Market Direction Remains Overbought and Consolidating

Market Direction cannot go straight up no matter how much investors want it to. There has to always be someone willing to pay more for a stock that the person who bought it in order for market direction to move higher. Despite all the yammering by the talking heads about how cheap stocks are, I just cannot agree. Some stocks are cheap but a lot of stocks are not. When the talking heads drone on and on about PE and earnings and historical standards they are forgetting that stocks have to stay up based on earnings and in order for many stocks to move higher from these lofty levels, the S&P stocks as a group will have to generate 15% more this year than last to justify higher valuations. As 2011 was one of the best years on records for companies and much of it was from cost cutting, low-interest on debt, employment cuts, what more can these companies do to get that kind of return.

It is important to ignore the talking heads and focus on fundamentals when predicting market direction. There is no reason not to stay invested with some capital in this market but articles like this one by BMO Analyst Sherry Cooper are part of the reason market direction is having trouble. The global economies are slowing. Investors are counting on the governments of the world pumping even more liquidity into the system which will boost stocks even further. Today the news on the economic front in the US turned in some better numbers than expected. The Consumer Confidence Index rose for the first time in five months to 65.9 in July from 62.7 in June. As well the S&P / Case-Shiller home price index for 20 US Cities rose 0.9% in May on the back of a 0.3% rise in April. Investors don’t like these numbers because they could get the Fed thinking about delaying more liquidity action.

So are investors just greedy? Do they care about the economy and the average working family? Are they overly concerned that market direction is being too concerned with Europe again as today Spain’s bond interest rates were back on the rise and Germany is once more talking tough. I don’t know if these are even fair questions to ask. Why not post your opinion in the comments section below. I would love to hear what you think about investors in general right now.

Overbought Market Direction

The chart below shows the S&P action for the past two days. After two huge up days at the end of last week I am not surprised to see the market direction trend sideways in a wait and see mood. Today’s S&P low is still above the previous highs and even if that breaks it does not mean the pattern of higher highs and higher lows is broken. There is a definite uptrend in place for market direction. This does not mean the market direction will not pull back here, but just as before dips remain opportunities for Put Selling or picking up favorite stock to trade if the stock sells off.

Market Direction Chart for May to July 2012

You can see in this market direction chart that the last two days are still keeping the S&P above the previous high.

Market Timing Indicators For July 31 2012

The end of the month of July is upon us. The market timing indicators are painting an interesting picture. While I know that a lot of investors do not think much of technical analysis of the market direction, I have to profess that I love the technical indicators and studying what they are telling me. Today they are telling me a lot.

Momentum is beginning to fall but it is still fairly positive with a reading of 101.15.

MACD Histogram is still climbing and has for both yesterday and today, totally ignoring the sideways motion of the market direction. MACD is an excellent predictor so right now it is showing a lot of strength in the underlying market direction. This is bullish for stocks.

Interestingly, the Ultimate Oscillator is not falling and has stayed overbought. Again a very bullish sign and a signal of underlying strength.

Rate Of Change is pulling back but still positive. This does not surprise me. The Rate of Change indicator is reflecting the past two days of weakness, but overall the positive reading is still bullish for now.

The Slow Stochastic is trending towards a more neutral reading but it is still forecasting that stocks will be higher in a few days.

The Fast Stochastic is moderately bullish despite the past two days.

Market Timing Indicators

Market Timing indicators for July 31 2012

All the market timing indicators are telling me that the market direction is simply consolidating while it awaits further news. Last week in my market direction call I indicated that I believed the first day or two would see some selling but that the market direction up remained intact. At this stage I see nothing to point to me that the rally which began at the start of June is about to end.

Market Direction Calls Have Been 63% Accurate This Year

This year my market direction calls have been 63% accurate and on the options forum a member asked if I traded against my market direction calls.

I use my market direction calls for two investment objectives:

1) Timing when to look to SPY PUT trades for income and profit. Whenever the market direction turns down I look for opportunities to buy SPY PUT options for income and to build up my hedge cushion.

2) I use my market direction calls to know when to be looking at selling puts and when to step back and wait for a clear market direction up signal so I know most of my Put Selling will result in expired options.

It never bothers me to sell puts and then find that the stock pulls back further and I either have to roll my naked puts or consider other rescue strategies or accept shares. What does bother me is if I failed to check the market direction outlook and find out that if I had followed the market direction call I would have earned a lot more for the naked puts I sold by just waiting a day or two longer. Decades ago before I started watching market direction and set up my market timing tools to assist me in plotting market direction, I continually found that I sold puts for perhaps .50 cents which a day or two later were $1.50, simply because the market had pulled back and stocks were lower. My market direction calls have gone a long way to assist in reducing the number of times I sell puts for less premium than a day or two later.

Last I want to mention that I have always found that buying SPY PUT options have always done well for me since the SPY PUT was introduced in 1993. But I have not had the same success with SPY CALLS. I think this is because when the market direction changes to down, stocks tend to fall harder and faster than when the market direction is up. When the market direction is up stocks tend to grind their way higher which instead of rapidly increasing my SPY CALLS options premiums, I find that the SPY CALLS only slowly increase in value because of time erosion. I usually buy my SPY Options two months out. I found that with SPY CALLS as the market direction climbed, it often took too long to climb high enough to boost my call premiums. Instead the SPY CALLS slowly eroded in value while I hung on waiting for the market to climb high enough to increase them SPY CALL Options large enough to make it profitable.

This has never been the case with SPY PUTS. When the market direction changes to down the SPY PUT options can double in a day. Therefore while many Spy Call Options trades were successful, about 40% were not. I found that at the end of the year the return on Spy Calls versus Spy Puts was so poor that it did not warrant my time and capital.

Market Direction Still Up But Overbought

Market Direction is still up and unless the pattern of higher lows is broken, the rally remains intact. I believe market direction will move back to up as soon as the overbought condition is worked out and the market has consolidated here.

  • Pietrusikm

    one of your better posts. very concise. thanks……………………do you ever trade the vxx or its options?…….would dovetail nice with this article.