Dear Friends,
VOLATILITY HAS REMAINED HIGH, BUT THE STOCK MARKET HAS SURVIVED THUS FAR.Our Hypothesis of a Calmer, Progressively Narrowing Trading Range has not materialized to date. The Dow continues to trade in a wildly volatile trading range, and there were times on 24th (US Friday Market) and 27th October (US Monday), when some of us thought that another crash might be in the offing, especially when the Dow Futures went limit down. However, this was not to be; which is interesting.
WHO IN HIS RIGHT MIND WILL BUY AT 800 POINTS UP?What is even more interesting was the 865 points rise in the Dow on 28th October (US Tuesday). Who in his right mind would be buying at 865 points up or even 800 points up, for that matter?
There are only
two major Hypothesis in answer to this question. Either it is some
Smart Money Hedge Funds who have poured in money to catch all the people who have taken Short Positions in the stock market, or it is the
Government's Money starting to pour into the market.
What's the difference? If it is the Hedge Funds Smart Money catching the Shorts, this fantastic Rally will not last long. If it is the Government's Money, prices should hold steady from here onwards.
How can we know? There is NO CERTAINTY other than taxes and death. Even worse is the certainty level of forecasting stock market. There is no way to know for sure, but
Technical Analysis gives us some clues as to which Hypothesis has a higher probability of becoming true.
Let's look at the Daily Chart. You will see quite a number of Black Arrows pointing both up and down, and you can also see two Purple Arrows pointing up in the month of June 2008.
The Arrows, irrespective of whether they are black or purple and whether they are pointing up or down, point to an interesting candlestick known as the
Spinning Top.
WHAT IS THE SPINNING TOP CANDLESTICK?The Spinning Top is a candle with a very small body, normally near the middle of the whole candle, including the wicks at the top and at the bottom. It doesn't matter whether the small body is green or red. A Red Body means that the Market Open is higher than the Market Close, while for a Green Body, the Market Open is lower than the Market Close, and thus, the market closed up compared to the Open.
WHAT DOES THE WEDNESDAY, 29TH OCTOBER 2008 SPINNING TOP CANDLE TELLS US?Let's look at yesterday, Wednesday 29th October 2008's Spinning Top candle. It is a red body, and thus, the Market Close was lower than the Market Open. The Dow opened at 9062.33 and closed at 8990.96. What is interesting is that the Dow hit an Intra-Day Low of 8890.29 and a High of 9363.32.
This Spinning Top tells us that the Dow went up quite high from the Open; 300.99 points higher, to be exact, and then fell 373.03 points, a very substantial fall, to Close below its Open. This means that the Dow could not sustain the bullish sentiment.
The market is now feeling indecisive once more about the future direction, in the Short Term of 3 to 5 days.In fact, with the body of the candle positioned in the lower half of the candle, it suggests Short Term Bearishness.
In summary, we have a Spinning Top candle suggesting Market Indecision with a Downward Bias.
HOW RELIABLE IS THIS SPINNING TOP SIGNAL?If you look at the Black Arrows pointing down, you will see that most of the while, where there is a Spinning Top and the Market has risen, the probability is reasonably high that the market will fall in the Short Term of the next 3 to 5 days. Japanese Candlesticks signals are usually indications of the market for the very Short Term, unless we are interpreting a Weekly or Monthly Candlestick Chart.
On the other hand, if we look at the Black Arrows pointing up, we will observe the Spinning Tops at Pivot Lows, i.e. these candles form after the Dow has fallen, and in the next few days, the Dow rose.
Please note that the interpretation of Spinning Tops have to be made in context of where the Spinning Top is formed, in relation to the overall market movements. Thus, a Spinning Top may mean a fall or a rise, depending on what happened prior to the formation of the candle.
HAVE THERE BEEN SITUATIONS WHERE THE SPINNING TOP PROVIDED UNRELIABLE SIGNALS? Yes. If you look at the two Purple Arrows pointing up, you will notice that the Dow fell, and Spinning Tops were formed, which would seem to indicate that the Dow should rise for a few days, but it did not.
Why? Because Spinning Tops tells us of Indecision, and when there is indecision, the market tends to go in the opposite direction. For example, when the market has risen, and the market hesitates, some people will sell to take profit, while the buying pressure dries up for a while. This brings down the market for the Short Term.
On the other hand, when the market has fallen, and the market hesitates, there will be "value investors" also known as Bottom Fishers, who will buy, thinking that a bottom has formed, whilst at the same time, the Bears / Shortists hesitate. This will bring the market up in the Short Term.
So, why did the Spinning Top signal per the Purple Arrows fail? Because there are times when the latest market news cause the market to resume its prevailing sentiment. In the case of the Purple Arrows, the Dow was in a bearish sentiment, but the Spinning Top suggested that the market could be oversold, and could have a few days of small rally. However, it is likely that bad news came into the market that pushed the Dow to lower levels.
SPINNING TOP - A WINNING EDGE CANDLESTICK SIGNALIf you look carefully at the 9 months of Daily Candlestick data, you will notice that the Spinning Top gives more signals that are correct than wrong, and this is a Winning Edge Higher Probability tool for trading.
MARKET UPTURN WAS MOST PROBABLY MERELY A BEAR TRAP ACTIVITYBased on the Spinning Top signal, I would submit that it is likely that the some Smart Money Hedge Funds had poured money into the stock market to buy and catch the Shorts in a Bear Trap. As the Dow rose past 500 points on Tuesday, 28th October, I am sure many people would have been extremely tempted to take Short Positions to take advantage of a Pullback in a theoretically Extremely Overbought Market condition. Once the Bear Trap Short covering is over, the market will fall.
VERY SHORT TERM OUTLOOK - DOW TO FALL IN THE NEXT 3 TO 5 DAYSIn summary, we expect the Dow to pullback in the Very Short Term of the next 3 to 5 days, based on the signal of this Spinning Top candle.
THREE TRADER DEVELOPMENT LESSONS - THE MOVING TRAIN, TECHNICAL INDICATORS & IMPORTANCE OF STOP LOSSThree Trader Development lessons to be learned here.
First Lesson: -
NEVER EVER stand in front of a Moving Train, i.e. don't take a Short Position just because you think the market run up is too much too soon.
Always let the price movement tell you when to take a trade. If you don't have a trading system that triggers a trade consistently in these kind of volatile situations, don't take a trade. Believe me, I have learnt from experience as well. I survived the nightmare of a Bear Trap, but that is another strategy altogether, and one I don't recommend, except to the very desperate.
Second Lesson: - For all of you Technical Indicator lovers, here is the truth.
Never take a trade just because the Market is at Gross Oversold or Gross Overbought Levels. Indicators are useful, or else I wouldn't be putting them on my charts. BUT, they serve as supporting evidence, NEVER as the MAIN TRIGGER for a trade to be taken. I've never been caught on this lesson because I did my research homework before I used the indicators.
What this means is that I wait for Price to tell me that a trade MAY be taken, i.e. the TRIGGER, and then, I check the Technical Indicators to ensure that there are no contradictory signals. If there are, I don't take the trade.
If there isn't, then I CAN take a trade, if I "Feel" right. My last Opportunity Filter is still an Intuition Factor. On the other hand, I don't take a trade based on "
Feel - Intuition". My Feel Intuition is only to STOP A TRADE, and not to trigger a trade. I do use my Intuition to scan and watch for interesting Opportunities.
Third Lesson: -
Always, Always have a Stop Loss Order in Place if you don't want to be caught in Bull Traps and Bear Traps. The idea is to preserve your capital at all times.Live to fight another day. The only way to avoid big losses is to take small losses when you are wrong. This is probably THE MOST IMPORTANT LESSON of all lessons that a trader can ever learn. Believe me, I've been there. You don't want to sweat out the nightmare of sitting on huge losses that is wiping out 10%, 20% or even 30% of your capital.
It's the SURE THING trades that causes you not to put in your Stop Loss Order, and it's the SURE THING, that will lose you a lot of money in the process.
WHAT IS HAPPENING FROM A PRICE PATTERN PERSPECTIVE?Let's zoom in on the last few days of the Daily Chart
. This Price Pattern has been confusing to say the least. It looked like a Triangle that has been breached to the downside, only to have a long Marubozu taking the Dow back to almost the Key Resistance Level. So how are we going to translate the current price data into useful information that we can trade profitably with?
Due to the High Uncertainty, and Ambiguity in the Price Movements, we have to use some Scenario Planning techniques rather than merely forecasting on a deterministic basis.
Since the Critical Pivot Low of 7882.52, the Dow made a Critical Pivot High, i.e. at 9794.37. From this Pivot High, we can see that there has been one Pivot Low formed at 9305.89, on 20th October, which is the Green Candle, i.e. two candles after the Pivot Low of 8197.67 formed on 16th October.
The next Pivot Low was formed on 27 October at 8085.37, which is important because it is lower than the recent Pivot Low of 8197.67. Thus, we have a situation of two lower Pivot Highs and two lower Pivot Lows. This suggests a resumption of the Primary Downtrend, if not for the last two candles.
The last candle, i.e. the Spinning Top of 29th October broke through the Pivot High of 9305.89, with a new High of 9363.32, and this adds even more confusion to the situation. In fact, it is precisely this confusion in the market place that we continue to experience high volatility in both directions.
SHORT TERM OUTLOOK - CALMER, PROGRESSIVELY NARROWER TRADING RANGE IN SIDEWAYS CONSOLIDATIONI don't believe that Forecasting is the correct usage of Technical Analysis. However, if I were forced to take a best guess, I would say that the Dow will still be in a Sideways Consolidation Mode in the Short Term period of 3 Days to 3 Weeks.Thus, we continue to persist in our Hypothesis of Calmer, Progressively Narrower Trading Range, despite being inaccurate thus far. We have been wrong in terms of volatility, but not in terms of the Dow's direction, which is sideways, albeit a much wider range.
The Market MUST calm down if it is going to perform a Corrective Medium Term Wave Rally back to the SMA200. Continued Volatility does not augur well for the market, and if it persists, it may be advisable to stay away, as the risk of another stock market crash grows with each passing "Wild" day.
THE SCENARIO PLANNING EDGE - LET THE MARKET TELL US WHAT TO DOHowever, if I were to adopt a Scenario Planning Approach, I would view this situation very differently. Here, I adopt the view that I do not know where the Price is going, but there are some interesting signposts.
First, the Dow made an effort to breakthrough the SMA20, i.e. the Red Line which is sloping down in between the two Bollinger Bands which are also red in color. From a historical evidence, in a situation where there is a breach of the SMA20 with a close above it, Price has tended to move towards the SMA50 (Blue Line), sometimes even to SMA200 (Green Line), and thus, such a SMA20 Breach with a Confirmational Close, would be viewed positively.
Traders who adopt this approach would enter a Long Position, provided they feel that there is enough Target Reward / Risk Ratio to justify the trade from a logical business sense. If you keep a tight Stop Loss just below the SMA20, then the Reward / Risk Ratio should be sufficiently attractive, with a Target Profitable Exit of 10250, i.e. just below the SMA50.
On the other hand, if the Dow falls below the 29th October Low of 8890, then it is a Short Position that is taken, with a Stop Loss at slightly above the SMA20 level of 9087.
MEDIUM TERM OUTLOOK - CLIMB BACK TO HEALTHThe Medium Term Outlook depends on the evidence from the Price Pattern being formed. However, given the confusing Price Pattern, or the Sideways Consolidation Pattern, depending on what you see, and what will happen tomorrow, I maintain the view that there is no reliable signal from such a formation.
Traditional Technical Analysis Theory have stated that Sideways Consolidation tends to be a Trend Continuation Pattern, and if this Hypothesis is true, then, the Downtrend will continue after it has consolidated enough.
However, Market Bottoms are also formed on a Sideways Line Formation basis, and thus, how can we be sure?
I have done some Systems Backtesting work on the MACD, and here, I think that the Probability is Higher that the MACD Crossover in an Extreme Gross Oversold Position will lead to a Medium Term "Climb Back to Health".
Can the MACD be wrong? Yes, but it is extremely rare for the MACD to whipsaw in its crossover for more than twice, and thus, the Probability is in our favor, in terms of the Medium Term Outlook of 3 weeks to 3 months.
LONGER TERM OUTLOOK - PRIMARY BEAR MARKET WILL PERSISTHowever, please note that this Upturn is a Medium Term Correction Wave within a Primary Downtrend, and once the Medium Term Uptrend Wave is over, the Primary Downtrend will resume, and the Dow should be much lower than 7882 eventually. That is the Longer Term Outlook.
The SMA200 is already in a Downtrend, and it is unlikely that the Dow will breach it any time soon in the next 3 months to a year.
CONCLUSIONVery Short Term Outlook (3 Days to 5 Days) - Bearish; Market will fall.
Short Term Outlook (3 Days to 3 Weeks) - Neutral; Sideways Consolidation with a Calmer, Progressively Narrowing Trading Range.
Medium Term Outlook (3 Weeks to 3 Months) - Bullish; Climb Back to Health.
Long Term Outlook - Bearish; Market will fall lower than the Critical Support Level of 7882.
Lastly, please be reminded on the Liability Exclusion Clause, which is at the top of my blog page, i.e. that the final trading decision is yours, and I will not be responsible or liable for any losses you may incur from whatsoever reason. :)
Best wishes,
Ooi
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