Stock index market will key off critical condition: Price

Indicators are important, but price action trumps all

In the 1986 film classic, “Top Gun,” Lt. Pete “Maverick” Mitchell said under fire in his F-14A Tomcat fighter aircraft, “I will not leave my wingman.” The “wingman” is defined in air force jargon as “a pilot whose plane is behind and next to the leader's aircraft.” Simply put, Maverick was saying that under no circumstances would he break discipline and abandon the flier upon whom he might have to depend and who might also need him.

In the stock market there is another sort of discipline. While there are untold numbers of indicators by which to gauge the market, ultimately it is price action that can be “bought” or “sold.” And whereas an investor enters and then ultimately exits an issue, executed trades based on price determine profits and losses. Indicators are simply tools used to gauge the “temperature” of that price action. To exit an “overbought” market based purely on indicator bias is, in our opinion, the worst kind of “top fishing” and could be a quick way to feel the negative pressure of a short position gone wrong. The same could be said for getting long too soon into a decline even though an indicator might be suggesting deeply “oversold” conditions. Market history has demonstrated repeatedly that “oversold” is not always “oversold” and “overbought” is not necessarily “overbought.” Or, as one of favorite social commentators and American humorist, Will Rogers, once said, “Buy the stocks that are going up and if they don’t go up don’t buy ‘em.” Same for the sell side.

For nearly five months and since the July lows, several of major indexes have made hefty gains. The Dow Jones Industrial Average has rallied 19%, the S&P 500 Index is up just under 23%, the NASDAQ Composite Index has added 28% while the Value Line Index has posted a whopping gain of nearly 31%. All four indexes have posted new highs relative to their March 2009 price lows. Only the Dow 30 has failed to recently better its early November peak.

But as with many disciplines relying on statistics, one of the biggest problems with indicators is that they often contradict one another. That is currently the case and is yet another reason not to rely solely on indicators to make final market decisions even though they are very important in the decision-making process.

Presently, “traditional” Advance/Decline data for the NYSE, NASDAQ, and NYSE Amex are mixed with only the NYSE series at new highs. The other two remain anemic. Up/Down Volume on the NYSE and NASDAQ remains well below the April highs while AMEX volume made a new high by fractions, probably because the bulk of the ETFs traded are bought and sold on the AMEX.

New Highs/New Lows data is indecisive. Data lags on both the NASDAQ and the AMEX while on the NYSE Highs/Lows are simply in synch with market pricing. Overbought/Oversold Ratios applied to VIX Volatility data now suggest that both the Short and Intermediate Cycles have moved back into zones of vulnerability following the July lows. Unfortunately this indicator does not tell us “when” either cycle end, only that it probably will

Two of our favorite indicators, the Most Actives Advance/Decline Line (MAAD) and the Call/Put Dollar Value Flow Line (CPFL) are mixed. MAAD on the Daily Cycle peaked back on April 14 and hasn’t revisited that level since. Weekly MAAD consistently made new highs from the March 2009 lows through November 5, but was last holding below that point. And then there is the fact that MAAD has done poorly relatively to overall pricing since March 2009 by recovering only about 25% of its decline following the October 2007 highs.

CPFL by contrast has bettered its April highs on both the Daily and Weekly Cycles to suggest that options buying and selling, a measure of market sentiment, remains positive and continues to predict higher prices.

Short- and Intermediate-term Momentum for the S&P, the Dow, the NASDAQ, and the Value Line Index has failed to make new highs for months to suggest that despite higher prices, the rate of ascent has been diminishing relative to those March 2009 lows.

And then we have Cumulative Volume which remains well below the April highs in the S&P 500, the Dow 30, and the NASDAQ Index. Such a negative divergence relative to price has traditionally suggested that strength under such conditions is being driven by weaker players and higher prices could prove to be unsustainable. This time could prove to be no exception to that rule.

So what’s to be done?

Keeping in mind our “wingman” analogy and the discipline required to execute “the mission” by finally relying on price action to exit the market, we will not abandon our discipline in favor of even a handful of negative indicators. With the poor showing from Cumulative Volume and Momentum, lingering concerns from MAAD on both the long and the short-term cycles, and mixed readings from some of the basic advance/decline indicators, we continue to wonder if the rally since March 2009 could ultimately prove to be a retracement rally in a bear market decline, albeit a very powerful move. Think July through October 1973. But with positive crosscurrents offered by CPFL data and higher market prices themselves, prices must be the final arbiter.

In our opinion, the only way to follow this market now is to use trailing “Stop Sell” levels defined by trailing Price Channel Moving Averages. In the Table below we have posted those downside “failsafe” exit levels on the Short (Daily), Intermediate (Weekly), and Major (Monthly) Cycle trends as measured by “weighted” moving averages of the lows for 10 periods. The “Stop Sell” points on the Daily and Weekly Cycles are for the week ending December 17 with the Monthly levels through December 31. One way to make the exit strategy work best is to “average” out of the market using the three cycles, Daily, Weekly, and Monthly instead of exiting everything held all at once.

Index

Daily Stops**

Weekly Stop Monthly Stop
12/13 12/14 12/15 12/16 12/17 12/17 12/31
S&P 1197.62 1203.47 1207.93 1212.96 1218.24 1160.72 1061.14
Dow 30 11148.97 11195.97 11232.70 11264.05 11294.82 10920.30 9978.80
NASDAQ 2539.01 2552.16 2562.73 2573.74 2584.84 2421.49 2154.04
Val. Line 2693.31 2712.63 2728.48 2743.71 2758.72 2541.84 2228.83

**Note: Stop Loss levels based on the trailing moving average of the lows presumes a continuation of recent market momentum.

In sum, we suspect that the next Intermediate Cycle high could prove to be the top of the price advance that began in March 2009. While indicators are an important function of market analysis, as with our “Top Gun” pilot, strategic discipline requires that it is ultimately prices that determine profits or losses.

McCurtain Most Actives Advance/Decline Line (MAAD)

MAAD demonstrated modest improvement last week on both the Daily and Weekly Cycles, but data set has yet to move back into new high territory. A negative divergence is still evident in Daily MAAD data which continues to hold below a level reached back on April 14 and at a point that preceded the late April price highs by nearly two weeks. Weekly MAAD is positioned somewhat better, but that series has yet to exceed its November 5 high.

While we cannot rule out the possibility MAAD on both Cycles will rally to new highs, weakness in the smaller series and the overall anemic tone of MAAD since the March 2009 lows continues to suggest that despite the power of the rally over the past 21 months, the indicator as a reflection of “Smart Money: continues to indicate, on a relative basis, that it would take little concerted selling to push the indicator to new all-time lows.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)

CPFL rallied to new highs for the move and the best levels since the March 2009 price lows last week. In a nutshell, options buying continues to reflect an overall optimistic market tone which could translate into higher index prices. In addition, so long as CPFL statistics continue to rally while making new highs, we can only surmise that major index prices will also move higher.

Click charts to enlarge

Conclusion

While last week’s gains clearly favored low prices stocks with the Value Line Index rallying 2.1% and the NASDAQ ahead by 1.7%, the S&P 500 Index also added 1.2% as the Dow 30 rallied .2%. Strength in only the Dow was not good enough to better the early November highs.

Nonetheless, additional short-term strength remains possible within the context of still positive Intermediate and Major Cycle trends. That tone is underscored by positive action in CPFL, index pricing, and the self-correcting nature of the market over the past several months. We remain concerned, however, by the lack of Cumulative and Upside Volume which may ultimately act as a drag on prices, an historic tendency. Such a weight could ultimately be the stone that could cap the rally that began in March 2009. And given the downward bias of some of our key long-term moving averages, a larger cycle reversal could occur sooner than later. In any event, price action will remain the ultimate decider of market exit strategies.

MAAD data for past 30 Weeks* CPFL data for past 30 Weeks

Date

NYSE Adv

NYSE Dec

Date

OEX Call $Volume

OEX Put $Volume

5-21-10

5

15

5-21-10

1172844

1654053

5-28-10

10

10

5-28-10

477797

584893

6-4-10

5

15

6-4-10

265339

515370

6-11-10

12

8

6-11-10

263791

544655

6-18-10

11

9

6-18-10

357965

119532

6-25-10

5

15

6-25-10

91068

599114

7-2-10

4

16

7-2-10

1034509

771231

7-9-10

18

2

7-9-10

635690

110808

7-16-10

9

11

7-16-10

171633

445073

7-23-10

16

4

7-23-10

322870

174663

7-30-10

15

5

7-30-10

199970

217368

8-6-10

15

5

8-6-10

271701

115037

8-13-10

3

16

8-13-10

132060

409972

8-20-10

8

12

8-20-10

176830

488032

8-27-10

6

14

8-27-10

207995

222943

9-3-10

17

3

9-3-10

488323

102016

9-10-10

12

7

9-10-10

287697

82863

9-17-10

15

5

9-17-10

289703

112410

9-24-10

12

8

9-24-10

209124

100570

10-1-10

9

11

10-1-10

145020

121894

10-8-10

14

6

10-8-10

394156

98483

10-15-10

10

10

10-15-10

476975

115923

10-22-10

11

9

10-22-10

2575024

116468

10-29-10

10

10

10-29-10

376133

120924

11-5-10

13

7

11-5-10

547056

71345

11-12-10

5

15

11-12-10

203906

305387

11-19-10

7

13

11-19-10

241420

143672

11-26-10

5

15

11-26-10

116916

149196

12-3-10

16

4

12-3-10

701973

55878

12-10-10

15

5

12-10-10

395991

42814



*Note: All data is for week ending on Friday even though ending date may be a holiday.
Unchanged issues in MAAD calculations are not counted.

MAAD data for past 30 days** CPFL data for past 30 Days

Date

NYSE Adv

NYSE Dec

Date

OEX Call $Volume

OEX Put $Volume

10-29-10

8

11

10-29-10

19943

32281

11-1-10

10

8

11-1-10

32748

43173

11-2-10

8

11

11-2-10

53000

26682

11-3-10

12

7

11-3-10

51603

27749

11-4-10

14

6

11-4-10

178789

37602

11-5-10

10

10

11-5-10

170900

27121

11-8-10

12

8

11-8-10

68863

17326

11-9-10

5

15

11-9-10

169694

45289

11-10-10

11

9

11-10-10

42694

33514

11-11-10

8

12

11-11-10

37089

30380

11-12-10

4

15

11-12-10

30639

94150

11-15-10

11

9

11-15-10

84443

47402

11-16-10

3

17

11-16-10

43071

180668

11-17-10

6

14

11-17-10

20420

78711

11-18-10

16

4

11-18-10

52596

35984

11-19-10

8

11

11-19-10

77047

28454

11-22-10

6

14

11-22-10

40764

46671

11-23-10

4

16

11-23-10

36998

63173

11-24-10

15

5

11-24-10

59261

23407

11-25-10

Holiday

11-25-10

Holiday

11-26-10

6

14

11-26-10

7371

22639

11-29-10

11

8

11-29-10

134852

34060

11-30-10

7

13

11-30-10

33479

24500

12-1-10

16

4

12-1-10

85253

28247

12-2-10

15

5

12-2-10

182715

28232

12-3-10

17

3

12-3-10

115848

24527

12-6-10

8

11

12-6-10

40933

17375

12-7-10

8

12

12-7-10

80650

30593

12-8-10

13

7

12-8-10

50397

15116

12-9-10

15

5

12-9-10

108582

14892

12-10-10

13

7

12-10-10

72621

16651

**Note: Unchanged issues are not counted.

Robert McCurtain is a technical analyst, market timer and private investor based in New York City. If you would like to read more about how the CPFL is constructed, read a Futures article on the concept. This will take you to the MAAD article. Robert can be reached at traderbob@nyc.rr.com.

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