Each weekend, I study market behavior using sentiment and technical indicators. The goal is to use clues, observation, and indicators to determine if we are in a bullish, bearish, or sideways market environment.
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
This is my latest MarketWatch article (Oct. 13): http://goo.gl/8pEsCL
AAII survey (10/8/2014)
39.9% Bullish. 31.0% Bearish.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (10/7/2014)
45.5% Bullish. 14.1% Bearish
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
VIX: 21.24 (on 10/10/2014)
Bearish: Less than or near 12.
Bullish: Greater than or near 40.
Moving Averages (daily): All the indexes are below their 50- and 100-day moving averages, and pointing down. All the indexes are either below or at their 200-day moving average and pointing down. Note: The Russell 2000 is in a correction.
Bearish (Short-term Downtrend): Index crosses below 50-, 100-, 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 and pointing down. (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 9-day signal line. MACD line crosses above zero line.
RSI (S&P 500): RSI is at 35.12 (on 10/10/2014)
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.
Bonds: U.S. 10-year yield is at 2.31% (on 10/10/2014)
Note: 3.0% or higher is significant (consider selling bond funds as yield rises). 3.5% or higher and risk increases (for bondholders).
Analysis: Last week was a tug-of-war but the bears won, especially on the Friday close. The bulls had one good day during the week but it was a head fake. Technically speaking, serious damage was done to the indexes. In fact, the charts look horrendous. If all the indexes fall below their 200-day moving averages (the Dow and S&P are slightly above), expect more pain if you are long. Sentiment has pulled back a little but most financial writers and the Wall Street crowd are still bullish. (It takes time for people to believe there is a trend change.) The VIX spiked as volatility increased, so expect to see more VIX spikes as investors wake up to a new reality. The odds are good that the bears are going to have a good week.
Opinion: I hope you are paying attention. A few commentators recommended that this is the time to go fishing, but they are wrong. This is not the time to relax. As you know, I’ve recommended “sitting and waiting” for a long time, but that’s over now. Now it’s time to get off the fishing boat and bring your “A” game to the market.
Right now, it appears the uptrend is faltering and that the bull market is coming to an end. This week will give us more clues. If the bull market is really ending, expect a lot more volatility. Judging by the charts and indicators, this seems like the real deal. As always, the Fed is ready to step in and try to prevent a stock market disaster. Everyone will be watching to see what they will do and say. In fact, if the market falls into the abyss, it’s guaranteed the Fed will announce a new program (Operation Twist 2?), a new promise (low interest rates forever?), or anything to stop the carnage. That’s when it will get interesting (and more volatile).
As I wrote in my newest column for MarketWatch (http://goo.gl/8pEsCL), instead of buying on the dip, it may be time to sell on the rallies. As for me, I added heavily to my short positions during the week, usually on the rallies. I also speculated with put options (read my book, Understanding Options, if you’ve never bought or sold options). My short trades were very successful, which tells me I’m on the right track. Still, it takes more than one good week to confirm a trend change.
Currently, most investors do not believe the market is any imminent danger. Only two weeks ago, investors were convinced the market will go up for the next two years: Dow 18,000 was within reach. Nevertheless, it takes a long time for investors to change from overconfidence to fear. As the market gets more volatile, this is also when day traders will shine, but again, take profits quickly (although that is an individual decision).
If you are not comfortable trading during a bear market, it’s understandable. It’s not an easy environment. In that case, it’s best to stay on the sidelines in cash until the bear market is over (it can take months and even a year). If this is a confirmed bear market, it can start slowly but end in a spectacular fashion (i.e. crash or capitulation).
The most bullish investors are still all in, and probably believe this recent pullback was a “buying opportunity,” or a chance to buy favorite stocks cheap. That’s what some analysts are saying on TV, but I disagree. Buying on the dip is a questionable strategy in a bear market. (Note: Even Warren Buffett is saying to buy the dip during the next correction.)
Hold onto your seats because there should be fireworks this week. With trillions of dollars in long positions, many investors are going to grit their teeth and hold, that is, until the pain gets too great. The most bullish commentators are promising a beautiful year-end rally, but I’m not convinced they are right.
Bottom line: This is going to be a very wild week. Be prepared for anything.
* Note: These signals are not actionable trades, but only guidelines. Always use other indicators, and your own research, to confirm before buying or selling.