This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com
Over the past few days, I have been reading more and more, and more posts about how a reversal is just around the next 15-min candlestick.
Before I go any further, let me first define the term reversal. By reversal, I mean a reversal of the current downtrend in the daily chart of ES.
The desire to be the definitive source of authority in prognosticating and predicting what the market will do next is seductive to say the least. And in each case, compelling reasons are offered to justify making such predictions. Let’s examine the reasoning for a reversal one by one.
1. % of stocks above their 40day MA is below a certain threshold.
All this really means is that a lot more stocks this week have broken down and reached oversold levels. But just because a stock is oversold does not mean it should be bought. In fact, according to Dan Fitzpatrick, a stock that is persistently oversold is a sign of bearish strength. (Well, he actually said that a stock that is persistently overbought is a sign of bullish strength, but you get the drift). It’s not unrealistic to apply that same logic to the market indicies as a whole. And I think this week could qualify as persistently oversold, can it not? The markets can remain irrational longer than you can remain solvent, can it not? Certainly there was more money to be made this past week by trading with the trend than trading against the trend.
2. Nasdaq Advance-Decline Says Buy.
I respectfully disagree with that notion. The Nasdaq Advance-Decline is actually saying oversold. Now, go back and read my first point.
3. Five Weak Days.
Historical patterns suggest that Five Weak Days have resulted in the market being net higher 5 days later for 51 out of the 69 times this occurred since 1990. The avg. 20day gain after 5 weak days was 3.21 %.
Well, my response to this is that let’s look at a chart.
Historical statistics know absolutely nothing about the context of the current market conditions. Notice how a +3% gain at this point will barely break the downtrend line? So even if the market were to move up in the next day or two (which I acknowledge that it very well might do), that would not necessarily mean a reversal has taken place. The reason is that at this point, the range and volatility has expanded so much that for the S&P500 Futures (ES) to close up +10 points no longer qualifies as a reversal. After all, that only takes us back up to 1468; it would have to move way more than that and also sustain that up move for a certain period of time in order to constitute a real reversal.
On the contrary, I will offer up three of my own reasons why we won’t see a reversal any time soon:
1) There are still fund managers that are trapped in long positions. Next week is month end, and guess what, they have to window dress their portfolio, and they need to provide the illusion of outperformance in those glossy brochures that they need to sell to their clients. So there will probably be a lot of volatility, range expansion, and churn, but a reversal is unlikely to be a result of all that.
2) This week’s move in the markets was not isolated to the US Equity markets. There was no divergence in the markets. Instead, it was the unifying shot heard round the world, as the All Ordinaries, FTSE, DAX, CAC, Nikkei, HangSeng, Sensex, Bovespa, and TSX indicies all participated in the correction and sank more than 1%. We are talking about a complete global rout here, that is how strong this bear is.
3) There are still many out there who still stubbornly cling onto the illusion that the stocks are cheap and on sale after this weeks’ drop.
Well, technically, they are correct, every stock out there is cheaper after this week. And it is these dip buyers that will add fuel to the bear as their stops get taken out.
4) Futures markets are forward looking. But on Friday, the S&P500 futures closed at the same price as the cash index – 1458. Usually there is a +10-15point premium built into the futures, and this is the first that I have seen it close at the same price as the cash index. That could mean the futures market has exaggerated this current down move, or it could actually mean a fundamental shift in sentiment taking place, ie. we are perhaps seeing the end of the bull market. Only time will tell which explanation is the correct one.
As a trader, I’ve learned not to guess nor predict what the chart will do, but WAIT for the chart to show me what it IS doing! And of course, Rule number one is that you must make the trend your friend – trading against the prevailing trend is high risk. So, while I do see the increased probability of an up day in the next day or two, I certainly don’t see any signs of a reversal. The markets alone will decide the time schedule for a reversal, and it is better to wait for it to show its hand, rather than try to take action prematurely.
A nice summary, thanks. I think any bounce will be met with agressive selling/shorting and thus short-lived.
in actuality, the markets have been in a solid uptrend for quite awhile…every reversal call was met with more buying…will this time be different?
it seems to me that u are calling a reversal of the overall uptrend…that has been a loser’s game for a long time, but eventually that call will be correct
i’m not making a prediction here either, i’m just pointing out the fact that u are actually calling for a reversal yourself
Good summary. I also believe in waiting for the market to show direction. I have no idea what we will see this week, but it feels like more selling.
- TraderD
@Luka, TraderD: thanks for the compliments.
@T’Worm – LOL, I didn’t realize my article was implying a reversal call. If my article sounds hypocritical, that was not my intention, but rather to point out that calling the bottom is not a profitable endeavour. It’s hard to predict the unpredictable, and the bottom can only be known when it has already happened.
At the same time, at the risk of sounding cliche, this time is different. There are many more signs that the bears are gaining control than there are of the bulls taking back control.
Lots of traders were fooled into believing that AAPL’s earnings report would save the day. That was when the Nasdaq Comp was +90pts higher (it seems like a distant memory now).
http://tinyurl.com/2lf79g
http://tinyurl.com/2r42s7
AlphaTrends – “There is something seriously wrong with this market right now.”
phileo: check out this link on the philosophy of tops…u can download the pdf at teresa lo’s site…very interesting article
http://www.powerswings.com/2007/07/28/the-nature-of-market-tops/