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

The Second Shoe is Ready to Drop
This market has serially lacked follow through to the point that it is an expected pattern of behavior. Traders have witnessed indices revert to a tight range of support and resistance and their trades have gone on autopilot, blindly buying support and selling at resistance. No breakouts and no break downs. Earlier this month this changed and we had a deep sell off below major support levels on all major indices. Since the 15th of the month however the indices and most stocks have reverted to a trading range. This has tempted many to believe that the market has reverted back to the norm and has led to a false sense of security. After today though there is little doubt left that a character change has taken place and that the new norm is that of volatility and trend as range trading is put on the shelf for a while. Indices had spent the last 6 or 7 trading days working off their near term oversold conditions on decreasing volume. Then today we saw a serious failure as indices tested major resistance. There is now a very strong chance that we will see another sharp leg down from these levels. If you have not positioned yourself on the short side we at least recommend moving to cash. Some sectors may withstand the heat better than others but cash or the short side is king for the next 5-10 days.

Bullish Blues
There is little to like about this market if you are a bull. Yes it reversed some of Friday’s ugliness, but volume levels today were less than half what they were during last Wednesday’s heavy distribution day. This low volume recovery is setting up for a very nice short. At long last we are finally getting some serious volatility and some good trending. It’s hard to see it from a microcosm but if you step back and look at what has occurred over the past few weeks the trend is very clear: Long term support lines broke down early this month followed by several days of heavy distribution. Now while the serial bottom callers are coming out of the woodwork, the major indices have merely pulled back to their 10-day averages on ever decreasing volume. The market could still pull off a recovery here, but from our vantage point the odds are very low that it will. Odds are much higher that we will see another spike down before serious buying interest returns. Don’t try fighting the current here; if by chance the market does recover there will be better long set ups than are now being presented.

S&P 500 Breakdown

SPY

The S&P 500 broke its long term trend last week. Since this time it has retraced 50% of its losses to its 20-day average on decreasing volume. This is an ideal short set up. One of two things is likely to happen here. Either the price on the SPY will drop from this level making a new leg down to its 110-112 support area. Or, the price will move back up to the broken trend near 119.

Bulls should want to see a drop to the lower area since this will create an excellent buying opportunity and a likely hard oversold bounce. If it continues to trade up to the 119 area first it will have longer term bearish implications; especially if it continues higher on anemic volume levels.

Waiting for Confirmation
Mood:  not sure
Today continue to focus on our open short positions. The market appears to be consolidating losses as it works off its near term oversold condition. Until the downtrend breaks it should be assumed that it is still in effect. Serial bottom pickers will get the bottom right eventually, but it doesn’t count if they get it on their third or fourth try since a lot of money is wasted on the wrong calls. We don’t know if the market put in a low that will hold on Wednesday, but it seems likely to us that that low will at least be tested once more before we get a significant turn around. On Friday the market showed some strength into the close, indicating that we may yet see another day of failed follow through – this time to the down side. Selling pressures over the intermediate term are still strong though and we are looking for another leg down before all is clear on the long side. Determining the big market picture is subjective and the interpretation largely depends on what you are focused on. What is less subjective is the types of set ups that show up in our scans. We scanned heavily over the weekend and couldn’t find one decent long set up from the 250 charts that we pulled up from our scan criteria. We did find plenty of short positions in fact. Even so, we expect to see at least another day or two of strength as oversold conditions are worked off. Thursday’s bounce let off a lot of steam, but not all of it. So again, today it is best not to get aggressive but instead wait on the sideline or in open trades for better positioning.