A Case for a Mid-Term Equity Bottom

[atto 20]

Let me start this by saying that I want this to turn into a productive and informative discussion regarding the dynamics of market tops and bottoms. Specifically, I outline a case below for a current mid-term market bottom. I'd like to stay away from "market calls", and would absolutely love anyone who differs (or agrees using similar or differing analysis) to respond. This is definitely a work in progress, and as usual, I may be completely wrong.

 

We're obviously still in a bear market, so any near term bottom will most likely not be "the" bottom. With that said, a few of us in the TL chatroom discussed this today, and I wanted to bring this to the greater TL community.

 

Market Internals / Support & Resistance

Here is a current $COMPQ chart spanning 6 months, with two popular market internals: $VNX (Nasdaq VIX) and $NAUD (Nasdaq Advance-Decline Issues Volume). This chart has been annotated for support/resistance, with divergant lines for $NAUD and (possible) tops and bottoms in $VNX.

 

 

As you can see, we are very near a possible support. So far, this line has been confirmed, as we have seen buying pressure overcome selling pressure. This area coincides with a new high on the $VNX, which measures market uncertainty and volatility. Previously on the March low's, the peak in $VNX near this area signaled a break from the downtrend. $VNX broke off its high's on today's bullish price action. $NAUD is also showing a big divergence. Typically, divergences like this indicate a shift in pressure, at least for the moment. Past divergences have also been highlighted. Other indicators based on market internals are also shifting pressure, such as the McClellan Oscillator, which is well off its lows.

 

Volume

Over the past couple of days, we have seen higher than normal volume. This could very well be "stopping" volume by the bulls. Several downward advances have been met with climactic volume. No strong advance has been made in this past wave down that hasn't been met very soon with the bears taking back all lost ground, so we will see if today's gains hold.

 

Volume-at-Price also shows significant volume in higher prices which can support a retrace.

 

Fundamentals

Today was a big news day. Most news recently has been fairly bad, which has been met with more selling. The CPI number this morning (1.1%, the worst in a while) was met with minimal selling, while the decent news that was released today encouraged more buying. This could be signaling bearish weakness, and a chance for bulls to take over for a bit. Most of the "bad news" seems to be priced in, and market sentiment is extremely low.

 

Additionally, this bear market has been led by the financials. Financials made a strong recovery today on some good news and more bull buying. If financials can recover, if even for a short time, the indexes in general could see a break.

 

Transports have also recently been affected, primarily from the bullish Oil market. Oil has subsided dramatically, which may release some of that pressure. International threats to low oil seem to be at bay right now (things could change overnight, however).

 

Target

If I had to pick a technical target, I would shoot for a 50% retrace of the May/June high's. This level is near a previous S/R line (drawn on the chart, above). Sufficient volume exists at these levels to support a rally.

 

__________________________________________________

 

What do you think? If you differ, could you elaborate with your views? I know a few Market Profile guys are looking for the same break in selling, but I'll let them share their views (I don't use MP). Does anyone have further insight into top/bottom picking? Is top/bottom picking a loser's game, and why?

Edited July 16, 2008 by atto

[That One Guy 10]

I, completely agree with your case. Taking a look at the Nasdaq New highs vs New lows. We see $NAHL made a lower low compared to the March 17th bottom. However, $COMPX wasn't able to break the March 17th lows. To me this suggest sellers aren't able to have there way with price, as easy as before.

 

http://www.traderslaboratory.com/forums/attachment.php?attachmentid=7305&stc=1&d=1216256360

 

Now taking a look at the Financial Select Sector SPDR. We see a nice downtrend, in which you can argue price became oversold, after exiting the channel. This ends up leading to a climatic like volume day. Followed by today's nice rally opening near the lows and closing on the highs, also on good volume. If the onslaught of selling in the financial sector subsides for a while and the oil market eases up some, sentiment for the short term may add to the case for a nice retracement. Either way good analysis Atto. I, also heard today was a new all-time record for option contracts traded in one day.

 

http://www.traderslaboratory.com/forums/attachment.php?attachmentid=7306&stc=1&d=1216257105

[atto 20]

Another opinion from a successful trader. SnP500Trader, who posts daily Youtube ES analysis, trades mostly off support and resistance. He is still bearish, but sees a divergence in Oil/Equities, and the MACD. He also has plenty of open air between his upper resistance lines, so is looking for a possible short-term rally.

 

[jasont 10]

I can't give you much of a different picture Atto as I agree with much of your analysis. I don't follow the Nasdaq as much as I do the S&P so I'll try to add a bit. The VIX showed a crazy move yesterday that can't really be seen on a simple close line chart so I have attached the candle version. It opened at the highest I have seen and made a massive move lower.

 

All that really does for me is show less interest in holding put options for the moment and less implied volatility. Granted I found the prior two weeks more volatile than yesterday so I'm not sure it is great for exact volatility implications.

 

Now it's still early days at this point but following the big spikes from the VIX on the January and March lows we had a pretty big gain the next following days, roughly around 50+ points. Just because those occurred last couple of bottoms doesn't mean it will have to bounce 50+ points again but its a possibility.

 

Now I personally have found the selling on this leg down much different to the January and March selling. Less panic has been hitting the markets from my observations on this leg down, it is almost as though we have changed from panic selling in a bull market to accepting we are selling in a bear market. Not sure if the news has contributed to this but the selling has been more steady as though it's just the thing we should be doing right now.

 

My concerns on steady selling is that it's out of the ordinary for the market most of the time. The past few days has shown a large number of contracts change hands and it does indicate a bounce. Whether it will result in a turn of trend or simply a reasonable bounce with continued selling is anyones guess right now.

 

I personally believe that we haven't yet seen the panic selling that accompanies a large sized move higher nor have we seen the slightest sign of fundamental optimism globally. Right now every country is hurting fundamentally. So I agree with your analysis that a bounce is coming, where it goes is not really my specialty so I'll leave that up to others, I do believe probability is on it being reasonably short lived at this stage.

[That One Guy 10]

Hey Atto,

here is a view from a MP guy.

 

http://my.wallst.net/blog/fbutera101/2008/07/16/balancetrader-outlook-for-17-july-2008/

[CRAYOLA 10]

I must say Atto that I agree with JasonT's response. And like him, I've given more attention to the S&P. it's anyone's guess, but personally, I believe a 50% retracement is too optimistic.

 

I believe this bounce could go another 600-800 points on the Dow -- and a bit more % wise on the Nasdaq -- before losing steam.

 

I view this bounce as a test of the right shoulder of a massive 18 month head and shoulders pattern that projects further downside on all major indices, but in the case of the Dow, to about 10,000. From there, I have no reliable indicators to suggest where we go.

 

I am not buying this upside move. I will be shorting into it -- hopefully somewhere near the top -- and taking it day by day.

 

Happy trading to all and thanks for posting this analyis, Atto, I enjoyed it.

[MC 10]

 

Get ready...somethings gotta give. 2 days now TRIN has been moving in tandem to the DJI. These are meant to be inverse to one another so divergence (or technically absence of divergence) is horribly blatant but with no direction. Looks like the DJI may have a double top since TRIN failed to make a new low with the retest though?

 

Thoughts??? I've not seen this in near 2 years that I can recall.

 

Also being new to MP today is what I believe is called double distribution. There are 2 levels on the profile with fat participation. I've actually marked my charts for tomorrow as if there is 2 POC. I can't lie, I'd love to see shorts get squeezed like an orange on a juice maker. LOL

[atto 20]

We could be setting up for a great short squeeze, but I expect a retrace if this bull run will have any length at all.. we've moved 50 ES for the first time in a while. Even a pop back to 1230 wouldn't be awful for the bulls.

 

As a side note, after pretty bad news last night, the ES has nearly recovered over night. I'd actually like to see a retrace, or you'll see bulls bleed.

[Hlm 10]

Hey atto, I just saw that your analysis got mentioned on the 7/17/08 SnP500Trader video located HERE. It starts around 1:15.

[atto 20]

Thanks for the additions guys. If anyone has anything else to add, feel free.

 

On a similar macro-market view (-ish), I saw this and thought it was interesting. It's projecting, with 97% historical accuracy, that inflation will be over 7.5% in a year. Eeesh.

[OAC 10]

Thanks for the additions guys. If anyone has anything else to add, feel free.

 

On a similar macro-market view (-ish), I saw this and thought it was interesting. It's projecting, with 97% historical accuracy, that inflation will be over 7.5% in a year. Eeesh.

 

With the federal bailout of Fannie Mea and Fredide Mac, and most likely many more financial institutions to come. This means only one thing: The Fed turning up the printing press into high gear. That will provide a big shockwave to the projection and inflation figure is likely to be a lot higher.

[atto 20]

With the federal bailout of Fannie Mea and Fredide Mac, and most likely many more financial institutions to come. This means only one thing: The Fed turning up the printing press into high gear. That will provide a big shockwave to the projection and inflation figure is likely to be a lot higher.

Yeah, I've thought so for a while also. But, the "official" numbers have always been much less. This study put a little kick into that notion (and remember, the bottom bound is around 7.5%.. it could just as easily go over 10%, or more).

[firewalker 10]

Let me start this by saying that I want this to turn into a productive and informative discussion regarding the dynamics of market tops and bottoms. Specifically, I outline a case below for a current mid-term market bottom. I'd like to stay away from "market calls", and would absolutely love anyone who differs (or agrees using similar or differing analysis) to respond. This is definitely a work in progress, and as usual, I may be completely wrong.

 

We're obviously still in a bear market, so any near term bottom will most likely not be "the" bottom. With that said, a few of us in the TL chatroom discussed this today, and I wanted to bring this to the greater TL community.

 

 

Interesting case & thread atto. As you point out that this might be a mid-term bottom but not 'the' bottom, it would be interesting to know how or what elements would define 'the' bottom. Are you looking for a certain number of downlegs in this bear market? Are you looking for a specific time window? Are you looking at extreme pessimist market sentiment (but how do you gauge that, other than using VIX & relatives)?

 

Personally, I think it looks like this second big "wave of selling" might have ended. As the Nasdaq and ES has been discussed, I might add that the DOW has also attained by initial target of 10800 (something I posted 6 months ago on another forum). I had that figure in mind, because of the price action in the first two, and final two months of 2005. Yes, that's a long way back, but the time price spent trading around those levels, proved to provide enough support even three years later to make up for a very decent bounce (+700 points).

 

So, with all indices reacting strongly (+50 ES has been mentioned), I think the market might be entering a period of sideways or consolidating price action. June was pretty straightforward one-way (not intraday obviously, but the big picture is fairly obvious) downtrending, and after strong trending days the market often needs some time to 'breathe'...

 

I also agree with jasont, the selling on the way down, especially near the beginning of July, was of a different kind than what we've seen in March/January. Personally, I've found the market more difficult to trade last couple of weeks, often making new lows, but immediately reacting to bounce higher. I wonder if I'm the only one having experienced this kind of "unusual" behaviour. Normally after a break of support (on decent volume) you'd expect some sort of continuation. But the market often turned violently back up. Only to resume selling the next day or several hours later.

 

I've also attached some charts, with trendlines to illustrate what I'm looking at right now. A break of these lines would clearly show more strength, but right now only the ES has broken one line, and the DOW and NQ are still below this. I've also added another NQ chart, where I think price is finding support on the midpoint of a hinge back from January (at that time a similar chart was posted by dbphoenix).

 

Thoughts, comments, suggestions,... very welcome

 

 

 

 

[firewalker 10]

... about divergences.

 

Despite the Industrials making decent now lows (1000 points below March lows), the DOW Transports is quite clearly much higher:

 

Atto posted a chart of the $COMPX, where we are again at the same price level from Jan & March, but the NASDAQ-100 ($NDX), set in a higher low...

 

 

[atto 20]

We are now close to my first technical target (a 50% retrace of June high's) on $COMPQ. Dow is close to a 50% retrace of June high's.

 

We are nearing some significant possible resistance areas, so we'll see. I expect at least a short term test of this new move, regardless of if we continue up, or head back down.

[OAC 10]

I got this interesting piece in the e-mail today:

 

"Since 1995, this stock market indicator has flashed "buy" on 41 days.

 

If you'd bought stocks the day it flashed, and simply held three months, you'd have made money 39 out of 41 times – that's 95% of the time!

 

The largest of the two losses was -1.7%. Meanwhile, the biggest gain was 33% – in three months. The average gain was an incredible 13% in three months. That's not an "annualized" number... 13% is what you would have made in three months.

 

I tell you this because the indicator flashed again on July 10.

 

Fortunately, you haven't missed the gains yet...

 

The stock market is only up about 2% since the indicator flashed. To equal their average 13%gain in "buy" mode, stocks still have to rise another 11% in just over two months.

 

The indicator is simple. It's from Jason Goepfert, who runs sentimenTrader.

 

The indicator is simply the difference in "Smart Money" Confidence versus "Dumb Money" Confidence. Jason says:

 

If the Dumb Money Confidence is at 100%, then that means that these bad market timers are supremely confident in a market rally. And history suggests that when these traders are confident, we should be very, very worried that the market is about to decline.

 

When the Dumb Money Confidence is at 0%, then from a contrary perspective we should be [buying stocks], expecting these traders to be wrong again and the market to rally.

 

Jason's "confidence indexes" are built based on real money – what real traders are actually doing.

 

 

In mid-July, the "Dumb Money" (essentially small traders) was remarkably scared. Jason's Dumb Money Confidence Index dropped to 17%. Readings this low are incredibly uncommon. Meanwhile, Smart Money Confidence stood at 67% – a whopping 50-point spread.

 

Whenever this spread hits 50 points, history says you have a 95% chance of making money over the next three months... with an average gain of 13%.

 

In general, I've found sentiment indicators are difficult to use as timing indicators. The results look good. But as they say, past performance is no guarantee of future results. It's better to use a sentiment indicator like this one from Jason as a "get ready to buy" or "get ready to sell" indicator.

 

Still, the timing this month wasn't bad... The indicator flashed on July 10, and the market appears to have bottomed just three trading days later, on July 15. Since then, the market has spent the last two weeks fighting its way into an uptrend. So far, the "up" move has been so weak, we can hardly call it an uptrend yet. But it's trying.

 

Actually, when you step back and size things up, we're very close to an ideal situation for making money in stocks:

 

1) Stocks are relatively cheap now... For example, the forward price-to-earnings ratio of the Dow is only 12.5 today.

 

2) Investors are scared, as Jason's Dumb Money Confidence Index shows.

 

3) We're just missing the uptrend. "

[MC 10]

 

The most recent down move has built bullish divergence where price tested lows yet the MACD as well as the MACD histogram failed to even come close to their prior lows. This was a VERY bullish indicator. I would have preferred the volume had been lower on the 2nd test giving a 2nd and more important diverging indication though. That would have told me there were less sellers at a prior key level and we didn't get that so I'm not a total believer of this rally yet. I will become more bullish if/when the same level (or lower) has very low volume aka: brings out very few sellers. I will become full bull when the red downtrend and structure resistance are cleared and legitimately defeated. Thoughts?

[RobS 10]

While my view is less based on indicators, I tend to agree that we saw the bottom in mid-July. On the lowest day, oil was $147 and the market feared a Fannie and Freddie collapse. Oil is now @116 and the Feds have stepped in to protect Fannie and Freddie. As a result, the market seems to react very positively to any good news and yet heavily discounts bad news. Today the Dow rose 300+ points even though the news was mixed. Therefore, I don't see us retesting the mid-July lows unless there is some VERY bad news that drives oil back up or there are new reports of significant financial system melt downs.

[firewalker 10]

While my view is less based on indicators, I tend to agree that we saw the bottom in mid-July. On the lowest day, oil was $147 and the market feared a Fannie and Freddie collapse. Oil is now @116 and the Feds have stepped in to protect Fannie and Freddie. As a result, the market seems to react very positively to any good news and yet heavily discounts bad news. Today the Dow rose 300+ points even though the news was mixed. Therefore, I don't see us retesting the mid-July lows unless there is some VERY bad news that drives oil back up or there are new reports of significant financial system melt downs.

 

(Very) bad news always comes out near bottoms... Northern Rock was the same. This doesn't mean the bear is over imo.