ShadowTrader Focus Report_2008

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Good Morning, Traders. As overall volume keeps dropping off the deep end in this shortened holiday week, and taking a lot of the import away from the recent market moves, let's analyze an alternative.

Much speculation has arisen recently about when the bond market will crack. This is probably the reason it keeps going higher. Let's put opinion and notions of value aside momentarily and just look at price action pure and simple.

<img border=5 width=560 height=650 src="http://www.shadowtrader.net/focus_report_charts2008/081224TLT.gif">

The above chart is <b>TLT</b>, an ETF that tracks the performance of longer term treasuries that have maturities of 20 years or greater. 'H' denotes a high and 'HH' denotes a higher high. Put in the simplest terms possible, a stock is still going up until it makes a lower high or breaks its uptrend line on whatever timeframe you are using to trade. In this case, it's a daily and neither has occurred. Note that in the advance from mid-November when the bonds started to take off, there has been not one instance yet where any single or group of daily bars has made a lower high. In order to create the full "lower high" scenario, not only does price need to make a high lower than the previous swing high, but prices must show some evidence of backing away from that first lower high aggressively and retracing (preferably) more than 61.8% of the last upwards move. Once this aggressive retracement happens, its usually a good move to initiate shorts in that stock as it rallies back upwards towards the lower high in anticipation of its failure. If you can get all of this happening right after a trendline break, all the better. That way the "back" or underside of the trendline coule make a great short initiation level with a stop placed just over the lower high area. Obviously, none of this has happened at all in <b>TLT</b>, so shorting at this juncture would not be prudent. We'll continue to keep an eye on this as the smackdown could be violent and worthy of a trade.
 
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Good Morning, Traders. In Wednesday's <i>Focus Report</i> we discussed an "alternative" investment which was the bond ETF, <b>TLT</b>. In the holiday spirit of the stock market not doing much, we'll focus on another one today that has caught our eye recently.

<img border=5 width=560 height=650 src="http://www.shadowtrader.net/focus_report_charts2008/081226FXY.gif">

<b>FXY</b> is an easy way to capitalize on the very strong Japanese Yen as of late. The chart is pretty straightforward with higher highs and higher lows throughout. Recently its gotten ahead of itself a bit and has corrected back to its main uptrendline. We feel the circled area should be a buy point where the trendline and the rising 20ma (green) are meeting price currently. We have listed the idea in the <i>Bulls & Bears</i> section below. If price can come down to the buy point, give it a whirl. Just don't let Peter catch you saying the <b>FXY</b> is strong due to "the unwinding of the Yen carry trade". We've seen him open up no. 10 size tin cans of <i>you know what</i> on those individuals. Believe us, its not pretty.
 
This week's video:

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enjoy,
Shadow
 
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Good Morning, Traders. Today we are officially changing the old saying "a picture is worth a thousand words" to "a picture is worth billions of dollars".

Below are two charts. The top chart is the weekly <STRONG>SPX</STRONG> for 2008. The bottom chart is the weekly NYSE breadth for 2008. We often discuss market breadth, along with the AD Line, <STRONG>$TICK</STRONG> and the core sector list, as leading indicators for day trading. What the picture below illustrates is just how important market breadth is as a leading indicator of medium and longer-term market direction.

<img border=5 width=560 height=650 src="http://assets.shadowtrader.net/charts/081228DAN.GIF"><BR><BR>Let's get right to it. Please observe the first large rectangular box on the left of the top chart. The only thing the top chart is telling us is the weekly price range during the period between January 1, 2008 and July 7, 2008. Recall during this time, there was a growing sense of pessimism regarding various areas of the U.S. financial system, but from the perspective of the price chart, the depth of the problems were either not as dramatic as what was being reported or they were not fully understood by investors.

Now look at the large rectangle on the left of the bottom chart. This is the NYSE breadth for the same time period and is the "billion dollar picture". From this chart you can see that developing economic problems actually were understood (by institutional investors no doubt) as the volume of declining stocks greatly outnumbered the volume of advancing stocks over the first six months of the year. It is as if the <STRONG>SPX</STRONG> was a beautiful house on Main Street, but it was infested with termites who were chewing away at the houses wooden support structure from the beginning of the year up to the week of July 7, 2008. By then, there was barely any wood left under the façade to support the house. The only thing it could do was collapse and as we all know now, that's exactly what the market started to do in earnest by mid September of 2008.

Before we go any further, we want to make another point about the power of market breadth as a leading indicator. You might have listened to Peter's interviews (available under the "<I>Archives</I>" then "<I>Education</i>" tabs at <i>www.ShadowTrader.net</i>) or Brad's broadcast on <i>ShadowTrader Squawk Box</i>. Both have stated that internal indicators can have a lead-time as great as 30 minutes on subsequent market price direction when day trading. Our curiosity caused us to find out if the same relative lead time applied to the longer time frames like the one we were analyzing here. Sure enough, using a scale of 2 minutes = 1 week, the market breadth gave us the same relative lead time from the week of July 7, 2008 for the major price breakdown that began in Sept of 2008. It just proves once again that what Peter has been beating us over the head with for years is true. Market internals are very powerful and reliable leading indicators, so watch them!!

We did not intend to sit here over our Holiday "vacation" and write a novella, but the "billion dollar picture" provides us with another subject that is just too juicy to ignore. Let's look at the second smaller rectangle (reddish tint) on both charts.

Notice that on the top chart, the first bar is a bottoming tail that we have labeled "fake out". When observing the market breadth in the corresponding rectangle on the second chart, it is easy to see why one might have been easily seduced into believing that market price had corrected from the low of the tail, with the support of incredibly strong market breadth, and was now headed higher. But even with these two encouraging developments, there is a third needed before we bought into the belief that the market was headed higher. The problem was, that third piece never showed up. It was a close above previous price highs (represented by red horizontal line) with continued positive breadth. Notice that even though we had a very nice looking bottoming tail, price never came close to touching previous high price levels, let alone breaking the previous lower high (white horizontal line). Also, consider this much simpler observation, one positive market breadth bar does not make a reversal, as the next week's price level was bearish with negative breadth, which was then followed by another very bearish week.

By late September, the weight of the selling pressure earlier in the year was too large for the market to overcome as investors bailed out of stocks and selling compounded for weeks.

Using the lessons learned above we can now approach early 2009 by answering the following question. What can we determine about future price direction by observing the latest weekly market breadth in relation to the latest price behavior?

First, in spite of the gloom and doom economic expectations being reported by the media for 2009, the last six weeks of NYSE Breadth has been positive (highlighted by circle on bottom chart). It is what it is and we know from the past that this is the most reliable information, not what is coming out of our high def televisions. This positive market breadth could lead us to higher prices if the trend continues over the next few months.

Second, the <STRONG>SPX</STRONG> has broken the downward (red) trend line and is now moving sideways. That is positive, BUT it still remains below the highs of the week of November 17, 2008 (918.85, purple horizontal line) when breadth was dramatically positive. So we are cautious of another "fake out" scenario. If price were to break 918.85 its next challenge would be to eclipse the high of 1007.51, but this event is for discussion in a future <i>ShadowTraderPro Focus Report</i>.

From these simple observations and analysis of 2008, we currently have a neutral bias going into January 2009. It is a bullish sign to see the breadth positive for six consecutive weeks, but we need to see price begin to move into and through the first point of resistance (918.85) along with positive breadth before we would commit to a more bullish bias.
<BR><BR>The good news for us going into 2009 is that by using market internals as leading indicators in all time frames, we have a proven edge. The only things left for us to do are to remain flexible, manage risk by honoring our stops and keep our analysis of market internals current in all time frames.
 
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Good Morning, Traders. Strong rebound in late day trade yesterday, or was it? All we can say is that we have never seen as much internal divergence (ie: when price goes up but the stuff <i>under the hood</i> doesn't really rev up) as we did yesterday. A strong rally off of the day's lows put all the majors within striking distance of Friday's close and left the the <i>bottoming tail hammer</i> that you see below on their daily snapshots.

<img border=5 width=560 height=650 src="http://www.shadowtrader.net/focus_report_charts2008/081230SPY.gif">

We like these tails because they setup <B>defined entries as to how to proceed on either side of the bar.</b> While price stays inside of yesterday's range do nothing. If price moves above, then the pattern is following through and bullishness should continue to the green circled area. If not, and the shadow (in this case the low) of yesterday's bar is violated, then you have what we like to call the <i>Larry Williams Setup</i> named after our favorite exiled tax evader who invented the play. In a nutshell, the setup calls for traders to short any bottoming tail if price moves below its lows. We like the thinking behind this because we would say that it would be just another variation on we like to call a <i>"disappointment play"</i>. For those unfamiliar with the concept, the disappointment play is simply a setup where we know that if price moves below a certain area, then a very large number of people will all be disappointed because prior price action dictated that price should not have moved below that area. As everyone is looking at the same charts, these plays can be powerful as everyone seems to be "disappointed" at once.

Since bottoming tail hammers (like yesterday's bar on the dailies) should resolve to the opposite direction that their shadow is pointing, expect fireworks to the downside if yesterday's lows are violated. Since we have no way of knowing right now which way it will go, we have provided trading ideas on both sides of the market in our <i>Bulls & Bears</i> section below.
 
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Good Morning, Traders. Considering the seasonal volume level, yesterday was a very bullish day. All of the internal indicators and the major indexes closed at or very close to their highs for the day and all but one of the core sectors ($GOX) finished green.

A <I>ShadowTraderPro Advisory</I> was sent out yesterday for a buy on Itron, Inc. (<strong>ITRI</strong>) and we wanted to share our thinking on the trade as it represents many of the qualities we look for when scanning for winning swing trades.

<img border=5 width=560 height=650 src="http://assets.shadowtrader.net/charts/081230DAN.GIF"><BR>
The chart above highlights the building list of bullish signals that became the catalyst for issuing a buy alert on the stock yesterday. Keep in mind as we look at each of the signaling events that not one of them alone was enough to cause a buy signal. Remember, no one gets a medal of valor for going into a trade early in a heroic attempt to pick up a point or two ahead of the crowd. To the contrary, if you are caught doing it, Peter will show up at your door and open an extra large holiday can of whoop ass on you.

The first thing that brought the stock to our attention was the large gap up on 12/8/08 with huge volume (highlighted purple oval). Take note however, that we did not issue a buy to play the gap to the upside because the next three consecutive days closed as topping tails with decreasing volume. In other words, confirmation of a continued rise off the gap was not there. The best we could do with it at that point was to place it under the bull heading of our tracking list.

The next bullish pattern that emerged was a "higher high (HH) - higher low (HL)" price pattern.

Then on the close of 12/22/08, the 20 DMA (green line) crossed over the 50 DMA (red line) (crossover highlighted by orange oval). So now we had three things going in the bulls favor, but notice by this time, volume was very low and we were still trading in a sideways price range. We needed something more.

On 12/29/08 price came back to test our ascending trend line (red circle) so we knew that if the price was going to move higher, the time was near. The price still needed to break out of the sideways range however and that would not be accomplished until it moved above the high of 61.18 made back on 12/10/2008 (small red line, top of ascending triangle). We took that level of 61.18 and added .20 for a buy stop order of 61.38 and placed the stop .20 below the low of 57.62 set 12/29/2008 (red circle) and below the ascending trend line at 57.42.<BR><BR>Now you might think at this point that was pretty much all there was to our thinking, but let's read the exact description we used in the ShadowTraderPro Advisory sent out yesterday: "<I>If the market strengthens up today, we want to have our buy stop set in <strong>ITRI</strong> to trigger us long if that price can break above the "shelf". Our stop is below the lows of 12/29. We will be long 125 shares on a market order if <strong>ITRI</strong> trades 61.38 or higher today.</i>"<BR><BR>This is a very important. The previous days close was at 59.00 so the only way the market was going to bring us into this trade was if it was done on a strong day that would lift <strong>ITRI</strong> to our buy price of 61.38. The only time we want to get involved in a long trade is on a strong day because it favors the probability of positive follow through. As it turned out yesterday, the market was strong and the volume on <strong>ITRI</strong> was especially strong which tells us that we should have good support at our buy point.

The final area to notice is the blue box. It highlights the last, but certainly not the least, important component of the trade. Resistance above the buy price. What would be the point of putting on a trade unless price had somewhere to go without having to fight through a lot of resistance that would greatly reduce our probability of success? The blue box shows that there is virtually no resistance until the bottom of the price bar that was formed on 10/10/2008. We drew an orange price line from that point to mark an area that we may consider selling a portion or all of our position. Depending on market action and how <strong>ITRI</strong> behaves, we may hold some of our position up to the second orange price line that is in the 70.00 range.

This trade has many of the qualifications we want to see in a long trade, but it will only continue to work if the overall market continues to rally and that could change on any day. Remember the market is still technically in a downtrend unless the S&P 500 can close above 915. This is a holiday shortened week, but there should be plenty of good trading ideas to come in 2009.
 
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Good Morning, Traders. Today we are following up on the December 24, 2008 <i>ShadowTraderPro Focus Report</i>. In that issue we discussed the iShares Lehman 20+ Year Treasury Bond (<b>TLT</b>). At that time, the price was making higher highs (HH) and higher lows on it's way up a very steep trajectory. We noted then that there had not been one red bar close below the rising black trend line and we could only assume the price would continue higher. Given such a fast and large appreciation in price however, we would definitely be monitoring it for a possible short play in the future<br><br>Since that last report, we feel <b>TLT</b> now presents a good short opportunity. We have placed it in the Bear section of today's <i>Bulls and Bears</i> and we discuss our trading plan below.

<img src="http://assets.shadowtrader.net/charts/090102Dan.GIF" width="560" border="5" height="650">

On the chart above we see that price has broken the steep rising trend. Since then it has trended sideways for eight days. On December 29, 2008 price failed to make a new higher high so we are marking this day as the first lower high (LH). Trading on December 31, 2008 produced a large red body that reached just below the previous low of the sideways trend with strong volume. We take special note that the strong volume, which is essential in a "normal" trading period is occurring during the holiday season where volume is usually much lighter.

Remember, even though you may observe a long list of indicators for entering a directional trade, the price must have room to run. If it were to encounter significant support or resistance levels too soon after the price trigger to enter the trade, it would be much less likely to provide enough reward for the level of risk you are taking on and hence not be worth pursuing. Notice on the chart that we have circled three gaps, obviously if a gap is penetrated, it offers zero support or resistance. Additionally, when price has run as far and fast as it has in this case, support and resistant to future retracement is limited most of the time. In fact, the first level of real downside support for <b>TLT</b> is in the 112.50 area.

We will set our stop loss 10 cents above the top of the sideways trend (123.15+.10=123.25), which also happens to be the last highest high. This is the best level because if we are wrong and <b>TLT</b> actually continues it's up trend, it has to break the last highest high (HH) to continue the bullish "higher high - higher low" price pattern. Secondly and even more importantly, the stop loss level fits into our acceptable risk reward parameters based on the entry points discussed below but is not so close to our entry level where we would be knocked out of the trade without giving it a reasonable chance to work.
<BR><BR>We have two options for an entry price. The first is the more conservative in that it reduces the possible loss that could be taken on in the trade. It would be an entry near the middle of the December 31, 2008 large red body. In this case, we would set the sell stop at 120 (indicated on the chart by "1") because at this level, price would meet the bottom of the previous days body which may act as resistance to price going higher.

The second entry price option is more aggressive. It is set 10 cents under the low on December 31, 2008, which is also the bottom of the sideways trend. This entry point would be 118.85-.10=118.75 and is marked by "2" on the chart.

Based on the stop loss level of 123.25 and target price of 112.50, the first entry option offers a risk reward ratio of just better than 2.3 to 1. The second entry level offers a risk reward ratio of 1.4 to 1. By choosing the first option, you risk less with a larger potential to gain, but what you must be aware of is that you also run the risk of missing the trade entirely because there is no guarantee price will retrace to this level. With the second price entry there is a much smaller risk of missing the trade. Traders should select the entry level that suits their individual risk tolerance.

<B>TLT</b> itself cannot be sold short, but you can <b>buy TBT</b> which is the inverse ETF of <B>TLT</B> or you can buy <b>TLT</b>put options to gain from a decline in <B>TLT</B>.

If this trade goes according to plan, we would be inclined to sell a portion of our position at the first target price and adjust our stop down behind the remaining position, but this decision would be made as we tracked the movement of <b>TLT</b> after we are actually in the trade.
 
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Good Morning, Traders. The markets ended the holiday season as strongly as one could have hoped. Coming into the first week of trading in 2009, we have a cautiously bullish outlook for certain price levels on the S&P 500. Let's examine a chart of the SPDR S&P 500 ETF (<b>SPY</b>) for a closer look of what we have in mind.

<img src="http://assets.shadowtrader.net/charts/090105Dan.GIF" width="560" border="5" height="650">

Immediately you can see that price of the <b>SPY</b> performed beautifully on Friday closing above the previous swing highs to reach a new higher high (HH, green oval). We love the higher high (HH) - higher low (HL) price action that has occurred since the low on November 21, 2008. However, we remain guarded as the volume has been divergent to the rising price trend throughout the duration of the advance.

What we will be looking for in early January is for price to maintain a level above the ascending orange trend line on greater volume. This would tell us that more buyers have come in and built stronger support around Friday's close. If this occurs, our first target for the <B>SPY</b> is 95.53, and our second target is 100.86. The 95.53 level will be key. Here, price could either stall and retrace to lower levels or build a base by trading sideways. The third possibility is that price powers through 95.53. If this is done on strong volume, the probability of getting to 100.86 becomes much greater.

We are cognizant of the fact that the market can "turn on a dime" so to protect ourselves from the market moving in a direction that we don't expect, we remain flexible and limit our risk by honoring our stops.
 
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Good Morning, Traders. Yesterday was a good reminder that the market moves on its own schedule. As much as we want to be able to detect where the market will go everyday, sometimes we have to be patient a little longer to allow the market to give a clear indication of where it is headed. We came into the office early yesterday morning optimistic that traders would be back from vacation to give us the higher positive volume needed to sustain the recent rally. It turned out that the only indication given yesterday was that many traders must have stayed on vacation because meaningful volume never showed up.

<img border=5 width=560 height=650 src="http://assets.shadowtrader.net/charts/090106Dan.GIF">

A doji price pattern formed on the Diamonds Trust Series (<b>DIA</b>) chart above, and on the S&P 500 (<b>SPX</B>) and the Russell 2000 (<b>RUT</b>). Additionally the bodies of all three major index price bars closed inside the range of the previous day price bar bodies. There is a nearer term possibility that price will retest the ascending orange trend line, but until that line is violated, with a close beneath it, the up trend from November 21, 2008 remains valid.
<BR><BR><img border=5 width=400 height=425 src="http://assets.shadowtrader.net/charts/090106Dan2.GIF">

The <i>ShadowTraderPro Core Sector List</i> (above) was split right down the middle creating what we call a "Christmas Tree pattern" with eight of the sectors closing green and eight closing red.

The low volume plus the inside doji price pattern and Christmas Tree core sector list shows us that the market was filled with indecision and was not ready to tell us where it plans to go next.

The problem here for bulls is that the longer the market goes without the support of meaningful volume the lower the probability becomes that it will reach new highs.

Our job today is to remain patient and allow the market give us more information to indicate which side of the trade is the right one. Remember, there are no medals handed out for placing a trade ahead of clear indication of where the market is going.<BR>
 
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Good Morning, Traders. We have good reason to revisit the short trade of iShares Barclays 20 (<B>TLT</b>) we discussed in the January 2, 2009 <i>ShadowTraderPro Forcus Report</i>. Whether you executed the first trade and took profits as price entered the current support area, or you decided not to get involved in the trade the first time, there very well could be another chance to short <b>TLT</b> sometime in the near future, so put it on your radar.

<img border=5 width=560 height=650 src="http://assets.shadowtrader.net/charts/090107Dan.GIF">

On the chart of <b>TLT</b> above you can see that price traded through the first gap and has now entered the first level of support (light blue highlighted box). This was also the target area for our first short trade of <b>TLT</b>. All of this happened very quickly and on heavy volume (highlighted blue oval), so <b>TLT</b> may take a rest and trade in a sideways pattern for a number of days. Of course, depending on market conditions, it could also trade through this support level quickly and continue its move down, or reverse suddenly.

The good news is we don't care what it does because it reached the target to take profits on the first trade and we will not re-enter for a second trade until <b>TLT</b> has moved through the support area to start the next leg down. We are happy to let the other traders take on the risk and duke it out in the support price range. There are still two more gaps to fill below the support level so there is not much to hinder the next leg down once the support level is broken.

<img border=5 width=560 height=650 src="http://assets.shadowtrader.net/charts/090107Dan2.GIF">

Some brokers have <b>TLT</b> listed as a "hard to borrow" meaning you might not be able to sell the shares short. As we mentioned in the January 2, 2009 <i>ShadowTraderPro Focus Report</i> you can play this trade by the purchase of <b>TLT</b> put options or by purchasing shares of another ETF called Proshares Trust (<b>TBT</b>). Be aware that <b>TBT</b> is the inverse Ultra ETF to <b>TLT</b>. What this means is it moves 2 times the percentage move of <b>TLT</b>. So if TLT moves 1% in one day, <b>TBT</b> moves 2%. Don't let this intimidate you. Like every trade, choose a proper stop loss level within a range of your entry price that will not cause you to risk more than you are willing to loose if the trade is unsuccessful.

When you compare the <B>TBT</b> chart above to the <b>TLT</b> chart, you see that they act opposite or inverse to each other. If you decided to use <b>TBT</b>, you would enter a <b>long position</b>, after the price has worked its way through and over the current level of resistance (light blue highlighted box), to 44.90. We have marked two target levels on the chart for you to work with, depending on how aggressive you want to be. For example, you could plan to liquidate half of your position at the first price target, and monitor the remaining half of the position to possibly reach the second target while using a tighter stop.

Whatever you decide, prepare your plan before you enter the trade and don't deviate from it once your entry order is filled. You will run into temptations during the course of many trades such as letting your entire position "ride" once price hits your first target (that is euphoria talking). Unless you planned to do this from the very beginning, chances are it will turn out to be the wrong course. The minute you deviate from your plan, the trade takes on new variables (including different brain chemicals) that were not present when you planned your trade in a more controlled setting where you had greater clarity.
 
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