Trade of a lifetime, or falling knife? Danger gives opportunity: charts views

There's blood in the water and sharks are circling. You either get out of the water, or become a shark. Well, if you think dolphins are coming to chase the sharks away, you can stick around - but you need a way to verify if those dolphins are coming! Let me explain. By "blood in the water" I'm referring to the increased selling volumes signified by red bars on the chart - see the S&P 500 (SPX) daily-bar chart at right. Not absolutely huge yet, but picked up enough to send the scent (signal) to the "sharks" - i.e., short-sellers. Those who short stocks or ETFs, or buy inverse ETFs like SDS, QID, TZA, or buy put options (or sell call options). Based on this - and the rest of what I've marked on the SPX chart, talked about in my own (Ariel) prior posts the last few weeks, and show in the technical charts below - the KI$$ (Keep It Simple Swings) as well as "normal investor" recommendation is, get out of the water!

A bounce is expected starting next week, based on cycle times as well as the Fibonacci level being tested at the 1157-1158 level in SPX. How long that bounce will last, and how high it will go, are not clear. I do not expect it to exceed 1222, and it may not even be able to surmount 1200. Bottom line, anyone who's long the stock market - including normal 401k and IRA fund investors - should sell into this strength. Look, I cannot make investment recommendations - read the disclaimers, and talk with your own advisors. Just consider an easy, bright-line way to look at the stock market - with all the dangers discussed in the news, and the weakness in the charts, it's safest to sell into strength be it next week or early December. You can re-enter (buy again) if the market goes above 1222 SPX.

Anyone who thinks that the current drop is a true long-term buying opportunity - a/k/a, who believes the "dolphins" (huge institutional investors like banks, pension funds, etc.) will come rescue us from the sharks, needs to understand that the technicals are bearish. Even if those huge investors had the strength to hold up the market (and let's face it, the banks are in trouble), why would they buy instead of selling, if they also see that they would lose money going forward? They may base their decisions on their sophisticated views of the economy (for just l'il ol' me, the economy looks bad). For our purposes, we can look at the unbiased technical charts and see that strength has been leaving the market. Sorry Charlie - it doesn't look like the dolphins will rescue us from the sharks anytime soon!

One more quick word about short sellers - the truth is, they don't bring down markets. What really brings down markets is the absence of investor buying, or worse, investors bailing out. The long-term cycles which incorporate everything from demographics (boomers buying less, retiring, and deflation setting in due to lower consumption aided by technological breakthroughs) to sunspots (go figure, but the correlations exist!) - tell us that the market will not make the next big, truly buyable low until the year 2013 or 2014. Frankly, it isn't the sharks that are bringing this down - it's just natural cycles.

If you want to profit from the decline, you become a shark, i.e., you buy inverse ETFs like SDS, QID, TZA, etc.; or you find another method that allows you to profit when the market drops. If you merely want to avoid the "falling knife" of a market that keeps dropping, dropping, dropping until you cannot stand it anymore - then you step aside by selling long positions, and wait.

Okay, here are more charts. First below are monthly views of the Dow Jones Industrial Average, and the Nasdaq Composite index. I've included various technical markings on them. If you take away nothing else from these, consider that the decline that's already underway (only unless the SPX can rise above 1222, and then of course continue higher) can easily retest and move lower underneath the lows made in 2002-2003 and 2009. Below these two charts are other technical charts I'll discuss.


Below are three views of the advance-decline data that show market strength by the breadth, mainly the number of advancing issues compared with the number declining. These three include an oscillator-type display of the A/D data (these are all for the Nasdaq, which I prefer because I understand that the NYSE data include bonds which can distort the picture for stocks). Plus two more traditinal views of the advance-decline data, both big-picture longer-term charts - which clearly show that market breadth has fallen below where it was during the 2010 lows, and is even challenging the lows of 2009. Ane worse, it's well under the lows of 2002-2003. It was the negative divergence that started showing up on these longer-term charts in recent weeks that turned me so bearish. I already knew the long-term cycle lows were coming up in 2013 or so, but the question whether we've completed the topping highs and only going downhill from here - looks pretty well settled now. Additional reasons why the safest thing looks like being in cash, or short, unless the stock market pulls off a miracle by having the SPX shoot above 1222. (Even then, it would only be to put another finishing touch on "the high" before turning again and dropping into the lows in 2013 or so.)


Below is a trio of my favorite technical charts - McClellan Oscillator (with its Summation Index in a lower window), bullish percent (here, for the SPX), and the Arms Index or TRIN. The McClellan Oscillator dropped sharply to oversold and is due for a bounce soon. It doesn't tell you if the stock market can make a new high, but the Summation Index movement which dropped back sharply suggests that the bigger picture is bearish. The Summation Index is above its moving average, so it supports the idea of a bounce, but if and when the Summation Index falls below its moving average, we're back to the "sky falling" type of bearish scenario.

Also look at the bullish percent (BPSPX) and TRIN. They also show that the market is oversold. In the TRIN for example, the 10-day MA (in white) has been rising but already curved downward, as an early signal to be ready to buy or cover shorts. This is mainly for traders, to say that we should look for a tradable bounce. But they don't say that it's time to get truly bullish - for that, we would have to see both of these charts moving past their respective midlines (proxy with 50-day and 200-day MA's for BPSPX, and 50-day MA for TRIN). If a bounce takes them to these midline areas, that may be a signal once again to sell into relative "strength" and/or resume shorting the market. Only if they move past those midline areas into bullish territory - and we'd want to see the SPX above 1222 too - would it be time to become truly bullish the stock markets again (merely to ride for one last higher high).

I realize this post is rather dense with concepts and charts. I don't want that to cloud the bottom line urgent message - if not already cash or short (per my KI$$ update a couple weeks ago for going into cash, or short, unless SPX 1292 is exceeded), then use the expected bounce coming up next week or the week after, to exit long positions. The "stop loss" level in order to turn bullish rather than bearish has now dropped to 1222.