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Technical Tuesday - Little Trouble in Big China?

Tuesday, March 20, 2012 | Chris Rowe

Dear Educated Investor,

A master investor -- one of the greatest in the world (who started out selling sweaters in my neighborhood "flea market" when I was a kid, but traded his net worth into the hundreds of millions) -- once told me:

"Investing is easy, unless you make it difficult." 

Then he mentored me, teaching me his greatest secrets for keeping investing very simple. 

I eventually realized that his secrets worked in trading as well.  Because being a trader is nothing more than being a shorter term investor -- one great investor working his focused skill with hundreds of investments per year.  In fact, it's this powerful secret of keeping it simple that allows traders to rapidly grow their wealth as they apply these simple investing secrets to their trading philosophy.

So let's take a quick look at one of the secrets my Wall Street mentor taught me.  Very much as I did, I know you'll realize that this is one of the easiest ways to increase your investing or trading success.  I'll tell you right up front that it's going to seem so darn obvious that you'll likely believe you're doing it already. 

But let me tell you right now...

Almost everyone, even the savviest of traders who think they already "get" this concept, can do a better job at applying it.  And most traders actually complicate the process by adding in a bunch of other factors that only confuse the approach. 

So what is this secret of simplicity?

Well, this ultra successful old-school investor told me to "buy the breakout after a pullback!".

Sounds simple enough, right?  So why do traders complicate it virtually every time?

They stray from their philosophy, usually because of the daily news that hits the wire.

Stocks in the U.S. declined today, led by industrial commodities on concerns about slowing growth in China, the world's second largest economy.  BHP Billiton said China's steel production is slowing and China is raising fuel prices for the second time in less than six weeks.  

To this I say "big deal!"

We all know China is slowing.  If it weren't slowing, people would be worried that there's a bubble in China that's out of control. 

The U.S. has the strongest stock market since the March 2009 low, and China has the worst.  The U.S. is stimulating its economy while China is slowing its economy.  Okay great.  Now that that groundbreaking news is out of the way, let's get back to keeping it simple and making money.

Look at the chart of the S&P 500, below.  I just snapped the shot of it 5 seconds ago...

S&P 500 4-Month Daily Chart  

First of all, the NYSE BPI -- the granddaddy of internal indicators -- has been on a buy signal since October of 2011.  The above chart only dates back to mid-November.  Demand has been in control this whole time. 

But second of all, look at the staircase pattern.  Remember "buy the breakout after a pullback!"

After the resistance levels (blue) are penetrated, the market pulls back and tests the old resistance as new support (black arrows), which is where your entry level should be.  You'll notice there is one time (the last two black arrows on the far right) where the pullbacks didn't actually touch the exact old resistance level. 

But why fight for pennies?  Just buy the pullbacks.  

Don't abandon the approach you originally set out with.  It's been working for centuries across all markets!  It's just a picture of human nature.  The pullbacks wouldn't happen without some kind of negative news. 

Now the next question:  What do we buy?

I have another simple secret my mentor gave me.  You are going to be a little mad about this one because it's just TOO simple:

"Buy what's going higher the most and lower the least!"


He was saying to buy what's working!  Here's another one:

"Don't be early to the party!  It's never fun being early to the party!  Wait to see which party is having the most fun and then GO!"

Below is the performance of the 9 S&P 500 major sectors from Select Sector SPDRs

First look at the last 5 trading days...

With the exception of Energy, which is up .05%, you can see Financials are the only sector that's been positive (+.7%)

Below is the last 30 days

Clearly the leader is the Financials sector.  Technology almost appears to be a close second place, but after doing 20 seconds worth of digging you'd find that Apple Inc. is responsible for most of that advance.  Financials are outperforming by far -- with many participants.

Now let's look at the last 3 months. 

Are we seeing a trend here?  Typically the leading sector continues to lead right up to the very end of the bull market.  And when the leaders reverse lower, breaking key technical levels, that's usually a sign that the bull market, as a whole, is ending.  (We'll update you when that happens.)

Now look at what's happening today: 

Obviously the market is selling off, with financials still up!

Now I'm no genius.  (Surprise.)

But it's clear to me that Financials want to keep going higher.  I don't know what happens in the short term.  In fact, it might make sense to wait for more of a pullback.  As long as this bull market pushes ahead (as it seems to want to do), my bet is that Financials lead the way.

Either buy individual financial stocks or the ETF that tracks the sector (Symbol: XLF).  But I'd try to buy it closer to $15.35 (it's at $15.88 right now). 

With any luck, there will be more talk of China slowing down, or Europe falling off a cliff, or Iran threatening higher oil prices, or Manufacturing slowing down.  This would give us the chance to buy more Financials, the leading sector of today, at even cheaper prices.

My mentor would be proud to see me repeating the concept of simplicity to a quarter million readers.  But something tells me he's not reading newsletter articles on his private island.

chris row signature
Chris Rowe
Chief Investment Officer
Technical Analysis Millionaire
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