The Dow did form a Short Term Market Bottom and Rebound, but not in the Behavior Expected.
Dow Outlook 081013 expected a calmer, progressively narrowing trading range where the Dow will start a “Climb Back to Health”, after an initial strong upturn.
The Dow did form the Short Term Market Bottom. It also rebounded, but not in the slower, steadier way expected, but in an exceedingly fierce upturn that saw it climb 24% from the Short Term Market Bottom. This represented an Upswing Value of 1,912 points reaching a Short Term High of 9,794 within two days.
This extreme volatility does not augur well for the Dow. In this respect, I made the following comments on the Dow in the Gold Outlook 081015 published yesterday as at 12.38 am in the early morning of 15th October 2008.
“And I think that tonight might be the last night that the Dow will experience a large upward movement. In fact, I expect some profit taking correction to set in either by the later part of tonight, or by tomorrow.”
We now have to revisit the Outlook and consider new scenarios, in light of the latest price movements.
Given the downturn in the last two nights, we are all wondering, "Is the Dow Rebound over?"
The Dow Rebound has been "Too Much, Too Soon".
To answer this question, we have to review the 1929 Great Crash for some form of guidance. However, we start by reviewing the Dow Jones Industrial Average (Dow) Index Daily Chart as at 15th October 2008.
The Dow Crash started on 29th September 2008 at a High of 11,139.29 and fell to a low of 7882.51. This represented a Downswing Value of 3,256.78 points or 29.2% loss from its Pre-Crash High.
From the Short Term Market Bottom of 7882.51, it rebounded fiercely to 9794.37 within a period of 2 trading days, which was an Upturn that is "too much too soon". This meant that the Short Term Upswing of 1,911.86 points had retraced 58.7% of its total Crash Downswing in merely two days. This Upswing also meant a gain of 24.25% from the Short Term Market Bottom, a super fantastic return on investment by any standard.
Profit Taking Correction has been equally fierce with a Retracement of 61.7% of the Rebound Upswing
Thus, it is only to be expected that the Weakholders who had not sold during last week's stock market crash would be taking advantage of the "good luck" to cash out. It also meant that those who had the "intestinal fortitude" to buy during the crash, especially if they had bought on last Friday, would be taking profit on their fantastic windfall.
This "Profit Taking" Correction was reflected by the Closing Price of 14th October 2008 of 9310.99, which was 483.38 points lower than its intra-day high. Thus, on 15th October, it is no wonder that the Dow encountered another down day, with the close of 8577.91, losing an additional 733.08 points. The Dow has now lost a total of 1,216.46 points from its Short Term Rebound High of 9,794.37. This represents a loss of 12.4% and a retracement of 61.7% of the latest rebound upswing value of 1,971.86.
The Great Crash of 1929 encountered such a Fierce Rebound and experienced a 2nd Crash
Now, we turn our attention to the Daily Chart of the Dow for 4th November 1929. The Chart of 15/10/08 looks similar to that of 4/11/29.
The Dow had gone down from a High of 329.94 as at 23rd October 1929, to a Short Term Market Bottom of 212.33 as at 29th October 1929. This represented a Crash Downswing Value of 117.6 points, which also meant a loss of 35.6% from the Pre-Crash High. In this sense, the 1st Phase of the 1929 Crash was more severe than the present 2008 Crash.
The Retracement Percentage of 58.7 % within 2 Trading Days is Spookishly Similar to the 1929 Pre 2nd Crash Situation
From the Short Term Market Bottom of 212.33, the Dow recovered fiercely as well, within two days, to a Short Term High of 281.54 as at 31st October 1929. This represented an Upswing Value of 69.24 points and a retracement of 58.8% of the Crash Downswing.
This is quite a coincidence to the Current Crash Downswing Retracement of 58.7%, which was also achieved within 2 days. The similarity of the two situations is extremely spookish, to say the least.
The Dow experienced a 2nd Crash from the Short Term Market Rebound High
We now have to look at the Daily Chart as at 13th November 1929 to understand what happened subsequently in the previous Great Crash of 1929. From the Short Term Pivot High of 281.54 set on 31st October 1929, the Dow crashed one more time, to a new Short Term Low of 198.69.
This represented a 2nd Crash Downswing of 82.85 points or a loss of 29.4% from this latest Short Term Pivot High. Taken from the Pre-Crash High of 329.94 set on 23rd October 1929, this would mean a total Crash Downswing of 131.25 points or a total loss of 39.8 % from this High, within a period of 14 trading days.
If there is a 2nd Crash, the next Short Term Market Bottom is projected at 6700
If we take the same total percentage loss of 39.8% to project onto the current Dow Crash to give us some guideline to consider, then, the Dow should fall a total Crash Downswing of 4,433.4 points to a new Short Term Market Bottom of 6,705.9.
This means that the Dow has to fall another 3,088.5 points from the latest Short Term Rebound High of 9,794.39, which represents a loss of 31.5% from this High. This is comparable to the 29.4% loss derived from the 2nd Crash in 1929.
The Dow Retraced 52.5% of its Total Downswing from the Market Bottom of the 2nd Crash within 15 Trading Days
From this 2nd Short Term Market Bottom, the Dow rebounded to 267.56 by 9th December 1929. This represented an Upswing Value of 68.87 points and a retracement of 52.5% of its total Crash Downswing. It also meant a ROI of 34.7% from the Market Bottom of 198.69.
This 2nd Post Crash Rebound was also steep, but involved narrower but steady range daily upswings, after the initial wide range up day from the 2nd Short Term Market Bottom. This meant that it took many more trading days to form the 2nd Short Term Market Rebound High; a total of 15 trading days to be precise. Volatility was therefore, much reduced compared to the 1st Rebound, and even the Down Days were not exceptionally large downturns relative to the Crash Daily Downturns. This was the Market Behavior I was expecting in the Outlook 081013, that did not materialize.
The Dow encountered Profit Taking Correction but Climbed further Back to Health for the next few months
The Dow spent the next six months in recovery mode, after an initial profit taking phase with a Downswing Value of 41.17 points or a loss of 15.4% from the Short Term Rebound High of 267.56 set on 9th December 1929. From this Profit Taking Low of 226.39 set on 23rd December 1929, it went on to a Recovery High of 297.25 set on 16th April 1930, before succumbing once more to the gravitational pressure from the fundamental picture of the Great Depression economic situation.
Will the Dow Perform as it did in the 1929 Great Crash by Crashing twice with total loss of 39.8% from its Pre-Crash High?
If we follow the Scenario of a two phase Stock Market Crash on the Dow in 1929, the situation is scary. The critical question to ask now is, “Will the Dow perform as it did in the 1929 Great Crash by crashing twice to a total loss of 39.8% from its Pre-Crash High?”
There is no way to tell until it is too late. Unfortunately, the Volatile Upswing seems to indicate further downside risk. It would have been better had the Dow climbed slowly but steadily back to health, rather than perform in such a volatile manner. A Slower but Steadier Climb Back to Health would have assured long term investors that the Dow had bottomed, at least for the next 6 months.
The Key to Avoiding a 2nd Crash is in Volatility
The probability that a 2nd Crash will be averted is somewhat correlated to volatility. Every time the market performs with extreme volatility, fear sets in. Whenever Fear sets in, there is a compulsive pressure for the average investor to want to get out. This will cause the Dow to fall much further. Thus, it is imperative that the Dow should calm down, and progressively narrow its trading range, in the next few days, if it is to reduce the probability of a 2nd Crash …. at least until the next extreme volatility sets in.
Please note that Low Volatility would suggest that the probability of a Crash being averted is higher, but extreme volatility need not necessarily translate into a Crash. However, the possibility of a Crash is higher when there is extreme volatility.
Fundamentals Are Still Negative But US Government Action Helped Improve an Extremely Risky Economic Situation
From a Fundamental Perspective, the US Government has put in place a number of financial measures that should help the banking crisis situation. Whether this is enough to solve the banking crisis situation, only time will tell. Rightfully, this should turn the Dow upwards on a Secondary W2 Wave that should last 3 weeks to 3 months.
Of course, the US Government’s action is insufficient to reverse the severe economic downturn, and thus, any significant upturn must be viewed as a Secondary W2 Wave Correction against a Daily Chart Primary W1 Wave Downtrend, which is still intact.
The Short Term Tertiary W3 Wave is Highly Uncertain as the Fear Factor causing Unit Trust Cash Redemptions Remain the Key Risk Factor that could cause a 2nd Crash
However, in the Short Term, i.e. between 3 days to 3 weeks, the Tertiary W3 Wave is extremely volatile, and thus, it is this wave that can cause the Dow to crash further. But, how can the Dow go down further? What other bad news can the market possibly come up with?
It is not a question of bad news. It is the FEAR Factor in the average layman investor’s mind. If the unit trust cash redemptions continue, despite the recent upturn, then the Dow is very likely to crash. Unfortunately, we cannot get such information on cash redemption of unit trust to make a good informed decision. By the time we get such information, it will be too late.
What Should We Do in Such a Volatile Situation with a Possibility of a 2nd Crash? It all depends on your Trading Expertise
Thus, we must manage this Uncertainty to the best of our ability based on what we know today. In this regard, we now have to seriously consider what to do in such a situation.
If you have the expertise to trade a highly volatile market, by all means, stay in the market and day trade. For me, I have always been biased in my trading style, i.e. I trade well behaved trends rather than volatile markets, where I have no basis to develop good strategic foresight that will yield me a positional advantage.
In other words, I don’t have the expertise to trade such volatile markets. In such a situation, I would protect and preserve my portfolio capital by closing my position, if any, and stay out until things settle down till a calmer, more stable, discernible trend emerge.
In this regard, I would repeat the trading strategy in my conclusion of the Dow Outlook 081013 article: -
“So, what should we do? I am inclined to wait for another day or two for the market situation to clear. There is no way of knowing what significant negative news will be announced in the next few days, and the still jittery market means that it will continue to experience wide daily trading range, which will progressively become more calm and stable as time goes by. If the market is kind, we will be able to get in a trade at a good position. If the market is unkind, then it will just go straight up when it feels like it, and the next thing you know, it has gone up by 300 points, and you still don't have a position.
However, I can't see the market going up too far before a wave of selling comes in. I expect this to be not so much an issue of profit taking, for few traders / investors bought and held shares through this weekend, but an issue of fear driven sales by people who had wanted to wait for a rebound before they sell.
Thus, in conclusion, I am inclined to wait for smaller range candles to form, which will provide me with even further clues as to the viability of this venture”.
This strategy still applies, should the Dow suddenly calm down into narrower trading range.
Given that the market was “unkind”, I did not enter any trades on the Dow, and thus, have no position to close. Unfortunately, I missed the great rebound, but that’s life. My trading system doesn’t provide me with a winning edge on such volatile trades, and I am too risk aversed to enter a market that had moved more than 1,000 points post crash within a day or two. In that sense, I am lucky that I do not have the abovementioned predicament of what to do now.
What about taking advantage of the volatility by Shorting? As I have mentioned, I do not have sufficient expertise to trade such volatile markets whether it is a Long Position or a Short Position. However, it is possible for traders to short when the Low of the Previous Day has broken down. Where exactly should the stop loss level be set is an interesting question. Some may set it at the High of the Previous Day, whilst others at slightly above the Close of the Previous Day.
As I have not done sufficient backtesting of such a trading system, I cannot say what will work with a Winning Edge. I would encourage you to perform the necessary scientific systems tests and consider the results of the backtesting before you adopt such Day Trading Systems.
Some Words of Caution to Preserve Capital
At this point, I would like to offer some words of caution. When you trade volatile markets, you must have a good contingency plan in place for such situations. If not, it is better to look for more well behaved markets to trade.
If you do intend to continue trading this volatile market, please ensure that you consider two questions. First, you must have some form of indicator that informs you of “WHEN” you decide that you are wrong, and have to trigger your stop loss and get out, so as to preserve your capital for days that offer better opportunities.
Second, you must have identified an exact stop loss level and put in that order straightaway, to ensure that if the market crashes, you will be protected from a “Falling Dagger” situation where the market just crash and crash. You may not get the exact price of your stop loss level, but the slippage should be minor compared to the fierce downfall should another crash happen.
If you don’t have answers to these two critical questions, you have no business to be in Long Positions in this current volatile market.
In this regard, this would be an excellent time to take an Options Trade, if you can get a reasonable price in this volatile market condition.
Conclusion
In conclusion, the possibility of a 2nd Crash is real, and represents a “Clear & Present Danger” to our trading capital.
The key to averting a 2nd Crash lies in whether the stock market’s extreme volatility can calm down within the next two days, thus, reducing the Fear Factor.
A persistent extreme volatility situation will instil Fear, which will translate into investor action to exercise cash redemptions of their unit trust. This in turn will force fund managers to liquidate their investment positions on a distressed selling basis, to raise cash to settle the redemptions.
Thus, there is a need to exercise extreme caution, i.e. to define a point where we decide our market call is wrong, and to cut loss and close our position, to preserve our trading capital for better opportunities.
If you have the trading expertise to handle such volatile markets, I wish you the best of luck in your trading. I would also like to learn from you how you do it. If you don’t have such a trading expertise, perhaps it might be wiser to close your positions at an appropriate point, and preserve your capital for better, more well behaved market opportunities.
Best wishes,
Ooi
© Copyright of Praesciens.blogspot.com, 2008
Posts
4 comments:
ooi- i hope this plays out more to the 69/70 or 73/74 recession not the 29 depression.just test previous low- i hope
check this site-www.mclarenreport.net.au ,this is more what im hoping for
i dont see depression because policymakers have acted on it much sooner.the fed was cutting (aggressively)much earlier & now they have backstopped it as well as having a spv to hold the toxic waste. the democrats r already talking about a stimulus package(Roubini NYU Prof who has been warning of this scenario 2 yrs ago also calling for package). Just needs time to play out.1929 govt kept a handsoff approach
Dear Jothi,
Sorry for the late reply, but better late than never. I thank you once again for your effort to be active and to take time to comment on my blog. I hope others will follow your leadership.
I agree that Economic Depression is not the most likely scenario at present. In any case, there is no official definition of what constitutes an Economic Depression.
However, I do think that despite the actions taken by the US Government, and other Governments of the world, we are going to be in for the worst recession of our lives. The amount of excesses and abuse, or misuse, or negligence, whatever one wants to call it, is so staggering that I am doubtful as to how much Uncle Sam can do, to solve the economic problems, without causing Hyper-Inflation.
It is also questionable as to whether the earlier economic stimulus package and the significant lowering of interest rates have helped one bit.
Lowering of Interest Rates do work, but only in times of a normal recession. However, these are highly abnormal times, also called the Fat Tailed Phenomenon from a statistical distribution curve perspective.
I am not fully convinced that any government, no matter how powerful, can stem the tide of a housing mortgage crisis of people buying homes they cannot afford. Only a few hours ago, I saw on CNBC that there is about US$600 billion of mortgages in California that are about to experience a readjustment of interest rates.
Imagine the significance of such challenges. Politicians like their voters to believe that they have the intelligence, the power, and the resources to solve such problems. If so, there would never be a severe housing property correction in Singapore.
What Government wields more intelligence, power, and more resources per capita than the Singaporean Government, and yet, Singapore went through a bad property market correction in the years 2002 to 2003 because of the SARS disease epidemic. In the next one to two years, Singapore will once again face another severe correction in the property market.
Boom and bust cycle in share markets, property markets, commodities markets, i.e. all financial markets in the world, is a natural phenomenon of human psychology. As long as there is greed and fear, there will be irrational exuberance and panic selling. That is life. And no government, in my opinion, can resolve the economic challenges that arise from the bust cycle.
So, the only way is to let nature run its course. Of course, that doesn't mean that I advocate a complete hands-off approach by the Government. I believe some form of government intervention is needed to ensure that the recession is not more painful than necessary.
In conclusion, I think that irrespective of what the US Government does, we will experience the worst recession we have ever seen. Whilst the Government should intervene to do damage control and minimize pain, there is a limit to what the Government should do, or else we will be facing even more problems than already in existence today. Where that fine line is, is extremely subjective, even for the most highly informed person like Bernanke and Paulson, so we are in no position to say.
I think our discussion is great because it puts into perspective the wide range of possible outcomes, and what we have done is to try to narrow these outcomes for better, informed investment decisions.
Best wishes,
Ooi
Post a Comment