Surveys Showing Large Decrease in Bearishness

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This week's results of the Investor's Intelligence and American Assoc. of Individual Investors surveys show a large decrease in bearish opinion. In fact, the current levels are near the lowest bearish opinion since the beginning of the bear market.


The chart above is the II bearish opinion survey with some standard deviation bands that help to put the data into context. Notice that the bearish % is now just a little above 30%. The last reading this low was last year around this time as the market approached the peak of its 44 day rally off the March lows. Also, notice that the current reading is below the standard deviation band which nicely marked the top this January.

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This chart is a screenshot from Sentimentrader.com of the AAII bull ratio (bulls/(bulls+bears)). The red dotted lines are 1.5 standard deviations from the 1 yr average reading. Notice that the current reading has just hit that red line. That standard deviation band has been a good guide for locating market peaks in this bear market with comparable readings this January, late last October, and the middle of last May. This reading is largely due to a big decrease in bearish %, but the bullish % has also risen substantially.

So, for about 3 weeks we have been seeing real money gauges from put/call ratios, Rydex fund flows, Nasdaq mini futures long positions, etc, reaching into "excessive optimism" territory. Now, we are seeing a noticeable increase in comfort with the market's prospects by both individual investors and investment advisors. To help confirm this other dataI, would like to see a sizeable increase in call buying and decrease in put buying from small lot orders when the data comes out this weekend. Also, while I have not discussed this on the blog, stocks are largely overvalued relative to bonds on a statistical basis currently. This type of relative valuation model is very helpful in indentifying price extremes against the long term trend (200 day MA).

In any case though, if this is truly a bear market rally, I have to expect that the market will begin to pullback within the next week or two. If new highs continue into June, then that would call things into question for me on the longer term outlook.

I wrote the previous part of this post this morning, but am just publishing now after the close. Today looks like a pretty classic reversal day. The candlestick patterns are very solid bearish engulfing patterns on the index ETFs. XLF ended with a high volume dark cloud cover off of a very large gap up. Take a look at SMH (semiconductors ETF)! It engulfed the real bodies of the last 5 trading days and marked the largest down day since near the bottom of the bear market. When those days occur coming off of highs, it usually indicates a trend change. Many energy stocks showed very wide range engulfing patterns on heavy volume. XHB (housing) broke its uptrend by completely retracing the last swing move to new highs.

The BGZ trade is off to a good start, but the short-term model for the S&P 500 is not yet oversold. Just maintain the current sell stop at 36.40, but I won't blame anyone for moving a stop to breakeven, particularly if there is a gap down tomorrow. This reversal looks "real", so my plan is to reduce risk ASAP but hope to catch what may be a large move down in the markets, which would make a huge gain on BGZ if this reversal sticks.

A buy the rumor - sell the news top seems almost too scripted here, but there is a plethora of supporting evidence for a significant pullback any day now. So let's keep the stop as loose as is sensible for now considering that even if stocks "just" pull back to the 50 day MA, the reward could easily exceed 6 times the current risk with the stop at 36.40.

Pete

"Triangles, Triangles Everywhere - And Not a Drop to Drink"

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This post may not be very interesting for anyone not obsessively interested in pattern identification, but I think it may at a minimum give chartists a few helpful ideas for understanding what it means when successive phases of market action (in the same direction) get progressively larger and what kind of action typically marks a true trend reversal.

The chart above is the 2000-2003 bear market in the S&P 500. First off I won't go into detail on the labeling other than to say what I will say again later. From a market logic/psychology perspective when a "wave" or "pattern" ends, it will completely retrace the most recent leg up or down in equal, or typically less, time than the recent leg took to form. Notice the successive overlapping moves from the bull market highs, with each move down larger on a % basis than the last down move. This forms a downward sloping expanding pattern.

The important part of an expanding triangle are the A, C, and E waves. They should be successively larger on a % basis. The intervening B and D waves may or may not be larger than the previous wave. In the case above, the B and D waves are smaller than A and C respectively. Another aspect of these patterns is that they commonly occur as the first phase of a large complex correction, or sometimes in what is called an "x" wave position in Elliot Wave theory. An "x" wave is a middle wave between other corrections in a complex correction. These patterns will almost always slope up or down in the direction of the larger complex pattern. This is all the more true in large scale patterns like the one above. If they formed on a horizontal axis, that would be odd as the market is gyrating wildly with no net loss or gain. There is almost always a force pulling the market one way or the other.

Another aspect of these patterns is that the E wave is so strong, that it almost never is retraced in less time than it took to form. That encompasses the basics of these patterns. Now to a couple more examples.

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This is a chart of the current market. I have recently said that an upward expanding triangle may be what is forming here. Each rally has been successively larger since the October bottom. But here is THE MOST IMPORTANT THING from my perspective........As I mentioned above, new psychological trends start with price moves that completely retrace the previous wave in less time than it took to form. This has not happened in the current market. Whether considering the last wave down as being from the February highs or the January highs, neither was retraced in less or equal time than it took to form. For this reason, I believe the current move is NOT the beginning of a new bull market, but a glorified bear market rally instead. At a minimum then we should expect a significant retracement of the current rally, but the pattern is suggestive of significant new bear market lows in months to come from my perspective. While the E wave doesn't have to be larger than wave D, it usually is, so I would guess a rather quick push up above 944ish would likely occur before this rally tops.

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This chart is the banking index, $BKX. The portion of the chart I have shown I believe is best viewed as an expanding triangle. One of the give aways is the slight undercut of the A-C trendline by wave E. Also, because wave E is typically so large and vertical, it is usually a very powerful corrective pattern on its own - often a double zig-zag or a smaller scale expanding triangle. The chart above is interesting because it appears that the E' wave of the large expanding triangle is a smaller degree expanding triangle and the E wave of that smaller expanding triangle looks like a complex correction, showing the two most common ways expanding triangles end in one chart.

While fibonacci relationships are not thought to be common in expanding triangles, wave E may relate to either wave A or C by 1.618 or 2.618. Wave E would equal 1.618 times wave C at 957ish on the S&P 500, so that may be an area to pay close attention to and consider going short/bearish if the market rises that far and is short-term overbought near those levels.

Tomorrow I plan to give a brief update on the Investor's Intelligence and the AAII surveys and see how the bullish % is coming along. If this week ends strong, then next week will be very interesting to see the II survey because each week's data is for the past week through Friday.

Looking to Get Bearish Again If/When S&P 500 Exceeds 944

I don't have any specific trade in mind that looks imminent, but the two possibilities I see that look promising are......

1) There is a "controlled" sell-off over the next few days that generates short-term oversold extremes. Initial reactions to major news are often times reversed after the initial knee-jerk reaction, so that would set up a potential bullish trade.

2) A move above 944 on the S&P 500 over the next few days that generates more overbought extremes. That would put the S&P in a major chart-based resistance window, and may draw in much Johnny come lately buying after the news is out, creating a good bearish set-up.


A few weeks ago I touched on the widening spread between the Dumb Money and Smart Money indicators from Sentimentrader.com. As of this week, the Smart Money confidence in a further rally has dropped even further, putting it at levels last seen in May 2007 when the bull market was nearing its peak. I would like to see some more signs of increasing bullishness among small traders like a nice jump in small lot call buying and a big jump in bullish % in the AAII survey to help confirm that the Dumb Money is "on board" for the rally.

I'm guessing the earliest possible next trade for the blog would be Friday, but I would want it to look especially nice.


Pete

Market Pattern Update - Likely More Near Term Upside

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I just wanted to show a chart with the price pattern that I have recently referenced that has suggested the possibility of a significant further rally before any major retracement. With today's move to new highs, I think this is now the most likely scenario.

When this rally started I had suggested that if the market was forming a triple three correction, the most likely ending pattern would probably be a contracting triangle, which could be either horizontal or a rising wedge type triangle.

The fact that the S&P 500 exceeded the 880 level makes it less likely that the pattern since October's low is technically a triple three. It may be an expanding triangle instead where waves A, C, and E get progressively longer in % gains. While I may make a post very soon regarding expanding triangles, I will just say that the E wave (which may be what we are in now) tends to be VERY directional and is usually a complex correction from a wave theory perspective. The fact that this upward rally is taking so long and is not really looking like an nice wedge, I would guess that a complex correction is occurring (i.e. ABC-x-ABC) as the E wave of an expanding triangle.

On the chart above I have the recent sideways action labeled as a contracting (upward slanting and hence very bullish) triangle in either a "D" position or an "x" position. In both these scenarios I would expect further upside from a pattern perspective. The 940 level would probably be a cap on the advance if the pattern is a large rising wedge since March's low. If the pattern since March is a complex correction, then I believe that should allow the market to rise even further over the next few weeks (say to 1000ish on the S&P). As I mentioned in the weekend post, as a pattern concludes, possibilities should become limited for what can happen, and we should be able to zero in on a coming "top." Since in either case above we are past the halfway point of pattern development, I think that things will get progressively clearer over the next week or so from a pattern perspective.

This time may provide nice very short-term trend trades, but probably won't register enough of short-term extremes for me to suggest trades for the blog. However, in either case above, I would expect a very significant top to form within the next couple weeks (almost certainly this month) which should make for a good bearish trading opportunity.

So don't expect much in the way of blog trades in the near future:)

Housing and Financials Signaling a Top Here???

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First off a couple blog related things......


For anyone that has used the "subscribe by email" feed, my experience is that when I put my own email in there, I do not get the blog updates until the next day, which doesn't do much good for trading purposes. So if anyone knows how to change that or if they have a similar experience let me know to try to figure out how to get it faster.


Also, the "subscribe in a reader" seems to work very nicely as it is simple to do, and every time you use the reader and hit refresh, you will be assured of the latest posts. So that may be the best option out of these two.


Also, I am not really interested in using Twitter on the blog, but occasionally I will have a comment to make that I don't feel justifies a whole post, so I have been and will continue to put those in the "comments" section under the most recent post. Anything important regarding trade management I will always put in a separate post though.


Now to the chart.......I have spent some limited time this weekend trying to look for clues as to what the most likely next direction for the market is because this past week or two has raised some possibility from my perspective for a significant further rally based on the price pattern. However, that does not really match well with the sentiment picture which has been on par (for a couple weeks) with significant imminent market peaks of the past.


I have looked at several things but just used one chart because it is loaded with potential market education. In short, the banking index $BKX is badly lagging the S&P 500 on this recent move to new rally highs. This has been a uniform occurence during bear market rallies during this bear. This would indicate stocks are likely to fall. Also, the total put/call ratio (index and equity) tends to be a leading indicator of future price at turns in that it will form divergences. Right now, that measure is showing a bearish divergence. That is largely because the index option put/call ratio has been rising on this recent rally. That measure is often a smart money indicator as they prepare for near term volatility to increase.



Lastly for this post, the housing index, XHB, is showing a minor non-confirmation the last couple days as it has fallen and is several percent off the highs of last week. More importantly, the chart is showing a compelling pattern both short and longer term that are suggestive of potentially severe weakness the next couple months. The chart above has the notes, but I will add a few here. First, the larger pattern looks like a large upward ABC "flat" pattern since the November lows. The rules associated with this pattern are......



1) waves B and C each have to take equal or more time than wave A.......check

2) if wave B takes substantially more time than wave A, wave C will most likely take about half the time of (A+B).......that is about dead on for the recent high this week.

3) wave B has to retrace more than 61.8% of wave A.....check (in this case since wave B is almost exactly the same size as wave A, then wave C should be almost the exact same size as well, hence the name "flat" due to the double bottom and double top appearance).

4)and here is the biggie.....after the pattern is over, price should retrace wave C in equal or less time than it took to form.



So if this is a flat pattern, then price should drop severely over the next 2 months. The technical indicators and candlestick patterns are both confirming a potential top here as well, so things look strong in support of this case.



So if I had to pick a direction for the market in the near term and intermediate term, I would say "down" from all this evidence.........possibly a major top in the forming. But bank related news, etc. may trump any other factors over the next couple weeks, so I am not extremely confident. Also, Friday looked like it is forming a continuation head and shoulders bottom on the very short term charts. So maybe we will get a gap up and/or test of Thursday's high even if the high does hold.

Lack of Pattern Clarity Says "Get Back to Basics"

It is probably a truism of trading that bad trades follow great trades or at least that periods of great success are often followed by periods of sub par success. I think that probably applies both to individuals and to systems, because some systems perform better under certain market conditions and not as good under others, and individuals naturally experience periods of bias or emotional attachment to behaviors that have been rewarding in the past, even if they are not now. I'm sure the more real live trading experience one has and the more refined his or her methodology, the more ablility to overcome these tendencies.

I feel that I personally had a period of rather good trading and pattern recognition clarity since the beginning of January this year through the middle of March. However, the last few weeks things have become considerably less clear, particularly after this week from my perspective. This leads me to believe that the market is forming a somewhat complex price pattern since the March lows and that it still has some time to go before completeing it.

It is the nature of pattern recogntion that things are only relatively clear at the beginning and end of a pattern, but have much greater flexibility toward the middle. As a brief illustration......it may be like someone driving from New York to LA. By looking at a map, we could probably have a large degree of certainty as to what routes they are, or should be, taking to leave New York and get headed west. Also as they approach LA, we once again would likely be able to limit the possible routes that they will be using to make the final approach to enter the city. However, there may be significant variability of the routes taken through the greater portion of the trip through the middle of the country. So for people who have followed this blog for some time, that's why it was possible to rather narrowly outline the bottoming range (end of a pattern) in March and to aggressively trade the expected initial strong thrust off the low (beginning of new pattern).

As relates to the current market, I feel that maybe I am in eastern Colorado somewhere where it is nice and flat, but things are obviously changing on the landscape ahead. Once I get through the Rockies, I think things will be considerably clearer, but right now I could see almost complete opposite scenarios as being about equally likely, which doesn't do much (if any) good.....or maybe that means I should make a straddle trade..........

So for the record, until I feel some legitimate level of certainty regarding the market pattern is returning, I am just going back to the basic (more mechanical) methodology of this blog which is to trade in the direction of the 20 and 50 day moving averages (with greater preference for the 50 day MA if they don't agree) at short-term extremes counter to that trend. Then when the next big turn is VERY close or already just underway, I think I should be able to quickly recognize it as this pattern nears completion.

So the safest bet at this point from that mechanical perspective is to assume the trend is "up" for now. Then if we see either a significantly larger decline than has occurred since the March lows, OR if we see an acceleration up into a potential climax type top, I think we could make a reasonable bet that the highs for this rally are in or close at hand.


Enjoy the weekend!

BGZ Trade Exit

While there are no short-term extremes either way right now, staying in counter trend trades is dangerous, and obviously the safest thing to do is to get out as soon as things don't do what you expect. When going with the trend I typically don't suggest tight stops or exiting without an indicator signal, but counter trend trades are different. At times the pullbacks are so weak that they don't ever register an exit signal and you get strung along.

So I don't know what next week will bring but I want to err on the side of caution here and wait for a new short-term extreme one way or the other before making potentially a new trade.

Exit the current BGZ trade ASAP with a market order. Current price is 43.85.


Pete