Playing Ball With Lucy

You ought to think that the bears have had enough by now – and based on what I’m seeing in the bear bashing blogosphere (BBB™) the bus is getting pretty empty at this point.

Now we may see a short term reversal here as this is where retail traders usually start chasing – but anything more sustained is a completely different story. And this is not a disgruntled or discouraged bear speaking – after all I have contrasted bullish evidence with my bearish charts for months now. No, I’m dealing with the facts only – any emotions have long gone by the wayside. Trading this tape is like making it through Combat Marine boot camp – you know it’s gonna suck, so you better smile and enjoy it.

But Mole – isn’t this exactly what the boyz want you to do? Give up just before we drop? Sorry folks – but that argument is getting pretty stale at this point – I remember tons of folks throwing in the towel over a year ago. They are all gone – you may remember their names – and most of them have gone back to their ‘day jobs’ – if they were luck enough to have one. No, this is not about psychology anymore – this is all about time – and more specifically theta burn. I know this market is going down – eventually. When exactly? Sorry – my crystal ball is still in the shop. So let’s just stick with what we got right now.

Maybe we’ll drop from here – yes possible – but that’s not the point! You can’t trade your emotions – you can’t trade on a sense of vengeance or retribution. That’ll get you killed in thirdy seconds flat. Alright – I bite – let’s just assume for some reason we gap down from here next Tuesday. So now what? What will happen at 1040 or 1020? Are we suddenly going to see bulls running for the hills and bearish tape devoid of any counter spikes? Express elevator to 980? What are the odds of that happening at this stage?

Exactly.

So, let’s look at some charts and then assess the odds right here. With each chart I will also suggest the type of readings the bears *would have to see* in order to see some a meaningful drop. After all – you can’t become disgruntled either and turn into an anti-bear (or an anti-bull for that matter). For any mental predisposition will invariably lead you to interpret charts the way you want them to see.

For that very reason I will also show you what the bulls want to see in order to sustain the current short squeeze rally. For if we push much higher from here we are looking at some mighty upside scenarios, leading into October and possibly into the next year.

This chart has been among my favorites as of late. It’s a simple channel and it is crystal clear. Once we saw a triple bottom the odds for a snap back increased significantly. And the bulls played it masterfully – faking a bit of downside and then slammed the pedal to the metal. We smashed right through the center ‘equilibrium line’ and now find ourselves at the upper 25% mark. Back to the future.

Now, quite obviously this is a good spot for a little reversal. Maybe we’ll drop back towards the equilibrium line. But the ‘dynamics’ of the game have now changed from down to up. Meaning that prices will have to drop through the equilibrium line and lower for the bears to even have a smidgen of a chance to conquer 1040 or even 1020. And than now seems lightyears away. Beam me up Scotty!

The bulls most likely will consider 1075 a nice dip buying opportunity – assuming we drop that low. If we bust straight higher from here on Tuesday then it will lower the odds for the bears even further. And finally a breach of the upper channel boundary around 1130 changes the entire game as we are then talking about an inverse H&S formation. We would have to see some significant divergences in various of my indicators to even consider fading such a move.

My ratio divergence chart between the SPX and the VIX has been in bearish territory but flat. As long as we stay below the zero mark the bears have a fighting chance medium term. But the type of stalling momentum we have see in the past two months (see blue rectangles) usually does not lead to major downside. So this one is pretty easy: We need to see expanding downside momentum in order for P3 to have any medium term probability. I think I made this point a week or two ago: Just look at the trend degradation we saw in mid April – that was beautiful. And what followed was a major drop that severely upset the longs.

For the past eight weeks or so the bears have been dressed up but nowhere to go. And if that goes on for too long there is a growing threat of a major sideways correction – in that bearish sentiment pushes to extremes without any significant downside. My take remains that any continuation of major downside will be preceded or at least be accompanied by a growing divergence between the SPX and the VIX. And that should show up on this very chart.

Similarly the longs may want to look out for a weakening of bearish readings right here. If we start pushing into green then the jig is probably up for a while as that would represent an inflection point for a move higher.

I have not shown this chart for a while, which is a shame as it’s a pretty good one. Simple RSI_EMA on the ES futures. Observe how we again painted a divergence around 1040. That was followed by a triple bottom – not good – and the rest is history.

Right now I don’t see any divergence here – the signal looks healthy. Maybe that’ll change early next week but until that happens I caution everyone to not get too excited about the short side here. It’s much easier to be reactive than to to be anticipatory in this tape. You can’t trade on a hunch – let the charts give you reasons to take on short positions. Again, bear in mind that this is a long term chart – so it will not show any potential for a quick reversal here.

And here’s the daily Zero again. It may be tempting to associate fast spikes in the signal with topping formations. However, I have drawn some arrows on similar fractal patterns and they seem to be a lot less reliable than the spikes to the downside. So again – the potential for a snap back exists but it may be short lived and may lead to further upside.

When would we start looking toward the downside again on a more extended basis? Look no further than the smoothed version of the daily Zero (the center panel) – and at this point it remains solidly and stubbornly above the zero mark. And as long as this continues the odds belong to the longs.

Again – look at what happened in early April here – the signal deteriorated and prepared the way for some further downside. Which is exactly what we got. However, since early July we have been spending more time going up than going down – so the signal has been correct, despite the fact that we had a three week drop in between. After all – this is a longer term trend indicator and except for downside fractals on the bottom panel the medium term panel shows us the ‘path of least resistance’. Remember Jesse Livermore? He always kept going on about the path of least resistance and I’m convinced that he would have loved this chart and probably bought the heck out of the 1040 dip.

I will skip the wave count chart until I see levels that are of interest. Right now I believe that counting waves is counter productive as there are too many scenarios I can imagine and none of them give me high confidence. Showing you three or four different Soylents would be unproductive as I cannot identify a clear trend here – thus counting waves would be an exercise in futility. If we had a third wave to the downside I would use the wave count to identify targets and dip buying opportunities. And if we bust higher then I can propose upside targets. But right now we are a bit in limbo and thus fractals and momentum charts rule the day for me – I hope you all concur.

Public Service Announcement:

This will be my last post until Tuesday, thus consider this to be my weekly update. It’s been a long and vacationless year for me and the ole’ Mole needs some time off. Besides I don’t think many of you will be around during the long Labor Day weekend.

Truth be told – as I have tasted blood I will most likely continue coding and optimizing my black box strategies. Thus far I have mainly focused on systems running against the ES futures but recent trading volume reports strongly suggest that the FX side is something I should explore more deeply. I have done some preliminary testing of various base strategies against the AUD/JPY and the EUR/USD FX pairs and they fared very well, which is encouraging. So, there is much work to be done.

Let me wish all of you a wonderful late summer Labor Day weekend. I strongly recommend that you recharge your batteries by spending time with your loved ones. If you don’t have one – don’t worry – you have a few more hours left to find one. Just forget about the market for a few days – believe me, whether you think about it or not, it will be there next Tuesday in all its ignominious ambiguity.