Bearish Rituals

I’ve poked around the bearish blogs and see a lot of anger and frustration out there, as would be expected after a pretty merciless short squeeze driven rally. Of course anger and emotions in general are futile. I find such rapid changes in sentiment fascinating on both sides as it reveals as much about the bears as it says about the bulls. The latter want their 2009 ramp up back – and the former want their bear market to finally continue.

Well, both are going to get hurt. The way I see it there has been a major disturbance in the force – just look at some of the long term charts I have been posting and it’s quite clear that a trend change is in the works. It started early this year and the shock waves continue to spread slowly but steadily. There is no escaping it – even QE 2.0, if it materializes, will only be able to slightly shift the timeline at best and most likely accomplish very little at worst.

The bears have been smacking their lips to get back into the game after over a year of pain and losses. Of course the impatient trader is soon separated from any prior gains. The bulls have been quick to dismiss any downside as a healthy correction (which they vehemently opposed when it began) and have been right for the past few days in riding this new wave up. As throughout the past year, the recent downside will be considered a bullish opportunity. Soon more of them will join the fray (as they always do late in the game) and we most likely will see a bit more bullish exuberance before gravity is starting to again exert its inexorable force. Thus, the same mistake committed by the grizzlies all throughout 2009 (and which has been the inspiration of much ridicule on the parts of the bulls) is about to be repeated by the opposing camp. How’s that for sweet irony? For throughout the history of the markets very few market participants have been capable of recognizing what’s usually staring them right in the phase. Thus they fight the trend – and as usual win a few battles. But in the end they lose the war. Fashion changes – governments change – markets change – but people never change.

I do not allow my possessions or my prepossessions either – to do any thinking for me. Taht is why I repeat that I never argue with the tape. To be angry at the market because it unexpectedly or even illogically goes against you is like getting mad at your lungs because you have pneumonia. — Jesse Livermore

Smart man! Or in other words:

Markets are never wrong, opinions are. — Jesse Livermore

Well, there you have it. So instead of trying to complain and fight the tape, let’s remain focused on how the recent gyrations fit into our overall picture. Because if it does not fit we may have to change our outlook – and if it does then anger and frustration should yield to strategic action. For we are stainless steel rats and as such we trade whatever markets we are given.

Let’s start out with some plain old vanilla charts. This is the SPX with a Keltner channel on the left and a 2.0 Bollinger on the right. The bears were able to stretch both toward the downside but in the end failed to breach that diagonal I pointed out last week. The consequences of this failure had to be paid since Wednesday and all through Friday.

The vehemence of the snap back was quite natural, especially considering what I presented on my NYSE Volume ratio chart – which had dropped to a point where a snapback was almost guaranteed. There is still ample space remaining for further upside in equities on this chart as well on both versions of the prior.

We never got that bonafide equities buy signal, but we may as well have as that Bollinger snap back was one put option crushing monster truck to say the least. The good news for the bears – we are nearing the lower border now. The bad news: First we have more space to drop plus it seems that the Bollinger bubble is now pushing downward. It’s possible we touch that border and then keep sliding it down again into 20. That for sure would dishearten a large percentage of the remaining bears.

Copper was spot on in calling a bullish divergence. What’s actually surprising is that we dropped so much further before we pushed back up in equities. Personally I interpret this as an implicit long term warning signal for the bulls – short term I don’t see anything yet that signals an immediate drop lower. It seems that we either go sideways or a bit higher from here.

Exotics

My CPCE Deluxe chart actually signaled the same way as copper. I first thought we may push all the way up into 0.75 and that may have happened if we had breached that diagonal on the SPX. However, we painted a divergence, which gave additional credence to a looming Soylent Blue scenario on our wave count chart. Now the question is how far we may drop down. What should be a bit scary for the bears is how much downside potential there is right now (highlighted on the chart). Of course it’s all relative as we may drop a bit and then ramp back up. Until we touch any of the diagonal lines on this chart it’s tough to make call – at best we can assess upside or downside potential after the market turns again.

Our McClellan/NYSE Bullish Percent ratio chart may be a bit more helpful at the moment. It also offers more upside potential to the bulls. Again, there is no guarantee that it will be exhausted but it’s there and we need to entertain the notion that Soylent Blue may stretch its legs up here.

My Zero subs get too look at this chart every day after the session. It again did a bang job predicting that a reversal was at hand (look at the dashed lines on the chart and the pattern that preceded them). Now, I do see a the potential for a fractal which I have attempted to sketch out on the chart. In a nutshell: We may drop on Monday or Tuesday – then reverse up and after another high reading (i.e 3.0+) start painting a divergence, just like last time. The previous pattern is in blue and the current one in orange – can you see it?

Similar fractal pattern on my NYSE A/D ratio chart. It also painted a bearish fractal (bottom panel) ahead of the ramp up. Now we are waiting for a bullish divergence that may indicate that Soylent Blue has run its course – preferably something like the Gothic Church Tower fractal I have been posting about recently.

Since we are talking fractals – let’s look at the potential of a long term candidate. This is Q4/2007 to Q1/2008 portion of my SPXA50 chart which I embellished with a zigzag following the moving average – the bottom shows a simple MACD. The chart also contains the wave count of Intermediate wave (1) of Primary {1}. The blue line highlights a region that appears to be pretty close to where we are right now.

This is the current chart – I have formatted it to resemble a similar time period. As you can see the number of stocks above their 50-day SMA has increased by quite a bit over the past few days. What we do not want to see is for this line to push above the 300 mark, which would defeat the case for distribution and with it the continuation of Minor 3 of Intermediate (1) of Primary {3}.

Wave Count

I’m still entertaining the immediate bearish count, which is Clockwork Orange, however my preferred scenario right now is Soylent Blue. Which has us drop fairly soon, maybe after one more push up, and then reverse around the 1067 mark to complete its final (y) leg. it just makes a lot of sense – we are in the summer doldrums and there is very little volume in the tape right now – so easy to bang stocks higher or at least keep the theta burn for the bears going a bit longer.

If we get Clockwork Orange then we should get it pretty soon – early next week. So, whatever the tape produces in the next few days should be the call sign for what’s coming. Keep in mind that this is but one of eleven possible corrective patterns in EWT – we may get a diagonal or a triangle, or some exotic combo pattern – who knows.

However, in early August it’ll be time for a reversal and if we push higher from here that will be the time to start legging into more short positions – assuming you have any ammo left after the crazy whipsaw of the past few months.

Words To the Wise

Always remember that the bus moves faster once everyone got off. But at the same time, that is not a reason to step in front of a bus speeding in the other direction either. So, let’s keep an eye on the charts and let those tell us whether or not we are on the wrong or right side of the tape. Thus far the charts I am seeing are telling the bears to curb their enthusiasm and to let the bearish rituals play out – no matter how frustrating it may be in the short term. The tape always goes through its motions before it shows its final cards – patience is key. Of course by the time the hammer drops it usually is too late to jump into the fray. Yes, the market is indeed a cruel mistress.

Before I go, please take a look at this H&S top reference and in particular at the shown example. That pullback is very typical for this pattern, even when it resolves – but the bears always fall for it – every single time. Proving over and over that human behavior does not change 🙂

Cheers,

Mole