Thoughts from Jan...
I wanted to talk about some observations I have made regarding sector reversals, volatility etc. I bring this up because all of our indicators are above the 60% level and the sectors are definitely skewed to the right side of the bellcurve.
For a recap on the bellcurve. The range is from 0% oversold (located on left) to 100% overbought (located on right). 50% obviously being the middle and what we would call a "normal" market. When sectors start to move to the right we start considering the risk in the market because of the overbought situation and conversely if it moves to the left we talk about opportunity because of the oversold condition of the market. Bellcurve looks like a seesaw for those who haven't seen it. There is a great cartoon that I wish I could post. It shows monkeys on a seesaw with all to one side. On the other side are a bunch of bananas hanging. All the monkeys run to that side to get the bananas but because of their weight, the seesaw teeters down and the bananas are out of reach. They keep going back and forth until finally one monkey figures it out and stays on the side the monkeys are now running from. So, when the majority of the monkeys run to the right to get the bananas, the smart monkey stays on the left and his side moves up so he can reach the bananas.
What does this mean? Well, when the market is in overbought territories is usually the time all the monkeys are running to the right stumbling over themselves to get the bananas. We don't want to be one of them, we want to actually get the bananas and the indicators tell us how to accomplish this. If you think about it, just by definition alone overbought has a negative connotation to it. Now, this doesn't mean there aren't opportunities out there but you have to know how to find them. Don't just run with the monkeys buying Dell every time it jumps 6pts in a day. Think about the overall situation, check the FA, market and sector risk and then find the stocks on pullbacks that aren't too extended.
What I have noticed in the past is when the sectors start to move past the 60% level things start to get volatile and the same when the sectors are below the 40% level. This again has been my observation. Things really get hairy when sectors are above 70% and below 30%.
For example: Let's take airlines since I had mentioned it might be time to be thinking puts in this sector. Admittedly this is jumping the gun somewhat because the sector has not reversed. Why then did I start to think in this direction? I had seen some stocks trading in a range without creating any new buy signals and some creating sell signals. Stocks were trading to resistance and then backing off only to make a lower high on their next reversal up. What this did is start to turn the stocks RS negative because even though the stock wasn't diving, it wasn't keeping up with the market. Now, there were actually enough buy signals to move the Aero sector up one box last week but looking at the numbers that may come out this week, it looks to be weakening. So I am keeping an eye on this sector. RS's turning negative in many of the big stocks is a warning sign that these guys are not keeping up. Besides the sector is at 63% which is a flashing red light as far as risk is concerned. Also, notice the volatility? AMR for example turns 4-5 points daily in either direction. I've noticed stocks in a high oversold and low overbought territory will do this.
I want to bring up the Oil Service sector because that was such an issue recently. When it reversed up from a very low, in fact the lowest level it had ever been, 16% to 22% people thought I was crazier than a baboon on crack to suggest it was time to buy. Tom was considered a loon on CNBC for even thinking about Oil and Oil Service. He knew what was going on but if you read the press, my God we were going to hell in a handbasket, ananlysts screaming GET OUT, and nobody was ever going to use oil again. We stuck to our guns and we are now enjoying a nice rally to 40%+. However, when it was below that 30% it sure was volatile wasn't it? Remember everyone was in a panic because of the price swings but if you were looking at the big picture you knew exactly what was going on. You had your indicators and you could sit back, drink your coffee check the FA and go about your business while everyone was frantically running around you. You still had to be selective but you knew the opportunity was there.
Sectors reversing down from above 60% carry more risk than those that reverse down at 40%. Always keep your perspective. If a sector reverses down from above 70% you better have a plan intact.
We can apply those techniques now. And folks, don't fool yourself this isn't easy. You have to do your homework. Investing isn't a game it is your retirement, your childrens' education, your down payment on a house or a car or the really great 2ct diamond that special girl deserves :-)
If you cannot put the time into investigating the equities the market and economics seriously consider getting a broker who can. I know they have been slammed lately because of high commissions but think about it? Do you really save money paying only 8$ a trade if you are constantly making mistakes and loosing money? I'm not a broker and don't use one because I've learned the skills and put the time into research however, I have respect for the profession. Another thing, don't trade on tips alone. I can't say it enough, do the research don't just take someone's word on a stock. I am very secure about my analysis on stocks but I would be disappointed if you bought on my recommendation alone. That would be irresponsible. Again, if you don't have the time, interview those who do. Find one that has successful, good track record and if you like the P&F method, find one who knows how to incorporate it with fundamentals. Enough said here.
Your plan now should be to have your eyes open. Don't chase the stocks. Semiconductor sector seems to be the first tech sector to go and it definitely is showing the volatility precursors prior to a reversal. It is at 68% and weakening even with yesterdays action. Remember it takes buy signals to move a sector up and sell signals to move a sector down. Watch those RS signals and always, always keep up on the FA.
I'll do another section on how you can cover yourself when the sectors and market are in risky territory.
Maybe I'll ask Tom to do a collaborative effort on this. I don't want you to think you have to bail once a sector reverses, there are ways to cover yourself.
Take care any questions you know where to find me.
Jan I am |
