WE BE OVERSOLD NOW MAN
The charts don't lie or twist and spin the truth. They are rather blunt and don't respond to the hopes of dreamers nor the hype of Wall Street paper peddlers. The charts tell you one simple truth. They tell you whether there are more buyers than sellers (prices go up), or more sellers than buyers (prices go down). Back on 5/01/2010 we sent out a newsletter titled Volatility is Great for Traders. In that update I used a daily chart of the SPX.
On that chart, titled THE SELLING HAS BEGUN I mentioned that the S+P500 had started into a SELL CYCLE based on the red candlesticks. When you study that chart you'll notice some rather dramatic bearish divergence between Snapback and price. The market was sharply overbought, we had bearish divergence and the red candlesticks confirmed a selling cycle in motion. You can review that newsletter in our archive by clicking on this link
http://archive.constantcontact.com/fs067/1102237833787/archive/1102670912717.html
I suggested that anybody that was long the stock market should take profits. Naturally, my suggestion was ignored by most, and for good reason as the media and market pundits were all convinced that a new bull market was underway and economic recovery was at hand based on the strength of the stock market rally and the positive spin placed on questionable government reports on key economic events. Here is what that chart looks like 3 weeks later.
From peak to the current trough, the S+P 500 has shed over 140 points AND WE'RE STILL GOING DOWN! Did I forecast a move of this magnitude? Of course not! Am I patting myself on the back for that call? Of course not! I am trying to make a very important point about sell cycles that set up in an overbought market. When the market is over extended on the upside and a sell signal sets up ... WE REALLY DON'T KNOW HOW LOW PRICES WILL TUMBLE. The quality or strength of the rally is questionable and the pullback may be shallow or serious. That's why I ended the paragraph with CAVEAT EMPTOR.
In other words, if the market is overbought and we don't really know how sharp the ensuing pullback will be, the prudent thing to do is to take your profits on long positions and get on the sidelines. If you are reluctant to sell for tax purposes, or whatever, then create a hedge using put options, but don't just sit there like a deer caught in the headlights of a tractor trailer truck bearing down on you. Like I mentioned earlier, THE CHARTS DON'T LIE. When those candlesticks turn red a selling cycle has begun and we really don't know how far prices will plunge before establishing some meaningful level of support.
You discover this reality when day trading the ES futures. If you are long and ignore a sell signal, sometimes you get lucky and the correction is minor and the market bounces back up again. Most other times the market goes down hard and you get butchered on your long position for trying to hold on too long. Futures trading teaches you to respond quickly to changes. It's a survival thing. In the investment arena, the slow die first and usually the public is pretty slow to respond. So here is a simple Kwik*POP rule: When you are LONG and the candlesticks turn RED ... BAIL OUT IMMEDIATELY!!
Study this 7,500 volume chart of the ES for a minute or two. The market was in an up trend and came off a new pivot high when a sell cycle kicked in.(see red candlestick ad red arrow). If you cut bait right there you walked away with a profit and sat on the bench with all your cash for awhile. If you ignored that sell signal ... you got hammered!
Could we predict that the market would drop 12 handles lower off a new high in an up trend? No way Jose! Our rules are very simple; if you are long and the bars turn red ... GET OUT! We don't know how far prices will tumble. WHY TAKE THE RISK OF HOPING FOR A BOUNCE BACK? Get on the sidelines and wait for the next buy signal.
THE MAGINOT LINE
OK, one last screen shot. This is a 180 minute chart of the EURO CURRENCY FUTURES CONTRACT. It is now 8:00 PM Eastern time as I send this out. There is a major battle taking place in the currency market this evening. The EURO bulls are desperately trying to defend the price level of 1.2350 This price level is a key short term level of support. A break below that level could eventually send the EURO currency down to the 1.1800 level ... a dangerous thing for EUROLAND. The bears keep pressing but the bulls (and I'm certain some central bank help) are digging in at this level. If the bulls win, a higher low BUY SIGNAL will form and the EURO could rally all the way back up to the 1.28 level. If the bears win ... the S^&% will hit the fan on Tuesday.
WOW ... this is HIGH STAKES POKER AT IT'S BEST ... EH?
Regards,
WDH
THE
COMMODITY FUTURES TRADING COMMISSION. ( C.F.T.C.) This brief statement does not
disclose all of the risks and other significant aspects of trading in futures
and options. In light of the risks, you should undertake such transactions only
if you understand the nature of the contracts ( and contractual relationships )
into which you are entering and the extent of your exposure to risk. Trading in
futures and options is not suitable for many members of the public. You should
carefully consider whether trading is appropriate for you in light of your
experience, objectives, financial resources and other relevant circumstances.
Some of the examples used are hypothetical. Hypothetical trading results have
many inherent limitations and may not reflect actual results since they are
done with the benefit of hindsight and do not accurately reflect market
conditions and the traders emotional level while under the stress of trading.
No representation is being made that any account will or is likely to achieve
profits or losses similar to those shown.
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