Saturday, February 5, 2011

Mid February 2011 - Be Careful

On January 12, 2011, I stated that the inflection point models were suggesting a top around mid February 2011 in the financial markets. Interestingly, SP500 has continued to rise since that time. Even during the brief decline due to Egypt fears, my model (Inflection Point Model + Market Matrix) did not generate a sell signal. In order to refine the turn dates based on the most recent market data, I re-ran the two inflection point models. 

Model 1 and model 2, both are suggesting that the next market turn date will be around February 14, 2011. Since both models are in agreement, we might witness a significant decline i.e. 5-10 %. Furthermore, week of February 14 is the options expirations week and normally market turns during options expiration. This date is also confirmed by several other market measures like:

1- Sentiment: Extreme Optimism (expectations of higher inflation and higher stock prices)
2- Almost complete Elliott Wave structure of Indices, US Dollar and Commodities 
3- Cycles 
4- Indicators

I will discuss these four components in forthcoming upcoming Market Matrix posts. In short, we might be nearing a significant top in the financial markets but nearing does not necessarily means topped and does not generate a signal to exit longs.  Therefore, even if the market does decline in the vicinity of the upcoming turn-date, I will wait for a confirmation from the second model before exiting longs and going short. This confirmation has prevented me from prematurely exiting the market on the recent insignificant declines. 
One question that I have been asking myself, is that how to use this data for trading purposes. In this regard, there are typically three scenarios in which this turn date can play out:

1- Market tops and Declines till the next turn date - Highest Probability
This is the highest probability scenario because of optimistic extremes evident from different surveys, almost complete EW structure and a faltering rally. Since this rally has been going on for the last 7 months, correction should at least last a few weeks. 

2- Market pauses (shallow decline/sideways), Resumes uptrend and Top at the next turn date - Medium Probability 
Although this is a lower probability option, if the market manages to rise above the high set around the vicinity of the forthcoming turn date then it would suggest that market will continue to rise. In that case market will most probably rise till March 2011.

3- Market rises, and then Falls into the next turn date - Lowest Probability
This situation is possible if market makes a top in late February 2011. The best technique to counter this scenario is to have a tight stop. Therefore, if the market falls below a particular level then one should exit. In this way, he will be sure of the new direction i.e. lower. As of today, the trend reversal level (on a closing basis) is 1280 for SP500. This scenario is low probability because over the course of last 2 years this scenario has played out very rarely.

1- If the market does not declines significantly or rises sharply after a trend reversal date, it would go sideways for some time: This kind of behavior is normally exhibited by strongly up or down trending markets.
2- Always trade in the direction of the trend. Even if there is a trend reversal date, wait for confirmation by other signals because "Markets can remain irrational, more than you can remain solvent."

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