Analysis, Perspective, Trading Strategy
At the Edge of Chaos: After the Dog Days Pass another Buy on the Dip Opportunity Could Lie Ahead
Duarte in the Money Options
long term trend for stocks remains up but shares could experience a
short term correction which, if it materializes may be worse in the
technology sector than other areas of the market. On the bright side,
if there is a correction and recent history repeats itself, unless
the Fed stops its forever money infusion into the banking sector, investors
will once again be given the opportunity, at some point, to buy stocks
on the proverbial dip.
If the action in the stock market over the last few days is any sign
of what lies ahead, we are clearly in the Dog Days of August where
the prices often consolidate and where investors who focus solely on
the indexes as an indicator of future price trends can run into a wall
of frustration. Fortunately, because the Federal Reserve continues
to put money into the banking system, the odds of a lasting meltdown,
although never out of the question, seem well below average, a fact
that offers the opportunity to find winners if you are willing to put
in the work.
Still, because of the potential for falling volumes as traders finally
take some time off, the algos are likely to switch their tactics to
the short side while lowering the bid and ask spread on a regular basis
and causing all kinds of problems in the short term.
In a Tricky Market Look for Relative Strength
After the market bottomed in March 2020 active investors have had
an excellent opportunity to make money as stocks have rebounded aggressively.
However, as market valuations have expanded and the uncertainty of
the election season and other economy related factors start to exert
their influence on prices, the likelihood of a sideways market or a
full blown correction is likely to increase. Of course, in a market
run by trading algos and heavily influenced by Fed liquidity there
are no guarantees as to which way things may shake out or how long
any pullback may last.
That said, by deploying common sense and sound trading principles,
we can still find stocks worth owning during a consolidation. Moreover,
if this turns out to be a meaningful top well placed sell stops should
protect the bulk of recent profits.
So in order to prepare for any occasion here are some important steps
- Take at least partial profits on positions which have gained 20%
- Expand your research focus beyond your comfort zone
- Stick with strong sectors and stocks
- Trade in small lots
- Look closely at lagging sectors for potential turnaround candidates
- Adjust sell stops to prevent losses beyond 5%
By following these three steps you will increase the odds of finding
potential winners and protecting your recent gains. And here is an
example of how to go about it.
Consider the broad technology sector (XLK), a market leader until
recently which of late has been struggling as investors start to look
beyond the work at home dynamic and the effects of COVID-19 into other
areas of the economy which may improve as a result of the Fed’s actions
and the politics of the moment. If I’m right, this heady advance could
well slow or even reverse.
So, when looking to expand your analysis horizons, you have two choices.
You can look for sectors which are displaying exceptional strength
or you can look at sectors which are laggards and seem poised to turn
up. Because many stocks in strong sectors can be overextended, I focus
on areas of the market which have been consolidating and which look
set to breakout to the upside.
At this time such as sector may be the large pharmaceutical stocks (PPH);
and here is why. Many large drug companies are involved in COVID-19 vaccines.
And although this is important work COVID-19 vaccines are not likely
to be huge money makers for these companies beyond the grants and other
funds which they have received from government contracts. Indeed, as
investors have recognized this fact these stocks have rolled over.
But a closer and contrarian look at the PPH charts shows a perfect
setup as the ETF has the following characteristics:
- The consolidation has been in place since April which has shaken
out many sellers
- The ETF is trading in the bullish complexity zone (above the 50
and 200 day moving averages)
- The Volume by Price indicator (VBP) shows excellent support at
$61 and little resistance immediately above the $65-$66 area.
- Accumulation Distribution (ADI) and On Balance Volume (OBV) are
Still, this is not a perfect setup because of the neutral ADI and
OBV. But it’s good enough to warrant a deeper look at its components.
So now that we’ve spotted a potentially bullish setup the key is to
find if there are good stocks in the sector, which I will describe
Merck Shows Strength as Cancer and Anesthesia Drugs Overshadow
Shares of pharmaceutical giant Merck and Company (MRK) seem to be
in the early stages of a breakout bucking the trend of similar companies
more reliant on potential COVID-19 vaccines.
Stocks of large pharmaceutical and biotech companies have been disappointing
of late as the reality and uncertainty of COVID-19 treatments hits
home with investors, which is why the price action in Merck is worth
noting. Sure, Merck has some credible entrants in the COVID-19 vaccine
race, but those are long shots from a profit standpoint compared to
its proven cancer franchise and its potential blockbuster anesthesia
Specifically, Merck owns the lung cancer treatment space with Keytruda,
where sales reached nearly $4 billion in the last quarter alone. Moreover
its Lynparza drug is also leading the fight against ovarian and related
cancers, giving MRK a credible and advantageous one-two punch in the
cancer space in the present while it further enhances and develops
its deep cancer pipeline.
Moreover, Merck has a potentially emerging blockbuster drug in Bridion,
which could be a nice icing on the profit cake. This is a drug which
reverses the induced paralysis required for many surgeries and which
it does with fewer side effects compared to previously used agents. Critically,
it is especially better than the traditional drugs in respect to the
respiratory problems which could occur in the recovery room due to a
return of paralysis if it is not fully reversed. In addition, studies
have proven that the higher cost of Bridion is worth the expense as it
reduces risk and costs which would ensue if there were major post operative
complications due to a return of the paralysis in some patients, a fact
that will make the drug attractive over time due to improved post operative
Furthermore, technically speaking, MRK is knocking on the door of
what could be a major breakout with key short term resistance at $84-$86
and the potential for a move to $90 in the short term. Moreover, ADI
and OBV have turned up while raw volume and Volume by Price (VBP) are
very favorable. Finally, the company recently gave upbeat guidance
for the rest of the year. Finally, a move above $90 could take the
stock significantly higher.
Incidentally, I own shares in MRK and recently recommended the stock
to subscribers of Joe Duarte in the Money Options.com. For a FREE trial
subscription to my service, click here.
NYAD Makes New High but Hits Overbought Territory
The New York Stock Exchange Advance Decline line (NYAD) made a new
high last week keeping the uptrend for the market in place. At the
same time the indicator has now reached overbought territory for the
first time since June 2020, having crossed above 70 on RSI. That means
that the odds of a sideways period or even a pullback to the 20 or
50 day moving average are on the rise.
However, even though the pullback, if it materializes could be a
bit unnerving as the algos exaggerate every move in the market, unless
NYAD breaks decisively below the 50 day moving average and the RSI
50 area simultaneously, triggering a Duarte 50-50 sell signal, the
uptrend should remain intact.
The S & P 500 (SPX) seems to have made a double top, at least
for now. Thus as with NYAD a move toward the 20-day moving average
will be the first likely outcome, with a break below the 50-day average
and the 3200 area suggesting that a move to the 200 day average could
The Nasdaq 100 index (NDX) has also formed a double top which means
that it too is likely to move lower in the short term. Key support
will be at 10,500 or so. A break below that, though could take us down
to the $9000 area which would likely be a fairly unpleasant development
even if the index finds support at its 200-day moving average.
Stick with Strength and Protect Your Gains if Market Rolls
If there is a correction as the indicators suggest, the best way
to survive it is to focus on strength. That means that if stocks you
own stop working it’s probably a good time to lighten up or sell the
shares. On the other hand, corrections are excellent times to look
for bargains. Either way the focus should be on stocks that act better
than the market.
Finally, consider that since the 2009 March bottom in stocks, due
to the Fed’s zero interest rate policy the robot traders have bought
every single meaningful dip in the market just as sentiment had reached
its darkest point. In fact the only two factors that have triggered
meaningful declines since 2009 have been higher interest rates and
more recently, the COVID-19 disaster.
What that means is that if we get another decline and nothing else
changes, until proven otherwise, get ready to buy the dip.
Joe Duarte is a former money manager, an active trader and a widely
recognized independent stock market analyst since 1987. He is author
of eight investment books, including the best sellingTrading
Options for Dummies, rated a TOP
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