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New Bull Market? Volume Says No

 August 04, 2010 09:56 AM

Experienced investors know that one of the first decisions they need to make relates to the selection the appropriate time frame they are looking to work with. This vital decision helps shape an investor's overall objective and assists in determining the appropriate strategies to be employed.

For example, in Monday's article entitled A Magical Signal Is Back on a Buy (and yes, there was sarcasm intended in the title) we detailed a trend-following system that has worked exceptionally well. However, it is vital to understand that the system we described is VERY long-term oriented as the indicator itself is updated only once a month. Thus, for those of the mind that "long term" refers to the upcoming weekend (regardless of what day it is), this approach would definitely not be appropriate.

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So, before we continue, let's take a moment and clarify our time frames. For the purposes of our discussion, there are five time frames to look at: Secular, Long-Term, Intermediate-Term, Short-Term, and what we call the Micro-Term.

While I'm sure to get an argument on our definitions, we consider a secular market to be one that lasts many, many years (usually more than 10). Then we are of the mind that a long-term view is one that entails something more than six months.. The intermediate-term is two to six months and we view the short-term as one week to a month or two. And then anything under a week is what we refer to as the micro-term.

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So before you launch into any investment strategy, it is probably a darn good idea to understand the time frame you are dealing with. For example, our Daily Decision trades tend to focus on the short- to intermediate-term time frame while the soon-to-be-introduced Daily Decision-PRO will focus on the micro- to short-term. And then for clarification purposes, most of our stock portfolios are intended to function in the intermediate-term arena. Thus, if you are looking for something that trades only in the short-term, the Top-5 Portfolio is definitely not your cup of tea.

It has been my experience over the past 25 years that the trick to succeeding in the stock market is to first identify the environment you are dealing with from a long-term perspective and then to apply the appropriate tools/strategies. For example, using the same "go go" type of approach that is successful during a bull market may be suicide during a bear.

It is for this reason that the very first question we ask ourselves is what type of animal are we dealing with? Long-time readers know that while the recent run for the roses that began on March 10, 2009 has been fun, we believe the market remains in the throes of the secular bear market that began in the spring of 2000.

I know, I know, the stock market has put up some impressive numbers since the bulls returned to the corner of Broad and Wall after it became apparent that the U.S. banking system just might survive after all in the spring of 2009. However, we believe what we are seeing is something more on the order of a "mini bull" market and not the start of a new secular bull.

While there are many reasons for this view, one of the most important is the volume relationship currently being displayed by the market. It is widely accepted that strong bull markets are accompanied by increasing volume. The idea is that if rising prices are met with higher demand, the move is likely to last a while.

However, over the past six months or so, just the opposite has been occurring. The folks at Ned Davis Research report that the negative correlation between volume and the market's action has reached its lowest level since the Crash of '87. This means that the volume has been heavy on the down days and lighter on the up days.

NDR found that over the past year, the median gain in the S&P 500 on light volume days has been 4.5 times greater than the median gain on heavy volume days. Thus, the statement that the market has been advancing on light volume appears to be correct. And in short, this is most certainly NOT the desired relationship for a move that is expected to last for many years to come.

So, while we reserve the right to be wrong, we will continue to play the current market as a "mini bull" from a long-term perspective and a trading range environment from the intermediate-term perspective. And okay, while we're at it, we view the short-term trend as modestly positive and the micro-trend as positive (as long as the near-term support is not violated).

While we recognize that there is clearly some conflicting ideas presented here, it is our sincere hope that this is helpful.



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