Market Observations

A few observations, the first, the market remains obsessed with filling gaps. I can't say for sure, but last year the S&P moved over 1234 points from May 1 to December 1 and closed the year nearly flat, actually down -1.12%, but the take away is add the rest of December and and January through April and the number is probably closer to 1800 points of movement and a flat close. You could say the market is exceptionally volatile.

Throughout 2011 we saw massive outflows from equity funds, $140 billion to be exact. The volatility that really increased starting May and running through the rest of 2011 may have some correlation with the fact that starting April of 2011 and running through the end of the year, there were 35/36 consecutive weeks in which money was pulled from the market, yet the market still managed to end the year with only a slight loss. The obvious answer to this (as we would expect redemptions to cause forced selling, in effect increasing supply and lowering demand which should have sent the market lower) is volatility is being used to prop up the market. Of course the more volatility in the market, the less investors want to be in the market. That would also seem to be the obvious answer as to why so many gaps are filled, the daily volatility that goes from lows of the day to highs of the day, but doesn't move the market much, certainly would be expected to fill a lot more gaps then usual; that's a hunch, not science.

Psychologically it seems the market is much more bullish then it actually is. Take today for instance.. Here are the major averages...

 The Dow 30, a complete gap fill, but ending the day down -.12%

 The NASDAQ 100 filled the gap early, but only gained .20%

 The NYSE composite of over 2000 stocks filled the gap and ended the day down .10%

 The Russell 2000 was the best performer gaining an unimpressive .30%

And the S&P-500 filled the gap and then some, but ended the day up .01%, that's about as close as you get to unchanged at 1/100th of 1%

Averaging the major averages, today yielded a gain of .058% . You might think to yourself, "It's still a green day", however, if you consider that yesterday the S&P was up .89%, the NASDAQ up .71%, the Dow up .56% and the Russell 2k up 1.49%; then even the measly returns of yesterday couldn't generate any follow through buying interest at the time of year when money is supposed to be flowing back in to the market. In that light, you have to ask yourself a question that is a little more farsighted then 1 day or even 2, "Is every green day a bullish day?"

If the Russell can put together a 1.49% gain yesterday (which is fairly solid for recent action), but it can't follow up the day with demand and produce a follow through day of at least 1% on some decent volume,  is that bullish or bearish?

I spent at least one class per semester (when I was teaching technical analysis) teaching students what a solid breakout or a solid move looks like. One day a trend does not make, so we look to the next day for what is called a follow through day. A follow through day ideally produces a bigger gain, it does so on increased volume and it closes at the top of the range; if any of those components are missing, a follow up day becomes suspicious.  Say a follow through day (after a 1.49% gain) moves as high as 3%, but then gives back half or so and ends the day at a gain of 1.75%. Literally speaking, you have the higher high and bigger gain, but you end up with a price candle that looks like this...

The long wick on the second candle is a rejection of higher prices, it's institutional money that trades near the close doing more selling then buying and this happens to be a stronger example then yesterday and today as the first price bar gained 2% and the second gained 2.19%, but was it a strong follow through day? The chart answers the question (and I didn't cherry pick or search for more then 10 seconds for this example).

Or how about a follow through day or even a series of them, but volume is declining? Even if the day closed near its highs, the lack of volume tells you that traders are not so enthusiastic about chasing prices higher.

Here we have a nice trend emerging, volume is increasing, many of the days are closing at the upper end of their range, but volume starts dropping off. Bullish? Using this exact same chart, lets take a look at the gains made in the series in the white box:

Day 1 +3.66%
Day 2 +4.41%
Day 3 +5.01%
Day 4  +5.29 % (so far so good, lots of good follow through days on increasing volume)
Day 5 +10.26%
Day 6 +3.61% on lower volume. You can't argue 3.61% is not a nice gain, but it should be sounding some alarm bells.
Day 7 +2.34% The day closed up, it closed near its high, but price gains are falling, volume is falling, the message of both are, "Traders are not so enthusiastic about chasing this higher". Looking at the single day you might be inclined to be happy with it, it has added to the gain, apparently closed strong, but 1 day doesn't make a trend and put in its proper context, your trade management should be tightening stops, you have been warned by the market.

Over the next 6 weeks you have a return of .51% -DEAD MONEY.

The point is, not every day that closes up is bullish.

Here's 1 more example (this may seem to contradict some of the above, but there are some concepts you are familiar with and honestly the importance of volume and changes in character, even slight, are becoming a lost art) :

We're not even using 3, just Wilder's RSI (Another simple indicator that's powerful, but becoming lost in a sea of exotic, latest craze indicators). Th first day to the left was a 14% gain on huge volume and a new breakout. You know about false breakouts so I won't cover that, but the volume, while increasing is good, is out of character for the stock, it also closed off its highs and RSI failed to make a new high, this is a great 1 day gain, but should raise some alarms. The second example is another breakout day, 7% gain, a new high as well, still, the volume is out of character, RSI doesn't make a new high, it doesn't even make a similar high like we see in July. There are a lot of indicators as well as market information for the day that could tell us a lot. The fact is though, these seemingly bullish days both could have cost you money.


One last example, the Russell 2000 performed the best today. A look at the 4 pre volume relationships reveals a piece of the puzzle, here's how they stacked up:

Stocks in the R2k

Close Down and Volume Down: 467
Close Down and Volume up: 256
Close Up and Volume Up: 451
Close Up and Volume Down: 644

The semi-dominant relationship is close up and volume down, it is also considered the most bearish relationship among the 4. Close Up and Volume Up is considered the most bullish relationship. Close Down and Volume Down r Close Down and Volume Up are subject to interpretation depending on where the market is. For instance, in an oversold pullback within a larger uptrend, Close Down and Volume Up can be considered bullish as it suggests a bottom has been put in. Here's an example...

Both red arrows would almost certainly have seen a dominant P/V relationship of Close Down and Volume Up, the first was a short term bottom, the second was the day before the powerful October rally kicked off. Look at some charts, you'll see more often then not that the last day in a move down before a reversal is a down day on increased volume.

Again, my point is simply, just because it is green, doesn't mean it's always bullish. The opposite is also true, just because it's a red day doesn't mean it is bearish. For example, pullbacks are necessary, stocks can't rise forever without becoming overbought and risking a huge down day. To take the example to the extreme, a capitulation day that may gap down 10% on huge volume and close at its lows is not always bearish, toward the end of a bear market, you need these capitulation days to start a new uptrend. I suppose more then anything, I'm saying you have to keep the big picture in mind, price alone is often deceiving. I would never make an assumption about any asset based on price alone, price is just 1 piece of the puzzle unless you are a day trader.