Wednesday, March 14, 2007

Why Did Stocks Bounce Today?

First of all, nobody can explain with 100% certainty why the market does what it does, but I'll take a shot at explaining why stocks bounced today.

In the above chart we have the Home Building Index (HGX).. The chart below that in red is a ratio line of the home building Index compared to the S&P. If the ratio line is falling, home building stocks are weaker than the S&P, if the ratio line is rising home building stocks are stronger than the S&P.

Over the past few days, home building stocks have been one of the weakest groups leading us down. Notice how the ratio line has been in a down trend over the past few days indicating that home builders have been weaker than the market.

Now I want you to look at what the ratio line did today. It diverged from price. As the HGX index and the S&P made new lows at 1:00, the ratio line diverged and began making a higher low. This indicates strength on a short term basis. When I say short term, I mean day trading or just for today.

One of my rules is that when the leader stops leading, you're probably going to see some kind of a pullback and that's what we saw this afternoon. Home builders stopped leading us down, so that put us at risk for a bounce up today.

If you don't look at ratios or relative strength, you still would have seen the potential for a rally this afternoon. All you had to do was look at the individual home building stocks and you would have seen that many of them stopped going down. Stocks like LEN, BZH TOL and RYL all made higher lows in the face of a falling market. These stocks didn't even take out yesterday's lows. When the leaders stop leading, time to get off the ride. Again, this example is just for today and nothing else. I'm still bearish on the market.

Some of you might disagree with my opinion as to why we bounced, but I trade this stuff and I watched it unfold before my eyes today. I think it's important to watch stock action and always be aware of what the leaders on any given day or week are doing. With that in mind, what is moving or leading the market at the moment are home builders, lenders/subprime, brokers and the Japanese yen. Those are the stocks and currency I'd be focused on. In other words,you don't want to be looking at semiconductors or Internet stocks for market direction. Remember there was a time that tech stocks were the leaders? That was such a long long time ago....(sigh)


TRS said...

Safe to say that if the market leader right now is the homebuilders, today's bounce was due to heavy short covering. As the homebuilders have built up sizeable short positions. Hard to think there would be people taking sizable new positions in this sector. I think the sector has to at least test the July lows. IMO

Kevin said...

I agree....I think this bounce was short covering.

Banker said...

This market is very dangerous. Everything seems to be trading off stocks.

Melinda said...

Very savvy analysis.

Peter said...

Kevin and/or others here,

What do you think might happen the next 2 days? We have quadruple witching hour on Friday, PPI tomorrow morning, CPI Friday morning...add the extreme volatility lately, I for one would not be surprised by very large swings up and down the next 2 days.

Kevin said...

This market can go anywhere...we'll probably see huge swings in both directions...If you are a short term trader, my advice would be to take profits when you get them.

Yaser Anwar said...

Kevin- Good stuff.

1 of the reasons market bounced is also 'cause the USD rose on good trade #s. As you know, the Yen/Market has been a key relationship to watch, today the market faded the early 15-30 min market open strength, but when it crossed 12K and deficit #s=rising$ had buyers come in.

Bulls haven't lost their resiliency.

Kevin said...

Hi Yaser,

Yes, the bulls are hanging tough but are losing ground. It's going to be interesting to see how we close for the week.

miamirenter said...

some bulls are hoping this is a reversal..
it may even look like that..
this is why it is so iffy.
but sensex (india) didnot particiapte in the rallyy.
i am looking at IBN to short..
kevin, any takes?

Kevin said...

I haven't really looked at IBN...I'm just going to stay short spy,qqqq and dia.

gurlate said...

i like ATM options that cost ~$1.The GS puts are darn expensive but i wait to short them..
Kevin, what do you make of 10000+ open interest in puts(say 5-10 times more than corresponding call)
i take it as a huge interest in buying puts...

Kevin said...

It appears that way...Although people can be buying puts to hedge against their long stock position. It's hard to say if people are actually bearish or just hedging.


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