Reading Chart Tea Leaves

OK, we’re going into a holiday. That usually means a volume slow down, but this is just a bit early for it. Just keep it in mind…

At the same time, we’ve had some run up this year to date in a couple of major vehicles. Gold (metals in general) and stocks (S&P 500 is the benchmark).

We also had a big down day (or three…) a couple of ‘go nowhere’ days and a big up day. So what the heck is going on? And what to do next?

To The Indicators, Batman!

First up, Gold. It’s still getting a fair amount of hype, and it may still have room to run (it isn’t at historical highs yet, but then again, we’re not at 18% interest rates and rampant inflation yet either…). With the US Dollar having become a bit of a ‘rubber ruler’ we first need to check our calibration against gold. I’ll use the GLD gold ETF (Exchange Traded Fund) for that.

GLD Gold 1 Year daily interterval with RSI, MACD, and DMI

GLD Gold 1 Year daily interterval with RSI, MACD, and DMI

OK, we’ve had a long run up, then a spike higher. That right there is a worry. Now the Simple Moving Average (SMA) stack is still “fastest on top, slowest on bottom” and that’s good, but the SMA(24) gold line, the 24 day Simple Moving Average has gone flat. Not made any money in 24 days, net. Could be a dip, as in “Buy the Dips, Sell the Rips” or could be the start of something worse… Need more input… (to quote Number 5 ;-)

Those two red lines on each side of the price bars are Bollinger Bands. They tell you how far, in statistical terms, the price is from it’s trend. Notice that when prices are ripping upward, it tends to track the Bollinger Band top line. When it gets a long ways from the SMA lines, prices tend to revert to the trend. When it’s a ‘dip’ it drops back to the SMA stack (typically to the Gold SMA(24) line) then takes off again. When price drops all the way to the blue SMA(48) line and through it, things are typically headed for a flat roll for a while or turning down. Right now, we’ve penetrated the SMA(24) and are playing with the SMA(48) line. Not good.

Sidebar on SMA

Sidebar on SMA sizes: The traditional numbers to use are SMA(50) and SMA(200) for trader and investor respectively. I use a stack of 3 lines so it’s made quite clear how the process is running. If Bigcharts gave me a choice of which three, I’d use one at 50, one at 200 and one at, most likely 150. But they don’t. You get to set ONE value, then it makes the 2 x and 3 x of that value. So 25 will give you 25, 50, 75 lines. I set my selection to 24 so that I’m seeing a ‘move’ just a bit sooner than the folks that slavishly follow the 50 day and trade the day after. Does it matter? Probably not. Most often, it’s best to ‘tune’ the number a few days either side until the prices touch one of the lines regularly. You are finding what indicators the Big Money is using and then keying off of them that way… Sometimes I’ll have two panels open. One with SMA3 (24) and one with SMA3 (70) – that gives the 70, 140, and 210 day moving averages. Close to the 150 and 200 that many folks use. Not ideal, but OK. Sometimes I’ll swap to a weekly chart and use an SMA3 (20) on that. That gives 20, 40, and 60 ‘weeks’ of trading days (at a 5 day trading week) or 100, 200, and 300 day moving averages. Better in many cases, but only really of use on the weekend reviews as the ‘week’ only ticks once on Friday… What about the EMA choice? That is the Exponential Moving Average. It exponentially weights newer data more. Responds faster, but then you need to ‘tune’ to different numbers. I’ve played with it. It works too. I’m just a bit too lazy to re-tune everything (including my brain) to the more twitchy nature of it. Is there a “magic” SMA or EMA setting to use? Not really. But since a large number of traders use the 50 day, and a large number of investors use the 200 day, they have more “clout”, but only because that is what the herd is doing…

Back at GLD and the RSI / MACD / DMI

OK, this could be a ‘one month pause’ that we’re already 1/2 a month into… or it could be the start of something a bit bigger. Not clear yet. So what do the other indicators say?

RSI:

We’ve touched 80. The classic ‘trade out soon’. Then the next ‘peak’ of RSI was only about 70. The classic ‘stay out a while’. RSI is saying it’s time for a modestly long pause, at least. Look back at May to August, the last time it did that. Not much to be made with “buy and hold” but some fast weekly trades would have worked.

MACD:

Here you can see why trading gold with MAC is a pain in the butt. Gold spikes, up or down, based on a “fix” done in London when the USA is closed. So it spikes someway or other, and a trend follower gets in AFTER the move. PITA at times.

But MACD is presently saying “red on top” be out, and it’s headed for a zero crossing “stay out for a while”. At best you could try to trade this thing with a 10 day hourly chart (or faster) but to do it properly needs a European account.

At any rate, right now it’s saying “no joy in Mudville”…

DMI:

The ADX line is below 25 (way below at about 20 barely) so it is saying ‘fast trade with the Slow Stochastic or swap to a faster chart like the 10 day hourly’. Again, not a time for the ‘safety investor’.

We have “red on top”. DMI- is saying “be out now”. Though I note that both DMI- and DMI+ are flat / sideways. Neither bullish nor bearish is giving a trend to work. Day trade or swing trade BOTH directions, but don’t have a directional attitude about it.

Newsflow:

One of my favorite indicators on the gold trade is when you see ads on TV telling you to Buy Gold Now! That has been a darned good indicator of a short term top. The major trading houses are having trouble filling the “other side of the trade” so they advertise for folks to take that side. Means a lot of money is selling gold, but not enough buying, typically.

Yeah, it’s a bit tricky to read as the time scale is variable. But right now we have plenty of adds for “buy gold now”…

One other minor point: China is raising reserve requirements on it’s banks. Loans will be harder to get in China and folks will be scrambling a bit more for cash. That will likely take a bit of the demand out of the consumer gold market there. But internationally, gold is typically driven by central bank demand. With EU central banks looking to hand buckets of Euros to Ireland, Greece, Portugal, et. al. they are not going to be buying gold, and may sell some. With China putting the squeeze on it’s banks, they will be raising cash more than gold (IMHO). The Swiss are trying to run their currency down some, so will mostly be doing Franc for USD and Franc for Euro swaps (though Franc for Gold would work too… but less targeted). I don’t see a lot of central bank demand for gold, but do see some reasons for them to sell a bit for funding bailouts. That just leaves the Oil Kingdoms. Oil isn’t terribly expensive right now, so they don’t have a bucket of spare cash to squirrel away (just the usual boat load ;-) so I expect them to be at about the normal demand level.

Ok, with that said, lets take a look at the volume in GLD, knowing that it’s not a major part of total gold sales.

GLD with Volume, Volatility, and Williams %R

GLD Gold with Volume, Volatility, Williams %R as 6 month chart

GLD Gold with Volume, Volatility, Williams %R as 6 month chart

Williams %R:

The quick and easy one first. It’s below zero. Time to be out. BUT, that is also the state for “be ready to buy”. IFF it crosses the zero line to the positive, it’s a buy. I prefer to use a ‘buy if touched’ order since Gold moves so fast, but with the general context, I think I’d rather be slow about throwing money at GLD right now.

Volatility:

Here we see that GLD tends to be the opposite of a stock. Stocks tend to go to low volatility at tops, high volatility at bottoms. Because folks run out of other stuff when panicked and into gold, we get the volatility acting backwards. Notice that back in August at that bottom volatility was NOT making big spikes, but was just kind of creeping sideways? Notice now it’s making lots of big spikes? Thats’ a worry.

This also indicates part of why trading gold is tricky. It has ‘backward volatility’ so a lot of folks instincts will be wrong if they watch that indicator…. Further, folks tend to run into gold at a top, right when volatility is highest, and get whipsawed something fierce as prices rock back and forth daily. Again a reason to be out right now.

Volume:

And here we also see a ‘backward indication’. Volume was very low at the bottom, now it’s being very high. We do know that a couple of hedge funds announced that they had sold some gold (and in particular some GLD). And we see a lot of volume lately. The RED down day volume is much greater than the BLACK up day volume. Folks are getting shaken out of positions or are just dumping. I’d rate that a ‘stay away’ a while…

Realize that this is exactly backwards from how stock volume is to be read. For stocks, the volume peaks happen at bottoms, the volume drys up at tops. Remember that is because a lot of folks use gold a a ‘safe haven’ to run TO when running away from the stock market.

PSAR:

Those red dots near the price bars. We’re below them. That means ‘be out now but buy in if you cross the dots’. It’s something of a trade oscillator that keeps you in a while after a reversal, then gets progressively more paranoid as a trend gets older.

Conclusion on GLD:

Looks to me like a local top, probably a sideways roll through Christmas / New Year. Fast trade only, but be ready to hop back in if The Fed does something stupid or the various world Central Banks suddenly decide to buy gold…

Longer term it will likely resume the rise. But only as inflation and central banks ratify it.

S&P 500

Since we’ve just covered volume on GLD, I’m going to lead with the VVW% chart for SPY for an easier compare.

SPY S&P 500 6 month daily interval; Volume Volatitily Williams %R

SPY S&P 500 6 month daily interval; Volume Volatitily Williams %R

Volume:

First, compare the volume behaviour with that of the GLD. Here we see that volume was quite a bit higher 6 months ago in mid May. It’s been a slow down hill slide since. Notice how at the end of June and the end of August we got a volume jump as prices dropped? Then 4 days ago a bit of a jump on that drop day? Now volume is low in general (compared to 6 months ago). But we’re not yet printing volumes of below 150 on a regular basis. Not a hard top indication, but a slowdown to sideways. (But if we start getting a series of 100 to 150 days – other than the days just before the holiday closures – that’s a ‘topping’ issue…)

Volatility:

Also going low. There is an odd anomaly in September where volatility went low just before a rise. Usually it goes high at a drop, then fades near a top. That low volume low volatility just at the start of the September rally is odd and unusual. Probably an artifact of election uncertainty. But that’s behind us now.

Now we’ve got low volatility AND modest volumes. Not a good combination. In the context of the holiday slowdown, I’d expect this means some funds and traders are taking early holiday time… Probably not going to be a big sell off, but not much juice to the upside either.

Williams %R:

It is below the center line and saying ‘be out now’. Though if it crosses to the upside, thats a ‘buy now’ signal (check the context with other indicators though, it can give a rapid day trade kind of buy / sell whipsaw on it’s own.)

PSAR:

Just like for gold… Those red dots near the price bars. We’re below them. That means ‘be out now but buy in if you cross the dots’.

All in all, everything is saying ‘not much reason to buy’ the biggest 500 companies in America..

RSI, MACD, DMI

SPY S&P 500 1 Year Daily interval; RSI MACD DMI

SPY S&P 500 1 Year Daily interval; RSI MACD DMI

SMA Stack:

Riding the Gold Line SMA(24) with fastest on top and slowest on bottom. That says right now it’s just a “dip” not a dropping trend. But look back at May. All “trend reversals” start with a ‘dip’… So caution and consult widely on indicators before ‘buying the dip’…

RSI:

Touched 80, now dropping. We still don’t have a ‘lower top’ but we could make one ‘soon’. Not yet a ‘get out’ lower top, but clearly a ‘touch 80 be worried’ call.

MACD:

We’ve got “red on top” be out with significant downward tilt. (It goes into a sideways weave on steady rises or falls as in Sept / Oct and is hard to read then, and certainly not a time to just blindly trust red or blue on top. Now it’s got enough strength to the ’tilt’ to be more trustworthy…) But MACD is also still above zero. So we’ve got a modest positive gain bias, but the timing looks off…

DMI:

We’ve got ADX at ‘below 25’ but note that due to the SPY being such a large basket, it is less volatile than most individual stocks. So that ADX ‘strength’ indication was around 20 during all that long run up the last couple of months. We do have DMI- on top, but just barely. It’s almost weaving with DMI+ for a ‘go nowhere’ market.

OK, with the recent flutter up and down, I’d figure it’s a ‘faster trade market’ into the end of the year, not a ‘buy and hold’ or trend trade market. Most likely you need to pick your sectors and look for sector rotations.

That price has stalled about where it was at the peak in April is a worry, but not a surprise. There is often ‘resistance’ to push past a prior peak. Expect prices to ‘work’ back and forth before resolving to a direction.

Conclusion on SPY:

Probably flat into the end of the year. Some drops possible as the Lame Duck Congress does stupid things. Trade on a faster time scale and look for individual sectors more than the broad market. Significant risk of a ‘correction’ as folks get spooked and the advance we’ve had is recognized as stalled. Not much reason to ‘buy and hold’ at this point. Plenty of reason to take a holiday break (with the pros…)

In Conclusion

Hope this helps demonstrate how to work out a reasonable risk containment strategy when a market has stopped doing what it was doing and the future is unclear.

Does it guarantee a right answer? Nope. It’s just looking at the aggregate votes of the market participants, and they can change with the latest News Flow.

But it is a systematic way to steer past your own hopes, needs, wants and desires.

So what am I going to do?

Homework.

It’s a time to look in finer grain at what is likely to come in the markets. What is likely to be sectors that show recovery from here. Where is there a narrower field to work, or a faster trade to make. The ‘broad market’ doesn’t look all that great, but a part of it is always moving somewhere.

Not my most happy task, homework. But a necessary one. So I’m likely to be ‘in cash’ for the next few days or doing very fast swing trades in ETF baskets. Not the kind of thing that makes for a great posting or that is useful for folks who just want to put money away for retirement; but it’s what I do to make the rent… (And having just spent a few hundred on a trip, I’ve got a hole in the credit card to fill… so if ‘fast trades’ are the only vehicle right now, that’s where I’ll go…)

My “usual suspects” for fast trades are the leveraged ETFs in the Nasdaq and the Russel 2000. I’ve also been known to use the EWZ or the EEM / EEV pair:

EWZ Brazil, BRF Small Cap Brazil, BZF Brazil cash, EEM /EEV emerging ETF

EWZ Brazil, BRF Small Cap Brazil, BZF Brazil cash, EEM /EEV emerging ETF

With the Brazilian currency (the Real – BZF) gone mostly flat with a bit of down trend, money is NOT flowing into Brazil. Given that they have had a Ministry Of Stupidity Speaks moment with taxing investment inflows, that’s not a surprise… but that makes the EWZ look like a ‘go nowhere’ vehicle for a while. The chart says rolling sideways at best and with some downward bias. BRF the Small Cap Brazil fund has been beating the EWZ, so one strategy would be a ‘long BRF / short EWZ’ with wobbles on relative sizes as indicators move to extremes. Another is the EEM / EEV Emerging Market Long / Short pair. Swapping between them on a 10 day hourly chart indication. Both have gotten a bit more ‘roll’ lately so there is some range to ‘swing trade’ as the trend has gone out of them.

OK, I’m off to do some homework, find out what IS trending (or what is so low priced it’s a decent investment anyway… perhaps UNG Natural Gas that looks a bit bottomed and with a big cold winter ahead… or the natural gas tankers TNK is flat but with a 10% dividend while TK is rising…) But the bottom line is that the ‘broad market’ is not very interesting right now. It’s time to become more narrow…

UNG Natural Gas, TK and TNK Teekay Shipping and CNG tankers

UNG Natural Gas, TK and TNK Teekay Shipping and CNG tankers

About E.M.Smith

A technical managerial sort interested in things from Stonehenge to computer science. My present "hot buttons' are the mythology of Climate Change and ancient metrology; but things change...
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