Bill Cara’s Blog for Aug 28, 2012
CTA Trading Desk Morning Report
[7:00am ET] Good morning.
Whenever there is a slowing of momentum in price series data that, for the most part, is still trending up, there is going to be a technical pattern called “bearish divergence”. Analysts typically point out this condition as a precursor of change. It often is; but not always.
For some reason – probably the fact that humans are programmed to hold fear on a higher level of emotion than greed – a bearish divergence is deemed more important to us traders than a bullish divergence.
What, in simple terms, is a bullish divergence other than saying that stopping pounding one’s head against the wall feels good? In trader-speak, this is the greed motivator at work.
So “bearish divergence” then is a fear motivator. If you hear it from enough people, particularly ones you respect, then fear will start to play on your emotions.
But; remember, the market is a game that plays people. As in any game, mistakes cause losses. And, in every game, there are mistakes. We all make them. So, the question is; how do we reduce them.
As I see it, rational behavior in the short-term, for traders, is best achieved by stretching one’s horizon, looking at the longer-term data charts, for example, and by examining the ratio charts I have been producing recently in the Week In Review blog for evidence that long-term trends are changing.
That’s easier said than done, of course; but something we must attempt.
We can also enter stop limit orders, like a Stop Sell or a Stop Buy.
Here is an example. Yesterday I discussed XHB, the US House Builders ETF. Because of a strengthening of the US economy in the past few months, ETF has been soaring. But interest rates may start lifting, causing mortgage rates to rise and home purchasing activity to stall. So the previous momentum in the XHB price series has cooled. Bearish divergence has set in. Traders who are psychologically incapable of taking losses are selling. Mistakes are being made.
Here is the short-term (Daily) chart of XHB, showing the bearish divergence.
What’s a trader to do?
If you take a look at the same chart, but for a monthly, not daily, data series, the bearish divergence is almost not apparent. Yes, the technical indicators I use are showing higher risk; but there is no absolute need to sell at this point.
What I suggest then is to go back to the short-term chart of XHB and see that the price (23.29) is just below the recent high of 23.43, and just above the 8-day Exponential Moving Average (EMA) of 23.08. If I was very nervous about this particular data series or about the market in general, I would place a Stop Sell limit order at ~23.08 and a Stop Buy at maybe 23.44.
I would not be initiating positions in XHB at this point, where the technical indicators are showing higher risk than when I would have been a buyer back in early June or early August, say, or at three different times in 2009, 2010 and 2011 (see the circles on the chart, which indicate the low-risk periods). But if I already held the position today, the Stop Buy price would be the time to possibly add a bit more or, more likely, the point I would become less concerned about the bearish divergence. The Stop Sell price, taken from the 8-period EMA, then, is simply a mathematically based discipline.
Maybe the Daily chart presents too short a time horizon for you. If so, then you can look to the Weekly chart for a basis to making decisions. The XHB 8-week EMA is 22.49. A week from now it could be close to 22.75.
These are trading concepts that Geoff and I will be discussing at the upcoming Cara Community Toronto Conference September 27-29. Hope to see you there!
As for market prices this morning, there is a significant anomaly between the falling price of Precious Metals and the falling price of the US Dollar ($USD). As I see it, the interventionists are selling PMs in order to take the focus off the Dollar, but the Dollar is key (since the forex market is much larger than the precious metals markets), so I would use this opportunity to buy the dip in the PM prices.
The British, French and Italian banks are all higher this morning except for BNP Paribas.
Have a good day.
Here are the 7:00am ET snapshots of the latest equity market trading results for Europe, and futures prices plus 5-minute charts of the futures for S&P 500, 30-year US Treasury Bond, US Dollar index, Gold and Crude Oil.
|Symbol||Name||Last Trade||Change||Related Info|
||6.27 (0.31%)||Components, Chart, More|
||9.00 (0.38%)||Components, Chart, More|
||22.27 (0.64%)||Components, Chart, More|
||31.14 (0.44%)||Components, Chart, More|
||1.95 (0.59%)||Components, Chart, More|
|^OSEAX||OSE All Share||485.90
||0.08 (0.02%)||Components, Chart, More|
||4.36 (1.33%)||Components, Chart, More|
||46.70 (0.72%)||Components, Chart, More|
||1.00 (0.02%)||Components, Chart, More|
||4.00 (0.42%)||Chart, More|
||5.83 (0.40%)||Chart, More|
|GD.AT||Athex Composite Share Price Index||637.12
||8.96 (1.39%)||Chart, More|
The team will check in during the day, reporting in the Discourse when there is a new entry.
Enjoy your day.