Another Stop-and-Reverse Situation
by David Nichols
The next few days should see volatility on the rise, with a Fed meeting this afternoon -- which could actually be a "yawner" -- and Cisco's earnings after the close. This is a 1-2 punch that could knock the market into a new state, provided the data points are uniform.
That is, if both are perceived to be bullish, the market could squeeze up some more. If both these data points come in bearish, then there is the potential to kick-off a big mid-term downtrend.
It's a particularly ripe situation for a mid-term downtrend, according to our sentiment readings. The sentiment tank is only 4% full. It's very rare for bullish sentiment to reach these levels.
There is a big crowd that will feel the squeeze once prices start moving against them. Indeed, this time I'm particularly fascinated to see how the "next bull market" crowd reacts to falling prices. My guess is the crowd is only bullish because prices have gone up. There isn't much for people to fall back on, fundamentally-speaking, once prices start moving down. It will be interesting to see how much conviction there really is on the long side.
Yesterday I suggested that a "stop-and-reverse" trade may end up being an appropriate strategy. Subscribers can check the archives on March 5th to 7th, for a discussion on how this strategy works during the end stages of mid-term advances and declines. That time it was the end-stage of a decline, but you'll get the general idea.
I came up with this strategy for the end-stages of mid-term trends, because these late moves can extend much longer than anybody can predict. I also came up with it because my strategy of using sentiment to define low risk position trades has an Achilles heel: often we're not going to participate in these emotional end-stage moves, when the crowd is reaching extremes of sentiment.
Positions in sync with a massive crowd are just far too risky. Yet such end-stage moves can carry on for quite a while, and travel quite a distance, as we're seeing now -- and as we saw on the last downtrend. Missing these moves frustrates people in a big way; indeed, they are all about frustration. These late-stage moves suck in every last dollar, or force every last seller to liquidate, right before the market reverses.
So I offer up the "stop-and-reverse" as a way to participate, without taking on inordinate risk.
In early March, I was writing how it was risky to be short, but if the market were going to go off a cliff, you could participate by going short below 815 or so (I was more precise back then, but I'm just trying to illustrate a point now), but -- and this is the crucial thing -- you would want to stop and reverse that short position if the market came roaring back up through your entry zone at 815 to 820.
Those following this strategy had the opportunity to participate in an emotional crash to new lows -- which never came -- and also a strategy mapped out ahead of time to get them long if the pendulum of sentiment swung back to squeeze the bearish majority -- which did actually happen. (Note: it always happens.) The best part is this position carried very little risk, as the entry points for short and long positions were right in the same area.
The key to this strategy is picking a good "line in the sand". The only thing that can trip you up is a market that flips back and forth in your chosen zone. You can get chewed up by a congesting market, as there will be slippage from trading costs and a losing a few points here and a few points there.
I think we've got a good line now, at the last high on the S&P 500 at 935. If the market is clearly above this line, a further short squeeze is underway. A move back below this line after such a blow-off top will almost certainly mean a mid-term downtrend is getting rolling, and the pendulum is swinging back against the bullish majority.
How far could such a down move go? Really far. The reason is nobody -- and I mean nobody -- is calling for a re-test of the bear market lows, or even a descent to new lows. That always gets my attention. The whole world thinks any coming pullback will be a buying opportunity, and that support is going to hold, because it's a "new bull market." It might be, but that's a supposition that can be dangerous to your financial health.
My guess is that the market is now going to frustrate the maximum number of people. The bulls have a sense of serenity right now, because the market has made such a nice move higher. They have momentum, and a profit cushion. The bears have the itchy trigger fingers, and are much quicker to cover shorts than the bulls are to liquidate longs.
So a path of maximum frustration would be to stop out every last short with a clear break over 935. A run higher would give the bulls that "I told you so" sense of elation, as another resistance hurdle is cleared; but then this massive crowd could be caught flat-footed by a vicious reversal right back down through 935 that never looks back.
The situation could look like the March bottom, only in reverse -- the bulls could look up 100 points lower on the SPX, and not know what hit them.
Of course, with such a bullish majority already built, the selling barrage can come at any time. All it needs is a catalyst. If the reversal comes under 935, then that would be more obviously bearish, and not quite the trickiest path the market could follow.
So we'll see how it goes this week. If you're dying to get long, then do so on a move above SPX 938 that holds for a full 30 minutes. I like to give 3 points of room above the obvious line, to make sure it's not a false breakout. If the market breaks out like this, and then reverses back down through 935, then you'll want to be stopped out of your long at that point, and immediately reverse to a short position. Remember, that's the key thing.
If the market starts to fall back here without pushing higher, and we see our "spark of fear", then we'll enter bearish Rydex positions.
Sentiment Dashboard
by Adam Oliensis
SENTIMENT TANK: The tank drained almost 1% to just over 4% full of negative sentiment on Monday. Relative to the past year this market is positively euphoric. Danger, Will Robinson!
SHORT-TERM: The hourly gauge remains essentially neutral with a slight positive bias (the green arrowhead). If the VIX breaks clearly below 23 then we COULD squeeze one more genuine hourly advance phase out of this tube of toothpaste.
MID-TERM: The mid-term gauge progressed a micro fraction within the decline phase that's struggling to develop but should be considered unchanged. Our Confidence Diffusion Index (CDI) continued to regress out of phase (on the wrong side of zero) with a bullish 2 reading. It's trying to pull the gauge back through neutral and into another advance phase. It's a tug of war. We have to wait to see who wins...CDI or the gauge.
LONG-TERM: The weekly gauge popped 10 points to 99% in its advance phase. The weekly momentum of sentiment is now extended to the extreme. Could it go further? Yes. Does it tend to? No. Our weekly CDI is still at a lowly 2.
The last two times the weekly gauge got this high? June 8, 2001, at which point the SPX began a 3-month decline from 1265 to 966 (even before the tragedy of 9/11 the SPX had moved from 1265 down to 1124); March 28, '02 at which point the SPX began its 4-month descent from 1147 to 800.
BOTTOM LINE: With both the mid-term and long-term gauges flickering up around the tops of their respective gauges and with the tank at 4% we had BETTER be headed for the mother of all bull markets. Either that or this thing has the potential to sting a lot of complacent investors very very hard...again.
Se não receio o erro é porque estou sempre pronto a corrigi-lo
There's no bull side and no bear side. JUST THE RIGHT SIDE!
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