I Beg To Differ!

Two quotes I came across recently and which I would like to respond to as they represent the inherent misconceptions that lead many traders to lose their shirt trading the this wood chipper of a market. I will not quote the source as I don’t engage in criticizing fellow analysts – besides I keep hearing the very same statements all over the blogosphere, thus this message goes out to everyone, in particular those with bearish dispositions for the last quarter of 2010:

Exhibit A:

The market is over-believed.

Yes, that is absolutely true. Monday’s Daily Sentiment Index logged in at 93% thus exceeding the April 14 high of 92% as well as the October 2007 all-time high of 85%.

Exhibit B:

The present situation appears unsustainable and the market needs to alleviate its extremes.

Oh really?

So what??

Let me show you something.
[amprotect=nonmember] Charts and commentary below for anyone donning a secret decoder ring. The rest of you guys will have to wait until tomorrow – sorry. If you are interested in becoming a Gold member then don’t waste time and sign up here. And if you are a Zero subscriber it includes access to all Gold posts, so you actually get double the bang for your buck.
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This is the number of stocks above their 200-day SMA plotted below the SPX. See what happened during the 2007 topping process? We painted some extremes in May and the SPX continued its melt up well into October.

Same situation during the 2008 bottoming process. The SPXA200R (which plots the percentage, not the number) ranked below the 10 percentile for almost six months! Talking about oversold. And all that time (and beyond the actual 666 low) a certain permabear was continuing to call for even lower prices. Isn’t that nice?

Then take a glance at the April 2009 to April 2010 period. We curled around the 90 percentile for an entire year until we saw a little plunge (which was promptly bought I may add).

There is an old saying I fervently believe in:

What’s good for the goose is good for the gander.

Or another one:

You can’t have your cake and eat it too.

My point being that you can’t expect prices to continue to sell off in oversold conditions but at the same time call for tops (for over a year) as soon as the market pushes into overbought conditions. Got it? I mean, we’re not talking mystic black magic charting here – this is something I pulled up on stockcharts.com in three minutes.

Yes, there are divergences and I don’t think we are in a new bull market that will continue for another year. BUT I have very clear evidence at hand that overbought (and oversold) momentum can sustain itself for quite a while. If you need an explanation of Scott’s feedback loop – look no further than the chart above.

Here is the SPXA50R version – same theme and it tells the medium story this time. Look how often we have been ‘extremely overbought’ in the past 18 months.

Yawn…

Yes, yes, we are due for a sell off. We have been for a long long time. And empirical evidence tells me that there is a zero edge in predicting a permanent high here. And I am NOT falling prey to recency bias here. Recency bias refers to expecting the same thing to happen just because it happened recently. True, but understand the subtle difference between ‘expecting the same thing to happen’ (which would lead me to go long, which I am not) and ‘not expecting the opposite’ (which leads me to expect a whole mixture of things here, but not necessarily a huge sell off).

Currencies, darling, currencies! That’s where the game is being played. Remember me lamenting about the 80% stochastic swirl on the AUD/HKD that kept stretching out for weeks? Finally we got a (cough cough) ‘retracement’ and it was good for – basically no price change. Look at all that downside momentum that was exhausted in a matter of days. And index futures even faded that one!

My count is almost academic as I don’t really know when the tape will break for good. It may happen today (we’re seeing some red candles in the futures as I’m typing this), tomorrow, next week, or it may happen in January. We are now about to push inside the 78.6% fib zone, which usually is the point of no return – no matter what the wave 2 Elliott Wave rules used to be. Maybe we have to change the rules – because the market has changed for sure. We have a permanent floor being constructed via currency games and POMO liquidity injections. And yes, I have a picture of that as well:

Every time we are seeing more than two red candles the marines storm in and we push back into positive territory. That reinforces an already existing positive feedback loop. It gives dip buyers needed confidence in knowing that whenever there is a slide that ‘buying the dip’ will lead to profits.

And for almost 18 months non stop this has been the case. Yes, it will stop one day – perhaps today is that day. But you cannot predict when – not in this tape. We will know when it happens and until then this market will remain overbought. Let’s trade the new trend when it presents itself, shall we?

What’s good for the goose is good for the gander. Deal with it – and don’t keep telling me that the market must sell off now becuase x is happening. That’s just outright silly. You know who you are.

Cheers,

Mole