4 day rule

With today's positive close the S&P has signaled a Sperandeo 4 day rule possible trend change.

The rule says that after a long intermediate decline or advance 4 days in a row in the opposite direction is often confirmation of a trend change.

I have a feeling that if we see the market close above the Nov. highs we are going to start seeing that performance anxiety that I've been warning about.

Buying panic?

In the last several posts I've gone over my take on human nature. The one constant is that it never changes. The other dependable is that we always go to extremes.

Well we just got the negative extreme. We may now be ready for the positive extreme. I pointed out in last nights update that all the short term indicators I watch are at extreme overbought levels. Usually this is the recipe for a pullback. In bear legs it's the recipe for another move down. On top of that we saw huge selling into strength yesterday (explanation in last nights update). I was expecting this, as selling into any rally has been very profitable the last 3 months.

However the futures are up strong this morning. A market that just rolls right over short term over bought levels is a strong sign of a bottom . Once the market becomes convinced the bottom is in we could see a buying panic on par with the selling panic we just saw, as money managers chase the market trying to improve their year end numbers.

I suggested in the weekend report that market participants would probably come in at the beginning of the week looking to sell the rally. I also thought they could get burned on the short side if this market had in fact bottomed. Yesterday they did get burned and burned bad. Not only that they missed a 400 point rally. All those that sold heavily at yesterday's close looking for the market to fall today are now in the red at the open. If a buying panic does start they will take more losses and miss another chunk of the rally. We have the ingredients in place for a runaway bear market rally. Will it happen? I don't know, we'll have to wait and see. I do know that I'm not willing to lose any of my long positions right now.

I would be very nervous about shorting at this point.

What a leg!

If we put in the final bottom for this leg down on Friday then this was the second largest percentage decline in history at 43.5% in 3 months and 7 days. Only the initial crash in 1929 exceeded this with a decline of 45% in 2 months and 6 days.

Does anyone remember Newtons third law. For every action there is a reaction. The same holds true for the stock market. The more extreme the decline the more extreme the counter trend rally. Action/reaction. In 1930 that 45% initial decline produced a counter trend rally of 50% in a matter of months.

Do I think we are going to see something similar? Yep I certainly do. I've stressed over and over how human nature never changes and I guarantee it still hasn't. We have the mother of all counter trend rallies coming. It's going to make everyone believe that we've seen the ultimate lows for this bear market. I guarantee it. I really doubt 741 is going to ultimately prove to be the final low but I think it has a good chance of marking the intermediate low.

I think anyone short the market is now taking a big risk of getting caught in an explosive move up. Everyone has to decide for themselves if they are willing to risk going long in a bear market. That being said counter trend rallies can be extremely profitable in bear markets. The catch is that intermediate bottoms are hard to spot in real time.

At this point though even if one doesn't catch the exact bottom the expected violent rally should be so powerful that any timing mistakes will be trivial. That is if you are willing to take long positions. Bears that just can't bring themselves to play both sides of the market might just consider going to cash until we have signs that any rally is running out of gas.

I would caution against trying to sell to quickly as I expect this rally will go much higher in percentage terms than anyone can imagine at this point.

Was breaking the 02 lows significant?

As expected the break of the 02 lows is bringing out all the technical traders now calling for a total collapse of the market. Maybe and then again maybe not.

Major tops and bottoms are often accomplished by the markets breaking major support levels. The dumb money investors jump heavily into a trade that they think is risk free. At the same time the smart money takes the opposite side of their trade.

We saw this exact pattern play out at the 02 bottom and the 07 top. Could we be seeing it in action now? Maybe!

We know the 22 week cycle is due to bottom anytime now. Yesterdays total panic into bonds suggests we saw completely irrational capitulation. Public short interest is at record highs. Cash sitting in money markets is at levels not even seen at the 02 lows and insiders are currently buying stock at levels last seen during the two weeks after the 87 crash.

All that being said, should one jump in right now? I'm going to suggest that a close above the 10 day moving average might be a safer entry and provide a margin of safety that we have in fact seen the weekly cycle bottom.

Reaching levels only seen once in history

At yesterdays close the S&P was 36% below the 200 DMA. There has only been one other time in history where the market has stretched further on the downside. That was at the bear market lows in 1932. The upside is that every time the market got anywhere near this stretched below the mean it was quickly followed by an extremely violent rally.

That being said I think we are very close to the bottom time wise. The daily trading cycle and weekly cycle are now in the timing band for that low. Smart money is starting to buy on sell offs. Dumb money is panicking. We have the ingredients in place for the mother of all counter trend rallies.

All that being said we probably need to put in at least two more down days before this is over.

Details in last nights update.

New 52 week lows are not confirming the recent decline

On Oct. 10th 92% of all stocks on the NYSE made new lows. So far that has been the internal bottom for this market. On each successive decline fewer and fewer stocks have been moving lower. Most of the stocks on the NYSE are not confirming the new lows. Not what you want to see happening if you are heavily short.

As of today the current trading cycle is on day 27 (the average length is between 28-43 days) The odds are very high that this trading cycle low will also mark the 22 week cycle low. The odds are also good that we will see a powerful counter trend rally out of this low.

Thursday's 2b reversal may have marked that low. At this point it remains to be seen. Either way we are getting very late in the cycle to be short. Sure we very well could see another move down but I dare say at this point it seems like that is what everyone is expecting. It seems like many bears are now anticipating a move to 500 quickly. I'm not so sure this bear market is going to make it that easy on the bears though. Remember the market will do what ever it takes to fleece the most participants. As of today the dumb money confidence was back down at levels that have marked intermediate lows in the past.

This late in the cycle I would rather be long or in cash than risk getting caught on the short side hoping for a few more days of declines. If the weekly cycle bottoms the ensuing rally could be deadly for bears caught on the wrong side.

Take a look at gold on Sept. 17th if you want to see what can happen as a weekly cycle bottoms in a bear market.

Where to now?

I'm going to take a guess and say investors at this point don't know where to turn? I suspect blog traffic is high everywhere as shell shocked investors frantically look for the market guru that can tell them what's going to happen and what they should do with their investments.

I'll make a few observations for what it's worth.

First off you might as well quit searching. No one knows what's going to happen tomorrow or the next day. We are already making history on a daily basis. The only other time in history even close to approaching what we are seeing now occurred in the 30's. Even then many of the extremes were far less than today. So expecting someone, anyone to have any realistic insight at this point is probably wishful thinking.

At times like this (granted there hasn't been any "times like this" before) I always try to remember one important fact. A fact that never changes no matter what the fundamental environment or technical basis of the market is. Human nature never changes. We are currently experiencing a level of pessimism never seen before in the last 100 years. If there's one thing I do know about human nature it's that we go to extremes. The other thing I realize is that these extremes can't be maintained for extended periods of time. (Extreme pessimism is harder to maintain than optimism. It's one of the reasons tops usually take longer to form than bottoms.)

Remember back in the summer when it appeared that oil would never stop going higher? The current bleak outlook will eventually burn itself out just like the excessive optimism in the oil market burned out. So unless human nature has changed the current negativity will be followed by extreme optimism.

So what do we do right now you ask? Common sense would suggest that human nature being what it is, extremes should be faded.

At the moment I have no idea if the market will continue lower or not. I do know that I don't want to short this extreme pessimism. It's usually much more profitable to short the other extreme...euphoria. I do think we will get the opportunity to do just that at some point as I think this bear will not be done until at least 2010.

At this point though I'm pretty sure the risk reward is better on the long side. However as I noted in my previous post I don't think we are going to spot the bottom with any of the tried methods. At this point I'm thinking more in terms of time than any technical or oversold levels. I'm pretty sure that if one is patient human nature will run it's course and eventually the tide will turn in the other direction.

I suspect that while we wait for that tide to turn most traders trying to pick the bottom are just going to take many losses and only manage to whittle down their account. At times like this it's probably better to just take your stand and do something else besides watch the market all day. Perhaps now is a better time to think like an investor than a trader.