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7 Small Words, But What an Impact
The FOMC statement was issued with little surprise yesterday. Hawkish statements on inflation remained, bulls hopes were crushed, and a large number of traders and funds put on short positions in the last hour of trading. Now the shocker! The statement was issued incomplete. One little sentence was omitted, but what a sentence to omit! “Longer-term inflation expectations remain well contained.” Understand that it positions were put on based on this statement that was in the original report: "Pressures on inflation have picked up in recent months and pricing power is more evident," which heavily implies that the Fed is no where near finished with the rate hikes. The omitted sentence heavily modifies this short-triggering sentence and since it was issued after the close a lot of shorts are likely to get caught in a bad position today. They really know how to keep us guessing. Scans turned up a neutral to negative picture today with a few, very few, areas of bullish interest. Stocks that have been trending lower and breaking down into 52-week lows are showing signs of continued deterioration and there just isn’t much evidence of accumulation taking place at the present levels to start predicting a turning point in this relentless downtrend. Bulls may open the market today on the Fed misstatement, but there is a reasonably good chance that bears will close it. The old stock trader’s adage “Sell in May, but don’t go away,” looks to ring true yet again.

How Will the Market React?
As mentioned yesterday, we plan to stay sidelined through today not wanting to gamble on the Fed announcement. This week’s Fed release has the potential to be one of the biggest market movers so far this year – or, it could be a non event, depending on the language. If they indicate that they are finished with rate hikes for a while it would be bullish and we are likely to see the market rally. If they remain hawkish and continue to be focused on inflation, then we may see recent market lows taken out quickly. A lot of people are betting, or better, gambling, on one of these two scenarios. We prefer to wait and see what sort of set ups, if any, result from the initial reaction.

Trading Range Continues
Another day in the trading range. This is getting old fast but we would be willing to bet this up and down action is leading to a crescendo event with the market breaking into a strong move. The direction of the move is yet unclear, but it will likely be determined by tomorrow’s Fed announcement. Volume was very weak today in front of the Fed meeting indicating we were correct when we stated that institutions would remain sidelined until this big unknown is unveiled.

Friday’s mid day reversal changed the near term playing field and put our shorts into the high risk category. As such we recommended closing them to preserve profits. This does not mean however that the near term outlook for the long side has dramatically improved. On the contrary, as we are now faced with a large looming unknown; that is ”What will the Fed do Tuesday afternoon?” Be prepared for fireworks this week. We still have a number of factors to deal with in this market. • Overhead resistance at the broken uptrend looms above; • The trading range started April 15 was preserved on Friday after a severe test; • The market downtrend is still in tact, and; • We don’t know yet if the Fed has finished raising interest rates, nor do we know how the market will perceive any comments the Fed might make in Tuesday’s report. These factors, and probably a few others we failed to mention, raise risk levels and make trades vulnerable to whipsaw effects. Until we see what reaction the market gives on Tuesday, a cash position is the safest alternative as we embark on the week. Institutional money promises to stay sidelined early this week leaving the market action nearly fully in the hands of speculators. The next best alternative would be to keep position sizes small to reduce risk exposure in the event of another market reversal.

Market Does a Mid Day Reversal
We haven’t had a chance to check in with the bottom callers yet but it looks like this time they may get it right. After an ugly start to the day fear we wrote about yesterday finally reached levels high enough to produce a significant end of day rally on volume that most likely solidified a near term bottom. We have mixed feelings about this since it puts a halt to our running short profits and still doesn’t address overhead resistance levels outlined in Wednesday’s detailed market analysis. On the other hand we can now lock in profits on our shorts and start seriously looking for long plays. The intermediate outlook still remains bearish, but this could potentially change if the rally off current levels is strong and has a significantly high level of volume.

One Day They Will Finally Get It Right
Again the bottom callers are out in force. Their argument is that traders are now sufficiently bearish that a bounce must be imminent. Data does back up the argument that when the hoi polloi becomes overly bearish a turn is near, however we would like to see a study that compares the accuracy of sentiment readings between trending markets and ranging markets.

Take the stochastics indicator for example. In a ranging market overbought and oversold readings for this indicator produce fairly accurate turning points and this is a useful tool under the correct conditions. When the market is trending however overbought or oversold readings take on a different meaning and the tool becomes less useful. For example, if the market is trending lower oversold stochastics are poor indicators of turning points whereas overbought stochastics still produce fairly accurate sell signals. We suspect that market sentiment is something like that. When the market is trending lower of course fear is produced. When is fear great enough to produce a turning point? We don’t know. Since oversold conditions can often continue much longer than seems reasonable fear can probably grow to fairly significant levels before it becomes sufficiently great enough to mark a turning point. Are we there yet? If the QQQQ and SPY follow through from yesterday’s selling to take out the April 20 lows we would say no, we are not yet at a turning point. Will taking out these lows produce more fear? You bet.

After Market Comments
Yesterday we saw the indices chipping away at minor resistance levels. The floodgates were not opened and the bottom did not drop out but stocks are starting to once again work lower. Since we are now heavily short we prefer this slow process where stocks steadily work on new lows. It is better than the quick panicky drops that get reversed mid day before we can update and make strategy adjustments. Breadth today was much stronger than price action on the indices would indicate. A large number of stocks were trending lower testing and breaking 52-week lows. Though the indices are still range bound, a large number of stocks are breaking down, and most importantly, the short stocks in our portfolio are following through with lower prices.

Bottom Yet?
Mood:  incredulous
We continue to be amazed by the ease which most market commentators flip their opinions. The Nasdaq has been in an objectively measurable downtrend since the first of the year and the S&P 500 has been trending down since early March. The market has been in a consolidation/distribution range for over a week now with a heavy bias for more downside before a true rally can ensue. Meanwhile nearly every commentator we read is willing to call a bottom off a minor one day reversal such as we witnessed yesterday. They were calling a bottom last Thursday to by the way. So, since calling the ultimate bottom seems to be this week’s market obsession we thought we would take some time to analyze the bigger picture to see if it makes sense to start buying at these levels or whether we should continue to sit tight in cash and in short positions. Remember, no one knows what is going to happen tomorrow. Those who are successful rely on experience and probabilities. Experience lets you know where probabilities are favorable and where they are not. Success is also achieved by the acceptance that you will be wrong almost as often as you are right. It is for this reason that we know where we will exit when things turn against us. Over time this keeps the probabilities working for us and not against us. As complicated as the market seems from day to day, ultimately managing your money in the market is as simple as what we outlined in this paragraph. Let’s take a look at what the probabilities favor right here and right now; forget about next week and next month, no one has gotten rich trying to read the future. Take a look at the SPY (ETF for the S&P 500). There are several important things to note about the chart’s technicals that will help us determine if we should start looking for a bottom yet or whether it is best to wait in cash and in short positions before we start to think about buying. Several characteristics objectively determine a downtrend is still in tact: • Both the 20- and 10-day averages are trending down; • The price is trading below its 200-day average; • It has a downtrend line that is still in tact, and; • The accumulation/distribution (AD) indicator continues to show distribution (note, this is not an overbought/oversold oscillator – when a trend is getting old we would expect to see this line diverging upward against the downtrending price). It can easily be established by these criteria that the downtrend is in fact still in tact. But, trends all reverse eventually, right? Should we start looking for a reversal and should we start thinking about getting long at current levels? Again, there are several characteristics that exist that raise a red flag of caution to those who are itchy to be the first one to pick the bottom: • When the two-year uptrend broke on April 13 the price quickly sliced through the 116.75 support level, which in the past had been heavily defended. The price now trades below this level, which now represents formidable resistance; • There is no measurable support before 110, and; • Even if the price were to somehow manage a recovery over 116.75, it will still have the broken downtrend to contend with (in our book, a return to a broken downtrend is a situation that just begs to be shorted). The market may or may not be at its ultimate low for the year and this may be the buying opportunity of a lifetime. Or, it may just be a temporary stop on its way lower. Experience shows us that we are most likely confronted with the later and that assuming the former would require a thought process comprised of wishful thinking and intellectual dishonesty. We will get a nice tradable bottom soon and just because the market is projecting lower prices does not mean that the world is ending and that the economy is collapsing. It is all just part of the normal cycles that the market takes us on as it responds to a sea of data, greed, and fear. When this current data is priced in we will get a bounce (Why? Because the market is an unconscionable over reactor). If the downtrend defies odds and does ultimately reverse from these levels there will be plenty of time to profit from such a reversal. But, trying to load up here in anticipation that a reversal is immanent simply amounts to nothing more than gambling and is a great way to lose a lot of money. There are times in the course of trading that the trend is difficult to discern and trading decisions are more complex. This is not one of them. Keep it simple and stay with the trend until it’s not a trend any more. As we can see, there are objective ways to measure this that trump the subjective observations of the guru analysts who are paid to make bold predictions every day.

Trading Report Download
Overview This report will examine the market environment for 2005 and will look at some practical ways for how to profit under conditions that are less than favorable for the average investor. In this report we will show you: • How the market behaves differently when it is trading below its 200-day average • How to profit from this knowledge and how some are even making a good income by putting these conditions in their favor • How the risks of going short are often over exaggerated and how to mitigate the risks that do exist Profiting In a Downtrending Market