Each weekend, I study market behavior using sentiment and technical indicators. My goal is to use clues, observation, and indicators to analyze underlying market conditions. If you can determine the current market environment and trend, it may help you to create profitable trading strategies.
RELEASED: Understanding Options (McGraw-Hill, 2E), Understanding Stocks (McGraw-Hill, 2E), Start Day Trading Now (Adams Media), and Predict the Next Bull or Bear Market and Win (Adams Media): http://bit.ly/1bl0ZNk
AAII survey (8/26/2015)
32.5% Bullish. 29.2% Neutral. 38.3% Bearish.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (8/25/2015)
31.6% Bullish. 22.5% Bearish.
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
VIX: 26.05 (on 8/28/2015)
Bearish: Less than or near 12.
Bullish: Greater than or near 40.
RSI (S&P 500): RSI is at 42.51 (on 8/28/2015)
Overbought (i.e. Bearish): When RSI rises to 70 or above.
Oversold (i.e. Bullish): When RSI falls to 30 or below.
Note: RSI can remain overbought or oversold for extended time periods.
Moving Averages (daily): The S&P 500 is below its 50-, 100-, and 200-day moving averages, and pointing up.
Bearish (Short-term Downtrend): Index crosses under 50-day, 100-day, or 200-day MA.
Bullish (Short-term Uptrend): Index crosses over 50-day, 100-day, and 200-day MA.
MACD (S&P 500): MACD is below its zero line and below its red 9-day signal line. (Note: I’m using the settings, 19,39,9, recommended by Gerald Appel, MACD’s creator.)
Bearish: MACD line crosses below 9-day (red or gray) signal line. MACD line (black line) crosses below zero line.
Bullish: MACD line crosses above zero line. MACD line crosses above 9-day signal line.
Bonds: U.S. 10-year yield is at 2.19% (on 8/28/2015).
Note: 3.0% or higher is significant (consider selling bond funds as yield rises). 3.5% or higher and risk increases (for bondholders).
Analysis: A lot of records were broken last Monday. The VIX went from extreme complacency to over 40, one of the highest one-day jumps in VIX’s history. Then the Dow went from the biggest two-day point loss in its history to its biggest two-day point gain. Now that is volatility! As expected, the indexes fell hard on Monday morning as margin calls were initiated. By Monday afternoon, the indexes fell well below their moving averages and caused severe technical damage. On Tuesday, however, the indexes bounced back strongly (the RSI correctly signaled the indexes were short-term oversold), but the indexes were unable to rise above their 200-day moving averages. Believe it or not, that parabolicly strong bounce-back was not a good sign. It’s better if the market has time to recover, rest, and repair the damage before trying to regain those lost points too quickly. A manic-depressive market is not a healthy sign. On the sentiment side, retail investors are feeling less bullish while financial writers and most on Wall Street are hopeful the worst is behind them. Bottom line: The odds are high the worst is not behind them. Meanwhile, expect more volatility this week as various Fed members make conflicting statements and jobs numbers are released on Friday.
Opinion: I could write a chapter about the current market but I’ll try and be brief. As money managers and others who work on Wall Street enjoy their final days in the Hamptons during Labor Day weekend, their underlings are telling investors not to panic, buy on the dip, this is a “buying opportunity,” and invest for the long term.
Did you see the confused looks on the faces of the hosts and financial commentators on TV? They had trouble keeping up with the many zigs and zags of the market. One clueless commentator even blamed the Monday selloff on panicked individual investors. Ridiculous. Sadly, individual investors don’t know whom to believe or what to do, and unfortunately, many are going to get hurt, and badly.
First, the current market is no place for the inexperienced. I know that this is the opposite of the message everyone is saying, but my message is simple: When the market is not acting normally, stay away. To use an analogy, over the last few months we heard thunder in the distance, but now the thunder is getting louder and there is lightning. This is the time to take cover from the rainstorm. The market is a dangerous place right now and most investors would be wise to reduce risk. It doesn’t mean sell everything in a panic (and many can’t sell because of tax reasons), but taking money off the table is a prudent strategy.
Here’s what I think: I never mind selling a stock or index and missing out if it zooms higher. That doesn’t bother me at all. But what bothers me is when I have a winning stock position and it turns into a loser. I hate that. Many investors have built up gains over the last few years and it will be destructive if those gains are erased. By the way, those are paper gains until they are actually sold. As for me, I like to convert paper gains into real gains on occasion, but that’s me. I’m not a long-term investor.
I follow my own advice. I am primarily in cash right now but I’m using a portion to speculate using call and put options (mostly put options). Buying puts is less risky than shorting because I know in advance how much I can lose if I’m wrong. Nevertheless, when you trade options, there is a chance you can lose 100% of your investment, although you’ll usually lose less money than if you short stock. As you know, I wrote a bestselling book on options, Understanding Options 2E. Nevertheless, options are not for everyone. It takes skill, discipline, and good timing to make money with options. Even trading stocks in this volatile environment is not easy, which is why most investors are wise to simply move to the sidelines for a while (at least three months in my opinion). Obviously, that is a choice only you can make. And don’t forget that financial professionals a lot smarter than me vehemently disagree with what I just wrote.
Now that I got that out of the way, let’s look at the facts. The next three months will be critical for the markets. No one can predict what the market will do during the next few days or weeks. I do know there are many warning signs telling us the market is in the danger zone (and has been for a while).
The wild card is Janet Yellin. I highly doubt she will raise interest rates because she doesn’t want to be blamed for a crash or correction. As I wrote last week, if the markets keep plunging, the Fed will surprise the markets with a QE type stimulus, similar to what they did in 2012 (QE3). It worked in 2012 so I assume the Fed thinks it will work again. (It will definitely cause a short-term rally.)
Bottom line: This is a chaotic market. I am looking for failed rallies, a retest of the lows from last week, and more volatility because of the Fed. Until the indexes rise above their 200-day moving averages on strong volume, this market is in trouble. More important, I believe the market is at a pivot point and going through a trend change. If that is true, this is a unique opportunity to make (or lose) money. The bulls really need the market to recover this week, and if they are successful, they will breathe a huge sigh of relief. As always, I will wait for the market to have the final say. Meanwhile, be careful out there.