Trading with the Stock Market’s Trend
When I take a bullish position in a stock I want to have a well-defined bottom behind me on its price chart. And when I am bearish on a stock I want to have a well-defined top behind me. Anybody who does otherwise runs a risk of betting one way while Mr. Market goes the other way. Let contrarians do whatever they please. I prefer to go with the flow of the market whatever it may be. And that is what this article is about.
Re: The Sobon Oscillator
As a market technician, I use a “base-period” pricing model of the market when doing my analysis. But sometimes I use two base periods simultaneously, with the first dealing with the established long-term trend and (when necessary) the second dealing with the emerging trend. It is the latter that is always more important to me than the former.
Almost everything that will be shown in these charts is proprietary with me and based upon lessons I learned while attending UConn, Wharton, and (of course) the School of Hard Knocks. I graduated from the first two schools but (like almost everybody else) I am still attending the third. In recent years I developed the “Sobon Oscillator” based on lessons learned while attending and paying my dues to the School of Hard Knocks and it will be used as described below.
The S&P Industrial Index (NYSEARCA: SPY) is the red line on the next chart. It is widely considered to be the most important of all market barometers. But in order to get a more comprehensive understanding of the market, it was necessary for me to consider many other market barometers and invent a few of my own.
This chart shows the performance of 10 broad-based ETFs during the last 150 trading days (that's about 7.5 months). Also shown is my index of 450 stocks (the dark blue line with white dots and referred to in the legend as S450). My index is unweighted and, by a small margin, it usually outperforms or underperforms the SPY.
All of the other indexes shown are well-known and they can be identified by the colors of their price lines as shown in the legend on the chart. They include the S&P 100 large-caps (^OEX), the S&P 400 mid-caps (NYSEARCA: MDY), the S&P 600 small caps (^SML), the NASDAQ 100 (NASDAQ: QQQ), and the Russell 2000 (NYSEARCA: IWM).
The two blue boxes on the chart frame from where the 1st base-period prices (on the left) were derived and likewise for the 2nd base-period prices (on the right).
I am not going to comment about the three graphs shown on the bottom of the chart because they are experimental at this time. They were constructed a few days ago and thus far the feedback shows promise. They were designed to provide insight into the strength or weakness of the market. In coming days, the formulas may need some tweaking.
If you look closely at the lines on the chart you will see that something strange is happening: It is late in the cycle and the small caps as measured by the IWM and the $SML were leading the market higher while the larger caps in the SPY and the QQQ peaked and then started to roll over. I have seen this happen on several occasions before and such price action was not sustainable and mostly bearish for the general market.
Below is a chart that relates to 15 of the top 20 stocks in the QQQ index which led the market higher most of the time. And combined they account for about 50% of the 100 weights in the index.
For each stock the chart shows the percentage profit or loss for the last 15 days from its respective base-period price that I use for analytical purposes. The blue column of the left of the set shows what the reading was 15 trading days ago with the black column on the right being the last trading day. In between the profit or loss (which is the percentage price change from the base) fluctuated.
While Facebook (NASDAQ:FB), Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN) showed gains ranging from 7% to 15% during the three weeks shown, many of the others showed losses ranging from 5% to 11%. So the good performance by the gainers in the QQQ was being offset by the poor performance of the losers. Much the same can be said about the SPY and especially some of the 25 industry sectors that I follow. What this portends for the future remains to be seen. But the market cannot break out up or down from its trading range while such mixed trends continue.
I interpreted this as a signal to take profits in recent winners on rallies so I sold half of my positions in the two oil stocks I bought about a month ago (HFC and DVN which showed profits of 33% and 20% as of last Friday, respectively).
During the last 85 trading days, the general market was volatile and stuck in a wide trading range. And there is scant evidence at this time that the market will break out of its range anytime soon. To understand why consider that which follows:
There are two parts to the Sobon Oscillator: the first part deals with the technical analysis of the general market and the second part deals with sector and stock selection. The next chart is a presentation of Part #1.
This chart shows breadth indicators for 32 indexes that I use for trend analysis purposes. The time span shown is for the last 30 trading days (about six weeks).
(1) The first panel shows price lines for the major market averages and all of them trended sideways in a range-bound market during much more than the past 30 days.
(2) The second and third panels show day-to-day price changes and the volume of trading for those averages, respectively. Such price changes and trading volumes show when there was broad-based and bullish or bearish participation by the investment community.
(3) The fourth panel shows breadth indicators for eight moving averages. When the stock market was making daily gains of more than 1% these moving averages were unusually strong, with net readings of plus 80% (meaning 90% were above trend and only 10% below trend). On sharply lower days these breadth indicators have plunged at times to net readings as low as minus 92%.
(4) The fifth panel shows breadth indicators for stocks making highs or lows for eight time periods ranging up to 150 days; all of which got much stronger right after Congress passed its tax bill (scam?) last December. During the last thirty trading days, there was virtually no sustainable strength or weakness in the high-low indicator as it waffled above or below its neutral (zero) line.
(5) The sixth panel shows the high and low data superimposed over the moving average data. This gives a comprehensive overview of stock market dynamics.
And (6) the bottom panel shows the most sensitive moving-average and high-and-low data that I use. Such show what these lead indicators are doing at all times.
If and when something significant starts to happen in the broad market that presages a bullish or bearish trend, such would be reflected in these panels almost immediately.
I will not waste time by explaining in detail what is shown on this chart because you can see by the ways the indicators oscillated above and below their zero (neutral) lines that the market was stuck in a trading range with almost no indication that a breakout was imminent.
The next chart shows Part #2 of the Sobon Oscillator. It was added to my workbook during recent months. Thus far its contribution to my model of the market has been impressive. Its purpose is to show (1) which sectors and stocks are trending higher (or lower) from their respective base-period price levels, (2) when they are making tops (or bottoms), or (3) when they are reversing during a reversal process.
The top panel on the chart shows that the oil industry stocks continue to be in the strongest sectors of the market as producers, refiners, and service companies showed average gains that range between 15% and 25% from their base-period prices, with a production stock showing a gain of 47% and a refiner showing a gain of 38% during the four week period. The MLPs (which had long been laggards) are another sector that continues to perform well by showing gains that now average about 10% for the four weeks. The technology stocks (excluding semiconductors and telecoms) are also doing well while the banks have started to perform well because of prospects for higher interest rates.
Regarding the banks, the Fed’s Williams recently admitted that “the market’s hand holding policies for the market are coming to an end.” And James Bullard said that they “didn’t want the yield curve to invert because that could signal a recession.” So we should expect to see higher yields on the long end of the curve in coming months. On those statements alone, I should be doing research on the banks because they were significantly bullish.
When I saw the oil sector stocks showing signs of a bullish technical reversal in the market about a month ago, that was a signal for me to do some research to determine the fundamental investment merits of the oil stocks. When I was employed as a securities analyst many years ago, one of the industries I specialized in for several years was the oil industry. So it wasn’t hard for me to do what I needed to do.
Below is an updated “StockCharts.com” chart for the price of WTI (West Texas intermediate) oil. And during recent days the price action on the chart continues to get stronger, so the chart still shows no signs of weakening. The WTI is a benchmark indicator for the industry and as such it influences the prices and/or crack spreads that oil companies get for their products. The chart shows that the price of crude oil broke up and out of its trading range about five weeks ago; and then it resumed making higher highs and higher lows on its price chart.
More than anything else, it was the rise in WTI oil prices that convinced me to buy a position in HollyFrontier (NYSE:HFC); which is benefitting big time from favorable crack spreads and management also resumed its share buy-back program. A few days later I took a position in Devon Energy (NYSE:DVN), which is benefiting significantly from new wells that are boosting crude oil production. And then much to my delight I watched the stocks go up in price.
My new set of base-period price-change (or percentage profit-or loss) charts has been a valuable source of timely information. It took a long time and much effort to design and construct these charts but once constructed they update automatically every time I update my workbook.
For each stock shown on the chart, the dark blue bar on the left of each 15-column set shows the percentage gain or loss from the relevant base price 15 trading days ago while the black bar on the right shows the most recent day’s gain or loss from its base price. In between, the gain or loss can be greater or less than it is currently. So when the black bar starts to decline relative to the other bars on a stock that I own, I have to decide if it is prudent to take profits at that time or cut my losses short or just hold on to my position.
What I look for on these charts is feedback for trends or reversals as such relate to sectors and individual stocks as well as relevant implications for the general market. My goal can be simply stated: (1) Go with the flow and take advantage of opportunities as they evolve. (2) It is better to be in a strong sector instead of a weak one. But (3) sometimes what looks like a weak sector does so because the very bad performance of few stocks which can distort the overall performance of the sector. Therefore, if I am very bullish on a stock’s fundamentals, I may choose to disregard the weak features about the sector.
The four charts that follow are examples of the 22 such panels that I have in my workbook. I show them here as examples of the kinds of performance I get to look at.
The chart on the top relates to electric utilities and MLPs. (1) The utilities were among the early gainers in the market until interest rates spiked last Wednesday and then all of their recent gains turned to losses vis-à-vis their base prices. (2) The MLPs have been evolving very nicely and it looks like their favorable price trends will continue in coming days. I am not in a hurry to add a new stock to my portfolio but I am tempted to open a position in Enterprise Products (NYSE:EPD) at this time. The company has a good business base and corporate development program; and the stock sports a 6.5% dividend yield.
The second panel deals with the REITs. They too lost ground on Wednesday because their stock prices are interest rate sensitive. So the spike in interest rates had a negative effect on the REITs. It is difficult to generalize about this sector because there are so many sub-sectors. Self-storage continues to be very strong followed by cyber storage and also lodging. The weak sub-sector is the shopping malls while others are mixed.
I haven’t looked at the fundamental merits of this group in a long time but I am not surprised to see Extra Space Storage (NYSE:EXR) doing well because it is in a good sector of the REIT industry and it is very well managed.
The third chart shows the market performance of the technology stocks. Most of them followed the market up in recent weeks but there were a few clunkers.
And, the bottom chart deals with semiconductor stocks and telecoms. In both sectors there were significant winners and losers; so overall sector strength was not impressive.
I displayed these charts to show that timing your purchases and sales of stocks can be done prudently if you do the work and are adequately informed about fundamental considerations and stock market dynamics.
Now that the heavy lifting involved in writing the programming for Part #2 of my oscillator has been completed, I can spend more time doing fundamental analysis relating to individual stocks. All I really need is feedback from my charts to indicate which sectors and stocks to consider.
The trick is to catch a positive reversal on a stock’s price chart before the subsequent gains are scored. So I want to buy in at the beginning of favorable trend and not near its end. By now every investor this side of the planet Jupiter should know that the oil stocks should have been bought four weeks ago.
At some time during my years as a securities analyst I analyzed many industry groups and the oil industry was one that I followed most extensively. I wouldn’t get carried away with the prosperity that the oil refiners and crude oil producers are experiencing at this time. Surging crude oil and gasoline prices is not a new phenomenon. I remember a time when the oil companies were making so much money because of an oil shortage that one major company made one of the worst acquisitions ever when it purchased Montgomery Ward, a mail order retailer. I also remember when an oil product shortage led one independent refiner (Atlantic Refining which produced some crude oil) to acquire another oil refiner at a premium price (Richfield which had no such production) and after a few years of prosperity the combined company was on the rocks. It is likely that the current surge in gasoline prices will prove to be transitory.
One question that needs an answer at this time is this: is it plausible that the current mix of strong sectors and stocks can provide effective leadership for the rest of the market? Time will tell. But right now it is hard for me to conclude that the oil, MLPs, technology and banks can provide effective leadership for the lagging semiconductor, home building, manufacturing, transportation, drugs, and food stocks. We need a significant plurality of good (or bad) performing stocks to move the market. If only half goes up and the other half goes down at similar rates, then we wind up in a trading range like the one extant.
Whatever happens with the market’s trend, in a very significant way it will be reflected in the price action in the market; and I believe the net result will be clearly displayed on a real time basis in Part #2 of my oscillator.
The market’s trend doesn’t just happen. The collective actions by the investment community make it happen. With the stock market stuck in a trading range, this is a time when stock selection is of paramount importance and both technical and fundamental analyses are critical for success.
I am a one-man shop with limited capabilities. When I see a stock that looks promising on a technical basis, I usually check Seeking Alpha’s archive to see if there are any recent articles relating to a given company and/or I will check the company’s news releases. I need good and valid reasons for risking my money in this or any other kind of investment environment. And I hope the reader is also discriminating about the way he invests his money.
In the first two articles in this series, I focused much more on macro analysis than I did on micro analysis. In subsequent articles in this “Go with the flow” series I hope to focus more on micro analysis. Macro analysis is great if you are ready and willing to trade triple leveraged ETFs like SPXL or SPXU-OLD as I am eager to do. But micro analysis can also be great if you are seeking to trade individual stocks like I also do, provided I can find stocks having sound fundamental merits on a timely basis.
Disclosure: I am/we are long DVN AND HFC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.