Monday’s Trading

More on the Rounding Turn
On Saturday, I discussed the “rounding turn” that the market made last week. According to Edwards & Magee, rounding tops and bottoms are very profound patterns when they appear at the end of a decline, or a rally. In those cases, they constitute powerful reversal patterns.

However, this particular rounding turn came in the middle of a trading range. So perhaps it will not have a long-lasting effect.

On Friday, we discussed how amazingly straight-up the move was. But that’s normal according to Edwards & Magee, page 88:

“Volume accelerates with the trend until often it reaches a sort of climactic peak in a few days of almost “vertical” price movement on the chart.”

Those words were probably written 65 years ago.

What happens next? Typically, prices will fall back, drift around in lackluster fashion, and eventually resume the trend. A cup-and-handle pattern, if you like.

There are some signs that the market will pull back soon. As I mentioned on Saturday, the IWM’s volume dropped off on Friday, which may indicate that the explosiveness of the move is complete. In addition, the XLF formed a three-day pattern that is very close to a bearish hanging man, and the VIX bounced at the “JungleGirl Gap” from 9/26/08. Furthermore, it would make sense for the move to end here because…

McClellan Oscillator at All-Time High
The McClellan boys say that their indicator is at a record overbought level. If you have TradeStation, you can make your own McClellan Oscillator as long as you make sure to add advancers and decliners first. I did that and have been studying the chart. It’s a very good indicator.

If you wait for the MacOs to hit 150, and then short the close of that day, you almost always have large profits within a few days. Sometimes the market will stay steady and the best you can do is get out even. But the MacOS is more than double that now at 344.57! My chart goes back 35 years, and this is only the third time in history it has been over 300.

The other two times were on November 4, 2008 – an excellent time to be short – and on May 27, 2004. If you sold the close there, you could have taken a small profit a couple of days later, or held on for larger profits as the market dove in July and August.

No matter how good this indicator is, it can fail during times when the public is stampeding into stocks. I doubt that is happening now, but it could be since many people make New Year’s Resolutions about investing that get implemented first thing in January. While SPY’s volume improved over the last three trading days, it was still lackluster. So, volume will be a very important indicator to watch at the beginning of this week.

New Indicator
Only about an hour after I established my short position on December 16th, I discovered a new, super-secret contrary sentiment indicator, the SSCSI. It fired again on Friday, so that’s another bearish signal. I won’t tell you what it is, but I will tell you when it fires. Let’s see if it can predict its second down-leg.

The K-Tangle
Here is the rectangle pattern that K posted on Wednesday. K’s chart turned out to be the correct interpretation. The SPX made its rounding turn at the bottom of the K-Tangle, and broke out above 918. That was the third attempt at the resistance line, which is exactly when the textbook says the breakout should occur.

On Friday, I mentioned that dip-buyers were eagerly stepping in at 857 instead of waiting for prices to hit the lower line at 850. That was bullish. Also, the SPX left behind an opening gap on December 30th, which was also bullish. The entire setup was blatantly bullish, and in retrospect, the breakout was entirely predictable. But will it stick? Here are three criteria for judging breakouts:

1) Are prices 3% or more above the breakout level?
2) Was there an explosion of volume?
3) Have prices held above the breakout level for 3 days?

We don’t know about #3 yet, but #1 and #2 are not satisfied. So, the breakout is questionable, and the MacOs is at an all-time high, along with many other indicators being at overbought extremes. It seems that a pullback is justified, especially since the market might not be quite so cheerful about a second -500k jobs report coming on Friday.

But first, lets see what the K-Tangle breakout projection would be. If the rectangle completes a bullish breakout, it could hit 986 (918+(918-850)). But in light of the overbought condition, if it were to hit that target it would likely be after a good deal of backing-and-filling.

A drop back to test the breakout at 918 is very likely. A 50% retracement of last week’s spike would take us to 896. And of course, since this is one of the fieriest bear markets in history, with the global economy continuing to execute a spectacular, synchronized nose-dive with no end in sight, a pullback could gather steam and just keep on going.

Personally, I am playing for a 100-point SPX, Inauguration Day rally. But since I believe that rally will begin at 700 and race up to 800, I am short. 🙂