Magic Triple Numbers

I hope you rats are enjoying the remainder of your long weekend because starting tomorrow I expect to see some fireworks across the board.

Full disclosure: I was a bit blonder as a kid – but was born with the same 666 birthmark and that should count for something, right? Evil is as evil does

Well, we were served the demonic 666 as the current low of the year and now it seems that it will again come down to a magic triple number – 888:

Not as evil as 666 – no – but the implications nevertheless are significant from a medium term perspective. A drop below 888 will most likely be a confirmation that more downside is ahead – it’s reasonable to expect that a breach would trigger a bunch of stops and thus it serves as a bearish inflection point. As long as we stay above 888 a snap back rally is something we should factor in – the Friday drop was pretty harsh and sustained, but it happened ahead of a long holiday. It wouldn’t be the first time that the big boys would return from getting blowjobs in the Hamptons and decide to turn the tape on a dime. Please don’t think that it can’t happen – after all we bears were fed a knuckle sandwich on several occasions in the past few months.

I’m not going to bother listing the three counts again today as they have not changed much since last Friday. What you really need to know is that 888 separates the bears from the bulls – and if you are exposed in either direction right now – know that this is your line in the sand. If you are sitting in cash there’s really nothing for you to do at this point. Taking positions right here is tantamount to betting on either red or black at a Las Vegas Roulette table (actually the odds might better there – less manipulated – LOL).

We are still inside that 80 point channel that has tormented us for two months now. Which I think is making the situation so difficult – after two months trapped in a whipsaw zone nobody was eager to load up at 957 and although we rode down one of the gyrations we found plenty of reasons to take profits quickly. This I believe will be the most difficult habit to break going forward as it might lead us to miss out on the bearish opportunity of a lifetime. At some point we will have to take a leap of faith and sit through some painful gyrations – look at last year’s Intermediate (2) of {1} for a good example of how long we got teased and how quickly things transpired from there.

For you long term traders who don’t care about the noise here are all three counts on the Dow starting at the Minor degree level.

Average trading volume on the Dow appears to keep dropping – which is a pretty bearish sign. Again, does not mean we can’t bust higher but to me it’s confirmation that we are dealing with a bear market rally.

Top Spinning

Over the weekend I’ve looked at a bunch of fellow bearish blogs and it seems that many have ‘called the top’ at the June 11th high.

Yes, we have dropped 60 points since then – granted – but why does this serve as a logical conclusion that we couldn’t recover here and pop higher? Bad economic news? Exqueeze me – but we rallied on the most horrid news for several months now – remember, we never ever trade the headlines as they only attempt to explain what already happened. Which doesn’t seem to deter at least half of the rats posting here to keep using it as a rationale for taking trades one way or the other. Is that approach really working out for you guys? I would be surprised…

Your favorite indicator? Yes, now you’re talking my language but many of my own favorites are pointing all over the place right now – which is something I will talk about further below. And it’s very easy to let our own human disposition towards wishful thinking do the trading for us instead of admitting to ourselves when we ’simply don’t know’. As I said before – taking chances based on incomplete or conflicting information is tantamount to gambling. What’s even worse is when you actually get away with it as it will re-affirm bad trading practices, which I guarantee you will wipe you out sooner than later (I won’t mention names but you know who you are).

Finally, one should always be very cautious about calling a top or a bottom – after all we constantly criticize Cramer for doing the very same. I often call a temporary high or a temporary low based on various technical indicators which I blend with supporting sentiment readings. But a long term top or bottom – that’s serious business and I only dare to make a call like that when I see the stars align in a very explicit and clear manner. Can I make such a call right now? Not in my book – and although many analysts seem to enjoy looking like geniuses when they wind up making a lucky call – almost none of them eat humble pie when it turns out that they were horribly wrong. BTW, I always call myself out – in case you haven’t noticed. Whether I like it or not many people who visit my digital den of doom at least partially base their trading on what I write here – thus I choose my words cautiously.

Of course on my own side of the equation I am worried about ‘missing the top’ – after all I was the one who’s been getting everyone all hyped up about trading Primary {3} down in the first place. Let’s assume you think the ‘top is in’- what do you do – right now? Buy a bunch of December puts nearly 60 points below the top? Chase the tape – especially if we gap down on Monday? That’s risky business, folks.

Getting confirmation that the tape will drop further is one thing – being able to trade it is quite another. Unfortunately the current trading environment is heavily manipulated and a lot of the big moves happen overnight – thus forcing you to take on considerable risk. Stops don’t really help you – on the contrary – many rats here have been swept by overnight monkey business only to see the tape move in their favor during the NYSE session. So, the only safe way is to sell the rips at this point – hoping that not too much upside remains. My preferred way of doing that is to wait for new highs and watch my indicators for bearish divergences.

Yes, perhaps this is Primary {3} but this is not where you take bets. Intermediate wave (2) of {3} is where we might want to back up the truck for several reasons:

1. Various sentiment indicators (e.g. IIAS and DSI) should give us an good indication that we have peaked.
2. We should see clear bearish divergences on a rally to the upside.
3. We should see various Dow averages non-confirm (e.g. the $TRAN not rising along with the $INDU)

The peak of Intermediate (2) of {3} should be near enough the top of {2} to comfortably load up on long term short positions. Of course if we somehow push higher and breach 957 I would be happy to start scaling into a boat load of puts as we proceed towards the finale of {2}. Disadvantage of course would be that we should have incurred higher volatility – thus option premiums will be a bit more expensive.

Actually, right now might be a much better moment for the bulls – yes, we had a pretty deep retracement but according to the rules we can easily pop higher here unless the prior lows at 888 are breached. So, if I was a bull (which I’m not) I would have gone long on Friday with a stop a few ticks below 888 for an easily managed long position (unless we gap lower – then you’re screwed – LOL).

Now, the above might sound a bit bullish to you – but my long term outlook is actually quite bearish. Let’s look at a few charts so I can make my point:

You are looking at the medium term McClellan on top of the SPX. What’s quite apparent (if you bother looking) is the clear downward channel we’ve been painting since the onset of this bear market rally. Which is actually what makes me question the longer term bearish potential here (i.e. the Primary {3} scenario). But if we happen to be inside {3} already then a drop towards -90 might bestow us with a rally into Intermediate (2) of {3}. If we are in {2} that reading might lead us into Intermediate (Z) of {2}.

The NYSE New Highs/Lows Index is painting something I have never seen before – a complete plateau entangling the 10/20/50-day SMAs – not that they are simply moving together – they are completely sideways. Plus – it’s happening exactly at the zero mark. So, on average we have not made any new highs or new lows all June – based on prior observations of similar (but not as clean) patterns more downside seems to be ahead. Which would mean Primary {3} most likely. However, it’s also possible we continue to rally on an extension of this plateau. you can bet your rectum that I will look for a break here on a daily basis.

The 5-day SMA NYSE Advance-Decline Volume Index is behaving similar to the McClellan – slowly grinding downward like a Spearmint Rhino stripper on fishbowl platforms. Strangely enough we’ve been moving up while this thing has been gyrating down. Question here again is whether or not we’ll rally back up on the next ‘buying opportunity’ for the bulls who don’t want to miss this dip – or if we drop and stay into negative territory whilst descending into Primary {3}. Frankly – I don’t know – the prior patterns I see don’t behave like that. At minimum this reading confirms my belief that this is a bear market rally.

Here we have the SPX Point & Figure chart. If you want to learn more about how point and figure charts work point your browser here for an excellent tutorial. The way I read this thing is that we need to hold the 900 mark to hold the longer term diagonal support line we started building back in March and April (i.e. 770 – 790).

Dow P&F chart shows its divergence from the SPX – we are getting dangerously close to breaking the current uptrend. P&F traders are quite adamant about those levels and a breach of 8,250 would put us into a short term sell signal. A great long entry might be at 8,150.

This is actually Thursday’s VIX chart as we pushed towards 28 on Friday. But the point here is that we did NOT get a sell signal confirmation. We got the close outside the 2.0 BB (check thrice actually) – we got the close inside – but we did not get a close higher the day after. So, being a purist I do not see this as a valid VIX buy (i.e. equities sell) signal.

The Dollar is driving me completely bonkers – we’ve been sideways here for six weeks now. Until this thing picks a direction assume that a drop remains a possibility (which would be a bullish bias for equities). For the record – this pattern does not look like the start of an uptrend to me – if it is that would be quite unusual.

Silver has now established a clear downward trend. We should however be close to a snap back which I expect should get us back near the 14.25 or 14.5 mark. This will be a great opportunity to load up on some long term puts (or short positions). Also note that Gold is now ‘outperforming’ Silver (i.e. it’s dropping slower than it’s more common cousin) – which is usually an indicator that asset holders are moving into lower risk investments. A rising Gold/Silver ratio traditionally is a sign of economic troubles ahead – again supporting our bear market rally argument.

Well, I kept my best chart for last This damn thing actually took me the last two days to first build and then analyze. What you are seeing is the spread between Moody’s BAA corporate bond yield (i.e. one step above junk bonds) and the TYX 30 year treasury yield (considered the most safest investment of all). I have also added the SPX so we have an equity baseline to compare against.

You might remember me talking about this spread in the past but the problem I always had was that I didn’t have a visual chart as the Moody’s bond yields are not being offered by any of the data providers (or trading apps) I have access to. So I always had to manually calculate the spread and log it numerically – which is not an ideal situation. After months of this I finally had enough last Friday and decided to use the day to manually import all the historical data from the St. Louis Fed into Excel and then write some macros to align all data points with each other – took me quite a while since I suck when it comes to programming Excel – fortunately Eric is pretty good with this stuff and helped me over a big hurdle – thanks mate!

Anyway, the spread between those two yields gives us a pretty good reflection of the state of the credit market. A widening spread means that money is quietly moving into safety – a slow gradual process most equity traders are usually blissfully ignorant of. However, it’s been a fairly reliable precursor of large market drops – take a look above at those highlighted regions:

• Blue: SPX Drop Period
• Red: Spread Widening Period (bearish)
• Green: Spread Narrowing Period (bullish)
• Yellow: Divergences

Now, in the recent past this thing has performed quite nicely and I used it as a supporting sentiment indicator when I expected that an Intermediate wave (or higher) turn either had happened or was looming. However, after some closer examination this weekend it seems that just recently we are seeing some anomalies which I don’t like – and some of them are quite large. The periods I’m talking about are highlighted in yellow:

• At the beginning of this year we started dropping – however the BAA-TYX kept narrowing for the majority of the descent into 666.
• After around February 15th our BAA-TYX spread started widening again, which is expected. Only problem is that it kept widening well into the first three weeks of the March rally – thus giving us no indication that we might be dealing with Primary {2}.

So, the lesson I’m learning here is the following: Various analysts are looking at this spread right now and are concluding that this is most likely not Primary {3} as there has been no divergence announcing a meaningful correction – as you can see we popped a little higher but as of 7/1/09 we are still below the 3% mark. Well, I am looking at this and it makes my toe nails coil up as, judging by recent anomalies at least, we could be weeks into Primary {3} until this thing responds. How do I know when this thing works and when not? I personally don’t have an answer right now – but decided to share this information with the rest of you rats as some of you might be able to offer some insight.

Well, now you might understand why I have a hard time picking a direction right now. My indicators are all over the place – they do look bearish but they also look like a rally might be in the works. Nothing is truly conclusive and thus I need to leave the door open for various scenarios (described above).

That’s all for tonight – I take it this should keep you rats busy for a while

Cheers,

Mole

This entry was posted on Sunday, July 5th, 2009 at 7:00 pm and is filed under Elliott Wave Theory, Market Outlook. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.