I tell you what, the Street is acting like a crack baby with its fix taken away. A tentative budget deal by Washington pols removed one of the near-term reasons for the Fed to continue its current pace of economic stimulus, and the Dow Industrials tumbled 129 points to close at 15,843.53. The S&P 500 Index lost 1.13% and the Nasdaq Composite was off 1.40%. Oil prices closed lower.
As the market fell volatility rose and UVXY, leveraged VIX short-term futures ETN, leaped 9.15%. FXP, the leveraged short China 25 ETF, gained 6.34% but is still well below its major moving averages. The small-cap index has been underperforming the other indexes and SRTY, the leveraged short Russell 2000 ETF gained 4.85%. SRS, the leveraged short Real Estate ETF, was up 4.17%. BOIL, the leveraged natural gas ETF, rose for another day and closed up 4.00%, back above its 200-day SMA for the first time since early June. Please click on the symbols for details.
A solid sell-off like today sends me to see what wolf-packs have been outperforming. By “wolf-pack” I mean a particular group of stocks in an industry that are outperforming others. Wolfs hunt in packs and good news or accumulation in a particular stock may bleed over to others in that industry group.
I began my search using High Growth Stock Investor software which as regular readers know is my favorite tool for data mining. I searched for stocks closing greater than $5/share with an average daily volume of 250,000 or more shares. Out of a database of almost 8,000 stocks this narrows the field down to 2,000. I then parse out the top 100 stocks as measured by their Raw Combo. HGSI allows the user to select data fields and then assign each field a weight. The higher the weight the more importance that data field is assigned. Raw Combo Ranking computes weighted values for each data field selected by the user and then combines all the weighted values. Here is the Combo I use in this search:
This particular Combo overweights the 2-day Force Index and the 13-day Force Index, an analytical measure developed by Dr. Alexander Elder. Dr. Elder is a well-known name in the field of technical analysis. A psychiatrist with a unique insight into the psychology of trading, he is also the author of Trading for a Living, Come Into My Trading Room and Entries & Exits, books that are well known among traders. I had the pleasure of meeting him many years ago at a Futures & Options Expo in Chicago, where he was selling his books.
Among the contributions he has made to technical analysis is the Force Index. Investopedia gives a very good explanation of what it is and how it is constructed:
“The three key components of the force index are the direction of price change, the extent of the price change and the trading volume. When the force index is used in conjunction with a moving average, the resulting figure can accurately measure significant changes in the power of bulls and bears.
“The force index is calculated by subtracting yesterday’s close from today’s close and multiplying the result by today’s volume. If closing prices are higher today than yesterday, the force is positive. If closing prices are lower than yesterday’s, the force is negative. The strength of the force is determined either by a larger change in price or a larger volume; either situation can independently influence the value and the change in force index.
“The raw value of force index is plotted as a histogram, with the center line set to zero. A higher market will result in a positive force index, plotted above the center line; a lower market points to a negative force index, below the center line. An unchanged market will return a force index directly on the zero line. The raw line that is plotted over the day-to-day on the histogram forms a jaggedness and the moving average smooths the line. Therefore, at minimum, you’ll want to use a two-day exponential moving average for the appropriate level of smoothing.”
So what stocks made this Top 100 list? HGSI’s spectrum analyzer makes short work of answering that question:
The internet software and services group was the largest slice of the pie, making up 11% of the top 100 stocks with the highest raw combo rank. The 11 stocks are a Wolf-Pack. It took a few minutes of searching to find an ETF that has in its holdings some of these 11 stocks and I found it in FDN, the Dow Jones Internet Index Fund ETF. FDN was down 1.46% today on below average volume and as of yesterday its YTD performance was +44.91%.
The key to using the Force Index is to look for short-term pullbacks while the intermediate-term is still strong. To keep on the right side of the trend it’s important for the ETF to be above whatever moving average you want to use to identify trend direction. An effective method for marrying these indicators is to look for ETF’s trading above both the 50-day SMA and below the 22-day EMA (pullback within a bullish trend); have a negative 2-day Force Index (short-term pullback); and a positive 13-day Force Index (intermediate-term strength). In other words, a pullback within a bullish trend.
But there are several element with FDN’s Force Index that don’t match these criteria. Please review the daily chart below:
While the 2-day Force Index is negative (less than zero), so too is the 13-day Force Index. The 13-day should be positive. And the price is above both the 50-day SMA and the 22-day EMA, so there really hasn’t been enough of a pullback yet. It appears that FDN may, I repeat, may have begun a trend reversal from Bullish to Neutral or worse. It’s still too early to say because FDN remains above its 22-day EMA but until the 13-day Force Index closes back above the zero line, I’ll stand aside.
This was a long explanation of why I decided to pass on buying FDN today. Sometimes the best course of action we can take is nothing. Sitting on your hands (away from the Enter key) can be the healthiest course of action you can take for your account balance.