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
My latest book (eBook) has been released: Prepare Now and Survive the Coming Bear Market. Amazon: http://goo.gl/2wWC8X Nook: http://goo.gl/VQstmr Smashwords: http://goo.gl/eBpYBT
AAII survey (9/2/2015)
32.4% Bullish. 35.9% Neutral. 31.7% Bearish.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (9/1/2015)
27.8% Bullish. 26.8% Bearish.
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
VIX: 27.80 (on 9/4/2015)
Bearish: Less than or near 12.
Bullish: Greater than or near 40.
RSI (S&P 500): RSI is at 37.19 (on 9/4/2015)
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 down.
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 2.13% (on 9/4/2015).
Note: 3.0% or higher is significant (consider selling bond funds as yield rises). 3.5% or higher and risk increases (for bondholders).
Analysis: The sentiment surveys tell us that retail investors and the financial media do not agree whether this is a bullish or bearish environment. As for me, I rely on the indicators, among other things, and they are telling me this is a damaged market. All of the indexes are below their 50-day, 100-day, and 200-day moving averages, and have remained there for over a week. In addition, many leading stocks are rolling over. This tells me the short-term trend is pointing down, and the odds are high it will be a longer-term downtrend. Wall Street and investors are hoping that the Fed will come to the rescue on a white horse with a bag of goodies: low interest rates and QE4. Unlike last week, the RSI is not oversold, so this market still has room to fall further…much further.
Opinion: I don’t remember the market being this dangerous since 2007. The indicators, along with many clues, are pointing to more selling. As you may know by reading my blog, a month ago, (before the 10% correction), my put options came to life. I started adding inverse ETFs to my portfolio, and that also worked. This tells me that the market is vulnerable, dangerous, and the odds are high we are going much lower. Even when Yellin announces no interest rate hike and hints at QE4, the subsequent rally will likely not last.
Last Friday, Jim Cramer confidently told his listeners on CNBC that his number one rule is that “I buy on weakness and sell on strength.” To be fair, nearly all the pundits are giving the same advice. This is also what most financial advisors and money managers tell their clients. In a bull market, buying on weakness works. But in a bear market or during a correction, this strategy is a huge mistake, with one exception….some investors have the patience to hold their losing stocks for months, years, or decades until they come back to even (i.e. evenitis). Keep in mind that some stocks never come back to even and you’re now a “stuckholder.”
I feel bad for many individual investors who are being told by the pros to “buy on the dip,” “stay the course,” “look for good stocks to buy,” or the worst strategy of all, dollar cost averaging. Sadly, retail investors are always the last to find out the market has changed and the old strategies stopped working. By then they will have given up much of the paper gains they made over the last few years. In addition, Wall Street is always slow to accept or believe the trend has changed until the market is smashed.
Nevertheless, the Fed is the wild card. In the past, when the Fed has initiated QE, the market has rallied. When Bernanke initiated QE3 in 2012, it stimulated the market for another three years. This year, as the markets plunge, there will be tremendous pressure on Yellin to do QE again, and she will do it (perhaps with a different name: How about, “Operation Twist and Shout”?). At first, there will be a tremendous rally. However, if that rally fails, then the market will plunge even harder. I can’t predict it will happen exactly this way, but prudent investors prepare for a market plunge, just as we prepare for a hurricane before it arrives. Better safe than sorry, don’t you think?
I could also be wrong. The market could rally back above its 200-day moving average, especially after Yellin announces more QE. In that case, I will still stick to the strategy that has been working: shorting the rallies. (This is the exact opposite of what the so-called experts are advising.) As a trader, I will keep shorting the rallies until the strategy stops working.
Bottom line: We are in the middle of a severe financial thunderstorm and it’s getting worse. Based on the clues and indicators, there will be short-lived rallies followed by huge selloffs. Investors would be wise to seek safety (advice very few will take until it’s too late). Because so many investors, including most pros, are slow to recognize the changing market environment, experienced and disciplined traders are going to clean up.
Note to traders: Volatility has returned to the markets and so have trading opportunities. Look for a relief rally on Tuesday that will fail quickly (the most likely scenario). If things are really dire, however, we will go straight down on Tuesday and beyond without an intraday reversal or rally. As I wrote earlier, shorting the rallies has been working, but look out for powerful reversals.