Securities Research Services

Friday, March 02, 2007

Rallies are Now Selling Opportunities

The Dow chart offers some clues on what to look for over the next few weeks. Right now the Dow, and nearly the entire market, is experiencing what looks to be a classic A, B, C correction.

Major momentum indicators diverge sharply against other recent corrections on the weekly index views this week. This shows us that this correction is something more than just a temporary set back in the larger uptrend. It also indicates to us that buyers who try to buy the dips here are facing an uphill battle unless they are daytraders who open and close their positions the same day. Any bounce here is quite likely to run out of momentum quickly until the market corrects further and washes out every last inkling of bullish hope that remains.

This is a normal cycle in the market and the pattern repeats itself so often that it's a wonder why so few recognize it until it's too late to profit from it.

Let's take a look.

Leg A:
May 10 of 2006 started off with a slide very similar to the correction we have seen this week. During this slide bulls who were caught off guard either sold in panic or gritted their teeth and held on for a bounce to sell into to get a better exit price. This all happened in leg A down, as seen in the Dow chart below.

After a very sharp sell off the market finally found support, much like the Dow has done over the past two trade days. This encouraged longs who had held their positions through the first leg down and they started to look for the ever elusive "V" type recovery as they imagined that the market would turn on a dime and march right back up the hill. Likewise, many who had sold in panic during leg A down, started to worry that they would miss out on a sharp recovery and they bought back in on the bounce. This occurred during the B leg of the corrective move.

Leg B:
One thing that many fail to understand is that the market is like an oil tanker. Oil tankers, when full, take miles to turn around and change course. The reason why is that they have so much momentum behind them that they need to make a slow and gradual turn. The market also is a gigantic mechanism and when it gets momentum going like it did this week, it needs to work off that momentum before it can make a full turn.

Leg C:
Thus, we see that wave B could not possibly find enough buying strength to overcome the market's momentum and a sharp leg C down ensued. Oftentimes during these corrections, those who held on during leg A down, finally give up hope and capitulate during leg C. When they capitulate, what they don't realize is that the momentum pressure has finally eased and smart institutional money moves back in.

This is why this pattern repeats itself. Human psychology almost demands that it does.

So then, take a look at the current Dow chart.

As mentioned above, momentum indicators are strongly diverged against recent minor corrections. As such, we have to interpret the momentum as down here. If we are correct about this developing pattern, then over the next week or week and a half, we should see a minor bounce, represented by B in the chart above. If this bounce does not turn into a sharp rally higher, which we seriously doubt it will, then we are very likely going to see a great buying opportunity emerge in a leg C down.

As we mentioned in yesterday's report, we will be looking for a minor bounce next week to short into.

You can see then how these corrective moves provide for strong trading opportunities both on the corrective move down and then at capitulation, which usually leads to a great rally back up; sometimes even on to higher highs.


Anonymous said...

i agree 100%ly (and my indicators say the same thing). the pullback in my comment yesterday was exactly the B part in your a-b-c correction. i was not as fast as you to foresee the v pullback at the very end. (i always trade in a very short term.)

so give me a sign for the part C. i will definitely short the spx500. (dow ist too expensive for me to trade.)


Anonymous said...

dear srs,

i believe, today as daytraders we could even short the market, starting from 12030(dow) and ending with 12830(dow).

do you agree? i wish i could have your confirmation.

regard, wez.

SRSFinance said...

It does look like today could be another rough day on the longs. We are not daytraders, however so can't comment on how far the Dow may or may not move today.

Anonymous said...

dear srs,

firstly thank you for the approximate confirmation today.

now I've got another question:

my short term indicators point to 11000(dow) and 1300(spx500) for the c part of your abc-correction.

at the same time, my short term indicators for german market forsake a large pullback to 7200(dax) after a correction till 6300.

now i don't really understand the market development of the both countries. dax should always follows dow and now we have dow dropping down to 11000 and dax only to 6300 and than back to 7200. for the moment it is quite stupid that i have conflicting indicators.

what do you think how all these markets would look like in a few weeks?

regard, wez.

SRSFinance said...

We don't generally track the DAX, so can't comment on the seeming divergence. Less exposure to the Asian markets perhaps?