Market Rally and Upcoming Earnings...

Wow, the market zoomed from 1265 to 1320 in 1 week. Understand, Survive and Thrive predicted an upcoming rally on June 24, 2011, when SP500 was at 1267. In less than 1 week market has risen more than 4%.

Today, I did some statistical calculations and came to the conclusion that during Bull markets the first 1.3 months of a new rally has a extremely low probability for a 5% decline. Therefore, the market can continue to rise into end of July before any significant correction. This will also be a place to exit longs, and wait to re-enter.

However, markets do not rise in a straight line. This means that we should expect at least a partial retracement during early July to digest current gains. July 11 will mark the beginning of the 2nd Quarter earning season. This can be a good point for the market to digest some gains.

The following chart shows that the symmetric market (Top-Bottom-Bottom-Top) response would take the market up until July 11, 2011.

Therefore, one should be careful around July 11, 2011. We will further analyze the Inflection Point Model to better gauge next potential market turn.

"Resignation to the will of God, is the cure of the disease of heart." (Hazrat Ali)

Future Rally & Risk Management!!

Today was a very exciting day. The market went down 200+ points and then came back up to close down just 60 points. While, Nasdaq and Russell 2000 ended positive. In my last post I mentioned that according to the Inflection point model, the market might have bottomed and the trading algorithm gave a partial buy signal. This observation remains true so far.

Now, if the market (SP500) declines below the 1258 low, made on June 16, after Monday, then we might be in some serious trouble. Otherwise, we might soon be seeing a good rally. I will write about trading algorithms full buy signal when it will be generated. Since this algorithm catches long term trend, it is imperative that one should obey the partial buys and full buys, as they are generated. 

Last week, I shared the Market Matrix with few people who inquired about subscription, and will post it on the blog within one week. The conclusion of the Market Matrix was that we are very close to a bottom with majority of the fields being green.

In July, Understand, Survive and Thrive's second Newsletter will also be released. In order to make it interactive, I would appreciate your suggestions for the newsletter.  

Market Bottomed?

It is possible that market might have already bottomed within the June 16 to June 27 Turn Window. 

If this is the case then the following chart would best summarize the current Market Structure:

 

This is the updated version of the chart presented earlier. It means that if we did see the bottom on June 16, 2011, we will not break that low for quite some time. Furthermore, this pattern suggests that once the current rally finishes market will experience a deeper correction. This action might coincide with the release of next quarter's earnings reports in early July 2011.

The major motivation behind the triangle formation is the 3 waves nature of the overall wave structure i.e. every wave a, b, c, d and e, are all sub-divided into 3 segments. Furthermore, since 4th waves are typically triangles, this interpretation could be the right one. Finally, if the SP500 rise above 1307 & DJIA rises above 12310, it would eliminate the five wave potential for the current decline since May 2011. 

In any case, I will wait for the Trading Algorithm to give a buy signal before going long because "it is better to be on the sideline and wishing you were in the trade, then being in the trade and wishing you were out of it."

Note: Trading Algorithm gave a partial buy signal today based on Market Matrix and Market Barometer Analysis. 

The Bond Story - Case for QE3

Over the last few days, I have heard a lot about a possible stock market crash, 10%+ correction, end of QE2, global socioeconomic uncertainty, impending Greek bankruptcy and much much more. As a result, I decided to look at long term Treasury Bonds charts to decipher the market behavior.

Following chart shows the 30 year bond yields since 1980 top. 

Figure 1

Bond yields have been falling since 1980s. Consequently bond prices have been in a long term bull market. However, recently we started hearing a lot about the end of the bond bull, and the beginning of a new multi-year bond bear market with higher yields.

I would agree that one year ago people were very bullish on bonds and rightly so because bonds had been rising for the past 30 years. However, to my amazement people turned bearish very fast. Many experts like Bill Gross of PIMCO not only exited his US treasury bond positions, he even went short. 

Figure 2

In this regard, I came to a totally different conclusion after carefully analyzing the historical bond market data from daily, weekly and monthly perspectives. It seems like that over the past 3 years, the bond market has been carving out a triangle pattern (not complete), as seen on the left. 

Triangles are continuation patterns, and lead to sharp move in the prior direction. In this case, the move out of the triangle pattern would mean that we will soon experience a sharp decline in bond yields and a sharp rise in bond prices.  

Implications of such a move are very severe because bond yields decline would mean the following: 

We are about to see a sharp rise in Bond prices, which happens in situations of extreme fear. Therefore, we might be heading towards a depression, sharp stock market decline and commodity bear market.

However, in order for the triangle pattern to complete the bond yields need to rise once more in an 'e' wave (shown in fig 2). This rise in yields would result in declining bond prices. The following chart paints a very interesting picture this regard.

Figure 3

This chart highlights the impact of QE announcements on the bond prices i.e. Bonds decline after the announcement of QE e.g. QE1 in Dec 2008 and QE2 in August 2010 (If you invert this chart, you will get the yields). Now, lets put together various pieces of the this convoluted puzzle:

1- Next week is the FOMC meeting 

2- Economy is lagging

3- Stock market is declining

4- Unemployment is high

5- Bond prices have been rising for the past several weeks

6- Bonds need final 'e' wave to complete the triangle pattern

Under these circumstances, it would be highly coincidental if the Fed announces QE3 or something similar. This announcement could result in lower bond prices completing the 'e' wave, and allowing the stock market to rise further into October 2011. After that bond prices might be ready to embark on their final rally leg, changing the face of economy as we know it. 

Note: In order for this scenario to play out, bond prices should not decline below the first low made after QE1 announcement. 

This is a hypothetical but an interesting possibility that I wanted to share with my readers. But it should not be treated as the best indicator of the future stock market movement. I will be presenting the latest readings of the Market Matrix & Market Barometer over the next few days, delineating the market behavior from various perspectives.

Market Structure & IPM - Part 2

After going over the Inflection Point Model, I decided to analyze the Market's Structure to determine possible market patterns which could result in a Stock Market Bottom next week. Since market structure is a primary determinant of trend changes, I will solely try to analyze the structure of SP500 in this post.

Looking at the weekly chart, it seems very clear that the rally from the March 2009 low has been impulsive. This means that individual rally segments have had 5 waves. Therefore, we are missing the final rally leg to complete the broader 5 wave sequence.

After looking at the above chart, it seems clear that we have strong trend line support near 1220 (SP500). Furthermore, in order for the above mentioned (4th Wave) scenario to play out, the market should bottom above 1222 (SP500).

The second most important aspect of the current correction is that it is tracing out a classic corrective pattern. This pattern is called 3-3-5, with the final wave having 5 sub-divisions.

However, right now we only have 3-3-3 structure. Therefore, in order for the market to complete the corrective pattern, it should hold up for 1 more day and then decline to a new low below the March 2011 low at 1248 (SP500). Since this is the most appropriate market structure meeting the upcoming market turn date (according to the last post), I am delineating it over here.

Note: Triangle pattern will take longer to complete. Therefore, it is a lower probability at this juncture.

Conclusion:
Market should bottom between 1250 and 1222. In any case, I will wait for the trading alogorithm to generate a buy signal before going long.

Inflection Point Model - June 16 to June 27

Model 1 and Model 2 first produced the May turn date in April 2011. In order to get a handle on the potential bottom of the market, these two Inflection Point Models have been re-run and following conclusions were achieved. 

Although Model 1 is suggesting that the next market turn date will be around June 21, 2011 (+/- 4 days), Model 2 is not giving us a clear indication. Consequently, we can have a turn window from June 17 to June 27, but this window is not very reliable due to presence of turn date only in one model. Furthermore, next week is the FOMC week and many times market turns during this week. 
         Now the question remains: What type of pattern will the market trace out over the next few days, which will suggest that we have seen th bottom? I will further analyze the market from other perspectives to better comprehend the future market trajectory.

Trading Algorithm Validity

Head Fakes are a part of the stock market game. Goal should be to remain stead fast with one's principles and techniques. A similar issue took place on June 2, 2011, when the market's rally was a great head fake. In any case, it seems like my Model Was Right after all.

I wrote this on May 22, 2011:

"However, over the past two days market has declined sharply. Invalidating the ending diagonal pattern and bringing the bearish pattern to the top of the list. This decline has also led to the fulfillment of the proprietary 8/4 rule, converting me into a seller of rallies from a buyer of dips." 

As a result, I did exit my 401K and got everything into cash. In future, I have realized that never trade against the model. 

In any case, current decline seems to be carving out a series of 3 waves i.e. 3 wave decline from Feb 2011 to March, then 3 wave rise from March to April, and then current decline in 3 waves from May to June 2011 (as seen below). Therefore, as long as market (SP500) stays above 1247, to me it would mean that the market is carving out a triangle. Triangles result in a sharp rally in the previous direction, which would be up in this case.

Stock Inflection Analysis

After today's drastic sell-off, after reading a lot about the impending correction in June, after listening to Dr. Doom, Nouriel Rubini's prediction of lower prices and after perusing through various blogs, I went back to basics to analyze the stock market's behavior in terms of my proprietary models.

According to the Inflection Point Model, it seems like there were two potential turning points in May 2011. First in mid May and second on May 25, 2011. The second inflection point was a relatively weaker turning point, in comparison to the mid May turning point. Furthermore, these turning points were not confirmed by Model 2. This non-confirmation can sometime mean that the suggested turning point is not strong enough.

In order to further analyze the weaker turning point (lower amplitude of the turn power), I went back to identify locations when the market bottomed or topped at the weaker turn point. After analysis, it seems like November 2010 bottom also coincided with a weaker turn point, and this bottom resulted in a 10% + stock market rally.

Therefore, it is possible that the market might have bottomed on May 25, 2011. However, if the market declines below the May 25, 2011 low then it would mean that the market did not bottom, and will continue to go down for the next two weeks. This is the time when we have the next turn date coming up.

June 1, 2011 Sentiment and EW:

If the above analysis is true, it would suggest that current decline was wave 2. Wave 2 normally brings about a lot of pessimism. This was particularly true for today's stock market action.

In this chart it is clearly evident that the fear did spike today. Since previous corrections have ended with a spike in fear, it would be very interesting to keep a close eye on the stock market performance over the next few days.

Finally, there are several non-conformances which might prove to be bullish. For example:

1-  Copper is well above its May low

2-  DJIA made a lower low today, where as SP500/Nasdaq/Russel did not make a lower low (similar to November 2010 low)  

3-  Euro has not declined significantly

Pattern Termination Level: Close below 1309 (SP500)

Stocks Rally, Housing Declines!!!

What a great relationship!!! This shows that fundamental news do not solely govern the movement of the stock market. Instead, collective social response of news is depicted through the stock price movement.

In my last post, I mentioned that it is very tough to gauge the stock market 100%. That is why I developed the Trading Algorithm. The best aspect of this algorithm is that is tries to inhibit whipsaws by going long/short by clearly defining the underlying trend condition.

In this regard, something very interesting happened today: the market broke above certain critical price levels, as calculated by the objective daily "trading algorithm." This break indicates that the stock market's primary trend is now up, and one should expect surprises to the upside. 

Although the last 4 weeks of declining stock market has resulted in one of the longest market correction since last summer, it is interesting to see that we are not seeing all out pessimism. This might be a signal that we should see further decline. However, keeping in mind the Elliott Wave count and the Market Matrix, it is possible that markets are on the verge of the 3rd wave. Third waves are normally the strongest waves, and before their start pessimism or optimism is not very extreme. For example, optimism was not very elevated in September 2008, just before the Lehman Brother's collapse but we saw several government bailout plans being introduced to thwart the problem. 

Similarly, at this time we are not seeing excessive pessimism and there are several government sponsored programs being introduced to curtail the commodities and stock bull run. For example, increase in margin requirements and end of the QE2. These developments are analogous to the events of September 2008 but in the opposite direction. Then they tried to stop the decline, now they are trying to stop the rise. 

In any case, the market will do whatever it intends on doing. As per the Elliott Wave Analysis (will be discussed in the next post), the highest potential trade will be to the upside, as long as the recent lows are held.