Friday, July 22, 2011

7 Month Trading Range: Breakdown or Breakout (Part 3)

"The billionaire trader said on the call that investing with him would never be free from turbulence, but he said that global economic factors have made this year's ride bumpier than he is willing to stomach." Reuters (Paulson: Our Bets Were Too Aggressive)

In contrast, the Understand, Survive and Thrive team has nailed this market from all directions, over the last 7 months or so. And I would like to thank God for such prime performance. 

Now lets look at the Breakout scenario. It is highly probable that this 7 month long consolidation, was a 7 month long sideways correction. Corrections can take various shapes i.e. either by time (sideways) or by price (down move). Once this correction ends, we will experience a very sharp rally. I have been favoring this scenario for the past few months. The following chart was published in June/July 2011. These charts show the evolving triangle formation.
If you would have known this scenario, you could have made serious profit over the past few months. In any case, following is the current chart of the SP500 - A fully complete triangle, ripe for a breakout above 1370.
Since February 2011 top, we have experienced 5 market moves between 1250 and 1370 (SP500). All of these moves have been in 3 wave format, which suggests that we are in a triangle formation. Triangle formations are consolidations, which lead to significant moves in the primary trend direction. Because we are currently in an uptrend, the next major move out of this triangle should be to the upside. 

Sentiment Support
If it were the top, we would be reading articles about the best of days are in front of us rather than articles about economic recession and layoffs. Furthermore, the article from Reuters about John Paulson, is a contrarion indicator. How Ironic will it be that a Star Hedge Fund manager says, "Eighty-one percent was way too high. We cannot operate the fund at that level, I'd like to bring the risk down further to about 50 percent," right as the stock market is about to stage a huge rally.

Historical Examples:
Following charts show what happens after the market breaks out of sideways correction - Triangle formation. In both instances, these indices experiences a sharp rally to the upside after they broke out of the trading range, as their primary trend was up.
Sensex - Indian Stock Market (2009-2010)
Emerging Markets ETF (EEM) - 2009-2011)
In the next post, I will discuss the current sentiment & fundamental picture in detail. It will support or negate either one of the two scenarios (Breakout or Breakdown).

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