The First Big Test of this Rally

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After today's decline the market is in very questionable technical position for a further advance to new highs. Despite the short-term model generating oversold signals yesterday, today was able to pull back deeper with the model never coming out of oversold condition. This type of behavior is one thing I look for to gauge trend changes. Prior to this oversold signal, the other signals had all bounced up by the next day. Also, the S&P has not had 3 straight down days this entire rally until today. So these are signs of a trend change, but there is not much technical damage yet.

The plus side for the bulls is that the S&P and Dow have held their 20 day MAs. The top chart above shows the S&P 500 with green vertical lines indicating times during prior bear market rallies that the RSI(3) has dropped below 30 and the S&P had not yet touched the lower bollinger band since the beginning of the rally. Today's decline has now set things up the same way. Other than in early January, all the other instances quickly led to nice short-term moves up. The January instance led to a further sharp slide for a few sessions before making a decent short-term rally that ever so slightly made it back to positive (if buying on this similar set-up) at the next overbought signal.

Also, the 875-880 level on the S&P is the breakout point from the January highs that many are watching for a re-test (blue horizontal line on the chart). This is only a few points below current levels. I would be surprised if the market did not put in a decent bounce from near the current levels or a little below. Maybe a gap down into that 875ish area tomorrow would be a short-term exhaustion point and would entice buyers, but we'll see.

The lower chart shown above is the VIX with the 63 day TSF study I showed before a few times. Today the VIX closed above that line for the first time since before the March lows. This signal has been so accurate at denoting market peaks and VIX bottoms for this entire bear market that I am paying serious attention to it. This signal last came in January after the market had made its first breakdown and showed oversold signals. However, I mentioned on the blog at that time that the short-term was probably too oversold to be a good intermediate sell point. That proved to be true with much better signals coming 2 and 4 weeks later after the first and second short-term rallies.

From this point I think the two most likely scenarios are a bounce starting tomorrow (maybe after a gap down or early weakness) followed by new highs for the index into next week OR a further slide for the next few days down to the 850 area followed by a nice bounce after that. If the market falls below 850 within the next few days, I would give the S&P basically no chance at new highs for this rally any time soon. That deep a pullback would be greater than all the pullbacks so far this rally and would also retrace what could be the E wave of the possible rising wedge I have shown in recent charts.

As far as the current SSO trade, the first scenario above (which I think is a little less likely) would probably result in a decent gain by the next exit signal. The second scenario would be lucky to breakeven by the exit signal. From my experience I would say that holding and waiting for the next overbought signal is the best thing to do even if there is some more short-term drawdown. I pretty much gaurantee that there are some eager potential buyers waiting for the first significant price break to try to catch a bargain. So even if there is further short-term weakness, I think the odds are good for a sharp bounce after that and would be the best exit point for the trade.

Sentiment Update

I didn't get around to updating the sentiment picture from the weekend data, so I will just give a quick recap here since there have been some further notable readings.

First, I had mentioned in recent posts that seeing increased small lot size call options bought to open would be something to watch for. As of this past week that call buying jumped to its highest level since last May. The put buying had already been significantly lower, but the combination of the increased call buying and lower put buying has pushed the ratio to levels once again not seen since last May. The ratio is now very close to the upper standard deviation band that has very nicely marked points at which the market has had trouble making further gains over the short to intermediate term even in bull markets.

Also corporate insiders (which tend to be a smarter money group) are net selling into this rally as of the last couple weeks and more heavily so than any time since mid 2007. Do they have a better gauge of future earnings and economic conditions? Probably.

I have touched on the "Smart Money" and "Dumb Money" confidence levels from Sentimentrader.com in recent weeks. As of last Friday's close the spread had increased even further from recent levels creating a disparity greater than any during this bear market. These are basically real money gauges - not "opinion" type indicators. So we know that the better market timers are showing decreasing confidence in and commitment to the market with each new high, while the poor market timers are speculating heavily on further gains.

The sentiment picture is nearing "as good as it gets" levels (from my opinion) to bet on a reversal in trend. Until this week, the technical picture was not confirming that really at all. However, the last 4 days have beat up a few sectors pretty hard, putting the market in a tedious technical spot.

This morning as the market pulled back, selling was met mid-day with strong buying interest. So as of now, things seems to still be holding together. The next couple days should be pivotal in determining if this rally is basically topped out or not.


Pete

New SSO Trade

As discussed yesterday, the S&P pullback this morning and generated short-term oversold signals. It has also formed a nice reversal candlestick on the 30 min chart at the common 10:30 AM reversal time.

New Trade Recommendation:

Buy SSO with a market order today. The current price is 25.40 which is the blog entry price.


Exit will be next overbought short-term signal. Following a 30 min stochastics chart is a good guide as well.


Pete

Bullish Trade Set-Up for Tomorrow

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Last Thursday the index ETFs showed bearish reversal candlesticks. However, Thursday's high in SPY and DIA was exceeded Friday, and today was not a type of session that gives much confirmation to that potentially bearish candle pattern. From a candlestick perspective this would suggest that the uptrend is still likely in effect.

Last week I had said that I thought that 940 would be a cap on prices if a rising wedge (contracting triangle) was the pattern that is forming off the March lows. The recent highs around 930 and change suggest to me that any further highs likely rule that scenario out, in favor of a complex corrective pattern that should continue at least a bit higher (see this post).



The short-term model for the S&P is back nearing oversold, and prices are easily holding the 20 day moving average as of today. If I throw all other types of analysis out the window, and just look at the moving averages for the main trend and the short-term model for extremes against the trend, I would say that a good bullish set-up is occurring, so that is how I am going to approach this tomorrow for a potential trade.



In addition, I had mentioned last week that a potentially good bullish set-up would occur if the market had an initial knee jerk negative reaction to the stress tests which generated oversold conditions. That is not clear cut in my eyes (prices ran up on the leaked news initially), but if we get oversold tomorrow with a controlled price decline, that would fit with the general picture I guess.



The chart above shows SPY with the RSI (3) which is usually a good guide to short-term overbought/oversold conditons, as well as the DMI and Aroon Indicator which are "trend finders." Last time I showed these, the Aroon indicated a strong uptrend, but the ADX line on the DMI had not turned up yet to confirm a trending market. Now both are showing trending signals. One thing to look for to help locate a potential top in coming days/weeks will be for the ADX line to decline for 2 straight days. I will re-evaluate whether or not to look for a longer term bearish trade when the short-term model reaches overbought levels again.


On the trading front, I will almost certainly post a trade tomorrow if the market is down and the short-term model becomes oversold.


If you happen to still be in the last BGZ trade :) then I would suggest watching a 15 minute stochastic chart of SPY and exit if/when the slow %D line gets oversold tomorrow or certainly exit if I post a bullish trade tomorrow.


Pete

Quick Money Management Post

I wanted to make a quick post rehashing and giving some more specifics on money management and account allocation ideas for these blog trades. I have suggested in the past to take a look at the "best posts" section on the right side of the page to get some basic ideas, but for most people who are into trading, I really assume that you know the basic rules that are often suggested regarding risk per trade etc. Also, there will probably be very significant differences in account sizes and risk tolerance for people following this blog, which makes it impossible to suggest one ideal strategy.

Because my focus for the last month has been on getting in at low risk points that have the potential to be a major bear market rally top, I have recently been suggesting stops more so than in the past. This has resulted in a couple breakeven type stop out trades and a couple stop outs for losses (not exited with short-term indicator signals). While basically all of those trades would have been positive if exited using my usual short-term exit signals, I have discussed that the purpose here is to try to get a huge reward on risk trade for a longer holding time, and then get back to concurrent short-term trades if/when the market clearly turns down in coming weeks/months.

So there are really two types of trades on this blog 1) those with stop losses and 2) those without stop losses. The first type are best handled by using the stop loss point to calculate a risk per share, and then use that to determine position size based on a predetermined standard percentage of your account that you risk on every trade (suggestions below). The second type I think is best handled by thinking in terms of how much of your entire account you will devote to the trade or by having a standard fixed dollar amount that you devote to every trade. Since there is no defined risk, you are instead relying on % allocation to roughly estimate risk.

So here are my basic ideas on this for anyone who is interested......


For trades with a stop loss recommendation (defined risk per share):

Account size over $100,000 risk 0.5% per trade
Account size $20,000-$100,000 risk 1% per trade
Account size $5,000-$20,000 risk 2% per trade
Accounts under $5,000 risk 3% per trade, but if you have a very low commision broker ($1 or less per trade) then just still go with 2% risk


For trades without a stop loss recommendation:

Since I have started the blog, the average losing trade has been 2-3%. So, 33% of an account devoted to the trade on average would be about 1% risk per trade if it ends in a loss. So that would be about right for $20,000+ account sizes.

For an account around $10,000 I would say you could go up to 50% or a little more, still being pretty conservative.

For small accounts like $5,000 or less (and if this blog is your only trading methodology) I think putting your whole account in on each trade would be fine until you build it up more.


Referring to the results of all blog trades in the past, devoting the entire account to each trade would have resulted in the best performance, but obviously you have all your capital tied up and potentially at risk and I wouldn't suggest that for larger accounts because a dollar is still a dollar no matter what fraction of your account that dollar happens to be.


So those are my rules of thumb for money management, but obviously if you have a good reason to deviate from them, then that is up to you.


As a quick side note, the last BGZ trade was stopped out for a loss on Friday. Based on the most recent data, I will be looking to get back in a trade as soon as a good opportunity presents itself. My only regret with this last trade is that I knew that the QQQQ/tech reversal candles were much stronger and less likely to get stopped out (they wouldn't have been even very close to being stopped out) on an otherwise good trade, but I went with BGZ (3x) for the trade rather than QID (2x). While the market may prove me wrong, the tech reversal this past week was so imposing, that I think this past week was basically the top of this rally. So, I didn't really WANT to be stopped out. But that is in the past now, so I would just encourage blog traders to continue to make the trades even if a couple losers shook your confidence. The "smart money" is selling into the "dumb money" buyers right now, and we want to bet with the smart money. More on this in the next post.


Pete

New BGZ Trade

Today's reversal after the gap up looks serious. When yesterday closes at a 3 month high then today gaps up like it did today, the returns are solidly negative over the next week historically.

Also, the market broke the first hour low and the advances, decliners, and TICK are confirming the break to new lows, indicating that the market may continue lower today.

Since we may be able to get in at a major top here with low risk, I am going to suggest a trade today with a stop loss above the day's highs.

New Trade Recommendation

Buy BGZ today with a market order. After entry place a sell stop order at 36.40 and use that to determine position size if necessary. 38.30 is the current price and the price I will use for blog entry.


Pete

Check Back Later Today, Possibly a New Trade

I can't say for sure, but today looks like it could be the high of this move. After a long run up, XLF gapped up nearly 5% today. QQQQ is lagging badly for 2 days in a row. Hanging man candlesticks yesterday on QQQQ. Bearish engulfing patterns on XHB and RTH yesterday with follow through today on XHB.

If today closes weak, then the trade would be an entry with a stop above today's high.

Pete