The last week of August ended with big moves on Thursday and Friday. Stocks look ready to break out of their dull trading range now, and a detailed indicator analysis favors an upside breakout.
Stocks gain after Bernanke's speech
SPDR S&P 500 (NYSE: SPY) moved up 0.48% on Friday, Aug. 28, after Federal Reserve Chairman Ben Bernanke promised that the Fed would do more to boost the economy, if necessary. That gain was not enough to push SPY into positive territory for the week as the ETF closed lower for the second week in a row with a loss of .25%. PowerShares QQQ (Nasdaq: QQQ), an ETF that tracks the 100 largest Nasdaq stocks, was down .19% last week.
From a technical perspective, the price action last week was constructive and may have set the stage for short-term gains. In the chart below, QQQ is shown along with the Relative Strength Index (RSI). A moving average has been added to RSI in the middle of the chart, and at the bottom of the chart RSI has been converted to a stochastic indicator. These techniques make it possible to analyze RSI objectively and with the same level of detail we would apply to price.
RSI briefly fell below its moving average last week and then pushed back above it. QQQ has closed higher in the month after this buy signal 63% of the time in the past five years. Following this signal would have led to an average annual gain of 10.53%, beating buy and hold while avoiding much of the loss suffered in 2008 and 2009.
At the bottom of the chart, RSI is converted to a stochastic-style indicator using a 14-week look-back period. Even though the raw RSI is relatively high at 62, the RSI as a stochastic reached an oversold level last week. Buying when this indicator breaks above 20 has been profitable 68% of the time in the past five years. This gives us two high probability buy signals in QQQ this week.
Gold waves a caution flag
SPDR Gold Trust (NYSE: GLD) posted big gains after Bernanke called unemployment a "grave concern" and promised that "the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability."
Gold traders seemed to believe that Bernanke promised additional easing and reacted by buying GLD as a hedge against possible inflation. On Friday, Aug. 28, after Bernanke's comments, GLD gained 2.31%.
At the same time, a cautionary note for GLD traders was seen in the futures markets. Every week, the Commodity Futures Trading Commission (CFTC) releases the Commitment of Traders (COT) report, which offers insight into which traders are active in the various futures markets. Generally, commercial traders are considered the "smart money" and small speculators are viewed as the "dumb money."
In gold, the commercials would include miners and manufacturers (like jewelers) who maintain inventories of gold. They will buy when they think prices are low and sell when they believe prices are high. Commercials are in the best position to understand the market, which makes them the smart money. Small speculators are individual futures traders and they are believed to be wrong more often than they are right, making them the dumb money.
In the chart below, the latest COT is showing that commercials sold gold's breakout while individual traders were buyers. This is bearish.
Raw CFTC data can be difficult to interpret. In the chart above, the data has been converted into an index using a stochastics formula that looks back during the past six months. This calculation shows the relative degree of bullishness or bearishness and makes signals clearer. Commercials (the green line) had been bulls during the consolidation that lasted through most of the summer but turned into bears when the price broke out, which is precisely when small traders (the red line) became bullish.
A month after small traders have become more bullish than the commercials, gold prices have fallen about 60% of the time. This is not a strong enough reason to close any open positions in GLD, but it is a good idea to consider tightening stops.
This week's news
Important economic news comes out the first week of every month, and traders will be watching closely for a clue on whether the economy is growing.
Action to Take --> Buy GLD at $158. Raise stop-loss to $158.60, the 20-day moving average. Set initial price target at $168. Buy QQQ at $68.60. Set stop-loss at $66.80. Set initial price target at $76