Weekend Strategy Review July 3, 2016

Posted by OMS  at July 3rd, 2016

The Dow rose 19 points on Friday, closing at 17,949.   It was up 549 points for the week.  The NASDAQ also finished up 20 points on Friday and up 155 points for the week.

With the Dow up almost 550 points for the week, it almost makes you forget about Brexit.  Hmmm?  Maybe not.

One of the reasons I say this is because of the chart of the Dow I’m posting today.  It helps explain a lot about what happened in both pre and post Brexit trading. 

If you look at the 2-period RSI Wilder pre-Brexit (the Blue Circle), you can see that immediately before the vote, it was in overbought territory and ready for a pull back.  That’s because the 2-period RSI was overbought with NO Trend in place.

When I say No Trend, it’s because the VTI is between 30 and 70.  I currently consider a value above 70 as an Uptrend, and below 30 as a Down Trend.  When the indicator is between 30 and 70, I consider the market to be Not Trending.  BTW, once the VTI moves into the Trend Mode, I will indicate this on the cockpit by adding the word ‘Trend’.

Then two days after Brexit, with the Dow down 870 points, the 2-period RSI Wilder became oversold …again with No Trend in place.  The next four days saw the Dow rally for 809 points. 

So forget Brexit, at least for the short term.  Something like Brexit is only a news event that triggers a move.  What really causes a market to move is overbought/oversold conditions and trends.

You can see this clearly from the attached chart.  During the past six months there have been all sorts of news events.  We seem to get at least one or two every day.  Some are more important than others.  When the monthly Jobs Report comes out on the first Friday of the month, it tends to move the market for a day or two, but it’s usually only a small blip in the grand scheme of things.  If the news event is a Big Deal like a Fed announcement that lowers or raises interest rates, or announces a new QE program, then the market could start trending.  This is what happened earlier this year when the Fed released a benign policy statement on inflation, unemployment, and an accommodative monetary policy.  The market started to trend up.

If you look at the VTI on 3 March, you can see the Dow starting to move into the Trend Mode.  It rose from 16,944 to 17,891 in the two months that followed for a gain of 947 Dow points.

But since 2 May, the VTI has NOT been in the Trend mode, and as a result, the Dow has not produced much of a gain.  On 2 May, the Dow was trading at 17,891.  Yesterday if finished at 17,949, for a gain of only 58 points.

Again, it shows the advantage of trading when there is a Trend in place. 

But markets only Trend about a third of the time.  The rest of the time they are either consolidating for additional gains or forming a top.  So when the market is Not Trending, we need to pay attention to our overbought/oversold indicator…the 2-period RSI Wilder. 

This is why I was so concerned about Brexit.  Going into the vote, the market was overbought with No Trend in place.  The conditions were ripe for a correction.  And that’s exactly what happened.  As an aside, I will always wonder what would have happened if the British voted to ‘Stay”.  The conditions were still ripe for a pullback no matter how the British voted.  So does this mean that the actual event doesn’t really matter?  Hmmm?

Similar conditions happened two days later, only then the Dow was oversold with No Trend in place.  So it rallied.

On the chart, I show a bunch of Yellow Circles to indicate times when the Dow was overbought with No Trend in place.  If you look closely, you can see that the Dow pulled back shortly after.

Finally, the last thing I want you to look at is where the VTI and 2-period RSI closed on Friday.  Once again the Dow is overbought with No Trend in place.

So now can you see why I’m concerned about a pullback starting next week?

Have a great Holiday weekend.

That’s what I’m doing,

h

Happy Birthday America!

Market Signals for

07-05-2016

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