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.

Those pesky patterns

I noted some time ago that Trading patterns was becoming too popular. I'm becoming even more convinced that it is going to get harder to succeed in the markets by TA alone. By that I not only mean pattern recognition but levels of support and resistance are not going to mean much during this bear market.

I suspect this bear is going to take away almost every tool that investors use to try and get an edge in the market before it's over. And yes that may mean the COT reports go out the window also.

I've included a recent example of what I'm talking about.

In the first chart we see a nice triangle consolidation forming. Often these are continuation patterns. Since the market had been falling apart it seemed reasonable to assume that it was going to continue to fall apart. The pattern breakdown suggested this was likely the case.

However moving on to the second chart we see the market quickly negating the triangle breakdown. A negation of the triangle should have been a very positive sign. A V shaped rally at this point would not be unexpected.

Umm not so fast with the rally. The triangle negation got negated. Whew is anyone else getting dizzy?

Granted this is just one example. But I think this kind of TA will only get worse as this bear market continues. I also expect levels of support and resistance to regularly fail only to quickly reverse course as this bear wears on.

One example that I think will be tested at some point is the 1200 level on the S&P. If we get the large rally that I think will separate the 1st and 2nd phase of the bear market it seems logical to expect the 1200 level to be tested. That was a major breakdown point. I'm guessing there will be many a bear that will go heavily short at that level.

I also suspect the market will likely push right through that level and take all the bears to the cleaners before reversing at a higher level and dealing out the same beating to all the bulls who will view a move above 1200 as proof the bear is dead.

I'm afraid this is going to be one tricky market to negotiate in the next couple of years. The extreme left translation of the current 4 year cycle suggests that the ultimate bottom when it does arrive is going to be much lower than anyone thinks or can even imagine at this point. However the road to that end is going to be anything but straight.

I'll elaborate in more detail in the weekend report.

I'm back

I'm back and working on the weekend update.

Out of town for the weekend

I will be leaving Friday morning to, you guessed it, go climbing for the weekend. I won't have the weekend report out till late Sunday evening. I also won't be around to respond to new subscribers. It wouldn't hurt to wait till Sunday if you wish to initiate a new subscription as I won't be able to respond till then anyway.

BTW we got a 2b reversal today. Old timers here know what I'm talking about. If you don't, just enter 2b reversal in the search bar.

Dollar Cycle

The rising dollar continues to pressure all asset markets. At times like these it seems like conditions will never change. I guarantee they will though :)

Over the last year investor emotions have been swinging to extremes. Why should now be any different. Last summer oil rallied to heights that convinced everyone that it was different this time. We were never going to see $100 again. However as we know that wasn't quite true.

Right now it seems like the market will never rally again and that the end of the world is near. At some point sentiment will turn and if the last year is any indication it will move just as violently in the opposite direction.

Part of the key is the dollar. We are now moving into the window for the weekly cycle low. The daily cycle is now on day 9. The average duration of the daily cycle is 18 days so we should be getting close to the top. I'm looking for the next swing high as the potential top of this run. At that point the dollar should start to work it's way down into the weekly cycle bottom. Once this process starts I expect it will spark a counter trend rally in all asset markets.

Forced selling

As subscribers know I'm not only bullish on the general market right now but I'm especially bullish on two sectors. One of them is mining stocks.

The last time the XAU traded as low as it did in Oct. Gold was around $325 an oz.. With Gold now priced more than 2X higher than that I doubt the mining industry is in any danger of bankruptcy, unlike the financial sector. If miners aren't going bankrupt then the only reason I can see for such ridiculously low prices is simply forced selling. Other wise know as emotions run amok.

When the market does something stupid I want to take advantage of it. No matter how I look at this it still looks stupid. Miners should be a big beneficiary if the market rallys.

McClellan Oscillator

One of the signs that the market is trying to put in an intermediate bottom is a quick flip in breadth. One of the things I watch for is a move above the zero line by the McClellan oscillator. Usually once this occurs the oscillator tends to hold above zero for a month or more.

We just got that move into positive territory. Consider that this move pushed the oscillator to levels not seen in 10 years and that it came from the most depressed level in 10 years. Just another sign that the market is likely setting up for a very powerful 4th quarter rally.

If and when the 1-2-3 reversal completes and signals a trend change I'm guessing we are going to start seeing performance anxiety from many fund managers as they try to improve their yearly numbers. That should add fuel to the fire.

I still think the market will likely trade up to and maybe even past the 200 DMA before this rally exhausts itself and the market rolls over into the second phase of the bear market.

Shall we try again?

It looks like the market is trying to form another 1-2-3 reversal. The last attempt failed. I think this one will likely succeed.

1-2-3 reversals

We now have several complete 1-2-3 reversals. I'm focusing on oil and gold. Specifically I want to take note of oil. The reason is that as oil collapsed it never really tested the 200 DMA. Seldom does an asset, especially one that's been in as powerful a bull market as oil, just slice through the 200 DMA and never look back.

You can see on the gold chart that recently gold shot back up to and above the 200 DMA. I think the odds are good that oil is also going to pop back up to the 200 DMA before rolling over again later this year or early next.

I've also included a long term chart of the CRB. Commodities are now bouncing off long term support. This looks like a logical level to launch a powerful counter trend rally.

Finally the dollar is also on the verge of completing a 1-2-3 reversal. I noted in a previous post that the dollar was likely topping and the weekly cycle bottom was due sometime between Nov. 7th and the beginning of Jan. As the dollar works into that bottom it should take a lot of pressure off all asset classes.

Capitulation or no capitulation?

There seems to be some debate about whether we saw enough of a decline to represent capitulation at the Oct. lows. I've seen everything from "the decline was too orderly" to "they didn't sell them hard enough" used as an excuse for why the bottom isn't in yet and this rally is going to quickly fail. Let me point out that we are always going to hear that at bottoms. I heard it at the 02 bottom.

Now take a look at the charts and you tell me if we went far enough to represent capitulation. Volume spiked higher than any other time in history. New lows pushed higher than any other time in history. As a matter of fact new lows almost doubled any other low in the last 28 years.

The Vix spiked to almost 100, again dwarfing any period in the last couple of decades except maybe Oct. 87.

So what do you think? Does historic extremes never before seen in the history of the stock market represent a selling climax or not? Some times I have to wonder how these people can come up with these off the wall ideas. Actually I know exactly how they come up with it. They went short as we were making new lows and now they are on the wrong side of the trade. They are trying to rationalize why they should continue to hold on to a losing trade.

As we've witnessed many times, investors want to be right more than they want to make money. I mentioned some time back that when I turned negative on energy a portion of my subscribers who were energy bulls left. I can't tell you how many e-mails I received trying to convert me back to bullish. Fundamentals this fundamentals that. Fundamentals be damned it was a parabolic spike for heavens sake. That has nothing to do with fundamentals and everything to do with emotions.

I'm getting the same thing happening now with many of the bears who some how aren't satisfied with a historic decline. They think the market should somehow go straight to zero. I'm not even sure that would satisfy some of the perma bears. Now that I don't confirm their position they need to find someone else who does. Again it's more important to be right than to make money. I suspect that when the rally runs out of steam and I turn bearish again many will be back but likely with a smaller portfolio because they couldn't take the small loss when they had the chance and they couldn't change their mindset.

Now let me say that anything is possible. The market could roll over again quickly and break to new lows. However the odds are against it. If you bet against the odds you will eventually lose. That doesn't mean that you will always win by betting with the odds either, just that your chances of making money are greater. I've got news for you. Since none of us can see the future the best we can do is to keep the odds on our side.

Parabolic moves

I've noted in the past that parabolic moves are not sustainable. Not on the upside or on the downside. We are now seeing an extreme decline in the CRB. I doubt this move is sustainable. As a matter of fact you can see on the weekly chart that we may be at the beginning of a bounce.

On the daily chart we can see that the trend from the last month has now been broken. Any bounce in the CRB will probably correspond to a correction in the dollar. As I noted in a previous post the dollar is now in a parabolic rise that will need to be corrected also. I think the odds are good that the dollar correction and commodity bounce is starting.