VARIOUS MARKET MEASURES SHOW AN OVERBOUGHT STOCK MARKET
BOLLINGER BANDS SHOW OVER-EXTENDED MARKET... There are several ways to measure when a market has moved into overbought territory and is vulnerable to some profi-taking. One way is to use longer-range Bollinger bands. I've written in the past about converting weekly and monthly signals into daily ones. That helps show where major support and resistance levels are located. In Chart 1, the lower dotted line is the 400-day moving average. I get that number by combining a 20-month average into days (20 months x 20 days). The 20-month (or 400-day moving average) acted as major support over the summer and has done so for the last three years. The upper line is the Bollinger band for the 400-day average. It's much wider than the standard 20-day line and gives us a better read on when the market has gotten ahead of itself. The circles in Chart 1 show the market correcting downward each time it exceeded the upper band during the first half of 2006. Chart 2 converts the numbers to a weekly chart. The circles show instances over the last three years when the S&P moved over the upper band. Each instance was followed by some profit-taking. The two down arrows show where the upper band acted as a resistance barrier. The chart isn't necessarily a sign of a market top. It just means that the S&P has come too far too fast and is in overbought territory. Other indicators show essentially the same situation.
Chart 1
Chart 2
THE S&P MAY BE TOO FAR ABOVE ITS 200-DAY MOVING AVERAGE ... Another sign that the market may be over-extended is the distance it's travelled over its 200-day moving average. The red line in Chart 3 is the 200-day moving average for the S&P 500. The market tends to stall when it's moved too far over that long-term support line. One way we can tell when that's happening is by plotting the spread between the two. That's what the black line in Chart 3 does. The black line (the S&P minus its 200-day line) has reached the same level that coincided with downside corrections throughout 2006 and 2005 which puts it in a potential resistance area (red line). Chart 4 compares the spread (black line) between the S&P and the 200-day average to the index for the last three years. It shows that the spread did move much higher at the start of 2004 in an earlier stage of the bull market. Over the last two years, however, the spread has tended to narrow (down arrows). Right now, the spread between the S&P and its 200-day line is at a level that interrupted rallies during 2005 and 2006. Here again, that's doesn't mean the uptrend is ending. It does suggest, however, that it may be in need of a breather.
Chart 3
Chart 4
COMBINING BANDS AND AVERAGES ... Chart 5 uses the standard 20-day Bollinger bands to show where underlying support levels exist. First, an acknowledgement that the 9-day RSI line (top of chart) has reached overbought territory over 70. If a short-term pullback does occur, the first line of potential support would be the 20-day moving average (dashed green line) which currently sits at 1334 (and rising). There's also potential chart support at 1326 which is the May peak. If a deeper correction were to occur, more substantial support is likely at the lower Bollinger band (green line) and the 50-day average (blue line). There's no convincing evidence to indicate a major decline at this point. All we're warning about here is an over-extended market condition at current levels, and the possibility for a short-term pullback or a period of consolidation within the market's ongoing uptrend.
Chart 5
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From where we stand, the rain seems random. If we could stand somewhere else, we would see the order in it.
- T. Hillerman (1990) Coyote Waits, Harper-Collins, New York
this is a great thing. Trust me, one day, trading will be free. It might be a while but it is going to happen.
This is a great thing for the industry. Now if they can prove they can keep the model up and still make money all will be wonderful in the world of a trader.
the change of commissions in the last 5years is hugely changing the sell side too......i used to get paid 1/8+ on trades when a client did a trade thru my firm.....then it got decimalization and went to 6cents then 5 then 4 and when i left the industry last year it was down to 4cents a share max...and yesterday i spoke with a buddy that a sellside broker and he said this clients are now mostly moving to paying in a quarterly research check becasue they can trade on the ECN's for less than 2cents a share commisssion so its good for mutual fund owners but bad for sellside brokers........
Success is a State of Mind - - Tommy Bahama Profits always take care of themselves but losses never do. The speculator has to insure himself against considerable losses by taking their first small loss. - - Jesse Livermore The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the man of inferior emotional balance, nor for the get-rich-quick adventurer. They will die poor. - - Jesse Livermore
Q: Can you explain stochastics, MACD, relative strength, the Chaiken corollary, etc. etc. etc.?
A: (Smith) Well, I could, but I honestly don't use any of those. My view of TA is that it is a reflection of investors' emotions and psychology. Therefore, the most important "indicators" are price, volume, support and resistance. Those are all you really need, and all I every use. Everything else is really a derivative of one of those areas, and in my view unnecessary for trading and analysis. "
Q: I don't agree with the above, and in fact, think I have a better method than what you espouse.
A: (Smith) Good! Although I talk about how I trade, I never propose you trade exactly as I do. My "GBS Classic" methods are custom built for one person: me. Folks are free to use all, part, or none of my strategies. Trust me, there's no hurt feelings on my end no matter what you pursue, and truth be known, I'd prefer you not trade like I do, because then we'd be taking a lot of the same trades
Do you have more of those ORKiter. To be honest with you, even though Sun Yoo invited me to NYC, he wasn't a mentor (per-se). GBS was the first chartist I read that had charts that appealed to my eyes. It seemed very simple and I remember back in 96 97 98 99 every breakout worked with his simple method. The ones that didnt work could be cut quickly using simple lines that he drew on his charts.
I remember when the market crashed in 2000, the first thing I did was went back to the street.com archives and i read EVERY SINGLE ONE of his articles.
I guarantee that helped speed up the education looking at all those charts.
His charts on Fox News: Bulls and Bears are very simple. KISS
Success is a State of Mind - - Tommy Bahama Profits always take care of themselves but losses never do. The speculator has to insure himself against considerable losses by taking their first small loss. - - Jesse Livermore The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the man of inferior emotional balance, nor for the get-rich-quick adventurer. They will die poor. - - Jesse Livermore
Those charts on Fox News blow. It is nice and simple but a line chart is horrible. A bar chart is at least needed. All individual investors would improve their trading by learning a bar chart. The simple line charts they draw on FOX/CNN/CNBC are too simple. If there can be such a thing.
So, Rule Number 1: Wait until a stock makes a new high. Not until it almost makes a new high. Not until you just know it's going to make a new high. Wait until it definitely makes a new high. I look back at least a year, and sometimes as many as five years to see where a stock last topped. If people are still holding after that long, they're probably in it for the long run. At least I hope so. Lo
And that leads to Rule Number 2: The length of time between new highs should be at least six weeks. You'll hear this time period referred to as "congestion" or "basing," but whatever it's called, it's goodness. It means the bears and bulls have duked it out and laid a nice foundation for the next move. When the stock finally breaks free, it's moving time!
Finally, Rule Number 3: Make sure the breakthrough comes on solid volume. What's solid? If the price rise comes when the volume is above this line, this is a good sign there's some "oomph" behind the move and the last of the irritated shareholders has been trounced.
I've been getting a fair amount of questions lately on my long strategy, which I have fondly named the GBS Classic. (I am sincerely hoping it's a self-fulfilling prophecy.) Therefore, I thought I'd revisit it one more time, update you on some changes I've made and give you a progress report on its 1998 performance.
The first thing you should do is go back to the archives and read through my Sept. 8 column. This will give you my rationale for why I trade this way. It also has a few "hows," and I'll elaborate on those for the remainder of this column.
The first major change, and one I alluded to in a Q&A column, but should have made clearer, is how I screen my stocks. Yes, I always look for stocks hitting new highs coming out of congestion. But I get this list by simply picking the bold-faced stocks from Investor's Business Daily under the column NYSE (or Nasdaq) Stocks with Greatest % Rise In Volume. In a tip of the hat to the fundamentalists, these stocks are all above the 80th percentile in earnings, and though I don't care about a stock's fundamentals, these seem to hold up better when the market gets rough. In addition, these stocks also are in the 80th percentile in relative strength, which is exactly what you want with this kind of momentum strategy.
Now there are a few nice benefits with this method of selection. One, I can generate my list without doing any computer runs, and while drinking a cup of coffee, and finishing my daughter's leftover bagel. More importantly, as the number of bold-faced stocks dry up, I have found this to be an excellent indicator that the market is rolling over. Last April, for example, my selections dwindled to zero well before the market dropped, and stayed at zero until the market started to come back. I honestly have not found a better way to gauge how well this bull market is enduring. Everyone agrees we're in rare air here, but until my candidates dramatically drop off, I'm compelled to play. This objective style makes it easy to figure out whether to be in or out.
When I look through these bold-faced stocks, I pick out only the ones that have made a 52-week high. The way the IBD charts are set up, you can do this quickly.
After you've cruised through IBD, you'll have anywhere from 10 to 20 candidates. With the market going crazy lately, I've been on the upper end of this range, but the low teens is more the norm. You then need to take this list and see if the chart indicates a breakout from congestion. A lot of your candidates will simply be stocks making higher highs and you want to avoid those. No, look for a chart like Technical Forum, someone questioned my definition of a "week," so I want to be as clear as I can. I define a week of trading as five trading days. Therefore, I want at least 30 bars between the two highs.
Regarding the volume, "heavy" means at least 50% greater than the 50-day moving average of the volume. The advantage of using the bold-faced IBD charts is that a stock has to have heavy volume to appear in this list, so that makes meeting requirement two straightforward.
After I have my final candidates, I try to get my market orders in as soon as possible. Now don't all gasp at once: That's right, I said market orders in as soon as possible. In other words, pre-market open. Now I'm well aware of all the arguments, supposed risk, foolhardiness, blah, blah, blah, regarding this practice. Trust me, though: Whether it's the stocks I pick, or the fact that they're just coming out of congestion, I have never -- over the long term -- found this to be a disadvantage. Yes, of course you'll occasionally get a big gap up and find yourself in the hole. But, this is far outweighed by the times you're in on a gap up ... and the stock never looks back. If there were a better, safer, more profitable way, I'd be the first to use it. But, I've tried them all. This is the most effective, and simplest.
To make things easy, I always order with a fixed quantity. In general, 1,000 shares, but of course, you'll want to vary this depending upon the amount of equity you have. But, whether the stock is $100 or $20, I always go in for 1,000 shares. As opposed to a fixed dollar amount, I have found this to be a simpler, and ironically more profitable, way to trade over the long term.
I generally get my fills pretty quickly, and as soon as I know the price, I put in a sell limit order. In the past, I had put this order in to be 5% greater than my fill price, with the corresponding stop loss at 7.5%. Recently, though, I have been using a straight $2 profit target and $3 loss. This is the same exact ratio, but has a number of advantages. One, I get a better overall return on each dollar, and two, I am out of the more expensive stocks and back to cash a lot quicker. This saves on margin charges and is a safer way to trade. Why these targets in general? Through my back tests and real results, I have found these to be the optimal targets for risk, reward and safety. My goal has always been to have a high win rate, but get back to cash as soon as possible with a reasonable profit. These targets enable me to do that.
And ... that's it. I just wait until either target is hit, and let the percentages work in my favor. The results this year are similar to last year: a win rate of 70%, while holding each position an average seven days. This year, though, there's one important change. My average win amount is nearly 50% higher than my average loss (on open positions -- obviously my average win amount will be less than my average loss on closed positions). Apparently, by keeping the stop loss amount fixed (as opposed to a percentage), I am able to keep the lower-priced losers long enough so that they turn into winners, while jettisoning the expensive stocks before their 7.5% debit charge breaks the bank.
Now, a few notes: I'm not an idiot (well, okay, sometimes I'm an idiot, but I'm not an idiot in this case) -- I fully realize that any long method looks great in this market. To date, I am outrunning all the averages, but not by a huge amount. Where this method shines is when the market turns, and I'm primarily in cash. But if the market keeps going straight up, I'd probably be better off in an index fund. Of course, who wouldn't?
Also, I had been limiting my picks by throwing out the low-volume stocks. But, you know what? I threw out more good ones than bad, so now I barely look at the volume traded (and for that matter the spread). About the only time I'll rule out a candidate is if it's made a huge one-day move. The attached chart of PV is a good example. I'd pass on it again, but boy, I wish I had made an exception in this case.
Finally, these rules aren't ironclad, but they're close. You will occasionally have to make a judgment call (i.e. everything looks great but it's 28 bars vs. 30 bars between highs; or the volume exceeds the moving average, but only by 30%), but the closer you stick to these parameters, the better off you'll be.
Finally, like in my day trading, I received some outside counsel, and owe a debt of gratitude to TSC reader Marsten Parker. He's been a GBS Classic follower for a while now, and has helped me greatly by thinking of, and then testing, things like stop losses, fixed dollar amounts, etc. Of course, he's using my methods more effectively than I am, so I hate his guts, but that's besides the point. Thanks, Marsten!
A spiffy ending? Here it is: I know there might be more profitable ways to trade. But for combining returns, with safety, with ease of use, this is a pretty good way to go. And it leaves you plenty of free time during the day. Trust me, after wading through numerous methodologies and techniques, it's good to fall back on the old "classic" and let it churn out the returns.
Just wondering, but if you're reading this column, do you also read my Monday column? And how about my Saturday column? Hmmm, guess I'll never know, but I do hope you read them ALL, because every single time I'm in print, it's a jewel worth saving!! (Man, it feels good sometimes to be so blatantly full of it!)
But, I give this preamble because I sincerely hope every GBS Classic fan is reading. (GBS Classic dissidents can skip over this hoohah.) Because herewith, my current thinking/changes/new rules to my methods. But first, so everyone is on the same page, make sure you check these out first:
The Essential Gary B. Smith Reader
GBS Classic Long: my March 30 column
GBS Classic Short: my May 18 and May 25 columns
Okay, read through those? Good, now for the changes:
Targets/Stops
Old: +2pts/-3 pts.
New: 5%/6%
Reason for change: They're not the best for surging markets, but they're optimal for both up and down markets, and Wesson and I prefer the one-size-fits-all strategy.
Volume cutoff
Old: No cutoff
New: Minimum 30K shares traded on average.
Reason: Anything less is a Roach Motel: You can check in, but you can't check out.
Other volume considerations
Old: None
New: Even if the stock trades with a 30K average or greater, I still reject it if the volume is "spotty." By that I mean if there are more than a few days where the volume traded is 9K or some ridiculous number, that's a pass.
Price cutoff
Old: No cutoff
New: Minimum of $20 per share
Reason: Anything cheaper doesn't perform as well. Don't know why, but that's what we found.
Price above resistance cutoff (i.e. If a long candidate was more than 3 points above prior resistance, I passed.)
Old: 3 points
New: 10%
Reason: The change from points to percentages necessitated a change here. In theory, we'd use 6%, but 10% also seems to work okay, and it's easier to compute.
Time Stop
Old: None
New: 30 days
Reason: It's more profitable, and frankly it's irritating to look at the same damn position day after day!
Time to close
Old: Day after limit or stop was hit
New: As soon as limit or stop is hit
Reason: The old way was probably the best way to go. What can I say, though -- I was just uncomfortable letting even one winner get away.
Strategies in addition to GBS Classic Longs and Shorts
Old: None
New: Wesson '45 (A new reversal, bottom-fishing, strategy to be unveiled soon)
Reason: Wesson invented it. Gotta give the guy some credit.
Okay, those are the changes. Are they perfect? No. In fact, some are not even close to optimal. But here's something to think about, and hopefully a point I've made before: Sometimes you just can't trade "optimal" parameters.
Let me give you an example. Wesson has determined that the optimal stop on short trades is well over 12%. Well, I just can't live with that much risk. So, we give up a bit of profit to be able to sleep better at night.
Also, closing out trades as soon as they hit the target doesn't always work as well as other methods. But, it's best for me emotionally. I'm willing to give up a few bucks to smile more at my kids.
Finally, as astute reader Tom Pilcher points out, "GBS Classic is a living, breathing, changing animal." And he's right. Hopefully, the changes will never be too dramatic, but as long as the market evolves, "Classic" will also.
And hopefully, no one out there is so rigid that you haven't made your own adaptations to my methods. Obviously, I made adjustments to things I picked up from William O'Neil, Nick Darvas and others. These adjustments made my methods my own. I trust you're now heading down your own customized, profitable path!
Okay, remember: clip and save, 'cause I'm not answering any more questions on the subject! Well, until Saturday, anyway.
* * * * *
Let me time-stamp this one: It's July 6th, 12:34 p.m. I am looking at AMZN. It is up 15 points. 15 POINTS!
It's incredible. It's the eighth wonder of the world. It's beautiful.
And it all reminds me of that last scene in Raiders of the Lost Ark. The Nazis have Harrison Ford tied up, and they're opening the Ark of the Covenant. They gaze inside, and the head Nazi says, "It's beautiful." Seconds later he and all the other Nazis are wiped out.
But, I'm not going to get wiped out. No sir, because I'm not going to do a thing. (Well, other than my ill-fated, laughable attempt to buy some puts on it a few weeks ago.)
You see I can't. But, it's not because I think it's overvalued. (Although, c'mon now, it surely is.) And it's not because I think it's a lunatic stock due to crash and explode (or implode, take your pick).
No, the only reason I'm not doing a thing with AMZN is that it just doesn't "fit" into any of my methods.
Remember, all my strategies involve both a psychological change in how the stock is viewed and a low amount of risk. Hence, breakouts from congestion. There, the psychological change is clearly met, and as long as I don't trade a stock too far away from congestion, the risk is limited.
But take a look at AMZN. It's straight up. It's not near any support. In fact, it's not near anything. If I went long, I wouldn't even know where to put my stop. I'd be totally out of my element.
"I'd be totally out of my element." Yep, I humbly submit that line's a keeper, and if you think of it every time you trade, you'll save yourself a lot of money. I do maybe two or three things well when I trade. Maybe you're accomplished at five or six. But every trader has some limits on their competence. Some trades are so outside their normal parameters that while they look enticing, they should be avoided at all costs.
Trust me, I've gotten more than a few emails from traders who've made a ton off AMZN. And good for them. They tackled it, they handled it and they made their money. Me? I'd end up like one of those nasty Germans taking on a force of nature I couldn't begin to comprehend.
No, my best bet is do what Indiana Jones did: Avert my eyes and try not to get in the way. When you don't understand something, sometimes the best thing to do is hide.
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