Structural Update

Yesterday market wiped out a nearly 200 point decline by the close of the day. An impressive achievement but in the process market lost a lot of energy. These kind of reversals either mark the start of a rally or start of a sharp decline. In the rally case, these reversals are considered to be outside day reversals where the selling pressure exhausts and buying pressure takes over. In such cases, market continues to rally over the next few days. This kind of situation is typically observed after a panic wipe out.

On the other hand, if the selling pressure is not truly exhausted then rally could exhaust the buyers, leaving behind only the sellers to sell this market down. Right now we are not seeing panic and wipe out conditions. In fact, the decline in May has been very orderly, therefore, it does not appear that we have achieved a selling climax.

In terms of the market's structural possibilities, the highest probability scenario suggests that the market has completed a counter trend rally and will soon decline. The following chart shows that the rally from Friday's low to Tuesday's top was a 3 wave rally, which was followed by a clear 5-wave decline (Tuesday and Wednesday). Yesterday's rally also has only 3-waves and it stopped at the .786 retracement level (a typical retraction for 2nd waves). 3-wave moves are counter trend moves.

As long as the market does not rise above 1330 (SP500), we will soon experience a sharp decline. Even if we do, there is significant resistance in the mid 1330s. In case market starts breaking down, wave 5 target will be around 1260-1270.

However, if SP500 manages to break above 1342 then we would have to reconsider the market structure and open more bullish possibilities.

As far as a slightly long-term chart is concerned, it is evident that the market is in a clear downtrend. The market will soon complete the 3rd wave down (with the next decline). This should happen during the upcoming IPM turn window. End of 3rd wave will be followed by a 4th wave correction. Based on the concept of alternating corrective patterns, next correction will most likely be a sideways correction because 2nd wave was a upward correction.

Inflection Point Model (Daily)

"In the name of Creator, most Gracious, most Merciful"

After declining for several days at a very rapid pace, sentiment became relatively soar to justify a 2 day market rally. This rally was not only internally weak, market never broke above critical levels to justify long positions. At the same time, we are still not seeing unanimous bearishness among advisers and investors to justify a bottom. This means that we still need more work to do on the downside. Therefore, this rally will most probably fail and will give way to another round of selling. 

Moreover, according to the wave structure market also needs one more down leg, before completing an intermediate term decline pattern (detailed market structural analysis will be discussed in future posts). Furthermore, recent Put/Call ratio activity also hints towards lower prices. Although market's 2 day rise was not very strong, the Put/Call ratio along with VIX collapsed. This kind of activity does not bode well for the market's immediate future. Lower Put/Call ratio means complacency and complacency leads to market declines. 

After witnessing this curious market action, I decided to re-run both Daily and Weekly IPM Turn Models, to gather some insight about the market direction and possible market bottom dates. (Weekly IPM will be presented later)

According to this analysis there are two IPM turn dates close to each other. The first date is scheduled for May 31, 2012 (+/- 4 days, Higher Probability: -2/+4 days), while the second is scheduled after 4-5 days of the first one. for June 12, 2012 (+/- 4 days, Higher Probability: -2/+4 days). The first date has a lower significance than the second date. 

Based on the optimization results, the next IPM turn date could mark a market bottom. This could be followed by a 6-7 day rally (4th wave), then another decline into later part of June. 

In order for this pattern to play out, the market (SP500) should not rise above 1346; ideally it should test 1320s and then resume its decline by the end of this week. However, if the market does manage to rise above 1346 accompanied by strong internal strength, it would suggest that markets can further rally. Based on the time symmetry aspect, the initial decline from 1415 to 1345 lasted for 6 days, the second decline from 1365 to 1294 lasted for 6-7 days, therefore, it would make sense if the last decline also lasts 4-6 days.

Please note that since primary indices have already confirmed the 8/4 test to the downside, we are now in a downtrend and rallies will typically fail.

Note: Weekly IPM turn window and Market structural update will be presented soon.

Sharp Decline & Blog Information

Market sharply declined during the last 3 days, bringing the SP500 down to 1305 level. It is a huge decline of more than 115 points in 1.5 months. As mentioned before UST gave a sell signal on April 5, 2012. This decline is even more severe in the Global Stock Index.

This breakdown has been so severe that the major indices have declined continuously for 10 out of last 11 days. Although this kind of market decline suggests that the market is in a strong downtrend, it also has pushed the markets into an oversold territory. Therefore, there can be a oversold bounce in the near future. However, one must keep it mind that the markets can remain oversold for a long period of time, like they remained overbought for a very long time in January and February 2012.

This observation forces us to look at the market participant's sentiment to gain some insight into the market's bottom prospects. As of today, few sentiment measures are exhibiting excessive pessimism, while majority of these surveys are not showing excessive pessimism. This kind of behavior tells us that the market is not yet ready for a major bottom. I will try to update the Market Matrix over the weekend to better understand the market's internal strength and potential buy signals.

Please note that it was mentioned in the last post that a VIX based buy signal was generated. However, the buy signal was never completed. In order for the signal to be generated the VIX has to decline sharply. At the moment, it seems like the market will continue to decline and the VIX will continue to rise without generating a true buy signal. One reason supporting this possibility is the fact that the VIX is not at a high which has corresponded to previous market bottoms. Therefore, it should rise further for true panic to set into the market place.

In terms of market structure, the Russell 2000 has just completed a Head and Shoulders topping pattern. This pattern signifies a significant market top. The target of the pattern is around 720/730 (shown by the line below). If the small caps have topped, it would mean that there are some serious problems in the economic system of the country such has liquidity issue and other fundamental issues, which will come to the limelight in the near future.

Please note that the long term chart of Russell 2000 shows a very interesting technical, fundamental and socioeconomic picture. We will share these on this blog in the near future.


Blog Notice:
As you might have noticed that due to limited time UST was not updated regularly over the last 3 months. But now, we will try to update this blog on a regular basis. Every day brings new developments in the financial markets ranging from Greek Bank Run to Facebook IPO. Every news has unique global implications and there are different ways of taking advantage of these developments. We would love to share every possible market aspect in an objective manner with our readers, however, everything requires time, research, effort and monetary expenses.

At the same time, we want to be different from the main stream financial blogs by being accurate and accessible to the general public by being free for as long as possible. Alongside these ambitions, it is always rewarding to be paid for unique market analysis, different analysis techniques and other time based models.

Therefore, UST is introducing a unique "Voluntary Performance Based Social  Bonus Model (VPSBM)". In this model, reader will award the UST team with performance bonus based on creative, interesting and actionable articles, analysis, and ideas. In this way, we will be encouraged to write objective market analysis on a regular basis and you can choose the payment time and amount.

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Market Analysis - May 15, 2012

The markets have been in a persistent downtrend since early April 2012 peak. It was mentioned on this blog on April 5, 2012 that the markets might have already topped. So far this analysis, seems to be true. There can be myriad of reasons given about the recent decline, such as Euro zone elections, political uncertainty and others. However, no one talked about these potential reasons a month ago. At that time, the only thing everyone talked about was the bullish prospects of the stock market and the associated rationale. For example, easy monetary policy by the Federal Reserves, picking up of US Housing sector and fixing of Euro zone problems.

These observations highlight the importance of objective stock market analysis. Please note that I have mentioned this several times before that accurate analysis is a gift of God.

Now coming to today's market, it was mentioned in the comments section one week ago that the market was supposed to put in a short term bottom with in the turn window. Although the market did bottom in the turn window, the bounce turned out to be very subdued i.e. it only retraced around 38% of the previous decline. This behavior tells us that the market is trading heavy and can decline further. 


In fact, several markets have completed the 8/4 test to the downside which means that the markets are in a downtrend. As long as the market remains below 1376 and ultimately below 1416, market remains in a down trend. Although the IPM turn model has not been run, the market's next turn date is estimated to be near the end of the month. Therefore, market can continue to decline in May.


Update May 15, 2012 - 1:50 PM

The market pattern shown above clearly suggests that the market is entering the 3 of 3 wave down. Some might regard this pattern as an ABC decline, which would be followed by a rally. However, the market turn date is far away, which means that markets should not turn soon. Therefore, the highest probability count at the current moment is a 1-2, 1-2 count, which means that the market decline will accelerate soon. 3 of 3 waves are the strongest part of the wave structure, and are accompanied by strongest momentum. 

In order for this structure to materialize, market should start declining sharply beginning today/tomorrow. If the market rises above 1366 level then we would have to re-evaluate the situation. Therefore, a good stop location is above 1366. As mentioned above, the market is in a primary downtrend. Hence, rallies are prone to failure until unless market completes the 8/4 test to the upside (which will take another 2-3 months).

Note: Yesterday market generated a VIX based buy signal. If the market does not start to rally soon based on this signal then the market's decline will accelerate to the down side. This observation is in harmony with the earlier analysis.