Thursday, June 11, 2009

Shooting Stars and DIA Northern Doji

Click on Chart to Enlarge

The chart above is DIA which is the Dow 30 ETF. The late day revesal today caused DIA to form a classic doji candlestick. The doji is a fairly reliable reversal candlestick in and of itself and dojis marked both the January 2009 top and the March 2009 bottom. Additionally, the S&P 500 has been stalling at a key chart based resistance point around the 945 level and the January highs. The Dow has been lagging and has not reached the January highs. Today DIA filled the breakaway gap down from early January and then reversed.

This set-up looks very promising for topping potential. If this is a significant top, then it would typically be followed by some strong follow through to the downside over the next 1-2 days. A gap down and a solid black candle tomorrow would provide enough confirmation for aggressive entry on short positions with a stop above today's high in the indexes. Additionally, a sell stop corresponding to last week's lows could be used to enter short on further weakness.

Over the last month or so, just about every bullish extreme conceivable has been objectively reached. The most recent ones from composite surveys and Nasdaq/NYSE volume ratio are typically longer term signals. I don't cover breadth data too much on the blog because I really don't think it is that useful for short-term trading. However, when looking for major turns and the health of market rallies, it is much more important. I'm not going to cover it here either other than to say that on the push to new highs above the May highs, the participation has been waning in terms of peak advancers versus decliners as well as stocks making new highs. So while we have seen extremely/"excessively" bullish breadth for a couple months, we are only recently seeing a breadth divergence with new price highs. This divergence is also confirmed by On Balance Volume in the indexes.

The investment herd has, as measured by objective and historically proven data covered in recent weeks on the blog, shifted to a decisively bullish posture. I think the current consensus is borderline manic from some anecdotal evidence as well. I frequently read the comments sections of a number of blogs looking for reader comments about what they think the market will do. I basically look for the type of comments that are non quantitative yet stated as matter of fact (or at least charmingly ignorant). Recently I have seen a surprising number of comments of people who are just now looking to re-enter the stock market because they are in danger of missing out on the new bull market, etc. Call me stupid, but I don't think you've done your homework if that is your view. I think you are panicing about missing an opportunity. That is raw emotion.

Maybe I'll go into more detail this weekend, but I've covered just about all the relevant data that one should need to see that the market is in danger of a significant pullback. The only missing piece is price confirmation in the form of a larger % decline than any pullback during this rally since the March lows. The largest pullback in the S&P 500 since March 6th was about 6.5%. So I think any decline greater than that, especially if it reaches 8% or so, should be treated like the angel on your right shoulder telling you that the market is going on to significantly lower price in coming weeks/months.


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