Trading Algorithm Update - September 20, 2011

Update: 11:00 AM

Why do I have the feeling that there is something wrong with this market? I know that pessimism is high but also the market itself is not trading very well. Why are the Small caps and Financials lagging both SP500 and Nasdaq? Small caps are supposed to be the leaders of a new rally!!! I do not know, but there is something wrong... Are we going to see another QE tomorrow? Are we going to experience "Sell the News" event with QE3? These are all the questions that are confusing me.

Original Post

Market: Bear	Defining Level: 1210 (closing)
Trend: Down	Defining Level: 1255
4/8 Trend Change Confirmation (Up to Down): Yes on July 27, 2011
Current Trade: Short from 1197 with tight stop above 1213 (CLOSING - 1210) Profit Objective 1: 1160                                                            Trailing Stop (closing): Profit Objective 2: 1124                                                            EW Stop: 1213 Status: Short from 1196. Risk associated with this trade: 1.4%
Next Trade / Model Based Approach: Long Stop:  Above highs                                                                    Risk:  Risk Associated with trade: Market conditions will be continuously evaluated for better entry
Turn Window: September 20 (+/- 4 days) Market has entered the turn window. Market's behavior over the last few days suggest that we will see a top	Scenarios 1-   Market bottoms in turn window 2-   Market tops in turn window 3-   Market double bottoms and breaks out 4-   Market double tops and breaks down
Observations:  US Markets declined sharply yesterday morning. However, by the end of the day they had regained most of the losses. If the market continues its decline and falls below 1188 then the down trend will be confirmed. On the other hand, if the market rises above 1215 and close above 1212 then we will be stopped out. The reason why I am not suggesting long is because it is never prudent to trade against the broader trend, especially within the Inflection Point Model turn window. Sharp decline from near current levels, will confirm the potential H&S pattern presented in the last Trading Algorithm Update. On the other hand, we should appreciate the fact that Market has risen more than 75 SP500 points (600 Dow points), and even with such significant rise we have not seen a significant increase in the overall optimism. In fact, investors are very pessimistic. This is bullish for the market and can lead to a sharp rally. Note: Downside decline structure has not been constructive (more of a corrective pattern rather than primary pattern) Interesting Scenario: Market bottoms tomorrow on the exact turn date and starts rallying sharply. We observed this kind of behavior during the February 2010 turn window. At that time, we also had very elevated pessimism. Although this is a low probability scenario, it is still possible because of market participants' pessimism. Pessimism: This emotion leads to extra defensive stock trades, with excessive hedging. Under such circumstances, whenever there is slightly better news market rallies because shorts cover and money on the sidelines come to buy.    As mentioned earlier, Trading Algorithm does not participate in counter trend trades until unless there is ample conviction through Inflection Point Model. We might be near one of those high conviction points. In the broader scheme of things, market is still struggling with the 1210 level (SP500). It will be prudent to stay on the sidelines if you are not in, and if you are in the keep your stops in place because we are about to see an explosive move in either direction.