Best setups are on the long side

After pretty much a straight shot up since the end of October it is no surprise to see the market consolidate near its August highs. Volume tapered off today after some distribution was seen yesterday. This is not ideal, but nothing to get too worried about. (Those readers that have followed this column for a while understand that distribution, even several days of it, is not nearly as big of an issue as most technicians make it out to be. If your new to the column and would like a copy of the distribution studies I published over the summer – shoot me an email.) More opportunities are appearing on the long side of the market and that is where my primary focus remains.

In sector action, Internets and Biotechs (BBH | Quote | Chart | News | PowerRating) are leading the pack and should be buyable on a pullback. The weakest groups include Drugs and Utilities.

I received a large number of questions following my last two columns, so I figured I would simply address a couple of the more popular ones in today’s column.

Q: “What does volatility say about the direction of the next move?” (Based on my Nov. 10th column which discussed volatility).

A: Nothing. Historical volatility is not useful in predicting market direction. By watching volatility you can spot situations where there is a high likelihood a spike in prices will soon occur. We saw this just after I published the column last week when the market had a sharp run-up on Thursday following the previous quiet period. You will need to use other indicators if you want to anticipate the direction of the move. For those traders that trade Cup & Handle patterns, consider the formation an ideal handle. It is a tight consolidation near the top of the base. The tight consolidation is accompanied by a contraction in volatility. The breakout is an explosion of that volatility as price moves to the upside. High Tight Flags are another example of a pattern which you could see a low volatility situation lead to an explosive move.

Q: Is your overbought/oversold analysis applicable to individual stocks and sectors as well as the broad market? (Based on my November 14th column).

A: As a quick review on Monday I demonstrated how overbought/oversold indicators are more reliable when viewed in the context of the long term trend. Your highest probability trades occur when you buy oversold markets in an uptrend and short overbought markets in a downtrend. Now, the answer – yes. This phenomenon generally holds true for whatever you are trading. It doesn’t matter if it is broad markets, sectors, or individual stocks. You should always look at the movement in the individual issue when determining trend. Also, while the broad market will not be the determinant of the trend for each issue, it will influence the number of opportunities you are seeing in either direction.

Best of luck with your trading,

Rob Hanna
RobHanna@Comcast.net

For those who may be looking to expand their knowledge beyond just market timing, my Hanna ETF Money Flow System utilizes the VIX in generating trading signals for spread trades.

Rob Hanna is the principal of a money management firm located in Massachusetts. He has spent the last several years developing and refining methods for trading in stocks across multiple time frames. He selects stocks using both fundamental and technical criteria, and then trades them using technical analysis techniques.