Downtrend Continues

Market resumed its decline in a major way today. More interesting than the decline was the muted reaction from the traders, as VIX did not spike. If fear doesn't spike with declines, it means that we have further decline ahead.

Market rallied last week but got way over-bought in just few days. In fact, a sell signal was generated on Friday. That sell signal resulted in decline yesterday from which the market initially recovered. However, it was too much weight for the market to carry. As a result, it gave way to serious selling today.

We have been maintaining that the stock market's inherent structure changed last year in August, and suggested a move to cash. Proprietary portfolio allocation model allowed us to diversify between bonds and short stocks. This portfolio has been performing very well so far this year (link). It is up +6.7% this year, while SP500 is down 6.7% this year. We will talk about latest results in the next post. Right mow, let's look at the structure of the market.

Nasdaq along with many other indices, is tracing out another head and shoulders pattern. This pattern is larger in magnitude than the prior pattern, and could result in substantial decline.

Over the next few days, market will fill the right shoulder of this pattern. Once right shoulder is filled and market breaks below the neck-line, significant decline can be in the offering.

Head and Shoulders are reversal patterns, and when you see a cluster of these patterns, as shown above, they become even more important. Overall, it means that the trend of the last 7 years has ended and we have entered a bear market. This would mean that the economy will slow down and we might see additional bad news coming from different market segments. Oil was the initial catalyst but now we could see other areas hurting.

However, many people are just realizing this new development and others are still oblivious to a market decline. But we prepared for this potential scenario and now are waiting for the downtrend to unfold over the next few months. Bonds remain in a bull market, as yields continue to decline.

Why Trading Algo Sold Before the Debt Deal?

On July 27, Trading Algo generated a sell signal at 1322 (SP500). Since then markets have continuously declined (SP500 low of 1273 seen today). Although we have seen the debt deal materialize, UST's proprietary model is still far away from a buy signal. Such market behavior gives rise to the question, "Why did the Trading Algorithm got into cash at 1322, when everyone knew that a debt deal was certain?" 

Debt Deal and Market Response

Let us start with a question that was asked yesterday at the blog, "Market futures up due to budget deal. What is the S&P buy signal number?? Thanks." My response was, "Buy Signal will be generated above 1320. It will be interesting to see how the next few days unfold. Since debt deal was a known, are we going to see sell the Rally approach? Moreover, the bill has not passed the Congress yet. You never know if the Congress pulls-off a last minute Tuesday night drama, which could send the market down again. In any case, it is time stand on the sidelines for next few days."

This question was very thought provoking as the futures were up more than 150 points over night. However, as suggested in the reply the market gave up all the gains and some, during the initial trading hour. This kind of behavior is not only strange, it shows us that "News" does not govern the market. 

The News based trading dilemma is widespread in the financial markets. This is primarily why, UST developed the Market Matrix - a comprehensive analysis of market's strength. This analysis not only tells us where the market is headed, but also whether to trade in that direction or not. At Understand, Survive, and Thrive, we believe that market is like a river, and trading along the flow of the river is the best strategy. This is why when the market declined below 1322 and triggered the proprietary 8/4 indicator, we sold. 

Primary Reasons of Selling

First of all, last week investment advisers were not worried at all. In fact at one point they were 49% bullish according to both HSNSI and Investor Intelligence survey. This was quite worrisome. After all, if the threat of Uncle Sam defaulting or a downgrade of his debt is not enough to build a robust wall of worry, what will it take?

Secondly, the market turn (top) coincided with the Inflection Point Model (shown on right) signal. This signal, though weak, was sufficient to trigger a warning signal. Technical indicators were continuously deteriorating, and market structure was evolving into a form which resembled correction rather than start of a new up trend.

All of these developments when coupled with the 8/4 sell trigger were sufficient to get us out of the market. Even though it was certain that the market might rally based on the news of Debt deal. So I hope that all of you have seen the benefits of using UST's Trading Algorithm.

Pick the Turn Point Challenge

Now, the trend is neutral to down. There are three possible market structure scenarios. New Inflection Point date has been generated. Trading Algorithm is continuously updating its buy points. This is the most opportune time to launch the Pick the Turn Point Challenge. Here, we will try to identify the next market turn point. So stay tuned.