On Big Gains & Losses

Today's gain in the Dow was the 3rd biggest point gain ever, but it didn't even make it into the top 20 in percentage gains. On the other hand, yesterday's loss was the largest point loss ever and the 18th largest percentage loss.

In looking back at the days when there were large point gains, most of them occurred in the bear market of 2000 to 2002 and since 2007. Interestingly, none of them occurred between 10/15/02 and 9/18/07 during the "bear" market rally that lasted almost 5 years. 5 of the 16 had rallies that lasted 4 days or less. 10 had rallies lasting 18 days or more. So the probability lies with gains in the coming days, but the problem here is the large loss yesterday. The 3rd and 4th largest percentage losses came 10/28 & 10/29/29 followed by the 3rd largest percentage gain on 10/30/29. The low of the decline occurred 8 days later.

Since we are clearly in a bear market with fundamental conditions that are beginning to look a lot like 1929 and 1930 by some accounts, odds lean toward another lower low in October.

The fact is however, there is not enough data to draw a conclusion one way or the other. What will tell the tale is whether or not there is follow through. If there is, we may expect 3 to 4 weeks of rally, probably followed by more declines. Don't be attached to your positions one way or the other or you may get burned.

Did Today's Rally Mark A Bottom?

The answer to that question - I don't know, but a couple of things are against it. One, almost all of the biggest rallies in the Dow have occurred during bear market declines. Two, the TC2000 T2101 Absolute Breadth index is 48.59 well below the 55 level that has been hit at every significant bottom in the last few years. Three, the Elliot Wave count for the Qs looks like it needs at least one or two more declines to complete a 5 wave move.

Also, in order to signal a beginning to a new rally, the Qs would need to move above last weeks high of 42.84, and above 47.08 to signal a monthly trend reversal. There is a lot of work to do to get to those levels.

The Dow needs to advance another 544 points to clear last weeks high and 940 points to move above the September high. Again, this probably isn't going to occur in one movement.

Lastly, the Dow Jones Transportation index closed below the July low yesterday which now brings the Industrials and the Trannies back into sync to the downside, which is an important component of Dow Theory.

Last week, I said that if the Qs broke below the September 18 low that I would go with them and I did. I exited my long positions and went short as soon as the previous low was broken yesterday. Today's rally was painful, but the discipline is to stay with the trend and the trend is still down.

On a side note, I got whipsawed out of a short in GOOG today because of wild price swings that occurred in the last three minutes. I am hoping that they will bust my stop loss exit trade and reinstate the position. It is impossible to plan for such "technical" exchange breakdowns , but traders need to remember that such things can and do happen, which is another reason not to take positions that are more than 20% of your account. You don't want to be wiped out on a fluke. As it stands I did not lose more than my predetermined risk on the trade, but still I am frustrated to say the least.

Buy Signal Nixed

The financials did not follow through on Friday's buy signal, but fell instead with the broader markets in the wake of more bank failures. As I stated Friday, the XLF needed to move above Friday's high to confirm the signal, which it did not, so you should have not taken the trade. This could still be an opportunity if the XLF holds above the September low, but that is not looking too likely right now.

With regard to the broader markets, strong rallies are likely, but until the intermediate term trend turns, trying to buy bottoms will be dangerous. When potentially bullish conditions are reversed almost immediately as happened yesterday in the wake of the failed bailout plan, it is particularly bearish. Any rally should be regarded with suspicion until a valid follow-through is seen.

Financial Buy Signal

The chart above is of the SPDR Financial Sector ETF, the XLF (click to enlarge chart). The 50dema, not shown, is flat or nearly so and we have the second MACD buy signal, which is typically a strong signal. The XLF has already tested the March low at 22.29 on 9/19/08 so it should be able to break through that level. The base pattern is a double bottom which projects a target of 30. This would only be a possibility if it closes above the January low of 24.11. The low of 9/22/08 of 19.45 should not be taken out if this rally is for real, but stops should be probably be around the 18 area due to the volatility.

Currently, the index futures are flat in response to the bailout agreement announced this afternoon. It would be best to wait until 10 or 10:30 tomorrow morning to see if the markets will continue this rally. Do not buy the XLF until Friday's high is exceeded. If it pulls back for a couple of days, then use Friday's high as an entry pivot.

One fly in the ointment here is that the ban on shorting of financial stocks is scheduled to expire on October 2, which is Friday. If the ban is not extended and there is little gain this week in the ETF, it would probably be best to exit and call it a scratch rather than risk being long in case the shorts take it down next week.

As always, this is not a recommendation to buy this ETF. Do your homework before taking a trade.

Follow Through Day

IBD called a follow-through day yesterday. It should always be remembered, every follow-through day does not lead to a lasting rally. Nevertheless, IBDs calls should be respected and this is no time to be heavily short. The rally will not be confirmed dead until the NYSE and the SP-500 take out the September 18 lows. Until then, cautiously long or cash is the only place to be.

Speculation On A Bottom

Recent events have put the markets in a precarious position. It's clear that if last week's lows are taken out on volume that a crash could unfold, but will that be the case? The short term bottom on September 17 occured at precisely 3x55=165 days + 1 day from the January 24 bottom earlier this year. This marks the bottom of the 3rd 11 week cycle in the 4x11=44 week cycle. After the January low, markets rallied for 7 days before falling to new lows. We now have a situation that could repeat that pattern, except this time the pent-up expectations of a government bailout of historical magnitude could enable the market to rally until the end of October which would coincide with the high of the 11 week cycle.

I have recalculated the 44 week cycle low date and the corrected date for a low is December 5th. However, there are some other longer term cycles due to bottom in mid-November so a bottom could come early. This would lead to an expected year end rally followed by another January swoon and another March low in 09.

I will be looking to get short again at the declining 50dema in the Qs which now also corresponds to the bottom of the upsloping channel from the 2002 low. I will only exit on a solid close above the August high. If the markets crash through the September lows before then, then I will be looking to jump on board because it should be straight down. However, in that case a smaller position size would be warranted due to the possibility of a massive whipsaw.

These are difficult times to trade and being heroic will not win you any awards. Better to sit it out and wait for clear signals than to take huge risks if you are uncertain about your plan of action.

I wish you all great success in the coming weeks.

What Now?

While it is entirely possible that the markets could head down from here, more than likely we will see the upward correction in the downtrend continue for at least two more days. Personally, I will be looking to get short the Qs at the declining 50dema if that level is seen. The Qs may top before the Dow and SP-500. I expect the Dow and SP-500 to make an attempt at their declining 200demas.

Once this rally is over, the subsequent decline will tell the story. Does it pullback on declining volume? Then, maybe higher highs will be seen. Does it head straight for the September lows? Then, probably much lower lows will be seen. In any case, the trend is down and that is the most likely direction.

Catastrophe Averted - For Now

The massive reversal in the financials - XLF and BKX as well as the Russell 200o IWM indicates that the decline is over for now. There is no point in riding this out short, particularly if the government is banning short selling. Short sellers have become the biggest scapegoat for the market's demise, but while there certainly have been abuses, it is highly doubtful that short sellers have caused the housing market to collapse, banks to make risky loans and the FED to pump up the money supply to the point that inflation became rampant. As long as short selling is being done in accordance with regulations, it is a direct hit on the free market and market efficiency to disallow it. In the end, regulators will find that the market can go down and violently with or without short sellers.

Our trend following indicators are still down, but the futures are indicating more gains for tomorrow so several short exit signals may be seen tomorrow. This is one of those times that it may not be worth the wait.

Parallel In Jeopardy

In my last two posts I discussed the similarities in the price pattern in the Dow to 2001. Yesterday's high volume reversal puts that similarity in jeopardy. The financials certainly appear to have put in a short term bottom and possibly the Dow as well.

If the downtrend is to continue, we would expect price not to close above its falling 20ema. A trendline drawn from the September 2 high in the Dow downward through the highs of this decline puts overhead resistance in the Dow at around 11230 to 11250 tomorrow.

If sideways action is followed by a continuation of the rebound, then look for another test of the August highs prior to a resumption of the downtrend. If sideways action is followed by a breakdown, expect the downtrend to accelerate. If the market moves sharply higher, wait for a retest or pullback to see if its for real.

At this point the trend is still down and there is no point in trying to second guess that.

Redux Follow-up

Around 7pm this evening the Dow futures were down almost 300 points. Of course, they could recover by the morning, but it looks like the expected selloff will be underway tomorrow. Confirmation will come when the July 15 lows are taken out.

Traders should keep in mind under these circumstances that the usual indicators of oversold conditions will not work in this type of selloff. Rather, look for climactic volume with large range days to signal short term bottoms. Also, be aware that due to the current cycle we are in, the ultimate bottom of this decline may not be until March 09 with a year end rally to separate a potential double bottom.

2001 Redux

The current pattern in the Dow is eerily similar to the pattern of 2001. I am not in anyway suggesting that there will be any kind of terrorism, just that the price pattern is similar with about a 1 to 2 week lag. If that is the case, then we can expect an acceleration of the downtrend once the July 15 lows are taken out which should occur within the next 10 trading days. If the Dow moves above the August highs prior to that event, then the similarity would be negated.

Including the breakdown day of 8/30/01 that selloff took exactly 13 trading days to reach a climax. The difference this time is that if it occurs, I think any bounce from the first climax will fail leading to a retest or lower low that occurs sometime in November. On that basis we might see the first climax low from October 1 to October 15. October 13 is a holiday so October 14 to 15 looks like a strong possibility.

This is all speculation, of course, so let's wait and see what happens first.

From Pullback To Breakdown

Today's breakdown and close below the July high of 46.15 in the Qs on volume greater than the 8/6/08 breakout is a sell signal on the Weekly - Daily price system. We never had a valid buy signal on the breakout due to the weak volume and now the Monthly downtrend has been reconfirmed. There is still a chance that a reversal from today's level back above 46.15 could "save" the markets, but it doesn't look like that will be the case. The Cabot's Tides also gave a sell (short) signal today.

In prior posts I indicated that we should expect a reversal no later than September 9. Today's breakdown probably indicates that the rally will not make it to that date. The fact that the 22 week cycle low came late (July 15 vs June 24) and the current 22 week cycle high is coming early portends significant weakness this fall.

Expect a test of 46 from below in the near term followed by an accelerating downtrend. If the current trend does accelerate, it would probably be unprofitable to try and trade the bounces as downside gaps may be common. This is a trend to hold onto once your in the trade.

If you get stopped out, don't be afraid to give a couple of more chances. It could be very rewarding on the short side.