Saturday, October 16, 2010

Everything Looks Like Big Reversals are at Hand.........Except for Stocks

Friday's internals were a little skewed with options expiry occurring.  But the down volume compared to up volume was quite noticable on the NYSE as 900 million shares traded to the downside versus 478 million to the upside.  Then, the Nasdaq Composite had even more noticable behavior in that up volume doubled down volume but the amount of decliners exceeded the amount of advancers.  So the Nasdaq's move was just heavy bets on a small amount of stocks.....primarily that surrounding Google and the big boys reporting next week.  By the way, it's about as sure of a thing as you can get that Apple will blow away earnings estimates.  Their for certain outstanding earnings report is not what's important, it's the reaction to the report that's important.  I think Apple is in a type of bubble right now, and is pulling all of tech higher in the process.  Once that bubble pops and reverses, so should the Nasdaqs.  But right now, Apple looks unstoppable, and it certainly can continue even higher and get even more so to an overbought extreme. 

Friday morning was exciting for the bears, but as the day moved forward, the bears had little to cheer about.  The rally and very sharp reversal is exactly the type of behavior I'd like to see at this juncture if we're to think a major top is in.  But after that reversal, the bears could not accomplish anything.  And the consolidation that took place appears to be pushing higher.  So again, the bulls were able to come in and slap the bears' attack around, stopping them short of gaining any momentum in this market.  Looking at the above chart by itself, it looks like we're heading higher early next week.

There's several ways to interpret the short term wave count, but I'll post the two most obvious here.  The consolidation after the big drop looks like a triangle.  Triangles can only occur in B, X and 4th waves.  It doesn't look like a 4th wave because the decline from 1184 is too long compared to the rest of the triangle, so a 4th wave triangle seems unlikely here.  So that suggests the decline from 1184 is part of a separate wave.  That would mean the triangle is an X or B wave. 

For the bears, there I posted a scenario on the 15min chart which has the triangle part of B or X wave that will have a C wave complete wave (2).  Of course this is problem because wave (2) cannot exceed 1184 and it will be forced to come awfully close to that level in order to be valid.  Trading on such an exact move in such a tight space seems foolish to me, but I have to post it as I see it, and the B or X wave triangle looks possible here.  And hey, you never know when waves will unfold perfectly, and that consolidation definitely looks like a triangle, so we'll see what happens. 

It's also possible that a large series of waves 1 and 2 are unfolding right now, but as a personal trading rule, whenever I have to count a bunch of 1s and 2s taking place, the count is usually wrong.  If they are a series of 1s and 2s, then right out of the gate tomorrow morning the market should fall straight down. If it doesn't do that, then we can completely remove that possibility from contention.

The more bullish scenario is listed here.  Under both counts though, the short term means lower levels ahead.  But here, after one more shot lower, the market will be back in bull mode again.  If this occurs, I'll have to check out the accompanying evidence to figure out how this would best fit into the larger wave count.

The top two VIX charts show how well elliott wave principle can project future action.  Late in the week I posted those top two charts and projected the future movement as part of an unfolding impulsive rally.  The VIX fulfilled the forecast quite nicely as you can see.  It has now fallen below the area of the prior 4th wave which is typical for the end of a correction.  So a spike higher in either wave ((3)) or perhaps a C wave is now in order.  Remember that we also had a second VIX stock market sell signal execute this week at the start of that impulsive rally, so the VIX may be preparing to takeoff aggressively higher here.  For those of you not familiar with the VIX, it basically moves opposite the S&P, so a surge higher in the VIX will result in a surge lower in the S&P.

This is on of the pieces of evidence that strongly suggest stocks are at, or very near, a major reversal downward.  Unfortunately, stocks themselves don't look like they're quite ready.

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Another big sign that stocks are topping is the financials' lack of participation in this frenzied stock market rally.  The overall stock market cannot sustain a long term rally without the financials participating.  But we've seen this before where the financials lag for a while and then turn on a dime higher and erase the divergences in a week.  But that hasn't happened yet, so we play it the way we see it now.  And right now, it appears the financials may have topped and reversed early.

From a fundamental standpoint only, I wouldn't like being bearish the financials.  If in fact this weakness we're seeing is tied to the new mortgage mess that has recently surfaced, then it's just an overdone panic in my view.  Eventually, folks will realize that the Fed is the financials' stop loss and will bail them out in a heartbeat, and they can rally back quickly.  But from a technical standpoint, the financials look horribly bearish right now and I think these boys are falling much lower in the coming days.  A close below the prior swing low at 14.20 would be a good sign that a major top is in.

Above is a daily comparison in the S&P and XLF financials ETF.  You can see how badly the financials are lagging the overall market.  Why is this signficant you ask?

This is why it's significant.  The last time the financials lagged this badly was going into the 2007 top.  You can see the result there.  The financials dipped out of the stock market rally early and proved to be a big warning sign for the overall market.  So the signs of a major stock market top are here. But with that said, we've seen this happen before, and stocks continue on higher.  So we'll see what happens this time.

Trading is all about probabilities.  And the probabilities seem to suggest we're at, or very near a major top.  But no matter how sure we are, we should always enter a trade assuming we'll be wrong, and know exactly where and when to get out of that trade to remain solvent and be able to fight another day.

On top of the VIX and financials' evidence of reversal, the euro also looks really good to have started a reversal.  There was a nice reversal spike during the Bernanke speech and then a decline that went below the pre-speech runup.  On top of that, the daily close was well beneath the previous swing low that marked the most recent Bernanke speech runup, so I interpret that as perhaps a reversal in thinking.  That is, it could be a sign that the thinking about the dollar's immenent doom from the Fed's constant easing has reversed.  Watch the action in the euro.  If it has topped, a top in equities should soon follow.

And when we look at the euro wave count we can see the exact behavior and structure I'd like to see going into a major top.  We had a small degree 5 waves up complete with a sharp reversal and close to a new low in an impulsive manner so far.  It doesn't get any more perfect than this in my view. 

So again, the evidence is strong that the euro has topped, and therefore one would think stocks have topped, or will top very soon, as well. 
Just a quick note, we've been in this position before.  We've seen several markets and indicators that would suggest a top is in for stocks.  When these things line up you would logically conclude that stocks will follow the rest of the indicators and markets and reverse as well since stocks are the only holdout.  But time and time again, stocks manage to be resilient, and end up turning up those indicators and markets back into bull mode with them.  So although the evidence of a major top is compelling, we still need to be cautious.  It is also in fact possible that stocks just eek out another new high or so which the current structure suggests, and then most likely make new highs on the year which it appears they want to do right now, and the VIX not make a new low, financials continue to lag, and the euro not make a new high.  So new highs in stocks won't negate the immediate bearish view, only a reversal in the other markets I discussed here will do that.  A new low in the VIX, new high in the euro, and financials surging aggressively higher to catch up with stocks would have me looking seriously at the longer term bullish alternatives I posted earlier this week.


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