Gap Down Filled

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The gap down at $116 is now filled on SPY and the other index ETF's IWM and QQQ. So that target for this rally is met. Thus far the last 2 days of gains have come on progressively declining volume. For a rally to have higher probability of lasting the market should put in an increasing volume up day of 1.7% or greater sometime soon. That is the IBD follow though day guideline.

From a price logic standpoint the last swing down into the low was 5 days. So if this rally exceeds the high of that swing move around 119.50 in 5 days up, then that would be sign of a trend shift in stocks, at least intermediate term. So the market has about 2 and a half more days to accomplish that. In an expanding environment, it is possible that this move up does break that 119.50 high and then fail with a pretty violent leg down.

As long as prices remain below that 119.50 level, if the hourly chart turns down with a bearish MACD cross and a -DI above +DI directional movement signal, I plan on posting a new bearish trade entry. If the rally retraces the recent swing down completely but SLOWER than the downward move, I will still likely post a bearish trade on a reversal sign if there is no follow thorough day by then.

If the market retraces that move faster than it occurred, then I may look to post a long trade on a pullback above support.

Short Covering Rally? Then Waterfall Decline?

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I'm a little short on time tonight, but there is a very important and maybe somewhat advanced concept that I wanted to point out here to help get a handle on how and why bear market short-covering rallies occur, and what to expect and to look for.

The more I study charts and understand the markets, I have learned to think of the market in terms of order structure, kind of like a market maker I suppose. So think about this, the market makers are there to provide liquidity to the market. They make the bid/ask spread on every order filled. So what is their goal?

To fill as many orders as possible. That way they make maximum profit. So when they are looking at a market and can see where the bulk of orders are placed, they fight to drive the market that direction in order to fill the most possible orders.

So when you look at a price chart, think in terms of where the most standing orders will be placed......above and below chart swing highs and lows (support and resistance) that effectively are breakout/breakdown or stop out points. So expect the market to run the stops at those levels before resuming trend. Once the market makers have cleaned out all the orders possible, they are basically just neutral on the market, and then the underlying trend can continue.

So applied to the current market, over the last couple weeks as the S&P 500 proceeded to come back down and break to new corrective lows, it broke through some prior swing lows. Now understand that many new sell stop orders to short the market will be placed at those lows and be the level at which new short positions are initiated. Those are shown with pink lines and arrows on the chart above.

So once the market has broken those lows and a bunch of new positions are established, stops are placed above the market. What happens very often at times like the current one, is that shortly after the breakdown, the market rallies back above all those swing lows. That effectively puts all the newly established short positions under pressure because they are now negative on the trade. Also, some stops may be trailed behind the market or set to breakeven shortly after the breakdown. So the snap back rally functions to stop newly established short positions out and once again fill as many orders as possible.

So what we have seen today in the chart above is that the market came back above all those swing lows. That is exactly what you WANT to see before establishing a new short position. There has been so much chop that the weak hands are being cleared out, and only the short holders with well placed stops, above the consolidation remain. Once that happens, then the market is free to resume trend. In this case, there is an unfilled gap down a little above the market, so I expect we see that filled before the market falls again.

Now there will be new sell stops building below yesterday's low which could function both to stop out newly established long positions and to initiate new short positions. In an expanding environment like this, where each initial new round of breakdowns and short covering rallies results in successively larger declines, realize that power is building to the downside, and once the market is "exhausted" a fresh break to new lows can just slice through with no power to snap back. This often happens with a gap down after the break to new lows.

So I think we may see that here. Probably a little more upside (making this rally larger than wave "b"). But then if the recent low is broken, we could get a big gap down and a sharp waterfall decline in the markets once more, taking it to the next support level (1050 S&P 500) at a minimum.

I apologize if this post was not extraordinarily coherent. But if you go through it a few times with your own chart and try to get the concepts, I believe you will be ahead of most out there when faced with a situation like this. I expect to post a new inverse ETF entry if the gap down around $116 on SPY is filled. Use an hourly chart to watch for loss of momentum and a new hourly time frame downtrend. Then keep the stops above chart resistance.

Volatility Likely to Remain High

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Today was an interesting day and not unexpected based off of past similar instances. When Monday and Friday are down, there is a noted "turnaround" Tuesday effect historically. Also, the August low was exceeded significantly today in the S&P 500 and Dow 30. When a significant low breaks it often invokes some fear and also a reaction rally. The rallies are almost invariably extremely sharp really hurting the short term holder, running the stops on traders who shorted on the break to new lows. However, it is possible that the rally fails. Noted failures happened in Sept and Nov 2008 as the July and Oct 2008 lows were penetrated, respectively.

On a major bottom reversal day that closes up, the best reversals have extremely strong breadth. So looking at the advance-decline line is helpful in gauging the strength of the reversal. What is notable on today's reversal is that the NYSE adv-dec was relatively weak. See chart below.

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Note that today the reading came in at 633. That is lower than either of the up days last week and is not high on a relative basis to past similar instances either. Strong new upward patterns have started over the last few years with reading around 2500 coming off a significant new low. Also, for an intermediate bottom to be in place, the breadth on the reversal will often be higher than the highest readings of the recent move down.

So this reversal today does not look that strong on this basis. The technical analysis picture is definitely showing a bullish divergence on these new lows, so a reversal must be respected here. I just am leaning toward this not holding. The time relation is not ideal from my perspective for this move down to bottom. I think next week or even a couple weeks out would be better. In addition there is a tendency for market turns to happen around options expiration. So that would also suggest a little more "work" before a bottom.

If this low fails to hold, what will the following decline look like? From how this chart is developing the Sept 2008 and Nov 2008 precedents look most similar. One thing of significant importance is that the "a" and "b" wave labels I have on the top chart of this post, show that "b" is larger than "a" at -10.2% vs -8.7%. So the pattern is starting with EXPANSION. So if today's low is broken I expect the next move down to be larger than -10.2%. So a 14% or greater decline is reasonable or expected from my analysis if that happens. Again, the 1050 S&P 500 level is the next major chart support area (long term support and resistance).

There are a few other points I could make here that I have touched on in the past, but my take is that I think today's low is failure prone and certainly likely to be retested. However, we could see a dramatic move up (a large gap up, etc) for a day or so before it fails.

It is very tempting for me to post a bullish/long trade here, but I think that in this scenario waiting for a higher swing low would be very wise. So if we get some upside then a higher swing low, I would likely take that trade with a stop below the low.

One point that I don't know what to make of is that at basically all of the past similar occurrences from 2007-2009, when a low like this was broken, the put call ratio spiked. We just didn't see that here yet. The equity put/call ratio has consistently exceeded 1.00 at times like this. But today it was just 0.78 down from 0.85 yesterday. What I interpret that as is that there has not been enough fear generated for a lasting rally to happen. That fits with the analysis above. The other interpretation is like at the end of the last bear market in March 2009 where the put/call ratios didn't spike and in retrospect was an obvious sign of bullish sentiment divergence.

Bottom line, the long term is pretty objectively down right now, and I would use stops very close below any reversal if trading long. The market could get whacked hard if any reversal fails.

Gold, US Dollar, Stocks

In a prior post on gold I showed the corrections in this recent bull market and the level at which we are likely to have a confirmed bear market. Those levels have been exceeded which confirms that we are likely to be in a bear market now - a significant high has been made in gold.

Also, in this prior post I outlined the largest and fastest moves up in the US Dollar Index over the last 2 years and noted that if the green dashed line was exceeded that we wold have confirmation of a new uptrend there. That occurred today. So we have all the information now that we need to confirm commodities are in a bear market.

Now the S&P 500 also broke to new corrective lows today, and the NYSE has been at new lows over recent weeks. That is out of character with what historical corrections in bull markets have looked like. So, this break to new lows is reasonably strong confirmation on a historical/statistical level that stocks are in a bear market as well. The Nasdaq is leading and not at new corrective lows yet, but the price action/logic suggests it will break to new lows as well.

TWM Sold

TWM sold at 59.33 at the open today.

Sell TWM at the Open Today

Exit the TWM trade at the open today/Monday. I expect this gap down to be bought and the market to rally this week. If not then it may be a bad call, but the price action and pattern suggest to me this is probable. Hopefully we'll get a re-entry at a better level.

2010 and 2011 Trade Data

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I haven't posted updated trade history on the blog in a while. So here are all the trades which were closed in 2010 in the top chart and all the 2011 closed trades and the still open trades as well. The profit numbers are simply calculated with no commissions added and assuming a flat $10,000 allocated to each trade every time.

The open TZA and UNG trade are obviously sore spots. However, sentiment on UNG has never returned from the extreme pessimism level at entry to extreme optimism for exit. So until that happens I will continue to hold this trade in the blog.

Given the longer term outlook on the markets right now, I expect TZA will increase substantially in value prior to exiting the trade. The markets are at a place right now where a breakdown below the August lows could happen in the next 1-2 weeks, possibly resulting in another substantial leg down in stocks, and as soon as I can safely do so, I will post stops on all the open trades.

I expect the best trades to be short sales in the current environment, but I will continue posting inverse ETF trades when possible for those who don't sell short.