Scanning the S&P 500

In my opinion, one of the big advancements in technical analysis over the past ten years has been in the increased ability to scan a large number of markets or issues quite quickly. This was not always the case, as before it was often only available in software packages, which may have left out many traders.

For many years, I have used the explorer tool in Metastock to run scans on sectors, industries, stocks, commodities, mutual funds, and currencies. Every weekend I run a series of scans, and it occurred to me that the process I go through might be of some use to other traders. My weekend stock market scans focus on the S&P or Dow sectors and industries, but I also run scans on individual stocks. The recent new high in the NYSE A/D line was positive and convinced me that it was a good time to run a scan on all of the stocks in the S&P 500. Before we get to the results, let’s first run through the process.

I always start with the weekly data, but this analysis could also start with the monthly data. My scan includes a series of technical studies (some proprietary), along with some momentum analysis and short-term moving averages. As an example, one of the indicators that you could use would be the crossover of the RSI with its 21WMA, and then also check that the current RSI value is greater than the previous period. A similar analysis is done using an indicator like the MACD-His. Therefore, the scan would look for stocks where the MACD-His is above zero and that the current period greater than the prior period. In addition, I would add as a filter whether the eight-period EMA is above the 21-period EMA. The stocks that meet these criteria should then be further filtered by scanning the daily data, and additional analysis such as the ADX or volume could be added.

Table 1 - Click to Enlarge

In my scan using the data as of the February 19 close, 74 of the S&P 500 stocks were selected, and of these, 31 qualified after the first daily scan. I ran a second daily scan, which narrowed the group to just 24 stocks, or about 5% of the S&P 500. These are listed in the table above. So what’s the next step? I then start looking at the individual charts of these stocks from both a daily and weekly perspective so as to narrow the list further. Let’s look at some examples.

Figure 1 - Click to Enlarge

The weekly chart of Becton Dickinson (BDX) looked very interesting as after breaking through resistance in November (line b), the stock retested the breakout level in February (point 3) and closed the week strong. The weekly downtrend, line a, is at $79.90. If the rally up from the low at point 3 is equal to that from points 1 to 2, then the 100% Fibonacci target is at $87.40, which also corresponds to strong chart resistance. The 161.8% projection target is at $86. The OBV is acting much stronger than prices as it has moved well above the 2007-2008 highs and shows a pattern of higher highs. The OBV also retested support (line d) on the recent pullback, and the key support for the OBV is at line e.

Figure 2 - Click to Enlarge

To determine an actual entry strategy, I usually combine analysis of the daily and intraday charts with the weekly pivot numbers. With a very bullish close—as was the case in BDX—my initial buying zone would be the midpoint between the close at $77.54 and the weekly pivot of $76.95, which would be at $77.25. A reasonable stop would be under the December 18 lows of $73.49—let’s say $73.37, which would be about 5% below the entry. An alternative or more finely tuned strategy would be to use the hourly chart of BDX (updated through midday February 23) as it shows 38.2% retracement support at $76.40 and the 50% support at $75.90. The 200-hour MA falls in the middle of this retracement support. If you were filled at the midpoint of this zone at $76.15 and used the same stop, the risk was reduced to 3.7%. Of course, the danger is that this lower buying zone would not be hit, thus leaving you on the sideline. So if you are fine tuning your entry, I would also recommend that you have a fallback strategy in case the stock only has a shallow pullback before turning higher. As for targets, I would sell out half at $81.60, which is the 126.2% extension of the correction from the late-December high (point 1) to the early-February low (point 2). The stop on the remainder of the position would then be raised.

NEXT: More Promising S&P 500 Stocks to Trade

Figure 3 - Click to Enlarge

Another quite bullish chart in my opinion is L 3 Communications (LLL) as it broke through resistance at line a in mid-December, retesting the breakout in late January and early February. The major 61.8% resistance stands at $93.20 with the 78.6% resistance just above $103. There is resistance from 2008 in the $107-$115 area. The OBV has already made new highs as it moved through resistance, line b, in the middle of December. It made further new highs this week and is well above its rising WMA and support at line c. So what strategy would I recommend? This is always a tough call because if you try to fine tune the entry point too much, you may get left on the sideline. Even though this can be pretty frustrating, I prefer not chasing a market because a poor entry is more likely to land you in trouble. A different way to look at it is to start with the stop. For LLL the best stop would be under $82.80, which was the low on February 5, so a stop slightly lower, say at $82.57 would be fine. If you picked an entry in the same manner as BDX, it would have been at $89.68, so the risk would have been $7.11, or almost 8%. A more conservative entry would be the midpoint between the pivot at $89.21 and the S1 at $87.69, which would give you an entry at $88.45, thus making the risk using the same stop only 6.6%. The hourly chart as of the February 19 close had a band of support at $87.29 to $88.23.

Figure 4 - Click to Enlarge

Home improvement was one of the few industry groups that were rated positive after last week’s scan, and Home Depot (HD) has a very nice chart. The close above two-year resistance ($30 - line a) was impressive, and one could make the case that this completed a reverse head-and-shoulders bottom formation. The targets from this formation are in the $39-$41 area, which corresponds to the 2007 highs. The OBV overcame its downtrend, line b, in September and it shows a pattern of higher highs. For a buying zone, the close at $30.15 down to weekly pivot at $29.84 would have bracketed the breakout level. Using a stop under the two-week low of $28 ($27.91) would be a 7% risk. (Editor: HD gapped higher on the February 22 opening at $30.40.)

Figure 5 - Click to Enlarge

The only materials sector stock to survive the screening was AK Steel Holdings (AKS), which closed near its highs last week. AKS bottomed at $5.39 in March and reached $26.75 in January, which was still below the 38.2% resistance at $31. The 50% retracement resistance is at $39. The rally from points 1 to 2 was quite dramatic, and the correction to the low at point 3 just retraced 38.2% of the rally. Using the rally from a to b and projecting up from point 3, the 100% target is at $34 with the 161.8% projection at $45.40. This is just below the major 61.8% resistance at $47.30. The weekly chart shows an upward trading channel (dashed lines), but the OBV has already broken out to the upside (point c) from a similar channel, lines a and b. This suggests prices should follow.

Figure 6 - Click to Enlarge

For the entry strategy, I added a second hourly chart up through February 23 during the editing process to give you a better perspective. The hourly chart on the left shows that the rally in AKS through February 19 failed to reach or overcome the 61.8% retracement resistance at $23.85. If this resistance had been overcome, a more bullish entry strategy would have been justified. From the weekly pivot data, the first potential buying zone would have been the midpoint between the pivot ($22.94) and S1 ($22.24), or $22.59, while a more conservative entry would have been between S1 and S2 ($21.70), or $21.97.

On the right, I have added a chart through February 23 to show that AKS stalled on February 22, so I added short-term retracement levels to better define the entry zone. This of course would have been invalidated on new rally highs. The 38.2% support is at $21.97 with the 50% support at $21.42. This combined with the pivot data allowed me to develop a more conservative buying zone between $21.15 and $21.69 (see blue box). The suggested stop (see red line) was at $19.87, which was just below the February 8 lows. Using an entry level of $21.42, this was a risk of 7.3%, while an entry at $21.97 with the same stop would risk 9.6%.

NEXT: Trades to Avoid in Current Market Conditions

Figure 7 - Click to Enlarge

Pepco Holdings (POM) also looked positive, though another higher close this week would help to confirm the uptrend. The decline from the January highs ended at $15.74, which was the short-term 50% support zone. This stock has been lagging since the March lows with the 38.2% resistance at $18 and the 50% level at $20.50. The midpoint between R1 and the pivot was equal to last Friday’s close at $17.13, which, with a stop at $15.57, would risk just over 9%. Using a lower entry at $16.85 (midway between the pivot and the S1) and the same stop would lower the risk to 7.6%. A weekly close below last week’s low of $16.60 could signal a retest of the $15 area, so a tighter stop—say at $16.37—could be used. With an entry at $16.85, this would decrease the risk to less than 3%.

Figure 8 - Click to Enlarge

So which of the scanned stocks would I not be recommending? There are several, and I will just discuss two that are good examples. The first is Lockheed Martin (LMT), which along with Northrop Grumman (NOC) and Raytheon (RTN) are the three defense industry stocks that came up in the scan. The trading range in LMT has been quite tight over the past 12 weeks with a high of $79.65 and a low of $74.77. The weekly chart shows a short-term triangle formation, lines a and b. A similar formation is evident on the OBV, but the higher highs in 2009 do indicate accumulation, which favors an upward resolution. I would watch for a breakout or in increase in volatility (Keltner channels of Bollinger bands) for an entry with upside targets at $87-$89 and then at $96.

O’Reilly Automotive (ORLY) also has formed a weekly triangle formation, lines c and d, but closed near the lows last week. There is initial support at $36.90 and then at $33.60, all with key resistance in the $41-$43 area. The OBV does show some weakness as it has formed lower highs recently, line 3, which is a reason for caution. A break of the OBV’s uptrend, line f, would further weaken the technical outlook, and therefore, I would stay on the sideline for now.

Now I am sure you can do a similar scan with some of the excellent online services available, and I have found this to be an excellent way to narrow my focus on a select group of stocks, ETFs or industry groups.  If you have a favorite online service that you use to scan, please e-mail me at tomaspray@moneyshow.com as I would love to take a look at what our readers are using.