A Breakout to Buy

Posted by Uncommon Wisdom

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Last week I said, “It looks like the S&P 500 can clear 2,000 before our next pullback.”

The S&P 500 climbed above 2,000 each day this week in intraday trading, and closed above this key level Tuesday (2,000.02) and Wednesday (2,000.12).

Just prior to these new all-time closing highs, I suggested it was time to invest in stocks again. And at an individual stock-picking level, we’ve been closely following one S&P 500 component, United Parcel Service (UPS).

Let’s see how “Brown” is delivering this week. I’ll also reveal another name that’s looking ripe for a breakout …

UPS had dropped from a high of $105.09 to its price last week of $99.35. The approach discussed was to buy the stock and to buy a put to protection from any more downside action.

A couple weeks ago we exited the UPS put, and now the recommendation is to be long the stock. The put was closed out at $4.05. So the new cost basis is $97.25, which adds in the gain on the put.

The stock is at $97.38, as of Wednesday night’s close, so what was a loss is now a gain and we remain confident the low is in. Stay long the stock.

Stocks are generally on the rise, and our Market Crash Indicators remain at 75% invested for a second week after ending the third five-week period of 50% invested since we began that model.

At 75% invested, we suggest owning the SPDR S&P 500 (SPY). But another stock index, the small cap Russell 2000, is also on the rise.

Last week I said setups abound for the Russell 2000 but we needed “final” confirmation of the move (as opposed to trading on just the “potential”). We now have that confirmation.

The Russell 2000, via the iShares Russell 2000 ETF (IWM), is back above its last retracement from the May low to July high at $115.80.

This is looking like a breakout to buy.

Gold is also poised for a breakout. Gold via the SPDR Gold Trust (GLD) is stuck in a range here of $124 to $128, but keep in mind that September is usually a strong month for gold.

But Will September Continue 
To Be Strong for Stocks, Too?

Next week the big dogs return to their desks and volume should improve as we enter the fall trading session.

Key to successful trading in the fall will be tracking volume.

Remember, for every buyer there is a seller … BUT the price at which shares are sold determines whether the buyers or sellers are in control.

A tool I use called the Erlanger Volume Swing (EVS) tracks up-to-down volume. It’s excellent for determiningwhen trading volume is really positive or negative, as opposed to “kind of” positive or negative.

Total volume for the period being reviewed is divided into two portions according to the position of the close between the period’s true high and true low.

  • True high is the higher of the period’s high and the prior period’s low.
  • True low is the lower of period’s low and the prior period’s high.

In other words, this volume indicator looks at the previous low and compares it to the current high.

If there is little difference, then the move is artificial and likely to fail. However, if day after day we observe a nice spread, then we know some large player is accumulating shares.

The importance of the EVS is to know when it is above or below 0. When it moves above 0, it is time to buy. It’s time to sell when it breaks below 0.

‘Volumes’ of Reasons to Buy IWM

As noted above, the Russell 2000 is starting to gain traction. So, let’s look at the EVS on the iShares Russell 2000 ETF (IWM).

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I prefer to look at EVS on both a daily and weekly basis. The daily EVS turned positive on the Aug. 19 close.

A nice way to track improvement on EVS is to create a Moving Average Convergence/Divergence (MACD) line on the EVS. Doing this produced an aggressive buy signal on Aug. 7.

The MACD confirmed when the signal and diffusion lines moved above 0 on Monday.

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The weekly EVS is currently positive. It turned down the week of July 14 and positive again last week.

The weekly MACD on EVS is still below 0, but the diffusion line is above the signal line.

Even Light Trading Volume 
Can Produce Strong Signals

Although moves in the market can be exaggerated by low volume, the EVS still works well in summer-light trading conditions. This model has done a great job of revealing legitimate buying activity.

Personally, I create my own scoring system using the daily and weekly EVS with the MACD on EVS. Currently, the daily gets 2 out of 2 points. One point is given for a positive EVS and a positive MACD on EVS.

The weekly get 1.5 out of 2 points. A point is given for a positive EVS and the MACD has yet to get a point. However, the cross nets 0.5, and the overall score is a 3.5.

This ranking system is my way of quantifying EVS across multiple time frames in such a way that I am right 75% of the time.

Bottom line, I will not buy a stock with a score below 2.5 and even then it would be started as a partial position.

Key to this fall will be the ability to buy weak stocks that have begun to rebound on the EVS from both a daily and weekly basis.

The IWM looks like a buy here because it’s breaking out, and I will be keeping a close eye on this indicator for more stock and ETF names to send your way in the coming months.

Cheers and Hit ‘Em Straight,
Geoff Garbacz