As the year winds down the market turned in another quiet but generally up day today, with the Dow Industrials gaining 20 points to close at 11,575.54.  The S&P 500 Index gained a few cents, up .08%, but the Nasdaq Composite fell .16%.  Consumer confidence fell in December.  Yesterday’s blizzard and cold weather pushed oil prices and energy shares higher.

China announced that it is reducing the amount of rare earths it will export next year by more than 10%, which helped push gold and silver prices much higher.  AGQ, the levered silver ETF, gapped open higher and gained 6.69% today.  GDXJ, the junior gold miners ETF, rose 5.38% on below-average volume and is back above its 50-day SMA.  Yields jumped today and TBT, the levered inverse 20+ year Treasury Bond ETF, rallied 3.80% after pulling back to and holding at its 20-day EMA.  This was below the 200-day SMA, however, so I believe holding at the EMA is coincidental. UNG, the natural gas ETF, floated 3.55% higher on above-average volume.  Please click on the symbols for details.

Yesterday I discussed how stepping back and looking at the bigger picture can be helpful.  This same philosophy applies to buying and selling ETFs for longer holding periods, not just a quick swing trade, because the bigger picture takes out some of the noise found in daily trading.  Two techniques I like to use are similar and you can use one or both to help keep you on the “right” side of a position: a 13-34 week EMA crossover and a 20-month SMA crossover.

The former is just what it sounds like – Go long when the 13-week EMA crosses above the 34-week EMA, and go short (or to cash) when it close below.  Please look at the weekly chart of SPY, the S&P 500 SPDR, below.  You can make it full-screen by clicking on it:

The upper portion of the chart shows the two EMAs, with the 34-week in blue and the 13-week in red.  The lower portion of the chart is a 13-34 week MACD (Moving Average Convergence-Divergence) indicator; it makes seeing when the crossover occurred a little easier to read when the EMAs start whipsawing through each other, like they did this summer.

The first trade short trade would have been taken in early January, 2008 (far left red circle in the MACD).  You would have been short the SPY from 141.31 down to 101.20, when you would have covered and gone long in early August 2009 (green circle).  The gain on that trade was 28%, which you could have capitalized on by going long SH, the short S&P 500 ETF.  If you were confident about the trade signal you could have gone long SDS, the levered short S&P 500 ETF.  I don’t recommend buying levered ETFs for long holding periods, however, because of problems with them not tracking exactly with or against their benchmark.

Going long in early August 2009 you would have stayed long until early July of this year, for a 6.7% gain (second red circle).  This gain could have been captured by buying SPY or if you felt confident about the signal, SSO, the levered S&P 500 Index ETF.   Between July and early September of this year there were three trades, two short and one long, which were whipsawed and resulted in a 11.6% loss (yellow rectangle).  This was followed by a bullish crossover in early September (second green circle) and going long has been a profitable open trade, up 11.86% as of today’s close.

So in the three years ending next week, just one buy and four round-trip buy-sell combinations generated total hypothetical profits of 35.32% before trading costs, compared to a buy & hold return of -10.94%.

Similar results can be achieved with even fewer trades using a 20-month SMA crossover.  Buy SPY when it closes above the SMA at the end of the month and sell it/go short/go long an inverse ETF when it closes below the SMA.  The chart below shows buys with blue up arrows and sells with red down arrows:

With only five round-trip trades and one opening short/inverse trade, this strategy realized hypothetical gains before transaction costs of 275% since November 1994, compared to a 176% return for a buy & hold strategy.  That’s an average of one trade every three or so years.

Hypothetical means just that – these weren’t real trades and in practice, the returns might not have been this good. That notwithstanding you see how by taking a step back and looking at the bigger picture you can improve your trading by staying on the “right” side of the trend.  This is essentially what my AAPTA colleague Dave Landry is doing with his Big Blue Arrow, and Larry Connors is doing by going long only when the ETF is trading above its 200-day SMA.

I’m taking the rest of this week and all of next week off to spend some time with friends and family.  I wish all of my readers a happy and healthy new year!  May your best trade of 2010 be your worst trade of 2011.

As the market slides down the razor blade of the final days of 2010, we can expect mostly quiet action.  China caught the investment world off-guard by raising rates; not that it mattered much because anyone living in the northeast with two functioning brain cells stayed home today courtesy of the Blizzard of 2010.  I drove from Boston to Connecticut during the blizzard of 1978 so I know how bad it can get!

The Dow Industrials lost 18 points to close at 11,555.03 while both the S&P 500 Index and the Nasdaq Composite gained .06%.  DRN, the 3x levered real estate ETF, rose 3.43% and has been trading sideways for the past six weeks.  LHB, the 3x Latin America ETF, gained 2.85% but has been trending lower for months.  FAS, the 3x levered Financial sector ETF, rose 2.27% after breaking out of a cup with handle pattern last week.  Please click on the symbols for details.

When the action is slow around holiday time I like to step back and take a look at the bigger picture; it’s always valuable not to lose sight of the forest through the trees.  The monthly chart of QQQQ, the Nasdaq-100 Index ETF, shows resistance just up ahead.  You can make the chart full-screen by clicking on it:

Resistance is around 55.05 -  55.10.  A pullback from here in the next few weeks would not be unexpected and could set up a nice entry for a new leg higher.

XLV, the Health Care SPDR, has formed a nice looking cup with handle pattern on its daily chart.  Note how the volume has rapidly dropped off as the down-sloping handle formed, which is the preferred pattern:

Although the technically correct buy point for a C&H is when price comes back above the right-side high of the cup (some buy on a break up through the descending handle trend line), XLV fired off a buy signal on its close today using the Multiple Down Day strategy developed by Larry Connors and Cesar Alvarez.   Described in their book “High Probability ETF Trading,” the MDD strategy is simple in concept.  The long entry rules are:

1) The ETF is trading above its 200-day SMA.

2) The ETF closes below its 5-day SMA on the entry day.

3) The ETF must fall 4 of the past 5 days.  This means closing prices were lower than the day before for 4 out of of the past 5 days.  If this happens you buy the ETF on the close today.

4) Aggressive version – Buy a second unit (scale-in) if prices close lower than your initial entry anytime you’re in the position.

5) Exit on the close when the ETF closes above its 5-day SMA.

The most recent five days are numbered, with Day 3 being the one day there wasn’t a lower close.  You can make the chart full-screen by clicking on it:

Today’s entry came at the close of 31.59.  The exit will be on a close above the 5-day SMA, shown in light blue.

When Connors and Alvarez backtested the MDD strategy against a group of 20 non-levered ETFs from their inception through 12/30/08, the average %P/L was .50% with an average hold time of 3.3 days and a %Winners of 73.6%.  The aggressive version had an average %P/L of .82% and a % Winners of 80.3%.

I ran a backtest on XLV using the aggressive version of the strategy, from its inception date through today.  The %Winners was 75.59% (before trading costs), very similar to the system backtest results.  Of course, past performance is no guarantee of future results.

With everyone and their cousin looking for a pullback in January, should it come to pass it is likely that health care, which is relatively inelastic and defensive, should perform well.  XLV includes companies from industries such as pharmaceuticals, healthcare equipment and supplies, healthcare providers and services, biotechnology, life sciences tools and services, and healthcare technology.  When I looked in High Growth Stock Investor at how the various healthcare groups performed relative to the other 154 industry groups in the data base, with one exception (HMO’s) the recent performance (using a three-week lookback period) was bullish:

Note how with the exception of HMO’s, the relative strength of all the healthcare-related groups has been improving.

Tomorrow will be my last blog entry for 2010; I’ll be taking off the rest of this week and all of next week to spend time with friends and family.  As to what happens in the market while I’m on vacation, that is something we will know in the fullness of time.

Not unexpectedly the market action today was quiet, capping a holiday-shortened week.  Economic reports showed small improvements in consumer spending and the job market, and bond prices fell slightly.  The Dow Industrials gained 14 points to close at 11,573.49 while the S&P 500 Index lost .16%.  The Nasdaq Composite also fell, down .22%.

ETFs were very quiet today with the second largest mover being VXX, the S&P 500 VIX Short-Term ETN, up 3.22%.  It reacts to the volatility of the market and has been in a downtrend since late May; earlier this week it made a three-year low.  Low VIX values represent investor complacency, which usually resolves itself with investor fear as the market tumbles.  FXP, the levered short China index ETF, rose 2.43%.  UCO, the levered crude oil ETF, added 1.55% and broke above a resistance level around 12.25 – 12.30.  Please click on the symbols for details.

Light trading also is expected next week and there is a seasonal bias to the upside, but I’m seeing signs that the December move is extended and due for a pullback.  If nothing else, a pullback is healthy – it puts some profits in the bank and lets traders and investors set up for another leg (hopefully) higher.

Moving averages are a very popular and relatively simple technical analytical technique to understand.  They smooth price data to form a trend following indicator.  The two most common forms of moving averages I use are the simple moving average (SMA) and the exponential moving average (EMA).  They can be used to identify the direction of the trend or define potential support and resistance levels.

A SMA is formed by computing the average price of a security over a specific number of periods.  I usually chart the 50- and 200-day SMAs.  For example, a 50-day SMA is the fifty day sum of closing prices divided by fifty.  As each day passes, the oldest data point is dropped and today’s data is added, so therefore the MA can change each day.  An EMA reduces the lag by applying more weight to recent prices.  I won’t go through a detailed construction example but you can Google “exponential moving average” for an explanation of how it’s calculated.

Why do moving averages act as resistance or support points?  While there is no “correct” answer, in part it’s because they are widely followed and if enough people think a price level will act as support or resistance, then it will…because they will buy at support or sell at resistance.  At some point, however, enough people won’t buy at support or sell at resistance and then the MA stops “working.”  Or put another way, a MA acts as resistance or support until it no longer does.

The 50-day (and 200-day) SMA are typically used as a gauge of the intermediate or long-term trend of an asset.  Trading above the MA is interpreted as meaning the trend is bullish, especially if both the closing price of the asset and the MA are trending higher.  Trading below the MA, especially if the MA is also trending lower, is considered bearish.

The 20-day EMA, being faster, i.e., calculated over a shorter time period and weighted toward more recent data, is more frequently used as a short-term trend indicator.  Crossing above or below the EMA on a closing basis is something I watch for as being a “canary in the coal mine,” alerting me to a possible change in short-term trend direction.

With this in mind, please take a look at a daily chart of SPY, the S&P 500 SPDR.  You can make it full-screen by clicking on it:

In early September the SPY rose up to close above both its 20-day EMA and its 50-day SMA.  The SPY continued closing higher and a few days later both moving averages started making higher highs, i.e., trending higher.

The first pullback came on September 23rd, the first blue up arrow.  Every pullback from then until mid-November held above the EMA, showing the uptrend was strong.  The last two weeks of November it whipsawed above and below the EMA before finding support at the 50-day SMA on November 29th and 30th (black up arrow).  On December 1st, SPY gapped open higher and closed well above its 20-day EMA where it has remained through today.

Eventually, SPY will pull back.  Given how strong support was for several months at the 20-day EMA, it’s likely that support will manifest itself again during the pullback.  Should SPY close below the EMA, look for further support at the 50-day SMA.  Incorporating the pullback techniques of both Larry Connors and Dave Landry, pullbacks to either or both moving averages could be used as a price level to start buying.

Sometime a moving average doesn’t seem to work at all – price seems to pass through it with impunity.  When that happens, consider using other technical analysis techniques for identifying resistance and support levels.  For example, please take a look at the updated chart of TBT, the levered short 20+ Year Treasury Bond ETF:

TBT found what looked to be support or resistance at the 200-day SMA this month but that didn’t last for more than a day or two.  But looking at a Fibonacci retracement series of the August – December advance, we see the 23.6% retracement level has held quite nicely as support despite being tested four out of the last five days.  Only one day (December 21st) closed below the level.  Given that this week was a bit of a consolidation zone, a trader could buy TBT on a break above this week’s high (38.74) or short it on a break below (37.33).  Rather than shorting TBT the trader could buy its inverse, UBT, the levered long 20+ year Treasury Bond ETF.

The last chart I’d like to present to you is a daily chart of EEB, the Guggenheim BRIC (Brazil, Russia India, and China) ETF:

Sometimes support and resistance levels are just plain ol’ hard to pin down without using esoteric technical analytics.  When that happens, look and see if readily identifiable chart patterns are present.  The EEB chart reveals that it formed a pennant.  A pennant is a type of symmetrical triangle that forms after a significant price advance.  As with most triangles they tend to break out in the direction of the prevailing trend.

That was the case here as seen by EEB breaking out above the descending trend line yesterday.  Today’s pullback was harami bar, a Japanese candlestick formation wherein today’s price range is completed encapsulated within yesterdays price range.  In Western terminology we call this pattern an “inside day.”  Inside days/harami bars typically indicate indecision on the part of market participants.  It’s worth noting that today’s action tested the descending line on a pullback but closed just two cents below the high.  Former resistance lines once broken tend to act is support, when tested.

I wish you all a Merry Christmas and an enjoyable weekend.

Talk about your quiet days…it was hard to believe it was a quadruple-witch expiration day.  Despite the passage of a tax bill that extended the Bush-era tax cuts for two more years, and the major indexes hitting two-year highs, the market closed mixed today.  The Dow Industrials lost 7 points to close at 11,491.91 while the S&P 500 Index gained .08%.  The Nasdaq Composite also inched higher, up .21%.  Oil and gold rose modestly but bonds pulled back sharply.

UBT, the levered 20+ Year Treasury Bond ETF, rose 4.11%.  GDXJ, the junior gold miner ETF, bounced off its 20-day EMA and gained 2.63%.  Please click on the symbols for details.

The major indexes all had a Narrow Range 7 bar today.  A NR7 day is where today’s range is the narrowest it’s been in the last seven days.  Narrow range days are typically followed within a day or two by days of increased range.  What with the next two weeks being pre- and post-holiday and only four-days long, it’s questionable as to whether the market will see a range expansion next week.

Having said that, watch the market have a huge move early next week and make me eat my words.

I blogged Wednesday about how TBT, the levered inverse 20+ year Treasury Bond ETF, had run into resistance at a Fibonacci price cluster around 40.45 – 40.50.  This confluence proved to be especially strong as TBT sharply pulled back from this week’s high and closed not far from the week’s low.  Please click on the weekly chart below to see this; you can make it full-screen by clicking on it:

This week’s bar is on the far right, the last bar in the yellow rectangle.

TBT closed back below its 200-day SMA.  It has retraced 23.6% of the rise from the August low to this week’s high:

Retracements of as much as 50% are not uncommon.  You can try to capture the pullback should it continue by buying TLT, the 20+ Year Treasury Bond ETF, or UBT, the levered ETF.

I will be out of town Monday and Tuesday of next week so the blog will resume on Wednesday.  Enjoy your weekend.

The market yawned as the Senate passed the tax bill extending tax cuts.  The Street is more concerned with Moody’s warning that Spain’s debt rating may be downgraded, spiking the Dollar and putting downside pressure on the U.S. stock market.

The Dow Industrials closed down 19 points at 11,457.47.  Volume continues to lighten as we get closer to Christmas and back-to-back four day weeks.  The S&P 500 Index dropped .51% and the Nasdaq Composite fell .40%.  Oil and other commodities dropped sharply on the dollar’s rise while bond yields continue to rise.

ZSL, the levered short silver ETF, gained 4.78%.  FXP, the levered short China ETF, rose 4.73%.  BZQ, the levered short Brazil ETF, added 4.01%.  Please click on the symbols for details.

I received an e-mail this morning from an eagle-eye blog reader asking a question about the ERG 270 list I blogged about yesterday.  How, he asked, could the number of of stocks be dropping below ERG 270 if their component ranks are relative to each other?  Something has to be ranked #99 and something else #1, regardless of their “raw” data.  Shouldn’t the number of stocks with an ERG equal to or greater than 270 be more or less unchanged?

Good question.  I left out an important piece of information…D’oh!

On May 18, 2010, I blogged about the Bongo Indicator.  Developed by a team of High Growth Stock Investor users, the Bongo describes a relationship between three Wells Wilder’s Relative Strength Indicators and a 9 period moving average. When the short term RSI (8-Period) is above the medium term RSI (14-Period) and the medium term RSI is also above the long term RSI (19-Period), and the closing price is above the 9-period SMA, then the Bongo is considered “Yes.” If the inverse is true, it is considered “No.” “Yes” has bullish implications while “No” has bearish implications.

Both daily and weekly Bongo work the same way but the reading is taken following the last close of the week for the Bongo Weekly, rather than the end of each day for the Bongo Daily. The weekly indicator has intermediate term implications usually lasting weeks if not longer. Divergences between daily and weekly Bongo can be an indication of a potential price reversal.

The best time to buy is the day (Bongo Daily) or Monday (Bongo Weekly) following a Bongo crossover from “False” to “True,” e.g., yesterday (or last week) the RSI’s were not lined up in the proper order or the closing price was below the 9-period MA but today (or Friday, if Bongo weekly), the RSI’s are in the proper order and the close is above the 9-period MA.  Backtesting showed somewhat better results taking Bongo Weekly signals than Daily signals but in a strongly trending market, the Daily signal will get you in and out sooner.

The information I left out in yesterday’s blog entry was that in addition to the ERG rank being greater than or equal to 270, HGSI power user Robert Minkowski also tracks whether stocks passing through this filter had a Weekly Bongo Yes or Weekly Bongo No.  As the market strengthens a greater number of ERG 270 stocks should be Weekly Bongo Yes – this is what Robert “counts” as making the ERG 270 list.  As the market weakens, the Yes’s turn to No’s and stocks drop off the list.  So it isn’t that the number of stocks with an ERG rank below 270 is falling (the number of stocks will remain more or less constant), it’s the number of ERG 270 stocks with a Weekly Bongo Yes that rises or falls.

Thanks to my readers for alerting me to this oversight!

TBT, the levered short 20+ Year Treasury Bond ETF, and TBF, the non-levered short 20+ Year Treasury Bond ETF, continue to rise as bond yields continue to rise.  There is a very interesting triple-Fibonacci retracement price confluence on TBT, easily seen (?) on the weekly chart.  Please click on the chart below to make it full-screen:

I’ve blogged a number of times about Fibonacci price clusters, the overlapping of Fibonacci price or time series.  When these overlap they tend to act as resistance or support zones (depending upon the direction from which it was reached).

I selected three time series, using a common low (week-ending August 27, 2010); the all-time high; and the subsequent swing highs as the end points.  The oldest series runs from week-ending June 6, 2006 to August 27, 2010 and is in black.  The first rally attempt topped out on week-ending June 12, 2009 (in blue) and the second rally attempt made its high on week-ending January 15, 2010 (in red).  Next, I’m going to zoom in on this week’s bar:

Note how the high (so far) this week halted right at the confluence of the 23.6% retracement level level of the longest-term Fibonacci series (black) at 40.44, and the 50% level of the shortest-term series at 40.49 (red).  Strong resistance indeed!  Should TBT move higher it has additional resistance at the 50% level of the intermediate-term series at 41.24.

A close this week below the 40.45 – 45.50 level could set up a short-term downside reversal.  We’re seeing how a failure to close above a Fibonacci confluence tends to meet with selling on an updated chart of VNM, the Vietnam ETF I blogged about last week (December 7):

Last week’s close well below the confluence at 29.75 – 30.0 was met with heavy selling this week.

The market’s action is likely to continue trading quietly through the end of the year, more news-driven than anything else.  End-of-year tax selling and portfolio window dressing will also enter into the equation.  Where will the market end up on December 30?  The answer to that question is something we will know in the fullness of time.

The bond market fell of a cliff today as the Fed announced it would maintain the pace of its $600 billion Treasury bond-buying program because a slowly improving economy is still too weak to bring down high unemployment.  The yield of the 10-year Treasury Note jumped to its highest level since May.

The Dow Industrials climbed 48 points to close at 11,476.54.  The S&P 500 Index rose .08% while the Nasdaq Composite gained .11%.  Precious metals and oil were relatively unchanged.  The Dollar rose slightly.

DRV, the triple-levered real estate bear ETF, rose 3.33%.  TBT, the levered short 20+ Year Treasury Bond ETF discussed yesterday gained 2.76%.  Please click on the symbols for details.

Although TBT and TBF, the short (unlevered) 20+ Year Treasury Bond ETF both broke out today, neither completed the Trend Knockout (TKO) pattern I discussed in yesterday’s blog.  Neither made two-bar lows, a necessary component of the set-up.  I received an e-mail this morning from Dave Landry, developer of the TKO, reminding me that the knockout bar should be a meaningful two-bar low or high.  Dave further said he prefers a wide-range bar for knocking out the weak hands.  Thanks, Dave!

Although the market continues to rise it’s beginning to look more and more like window dressing.  I’ve mentioned past blog entries that I use High Growth Stock Investor software (HGSI) to, among other things, help identify which groups or sectors are gaining or losing strength.  Once I know this I can look for ETFs that correspond to these groups and sectors.  A friend of mine, Robert Minkowski, is a HGSI power user.  One of the metrics he uses to identify a strengthening or weakening market is the ERG 270/255 list.

“ERG” is an acronym for the summation of Earnings Per Share (EPS) Rank + Relative Strength (RS) rank + Group Strength (GS) rank.  For example, if EPS = 81, RS = 82, and GS = 77, then ERG = 240.  HGSI gathers data on well over 7,000 stocks and calculates the rankings for each one.  From here it will calculate the ERG rank for each stock.  The user can list the ERG for all stocks or set up a filter for whatever minimum or maximum ERG rank desired.

If a stock has an ERG rank of 270 or higher, that means the average rank of each of the ERG components was 90 or higher.  Obviously, these are strong stocks to be ranked so highly.  By checking on a daily or weekly basis how many stocks are ranked 270 or higher, or 255 or higher, you get a read as to the “health” of the market.  An increasing number of 270 or higher stocks means the market is getting stronger.  A decreasing number means the market is getting weaker.

Robert noted in an e-mail this morning that the number of ERG 270 stocks dropped from 65 to 48 last week. Last night it dropped further to 44 and is below a trendline from early September.  The number of ERG 255 stocks dropped from 137 to 124 last week and fell to 117 yesterday, sitting right on a trendline from early July.  The major indexes making higher highs while the number of top-ranked stocks is declining is a potential bearish divergence.  It’s not weakening internals per se but the breadth of the rise is getting narrower and narrower.

You can see this in DIA, the Dow Diamonds.  It broke out of a cup & handle pattern today but the volume was well below average and far below William O’Neil’s recommendation that the breakout should be accompanied by at least 150% of average daily volume.  Please click on the chart to make it full-screen:

Similar breakouts or moves higher accompanied by light(er) volume can be found on the SPY and QQQQ.  Aggressive traders may want to dip their toes into short (inverse) ETFs like SH (short SP 500) or DOG (short Dow 30), but with the indexes well above their 50- and 200-day SMAs, the trend is higher so you would be trading against Landry’s Big Blue Arrow (which he draws in the direction of the primary trend).

I’m a believer in staying on the sidelines when you’re unsure of the future direction of the market.  While no one likes sitting in cash when the market is moving, it sure beats losing it.  Better to be safe than sorry so that you can trade another day.

“Make up your mind already!  Go up, go down, but pick a direction!”

Such was the lament I heard today from an old friend who works in the financial services business.  Range swinging is the opiate of traders that drives investors a little crazy.  The Dow Industrials were up almost 70 points at the high today but closed up only 18 points at 11,428.56.  The S&P 500 Index was unchanged (technically-speaking it was up…6 cents) and the Nasdaq Composite fell .48%.

What was up today was precious metals, commodities, and Asian markets on news that China held off raising rates.  Not surprisingly, this sent the U.S. Dollar sharply lower.  AGQ, the levered silver ETF, was the biggest winner of the day after 6.35%.  Next up was the Vietnam ETF VNM, up 5.89%.  DAG, the levered agriculture ETN, rose 4.29% after breaking out of a mini-cup & handle pattern (“mini” being defined as a pattern that formed in less than one month).  EZJ, the levered Japan ETF, gained 3.47%.  Please click on the symbols for more details.

Although I’d never buy FUD, the food ETN, because the average volume is only 8,500 shares per day, if it were up to me I’d nickname this one “Elmer.”  Think about it and you’ll understand….

On Friday I discussed how EEM, the emerging markets ETF, went long at 46.59 using the Multiple Days Down (MDD) strategy.  It exited today on a close above its 5-day SMA, at 46.90, for a gain of 0.66%.  Not earth-shattering but it still made a buck or two after trading costs.  Doesn’t mean it will next time, of course, because past performance is no guarantee of future results.

TBT, the levered inverse 20+ year Treasury Bond ETF, continues to run into resistance at its 200-day SMA.  Point in fact, it very possibly made a bearish engulfing bar today.   Interestingly enough,  TBF, the non-levered inverse 20+ year Treasury Bond ETF, continues to trade above its 200-day SMA.  Lower TBT and TBF prices = lower bond yields so if the trend is for yields to continue climbing (as they have been since late August), this pullback could be setting up a buying opportunity.

Both TBT and TBF are setting up Trend Knockout (TKO) patterns.  Developed by my AAPTA colleague Dave Landry, TKO’s identify strong trends from which the weak hands have already been knocked out of the market.  By placing your order above the market, you have the potential to capture profits as the trend resumes.

As always, you want to buy in the direction of the primary trend.  I recommend long trades only when the ETF is above its 200-day SMA.  Take short trades (or buy inverse ETFs) only when the ETF is below its 200-day SMA.

Here are the Buy rules for TKOs (short sales are reversed):

1.  The ETF you’re watching to buy should be in a strong trend, as defined by an ADX >= 30 and +DMI > -DMI.  You can also use rectangular bases that successfully broke out to the upside.  If you’re unfamiliar with ADX or DMI, please read my 8/7/09 blog entry for a complete description.

2. The ETF should make at least a 2-bar low.  Buy tomorrow or the next day 1 – 2 ticks above today’s high.

3. Place a protective stop below the low of the knockout bar.  If this is more than 5% away from your entry price, risk no more than 5% of the ETF’s value.

Please take a look at the daily chart of TBF, below.  You can make it full-screen by clicking on it:

ADX is the Average Directional Index indicator.   It measures the strength of a trend and can be useful to determine if a trend is strong or weak.  The indicator is a combination of the positive directional indicator (+DI) and the negative directional indicator (-DI). The +DI tracks the upward trend of the stock, while the -DI tracks the downward trend. ADX combines the two and produces a unified trend strength indicator.  High readings indicate a strong trend and low readings indicate a weak trend or lack thereof.

It is very important to note that ADX measures the strength, not the direction, of a trend.  You could take two ETF’s moving at the same rate of speed, one trending  higher and the other trending lower, and they will have similar ADX values.  When the ADX is above 30 and rising, the trend is strengthening.  When it’s below 25 and falling, the trend is weakening, i.e., becoming non-trending.

As of today TBF has not made a two-bar low so the TKO pattern is not yet complete.  You can see the high ADX (closed today at 39.38) and +DMI is greater than -DMI (showing that the trend is for higher prices) so all that’s needed now is the two-bar low to complete the setup.  Once (if) that occurs, buy the next day above the high of the day the second lower low is made.

I’ll post a followup to this pattern if and when TBF does make a two-day low.  Until that time, keep your powder dry and look for other trading opportunities using the techniques I’ve discussed in previous blog entries.  And if nothing sets up then sit back and wait patiently – don’t force a trade.

The stock market continues to grind away with the Dow Industrials making little headway this week but the S&P 500 Index and the Nasdaq Composite both closing at 52-week highs.  The Dow rose 40 points today to close at 11,410.32 while the S&P gained .60% and the Nasdaq rose .80%.  Bond yields rose sharply again as prospects brightened for a passage of the tax bill and an improving economic picture – the trade deficit fell to its lowest level in nine months in October.  Gold and oil prices dropped.

With the exception of a few ETFs that trade by appointment only (very low average volume), most were very quiet today.  FAS, the triple-levered financials ETF, rose 2.68%.  UWM, the levered Russell 2000 ETF, gained 2.55%. PIN, the Powershares India Portfolio ETF, added 2.19%.  Please click on the symbols for details.

TBT, the levered short 20+ Year Treasury Bond ETF, has made one heck of a gain since its upside bow-tie crossover back in mid-October.  Developed by my AAPTA colleague Dave Landry, the bow-tie strategy is effective in catching reversals that tend to persist for several weeks or longer.

This strategy is a very simple technique that uses three moving averages: the 10-day SMA, the 20-day EMA, and the 30-day EMA. The moving averages should converge and spread out again, transitioning from a proper downtrend order (10-SMA < 20-EMA < 30-EMA) to a proper uptrend order (10-SMA > 20-EMA > 30-EMA).  According to Landry, ideally this should happen over a period of three to four days.  The creates the appearance of a bow-tie in the averages.

Here are the entry rules:

1. The moving averages transition from proper downtrend order to proper uptrend order.

2. The ETF must make a lower low and a lower high.

3. Once #2 has happened, go long above the high of #2 until filled.  If the ETF starts trading below its 20- or 30-day EMA before you’re filled, reevaluate the trade and consider standing aside.

Please review the daily chart below of TBT.  The crossover is at the yellow ellipse.  You can enlarge the chart to full-screen by clicking on it:

Ordinarily, my personal preference is to hold the trade as long as the moving averages don’t reverse into the proper downtrend order.  It’s okay to continue holding the trade if the 10-SMA falls below the 20-EMA, as long as the 10 and/or 20 are still above the 30-day EMA.  Landry suggests holding the trade until the ETF starts trading back to or below its 20- or 30-day EMA.  That doesn’t mean you should automatically sell there, although taking partial profits is never a bad idea.  Use other technical indicators to confirm the trend is changing.  If you’re still in the ETF and the moving averages reverse to a proper downtrend order, however, exit the trade.

But note how TBT has run into resistance at its 200-day SMA.  Considering that it has gained 15% or so since its entry, taking partial profits here (or at least, please a protective sell stop) may not be a bad idea.

EEM set off a buy signal today using the Multiple Days Down (MDD) strategy.  Developed by Larry Connors and Cesar Alvarez and described in their book “High Probability ETF Trading,” the MDD strategy is simple in concept.  The long entry rules are:

1) The ETF is trading above its 200-day SMA.

2) The ETF closes below its 5-day SMA on the entry day.

3) The ETF must fall 4 of the past 5 days.  This means closing prices were lower than the day before for 4 out of of the past 5 days.  If this happens you buy the ETF on the close today.

4) Aggressive version – Buy a second unit (scale-in) if prices close lower than your initial entry anytime you’re in the position.

5) Exit on the close when the ETF closes above its 5-day SMA.

The most recent five days are numbered, with Day 5 being the one day there wasn’t a lower close.  You can make the chart full-screen by clicking on it:

Today’s entry came at the close of 46.59.

When Connors and Alvarez backtested the MDD strategy against a group of 20 non-levered ETFs from their inception through 12/30/08, the average %P/L was .50% with an average hold time of 3.3 days and a %Winners of 73.6%.  The aggressive version had an average %P/L of .82% and a % Winners of 80.3%.

I ran a backtest on EEM using the strategy, from its inception date through today.  The %Winners using an aggressive version of the strategy of was 80.26% (before trading costs).  Of course, past performance is no guarantee of future results.

The economy appears to be slowly mending and Congress leaving for winter break soon is a good thing, as far as Wall Street is concerned.  Will Mr. Market be naughty or nice over the next two weeks?  That is something we will know in the fullness of time.

Enjoy your weekend.