Bull or Bear? Or Both?!

I don't wax on too often about stock trading charts anymore. Not since I hung up my spurs many years ago as a long/short hedge fund portfolio manager. But I do keep an interested and watchful eye out for things that I think are worth noting. 

One such tidbit caught my eye today. I'll illustrate with a couple of charts below. These is  daily charts of basically the S&P500 (the market to some) in a bar and point and figure chart formats, and they are flashing some interesting hints with today's closing bell.

Here's what I see. A nice uptrend has been in place illustrated by the blue line. However, a 21 day moving average (21 SMA) of daily prices (my favorite trend line for trading) has begun to rollover due to recent price action. The dated green trend line (a 10 day moving average, 10 SMA) has already crossed the 21 day alerting us to a possible weakening of our trend. The 21 SMA looks like it may cross the blue line which is an even long term moving average. We call this type of setup a bow tie crossover. Watching price action unfold with moving averages that move at different rates can mean a lot and also mean nothing! More important to me is we had a classic swing trading short setup off of the 21 SMA. I labeled an orange price bar 1, indicating the bar that tells me that, exceeding the previous day's low against a slightly negative trend, there may be downward price action ahead. What caught my attention today was the green bar labelled 2. I was watching to see if the trading short signal given was negated by today's price action exceeding the orange bar before bar 1. (I know, I should have labelled the setup bar 0 or something!)

 

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In any event, I now have a short sale setup on "the market," moving averages crossing and possible indicating weak proces ahead, a failure to breach the setup high and a beautiful short sale entry point with very little risk. You short here around 164, set a stop to cover around 166.50 or so, and risk $2.50 to make ??? Now enter the point and figure chart! 

Thankfully we have the internet so I can provide you with a link to the wikipedia entry on point and figure charting: http://en.wikipedia.org/wiki/Point_and_figure_chart. I'm a long time fan and user of this methodology for giving me great 30,000 foot visibility over price action without the influence of time.  Here's the p&f chart of the "market" with some notes.

 

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In point and figure charting we're simply measuring supply and demand. When prices go above a level they previously "couldn't," we have a new high and higher prices are likely ahead. This is illustrated by one column of x's exceeding a previous column of x's height.  When prices drop below a level they previously wouldn't, we have a new low and possibly lower prices ahead. This is illustrated by a column of o's exceeding the low point of a previous column of o's. Just look at my notes I drew, you'll get it! The market rallied up to about $169 as illustrated in the last column of x's. But we've had some price movement lower recently. Enough of a reversal to register on the p&f chart. When I look at my nearest column of o's for a support indication, i.e. a level to which the market COULD drop and STILL technically be bullish, I find it WAYYYY down at $133! That's 19.11% below where the market closed today.

 Now remember, I identified a nice short sale setup a couple of days back that has held so far. I had an entry point identified that had me risking $2.50. If the market dropped back to its p&f support at $133, I'm risking $2.50 to make......about $33! That's almost 15:1 odds on my trade. I love that kind of opportunity...risking less than 2% of capital to make about 20% on my money. 

Ahhh...but who's short? Are you? Can you? This kind of trading takes real discipline and iron guts to make the "whale trade....," that trade that can make your year. (J.P. Morgan anyone?) But for most mere mortals I serve this up just as a reminder that the market can have pretty severe corrections within the context of an uptrend. Paying attention to these types of signals can help investors to scale back risk, take profits, park cash in anticipation of lower prices. 

Just a tidbit that a felt compelled to share. Make some quick notes, put them in your calendar and let's see how that short trade would have worked out! 

Order: Sell Short ______shares of SPY @ market for the day. Don't forget to set your stops!