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Decision Time

The SPY is now at a price where the market needs to decide one way or the other where things go next. The price has been squeezed into a corner here and we will either see soon see a breakout or a decline that could lead to a retest of November's lows.

Our thoughts here, and they're just our thoughts, is that we will see the minor uptrend break and prices will move back to November lows and perhaps slightly beyond.

Despite the interest rate cut this week, prices have moved quite a way off their November lows and all the bottom callers are back as the crowd turns semi bullish.

Moreover, V-shape recoveries don't often survive in bear markets to which we remain.

The market was showing some good bullish divergences of late but it has failed to follow through with volume buying and as such we feel that the market must fall on its own weight once again. We wouldn't put money down either way until there is confirmation, but be prepared with a list of stocks to short should it break here as it could break fast.

Below are a couple of potential scenarios that could unfold from here:

When Will The Market Bottom?

That's the question that is on everyone's mind right now. The answer is, no one knows.

That doesn't mean that there won't be clues however.

We have put together an report that explains how to recognize a market bottom and how to trade it. Get in for the next bull market well before the crowd by downloading this report.

Rising Wedge

Yesterday the market failed to follow through on the buying that incurred following Tuesday's huge rate cut. As such, a trend has not yet been established and prices remain vulnerable to intraday reversals.

The SPY is trading in a rising wedge pattern. This pattern is quite bearish and unless we see some large volume up days we suspect that this pattern will resolve in a retest of November's lows.

We aren't comfortable shorting the market yet due to the recent bullish money flow divergences but unless buyers step up here this market is just going to fall on its own weight once again.

A Trend May Be Developing

The market has been range bound for the past two months. This has not offered position or swing traders much to work with as prices have stopped and reversed on an almost daily basis.

Yesterday stocks responded well to the Fed rate cut and the major indexes all closed above their 50-day averages for the first time since August.

What is different between the August breakout and this month's breakout are two important details. First, volume has been very heavy over recent weeks as a base of support was being built. Second, breadth was excellent yesterday as the vast majority of stocks were up on volume increases.

The trend is as yet unproven but if we can see a base of support establish above the 50-day averages then the rally potential into year's end could offer some excellent swing trades.

We still think that SPY $700 needs to be tested before any longer term rallies can develop but that doesn't mean that this rally can't be traded for a profit if it can first confirm.

Sentiment

Friday the market once again bought the weakness. This is bullish. Near term, however, sentiment readings are not favorable to the bulls. Long term sentiment has moved below neutral into the slightly bullish category. This does not favor a lasting move and may be a reason to short strength if we get it this week.

News Driven Market Demands Adjustments

Problem:

There are two important factors about the current market environment that play an important role into how we approach our trading strategies going forward:

A) The first factor that requires careful consideration is the fact that buyers have been fairly aggressive about buying dips. We have now seen the market hammered with bad news for weeks. This tells us that bad news is likely priced in and that a slightly bullish bias exists at this current time. That said, this is probably not a market that is ready to rally significantly; rather it's a market that is fighting off efforts to take it lower. This is an important distinction.

B) Second, on a daily basis this market is news driven and range bound.

The second factor is probably the most important factor to consider because it is this that has been affecting our trading results and it is to this that we must adjust our strategies to meet the current challenges that we are faced with in this unusual market.

The lack of a trend and the extreme volatility driven by daily news events has caused trade set ups to appear good and solid on one day only to evaporate the following day. Agilent Technologies (Ticker Symbol: A) is a great example. Two days of heavy volume and a tight range indicated that it was ready to break higher. When the market gapped down Friday the set up that drew us in eroded and A gapped down with the market.

Solution:

The solution to this is to adjust our strategies to the market conditions that exist. That means we must anticipate gaps and weak opens on some days. Likewise, because we have good evidence that dip buyers are aggressive even if follow through buying is not, we need to look for ultimate support on the strongest stocks and wait for the price to come back to us.

In other words, forget about following strength in this market. We need to buy weakness in strong stocks. This means we need to be patient. Much more patient than we have been; waiting for the weak open like the one last Friday before buying in.

Another Weak Friday Open

Stocks are set for another sharp drop for the second Friday in a row. Last Friday buyers bought the bad news. Will they do so again today?

Base Breakout

The market formed a base after trading in a range over the past 6 or so weeks. On Friday buyers bought the bad employment report and on Monday stocks broke out of the base.

All this is quite bullish for the intermediate term outlook. Nevertheless, volatility remains at historic highs so chasing prices is not advisable. At best this provides the all clear sign to buy the dips as long as position sizes are kept low and stops are used.

Inverted Head and Shoulders

The SPY has formed an inverted head and shoulders pattern on its daily chart after last week's breakdown failed to follow through. We have seen great accumulation over the past two days as the right shoulder has been heavily defended.

Interesting Development

Yesterday sellers came back from the holiday break and hit the market hard. Unfortunately, all this did was mess up the charts so as to keep everyone guessing what to expect next.

It is our gut feeling that this market has gone down too far to provide good shorting opportunities that are worth more than just a quick day trade. We are not convinced that the downtrend is resuming here and we have the idea that this may just be part of a bottoming process. What type of bottom is anyone's best guess.

What we do find interesting is this. [Warning: What follows is a bit data intensive] Today we scanned all stocks above $10 per share that trade at least 1 million shares per day. Of this group we discovered that more than half (about 55%) are showing bullish accumulation divergences. About 35% of these stocks are showing no divergences while only 10% are showing bearish divergences.

We don't know if this means anything yet and it is certainly not reason to start buying stocks here but it may be telling us it's too late to go short even while it's still too early to go long.

In other words, it may remain just a day trader's market while a base-building process works itself out.

Overbought?

Stocks are overbought here after 5 days in a row without a pullback. Traders are also probably well aware that volume shrank on the rise. This is absolutely a classic short set up. The question is, will it work?

Our scans are showing us quite a large number of stocks behaving well here. A big, high volume down day would probably eliminate this finding, but it is what it is at this moment. The market usually does what everyone thinks it won't do, so does that mean this time it's going to continue higher?

We wouldn't put a lot of money on this idea, but we wouldn't short without confirmation either. Taking a wait-and-see view here seems to be the most prudent course of action as we enter arguably the most bullish month of the year.

How To Recognize When A Stock Market Bottom Is In Place

The stock market fell 50% from its high this year but if investors were paying attention, they could have avoided most, if not all of the loss. The big questions that remain, however, is where is the bottom and when will it be safe to buy again? Click here in order to learn to recognize a bottom and avoid buying too early the way Warren Buffet did when he lost 50%.

Any thoughts? We would appreciate your comments, good or bad.

Is This Short Squeeze Any Different?

Over the past two trading days we have experienced a short squeeze. Late Friday the market rallied on the news of Obama's Treasury Secretary nominee and then yesterday bulls had the impetus of a Citigroup bailout.

But is it enough?

So far we see no evidence that this short squeeze is any different than the short lived squeezes we have witnessed over the past couple of months. Volume shrank on Monday and prices merely rallied back into resistance.

That said, this is a holiday week and just rallying into resistance is not a good reason to re enter short positions. The big cats will be away this week leaving the mice room to play.

Moreover, it is important to keep in mind that the market remains historically oversold. At some point a significant bear market rally will develop.

The bottom line here is that trading conditions are not very favorable here. If the market can continue to drift higher on decreasing volume then we would go ahead and short again. If it pulls back on lighter volume there might be a good bounce trade to play. As things now sit, we just don't see any real advantages either way (at least ones that fit our trading style) so we will be sitting on our hands in cash waiting to see how things develop from here.

Very Scary S&P 500 Chart

While the SPY has yet to reach its 2002 lows of $71.20, the S&P 500 has now breached those lows.

We try not to make too much of technical analysis when applied to such large time frames since it seems rather dubious that such long term charts expanded to multi year monthly levels can accurately portray institutional positioning for future events. This is because the future is dynamic and investors will be reacting to unknown events in the future.

Let us try and put this in more simple language. Technical analysis lets us peak into the inner workings of the market and lets us know if there is current accumulation or current distribution. Current accumulation and distribution typically is a response to the outlook in the near term, whether it be last week's earnings or next quarter's projections.

But no one has a crystal ball that can tell us what is going to happen a year from now and every day the market reassesses the current outlook based on what the Fed does with interest rates, what the companies are projecting in future earnings, whether the government will bail out GM, etc...

Nevertheless, technically the S&P is in worse shape now than it was in 2002 when it struck bottom last. Technically, there is no real support before S&P 500 $450 and that's a scary prospect. Let's hope the outlook starts to change and change quick.

SPY $85 is Key

On Thursday buyers saved the day and gave bulls hope that a bottom was put in place. Typically a high volume save at support does indeed indicate that buyers are taking back control.

The problem is, on Friday prices once again eroded.

Sellers may have been on strike, but buyers did not step into the void and now we have a market that is just falling on its own weight.

We will get the countertrend rally we wrote about in yesterday's report. However, if the SPY breaks back below $85 on a closing basis then that rally may have to start from lower prices.

The Potential for a Large Stock Market Rally

This week economist John Mauldin writes:

The Potential for a Large Stock Market Rally Everyone knows that there are large amounts of hedge fund redemptions being processed. Some blame the current vicious sell-off on forced hedge fund sales as they have to meet these redemptions at the end of the quarter. This brings up an interesting possibility. My guess is that the large bulk of that money is going back to institutions that will need to put the money to work. Where will they deploy it? If they are projecting 7-8% total portfolio returns, they cannot put that money in bonds. My guess is that it will go back to other hedge funds or into long-only managers. This money will start to go to work in mid- to late January. We could see a very large rally the first quarter of next year. For traders, this will be a chance to make some money. I think it will be a bear market rally, as the recession will still be in full swing, and we could see a pullback when that money gets fully deployed. But it will be fun while it lasts. As traders begin to sense that possibility, we could see a serious year-end rally as well. Would I bet the farm? No, but I offer up the idea as a possibility. And I know a lot of people have large short positions that have made them a lot of money this year. Maybe it is time to think about taking profits. And now a few thoughts on the possibility of bailing out GM.

So let's take a look at the market and see if there are any clues that back up this possibility.

In October we saw the market essentially fall off the edge of a cliff, which changed the volatility parameters and threw our Risk Assessment Meter (RAM) for a loop.

Just a quick summary, the RAM measured the distance of price from the mean (or 50-week average). When prices revert too far from the mean in either direction, then a counter trend rally or decline typically ensues as prices revert back to their mean.

The steep market decline changed the parameters of "normal" oversold conditions as volatility increased dramatically to historic all time highs.

Nevertheless, this does not discount the rule that prices still return to the mean, the increase in volatility just expanded the range. In other words, despite the massive sell off, prices will not go down forever. At some point a countertrend rally will develop as prices return to the newly expanded mean. Except now, since we don't have historical measures to rely on, we won't know how oversold is too oversold until we see prices turn around and rally. We do know, however, that prices will at some point turn around and rally and that that rally will very likely be a whopper.

Back to the SPY chart again:

The SPY declined by a massive amount in October, but over the past 6 weeks we have seen prices settle into a trading range. Last week prices threatened to break down through the floor of this range, but on Thursday buyers stepped in and pushed prices back into the range on a closing basis.

This is our first clue that we are potentially nearing the line in the sand that marks the point at which the markets are now too oversold to go any lower before we get the regression to the mean rally that is inevitable at some point.

We don't know yet if this is it, but the fact that prices have not been able to push through $85 on the SPY on a closing basis is interesting.

This does not mean it is time to buy. Rather, it means it is time to be careful and observant. If prices can break through $85 on a closing basis then we may be in for another decline before a countertrend rally develops. But we haven't seen that yet. Until we do, it's dangerous to open new short positions. At the same time, it's dangerous to open new long positions as well until we get a follow through day to the upside.

We made that mistake on Friday and we paid for it. We are now licking our wounds are will wait for either a follow through day or a breakdown before acting further.

Slip Slidn' Away

What is significant about the market here is the fact that more than 300 heavily traded stocks have already closed below October lows. If the current trading range were a bottoming base we would expect to see market leaders breaking out to the upside, not the downside.

In fact, the only stocks seeing significant buying interest are the recession stocks like NDN.

Meanwhile, major retailers are trading at 52-week lows and oil and construction oriented stocks are down their with them.

It appears as if we are headed for another washout low before any significant buying interest reemerges.

Too Many Still Looking For Upside

Sentiment continues to be unfavorable for the bulls. Even as the market struggled yesterday more became convinced of upside potential. This overly bullish sentiment does not bode well for SPY support, which stands at $90. A break below that level will very likely lead to a retest of last month's lows and could potentially lead to a breakdown and the possibility of a true capitulation event.

Market Sentiment

We had an up day on decreased volume today. This doesn't give a lot of cause for confidence. Even moreso heightened bullishness readings give one a reason for pause as the market continues to struggle to mount a rally: Sentiment readings from Ticker Sense. Sentiment Trader has investment sentiment back at neutral. This is where it has been during each market downturn over the past few months.

Market Rolls Over

The inverted head and shoulders pattern on the SPY is in jeopardy of failing. Leading the way lower are commodities, retail and banking. This could be just trading range activity, but it has a much more ominous look to it.

Break Fails to Show Follow Through

The SPY broke out above the neckline of an inverted head and shoulders pattern this week. However, the breakout failed to follow through and was turned back on slightly larger volume today.

It's a good idea to lighten up on all long positions that are underperforming. We are unsure if this gives us a good short set up. From failed moves come fast moves, so there is some potential that short positions will work here. However, with the flattening 20-day average one has to wonder if we aren't just in for a period of consolidation rather than another sweep lower.

In any case, it's best to exit recently opened longs and wait for better entry set ups again rather than to get agressive in either direction here.

Short Squeeze Underway

Prices rallied higher on increased volume today. The S&P 500 has broken the neckline of an inverted head and shoulders pattern. The price target, if the pattern holds up, should be roughly $110; a significant gain from current price levels.

Stalemate

The indices sit right below resistance and no one has yet blinked. Do we get a breakout and ensuing short squeeze or do we get another rejection? Time will tell so hedge your positions here.

Falling 20-day Average Attracts More Selling

The ever elusive follow through day day failed to arrive. Buyers may surprise us here over the next few days but the fact that the S&P 500 was turned back at its falling 20-day average must be sobering to the bulls.

A couple of days ago it looked as if the October lows would fail. Now we have to wonder if a retest and perhaps a failure of those lows remains in the picture.

Time will certainly tell.

SPY Takes a Goal line Stand

The market stood once again at the abyss but buyers stepped in and saved it at what could potentially turn out to be a double bottom.

What traders need before they can once again hold long positions overnight, however, is to find that ever elusive animal called "a follow through day."

Traders might wish to tighten up stops on short positions though.

October Low Unlikely to Hold

October's low clearly is in jeopardy of breaking down. Considering the lack of bullish divergences on any major index or on the majority of stocks a break through the October 10th low has a great deal of potential to create a panic washout.

Moreover, sentiment readings remain surprisingly bullish with 52% of the traders still looking for a bullish bounce against only 21% looking for more lows to come. With readings like this and with the sellers still in charge of the tape, the short side looks to continue to be profitable.

Continued Distribution Takes Place

Last week the major indices tested October lows. Unfortunately for those looking for a bounce, there is no sign yet that the selling is letting up or that buyers are ready and willing to step in and support the lows put in earlier this month.

In fact, what we are seeing instead is continued distribution and continuation set ups.

Let’s take a look at the intraday chart on the SPY for an example of what is taking place almost across the board.

Note that following the big up day on October 13, which can be seen on the chart above as the first wave up, prices have consolidated in a contracting continuation pattern.

Generally these patterns resolve themselves in the direction of the trend and indeed, on Friday, it did resolve to the downside.

This appears to be the beginning of a fresh leg lower.

The only qualification that needs to be made here is the acknowledgment that the market is just so oversold here. The breakdown of this continuation pattern could potentially be a headfake that squeezes new short positions. But, there is no reason to conclude that it might be a headfake other than the fact that the market has supposedly already traveled far enough. We have no evidence that it has and all indicators are showing continued distribution here so probabilities are higher that the breakdown was real and that we will see lower prices from here.

Continuation Patterns

The market is awash in continuation pattern breakdowns after yet another day of selling. We will take a look at these in a moment. First, we need to note that we are suspending the use of the SRS Risk Assessment Meter (RAM) for the time being. The character of the market changed when we experienced what can only be considered a market crash.

The RAM will be useful again, but it will take some time for the market to repair itself and for a new price mean to appear which we can use in our regression analysis.

Let's take a look now at pennant continuation patterns:

The stock CF, which we recommended to our subscribers this week, is a good example as there are a large number of stocks in the market exhibiting similar patterns right now.

CF is in a strong downtrend, represented by an ADX reading near 50 (35 is typically considered a very strong trend, so 50 is extreme). CF broke down from its consolidation area, which formed a pennant pattern on the daily chart. This should kick off a fresh leg lower from here.

Light Volume Rise - Don't Trust It

Prices have risen on decreasing volume over the past two trading days. There is no reason to chase prices here. Volatility is likely to remain. A retest of the bottom may yet be in store. If prices continue to rise on lower volume shorting would make much more sense than buying.

Warning

The SRS Risk Assessment meter tells us that the downtrend is close to a bounce. However, the sellers are just not letting up here. We recommended in yesterday's report to start looking for long positions. We were early.

Until the sellers let up and we get confirmation via a follow through day - which we have not seen yet - then it is best to stay defensive.

In fact, a plethora of stocks broke lower out of thrust pullback patterns today indicating that more downside may be ahead.

Again, stay defensive. The S&P may have to test $750 before serious buyers step back in. It boggles the mind, but it is what it is.

Short Side Risk Very High

The beauty of the SRS Risk Assessment Meter (RAM) is that it gives us a reasonably accurate view of the risk factors when the market is at extremes.

For example, last May when the market was going up we warned based on the RAM that the market was due for a big correction and that it was best to start looking for short positions. We started warning when the SPY was trading near $138. The SPY was able to trade just over $142 following our warnings trapping in new longs before it turned sharply lower. The RAM did its job.

Now we are at a juncture that is the exact opposite of the situation we had back in May. The RAM is warning that risk is extremely high on the short side and probabilities heavily favor a price rally that allows the market to revert back to its mean. Reversion back to the mean might mean a lower high, but given the extreme sell off we have just experienced a rally that creates a lower high can indeed still be a significant tradable rally.

We don’t know just how far the pullbacks will be here but rest assured probabilities heavily favor the dip buyers here after last week’s intermediate capitulation event.

Near Term Sentiment Finally Spikes

Throughout this crash near term sentiment readings have showed bearish readings, but have failed to reach up to the type of extremes we needed to see to mark the end, or at least begining to the end of this waterfall crash we have been experiencing.

This has finally changed. Sentiment Trader's Short Term Sentiment indicator finally spiked today giving us an overly fearful situation. With the VIX now at all time highs traders have to consider the fact that this decline is very close to an end; or at a minimum a relief rally.

Keep The Big Picture In Mind

All anyone can do after a day like today – or a month like this month – is just shake one’s head in disbelief. We have never seen declines like we have seen in the market over the past few weeks. The one month decline in the SPY is now almost 27 points or 23% and the month is only 9 days old. By comparison, the biggest one month decline in the SPY during the last bear market was only 20 points, or 22%.

Moreover, the fear index (VIX) is now trading at all time highs.

In times like this it is important to keep the big picture in mind. We admit we were astounded today when our stops on SPY and SSO were sliced through like a hot knife through butter, but realistically we have taken a very conservative approach to this market throughout the year. We still have significant gains on the year. A quick look at Morningstar tells us that the only funds that have a gain on the year are just a small handful of bear market funds; roughly only 20 out of 13,000 funds. The rest of them have losses on the books as of the end of September; significant losses after this market crash to be sure.

More importantly, however, is the vast opportunities that this produces for us. Having preserved our cash we will be in great shape to participate in the upcoming rally. And considering the strength of the sell off and the fact that world governments are now moving heaven and earth to stop the spiraling out of control, we are looking at a massive rally out of this bear market.

First, we a huge bear market rally WILL follow this extraordinary sell off and that rally will offer us moves that are likely to easily surpass our typical 10% price targets. We still contend that that rally could kick off any day now. And, and this is even more compelling, considering fear levels now, a lot of babies have been thrown out with the bathwater here and valuations in some companies are exceedingly cheap here, we are likely very close to the end of this bear market altogether.

Bear markets tend to end much sooner than recessions do as the stock market is forward looking. What is truly great about the prospects for the next bull market is the fact that they are just so much easier to profit from. In 2003, when the last bear market was recovering, we saw huge gains. Stocks that rallied 20, 40, 50, and even 100% in one day were common during this phase and they will be again. Over the past couple of years the market had lost its momentum and it was hard work getting just 10% gains. This will not be the case during the first phase of the bull market when undervalued stocks revalue.

So today, we have moved back to cash, but we eagerly wait for the profitable bounce and have no doubt it will be a big one following this historic sell off. There is nothing new under the sun and this sell off certainly is no exception.

The Spring is Wound Tight

The further away from the 50-week average the SPY trades the bigger the rebound rally that will follow.

Right now the SPY is an astounding 30 points away from this area where it has historically regressed to in bear markets. Moreover, the price is over 9 points below its weekly Bollinger Band support. This is a classic oversold condition.

The spring is wound tight in this market and a rebound is surely just around the corner.

Today we panned back to the monthly view to see where we might find support. During the last bear market the SPY tagged the 200-month average two times right before a new bull market kicked off.

It’s too early to tell if this is the final capitulation in this bear market, but the 200-week average appears to be drawing the price in like a magnet. In our opinion, a touch down at that average would make for an incredible buying opportunity.

Hammers Are NOT Giving Us An All Clear Signal

We really wanted to get in there tomorrow and start picking up some of these beaten down shares that are just sooooo technically extended at this point. Today we scanned for hammer bottoming signals and incredibly more than 1100 showed up in stocks that trade more than 200k shares per day.

Hammer buying signals are signals which occur when the price washes lower for the day but then experiences a rally late in the day and closes near the opening price.

We have decided against buying any new shares tomorrow as the hammer signals we found have some problems with them, which we will explain.

First, let’s take a look at a classic hammer buy signal put in by the stock STLD today.

Note that STLD was able to close out the day near daily highs after quite a frightening sell off intraday. Typically this type of trading gives us an indication that capitulation has taken place, which is a pretty good buy signal under the right circumstances.

Nevertheless, the hammer signal on STLD has some problems; not the least of which there is no clear support in sight. Even more problematic, however, is the fact that we don’t have strong evidence that late day buying was serious. In fact, just the opposite is true.

If we drill down to STLD’s intraday chart (hourly) we can get a better look at the seriousness or lack thereof that late day buying entailed. STLD sold off on heavy volume, which is potential capitulation, but where is the buying volume late in the day?

Clearly late day buyers were not very enthusiastic. In fact, the late day bounce looks to us to be more of the short covering variety than it does serious institutional interest or program trading.

This intraday picture is repeated over and over in the market today. Yes we had a late day bounce. No, that late day bounce does not give us the all clear signal.

We are probably near a tradable bottom, and if tomorrow we see a rate cut in the US and Europe then buyers might start getting serious. But for now, all we have seen is a late day lull in the selling and that is no reason to buy stocks by any shape or means.

Weekly Bollinger Band

During the last bear market the SPY closed the week out below the lower weekly Bollinger Band three times. Following each time this occured the market turned higher into a multi week rally.

This bear market has now seen its second weekly close below the weekly Bollinger Band. The first time this occured was Friday, January 18. Monday, January 21 the SPY gapped lower at the open, but buyers stepped in immediately and they didn't quit until the SPY had rallied all the way from $129 to over $135.

Taking a Look at Recent Trades

Using the Risk Assessor as our guide it is our opinion that the recent downtrend has stretched too far from the 50-week average for a safe short trade. We would prefer to play the trends when risk is low, but when trends get extended, we would rather let others assume the extraordinary risk if that is their desire while we wait for the inevitable turn.

We keep an eye on a number of blogs and read a large number of analysts in our daily research. One common experience we have read over the past week has been that traders are getting stopped out by the massive volatility that exists in this market; and this includes those who are attempting to play the short side.

We, on the other hand, took profit on our short trades last week and started looking at areas where the heavy risk in this market could be mitigated. As a result we missed some of the sharp downside moves we have seen but at the same time we have not been experiencing painful stop outs either.

In fact, we have been able to turn a small profit in this environment.

Let's take a look at two of our trades this week:

CPB

Earlier this week we noted that attempting to pick a bottom in this market was akin to trading suicide. What we recommended instead was a focus on stocks that have both held up well during the recent downturn and which are experiencing institutional buying interest. Cambell's Soup (CBP) was just such a stock.

On Wednesday we put in an order to buy CPB at $38.25. As you can see on the chart above that order filled and then shot sharply higher. This market has been tough and it has rewarded those who are not greedy, so we plan to take profit at $41.10. We have moved our stop up above our entry point just in case something goes wrong.

THS

THS is another stock that fit our criteria. This sector isn't prone to the same types of risk other sectors are prone to in this market. People don't stop buying food when the economy turns down. We attempted to buy THS at $28.60 on Wednesday. When that didn't fill we moved up our order to $29.50 today.

THS found early buying interest and our order didn't fill. Nevertheless, it serves as a great example of a stock that both works well in this market environment and one that does not require traders to stick their face in the buzz saw of risk that exists when the market is so extended like it is right now.

Upside Surprise Potential Remains High

As we have been discussing in recent updates, this is no time to step in and try to catch a falling knife. Nevertheless, the potential for an upside surprise remains strong.

The SPY is extremely oversold on a weekly basis and has dipped down below monthly support. The potential for prices to hold near current levels and rally firmly higher are much more likely from a technical point of view than further significant downside is.

Time to Look For Buying Opportunities

Today we would like to once again reiterate the concept of price regression. What we have seen thus far this week is classic bear market activity. Despite what may appear to be so, the sky is not falling here, the market is just making some much needed adjustments to the fact that banks were over leveraged. This has been in the works for a long time and we are now seeing the market correct the situation that regulators refused to do themselves.

So, let’s get back to price regression. Monday’s sell off was likely a capitulation-type event. We hesitate to call it “the capitulation” that ends the bear market because there is just not evidence for that at this time. Nevertheless, the washout on Monday took prices down to extreme levels in relation to the 50-week average and the lower weekly B-Band on the SPY. We saw a lot of these types of wash out events during the last bear market and each and every one of them led to a regression back to the mean (50-week average) which shortly followed. We seriously doubt that this time will be different.

What does this mean for traders? For starters it means that it’s too late to short anything on longer than a day trading basis; at least for the near term. It also means that over the next few weeks we are likely to see prices regress back toward the 50-week average, which as you can see from the table below gives us a lot of near term upside potential.

With that in mind we would offer a warning. This does not mean that it’s safe to go out and start buying beat down stocks. Remember, we are still in a bear market and as such surprises can and probably will occur in the direction of the longer term trend, which is down.

Rather, in our opinion, it is better to focus on those stocks that both held up well during the latest slide and that are showing buying interest at these levels. This rules out buying stocks at 52-week lows for example; they may bounce hard, but then again, they might surprise lower as well.

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Moreover, don’t look for an easy ride back up. There is still a lot of confusion out there. The market takes time to put in a bottom, even a near term bottom. It would not be out of the question that prices retest recent lows and it wouldn’t be impossible that they might even take out those lows before a real rally gets under way.

This is certainly no time to just throw caution to the wind and buy a falling knife. Be very choosy and trade only those stocks that offer the least amount of risk in this environment. High risk might offer high reward but it also offers the chance to lose big. Set your sites on consistent gains over time by always staying focused on risk management and reap the rewards. Anything less is gambling and we all know the long term results of that.

Was this Capitulation?

Last week we moved to a 100% cash position. Betting on a bailout was just too risky. It would have been nice had we bet against a bailout, but as we noted any bet made last week was a crap shoot pure and simple.

Our primary goal is to protect the assets of our subscribers. We are not gamblers. By moving to cash we have given ourselves a huge advantage in this market. Today we experienced a Black Monday event as the market took one of the biggest losses in recent history. Our subscribers experienced no loss on this event.

Let’s take a step back now and evaluate this situation from a trader’s perspective. We protected our assets against a risk situation that was impossible to manage. Blood flowed heavily in the streets today as Congress voted down the bail out. We now have our trading accounts fully in tact to take advantage of the fallout.

It seems likely to us that a bailout package of some sort will get passed this week. Like it or hate it Congress can’t just throw up their hands in defeat over this and the public who takes a look at the damage to their retirement accounts are now likely to second guess their position on this situation.

It would then appear that this sell off creates a huge buying opportunity rather than a reason to sell more. The bulk of the selling is likely now behind us. We certainly won’t now step in and try and catch a falling knife, but we are well positioned now to go long as soon as we see some evidence that the selling has played itself out. We were not willing to bet on this bail out vote but we are willing to bet that we will get that evidence that buyers are stepping back in this week; likely as early as tomorrow.

Bottom Line: Today’s sell off was not a reason to buy. We don’t have that yet. But, it was a reason to start watching for reasons to buy and those reasons might be just around the corner.

This is NOT Business As Usual

Under normal market circumstances it is possible to come to a relatively reasonable conclusion about the market’s potential just by paying close attention to price and volume. For example, when the Fed is getting ready to act institutional money usually has a pretty good clue about how that action will affect the future outcome of the market and they tend to build positions accordingly. When they are building those positions they tend to leave footprints, sometimes subtle, that betray what they are doing.

What is different about the situation this time is the fact that the major game changer that the market is waiting on is in the hands of Congress. Congress isn’t nearly as predictable as the Fed.

It seems likely that the market will rally, at least initially, if a government bailout plan is passed. But what happens if that bailout plan is delayed? It’s altogether possible that positions taken here in anticipation of a bailout rally could easily get stopped out as the market drifts in wait for Congress to vote on this bill.

So which side do you put your money on here? Do you bet that Congress will drag its heels and short the market? What happens if Congress surprises and the market gaps up 400 points?

We really hate the odds on this. Moreover, it appears that institutional money doesn’t like the odds either as market volume and volatility have both been way down over the past couple of days.

If the bailout is announced wouldn’t you rather have a large cash position that you could then put to work after the market shows its hand in response to the package? Wouldn’t it be much worse to bet on a bailout, get stopped out as the bailout is delayed only to see the market gap up a few days later?

This is the hand that the government is dealing us here since they determined they would get involved in business that is probably not theirs to get involved in in the first place.

Recommended Position: Cash

Trading Positions

We took profit on BKE late last week at $65 and remain primarily in cash this week with only one small short position. With market surprise risk as high as it is here we will let others take on the risk exposure while we remain primarily in cash.

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10-Year Trend

The SPY is resting right near its 10-year trendline. Technically it's not in good shape and a trendline isn't necessarily a reason to buy. Nevertheless, it's important not to have too much short exposure here. With a government bailout looming and with the trendline still in tact there is potential for an upside surprise.

Keeping a mostly cash position is recommended until we get through this difficult week.

Sellers Taking Back Control

Early last week we recommended closing short positions due to the fact that the SPY had extended too far away from its 50-week average and was trading near weekly B-Band support. This recommendation kept a lot of traders out of trouble as the SPY gapped up an astounding 6% on Friday following a big up day on Thursday.

Unfortunately for longs buyers failed to follow through on Monday and we are now seeing continued price erosion.

Two weeks ago we noted that the market was not showing signs of stabilization given the fact that both the 50-week average and lower weekly B-Band were both continuing to make new lows. Based on this steady indicator erosion we recommended getting more short at that time. That recommendation also proved to be profitable for those who closed those short positions early last week as we recommended.

Now that shorts have been squeezed, as risk indicators indicated they might, we once again find ourselves back in the same boat we were in a couple of weeks back. The 50-week average and the lower B-Band continue to erode. And with the short squeeze out of the way, there now seems to be a lot of traders who bought into the excitement late last week who are now stuck on the wrong side of the trade.

Short risk remains high just due to the fact that the market is still technically oversold. Near term, however, a lot of pressure was released and sellers appear to once again be in control.

We recommend a light short position at current levels as long as tight stops are used. Shorting bans on the financials are not going to keep prices from going down if sellers continue to unload their positions, which they were certainly doing today.

Tale of Two Trades

After assessing the risk we offered clients two long side trades earlier this week. We reasoned that the market was very likely to be defended in the current area and as such dips would be buying opportunities, not reasons to panic.

As always, this did not mean throwing caution to the wind, but rather carefully choosing entry points and establishing stops to get us out in case something went wrong.

One trade worked and the other one failed.

This brings us to an important reality of the market. No one is ever right 100% of the time. In fact, no one is ever right even 80% of the time.

The good news is that with careful and thoughtful risk management procedures in place it is possible to be right only 50% of the time and still enjoy huge profits.

Let's take a look at this week's trades and see why:

OCR



OCR failed at its trend and we quickly stopped out.

BKE

BKE rallied sharply higher and remains open. Profits on the BKE trade have erased the loss on the OCR trade and then some giving us a net gain on the week and the trade is not even over yet.

Our primary concern is risk management. We have found that over time focus on limiting risk allows profits to take care of themselves.

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Tradable Bottom Likely in Place

As we have been discussing over the past few trading days there was a strong likelihood that it was late in the game for the short trade. The SPY tested the downside in the morning almost reaching $113, the price we predicted it could stretch to mid week. On Monday we wrote:

As we mentioned a couple of weeks ago, the $117 level is likely going to act as a magnet. In fact, with the ferocity of the decline today there is some potential that we will see the SPY make an intraweek low as far down as $113.

After the scary shakeout dip in the morning session where the VIX spiked as high as $42, buyers stepped up to the plate and defended the $117 20-year trend as we predicted they would. The VIX sharply plummeted back to $33 and the SPY rallied to close back above $120.

It’s doubtful the bear has had its last growl, but it is certainly very likely that an important multi week bottom is now in place that will offer some great long side opportunities.

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VIX

The VIX is now back at the area where the market has put in significant lows over the past year. Volume continues to spike as well. Either we are putting in a significant tradable bottom or something is different this time. We suspect that despite the gloom and doom in the news that a bounce is in the offering from current levels. Time will tell.

Regression Theory and Key Reversal Days

If you return to our May, 2008 archives you will note that we indicated during that month that short risk was low. Our reasoning was based on the fact that the SPY had rallied up to its 200-day average, an area which coincided with the bear market downtrend. We advised shorting strength in this area.

Indeed, the market declined more than 15% from the May top and shorting strength in the early May rally proved to be the most profitable position to take.

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It's time for traders to start looking at the long side once again. Enter your name and email address above to receive stocks that offer the best upside potential for this new market development.

Now that the market has experienced a multi month decline from its May top the risk situation has reversed. Note that over the past month we have indicated that risk on the short side has increased even as short positions have been paying off well. The increase in risk can be measured objectively based on the relation to the weekly B-Band and the 50-week average.

Today the SPY tagged the lower weekly B-Band.

Also recall an interesting characteristic of bear markets wherein prices tend to regress to their mean, which we outlined in February. The mean that bear markets tend to regress to is their 50-week averages. As of today’s close the 50-week average is at $133.60, or more than 8% above today’s closing price.

Moreover, note that $117 represents support at the SPY’s 20-year trendline.

The market’s downtrend is still in tact and the road is bound to remain bumpy for some weeks to come. But, what has changed since May highs is the fact that the SPY is oversold, it is at an area where support is very likely to be found, and volume at today’s $117 test was the type of volume that can be expected at key reversal points.

In other words, shorting at these levels offers too much risk to manage and traders should begin looking for buying opportunities into dips.

Recent Trade Performance

The market has been extremely volatile of late so we thought we would take a look at some of our recent trades to give an idea of what has been working and to show why this environment has been so difficult to trade.

Before we get started we would like to point out an important truism about all markets. If you manage risk properly, profits will take care of themselves.

One of the number one factors in risk management is the idea that you carefully avoid trading against the trend. Bear markets tend to experience strong bounces and they tend to be more volatile than bull markets.

Bounces that occur during market downswings can oftentimes lead to bullish chart set ups. And this is where traders get into a great deal of trouble. Bullish chart set ups that were working during stronger markets tend to be traps during bear markets. Surprises most often occur in the direction of the trend and those who bought into some of the many bullish set ups that emerged after last week's market rally paid dearly today as the market took one of the biggest hits since 911.

We advised readers and clients alike to hold short positions and keep a heavy supply of cash handy last week and so we ended up having a good day today while a lot of others who exposed themselves to too much risk did not.

On to the charts:

EEV

EEV is an ETF that trades contra to the Emerging Markets ETF (EEM). We probably exited a bit early but considering the volatility in this market we were happy to lock in our profits when available.

EWW

EWW offered clients excellent risk:reward after breaking through support to new lows. We plan to take profit on this short position tomorrow.

ADM

ADM offered quick profits and excellent risk:reward.

Now lets take a look at a couple of positions that didn't work out for us and see what lessons we can learn from them:

HBC

HBC initially worked for us. After we had a decent profit we lowered our stop loss so that if it did move against us we would lose no money. This is a perfect example of the frustrating behavior that stocks in this current market have offered traders. It offered great risk reward, it quickly moved in our direction, but then it whipsawed and quickly gave back profits.

Lessons learned here are twofold: First, it is important to adjust stops when profits are on the table, and Second, stocks can and do whipsaw in this market so it's important to not get greedy. If you look at EEV you might wonder why we didn't hold this position longer. The reason we locked in profits when we had them is because it's nearly impossible to know which stocks will keep on going and which ones will whipsaw back.

CNI

CNI is another perfect example of a stock that started out strong and then turned around in this volatile environment.

So remember, risk management is Job Number One. Trade only in the direction of the trend. Adjust stops after profit is on the table. And lock in profit when it's there because it might not be there very long.

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If you would like to receive free stock trades like the ones presented above, simply provide your name and email address in the form above.

Let the Indicators be Your Guide

Pilots understand that when flying through a storm they can’t rely on their feelings and they can’t rely on what they see through the cockpit window. In order to fly safely through the storm they must depend on their instrument gages to tell them where they are at in relation to the horizon.

Last week, the SPY moved down to its lows and then bounced weakly later in the week. This caused a lot of traders to buy in thinking that the market was ready to carve out a double bottom.

We warned, however, that the B-Band support and the 50-week average were continuing to decline to lower prices and we argued that this meant that the market was not stabilizing as it might have appeared late in the week. Likewise, the sentiment readings remained stuck in neutral.

The Risk Assessment Meter is our gage that helps us navigate the storm. Appearances can be deceiving but indicators that continue to decline showed us that the upside move was not to be trusted and that only the short side offered good risk management potential.

Indeed, today the market responded to the LEH implosion and a potential destruction in AIG.

As we mentioned a couple of weeks ago, the $117 level is likely going to act as a magnet. In fact, with the ferocity of the decline today there is some potential that we will see the SPY make an intraweek low as far down as $113.

Tomorrow the Fed meets and there is some talk of a .50 basis point rate cut to stem the tide of selling. How the market responds to this is just about anyone’s guess. If the Fed does make a big cut and the market responds favorably, it will no doubt just offer up another shorting opportunity at higher prices. This will continue to be true until the indicators start to stabilize and they certainly aren’t there yet.

It's a Craps Shoot

Over the past two trading days the market has shown moderately bullish resillience. Near term trends have turned slightly bullish in most major indices but intermediate and long term trends remain decisively down, which does not offer us a good risk:reward ratio.

Over the weekend it is possible that LEH and AIG may get government financing, which could give the market a boost on Monday. On the other hand, the oil rigs in the gulf are in the path of another hurricane, which could spike oil prices.

The market has been in a tug-o-war between bulls and the bears so it's really hard to know what to expect on Monday. At best trying to predict Monday's action is a craps shoot.

We really don't like the odds on either side right now.

When risk:reward improves, we will put our sidelined cash back to work.

No Stabilization In Sight

The market continues to show no signs of stabilization. If you check back through past reports here you will note that the 50-week average and the lower weekly Bollinger Band continue to steadily drift lower. When the market starts to put in a real bottom these two indicators should flatten out, which is just not happening right now.

In fact, the only thing the bulls have in their favor right now is the fact that near term sentiment readings are starting to move into the excessively pessimistic range. In an established downtrend pessimism does not make for a good reason to step in and start buying stocks.

Moreover, the fact that the market couldn’t put together more than a one day rally following the FAN/FRED bailout just adds emphasis to the precarious position that stocks are in here.

Keep Your Powder Dry

Socialization of the mortgage guarantors caught short traders off balance today as the market gapped up big. The SPY gapped back inside the trading range that it broke down from last week putting into question the hypothesis that a fresh leg lower was the destiny of this fall’s trading.

Benefiting most from this government takeover were the homebuilders, REITs and other property holding companies. The tech sector continued to lag.

The market is not out of the woods yet, however. It still faces formidable overhead resistance. Unless and until the SPY can close back over $130.75 it will be a good idea to not invest too heavily on the long side.

Today was a one day event. It needs follow through and a close over important resistance levels before it can be trusted. There will be plenty of time to get long when and if that should occur. Until then, keep your powder dry and tighten up stops on short positions.

Don't Say We Didn't Warn You

Sentiment readings remain surprisingly stuck at neutral and the VIX still has plenty of room to move before reaching fear levels struck during March and July lows.

The SPY has support at a multi decade trend line in the $117-$120 area, so this is likely going to act like a price magnet as we move into the fall trading session.

Don’t expect the market to head straight down, but certainly use any strength to go short again until the SPY reaches its trend line.

Big Boys Come Back In Selling Mood

The VIX broke out to the upside today and near term sentiment measures remain close to neutral. With the heavy volume today it looks like institutional money will remain in a selling mood for the next few weeks.

Market Once Again at the Brink

Stocks turned lower again after Friday’s one day short squeeze. Note that the bottom B-Band turned sharply lower over the past two days, as did the 50-week average.

We are likely to get more short squeezes along the way down, but it is clear that this market remains in a long term downtrend.

SPY has support at $126.25. If this level gives way, and it looks more and more like a strong probability, then a retest of $120 would be the most likely target.

Bulls Looking to Regain Control

Short sellers were able to take the SPY below its near term uptrend last Monday. Following prices consolidated in a sideways move that lasted for 3 days. It looked as if the market was headed for a quick washout move back to this year’s lows. On Friday, however, this consolidation range broke to the upside instead of breaking down and Monday’s breakdown is now looking more like a failed move than it is an eerie omen of lower prices to come.

Friday’s move puts heavy emphasis on the fact that it is important to trade what you see and be prepared for anything while not anticipating anything.

Getting short was the right thing to do following the breakdown, but now that we appear to have a failed breakdown it is equally important to not fight the market by tightening up stops on short positions.

It’s probably early to start getting overly bullish on the market as the indices still have a lot of healing to do, but signs as of Friday are encouraging for the building of a bullish case as we move into the Fall.

Path of Least Resistance Lower

The SPY broke down early this week and has since been consolidating below resistance. The near term and long term trend are both down and so is the path of least resistance.

The only fly in the ointment is the fact that stocks like FNM, FRE, and AIG are getting hammered so badly that the odds of the Fed stepping in to rescue them are increasing by the day. A Fed rescue will probably not save the market, but it could certainly lead to a gap up that hurts short positions.

Breakdown Watch In Effect

Near term trends for the QQQQ and IWM have been up over recent weeks while the same near term trend for the SPY has been trading sideways, or neutral. Attempts to move higher have all been rebuffed and it now looks increasingly likely we will see a breakdown this week switching the near term trend back to down.

When and if the SPY’s near term trend turns lower it will offer improved risk:reward as it will compliment the long term downtrend. Think of it like a car that gets a tune up and is once again firing on all cylinders.

Today’s scans revealed a great deal of set ups weighing heavily on the short side. Unless the Fed steps in and attempts to rescue Fannie Mae again, or some other vital news emerges, we are likely looking at lower prices this week.

Watch For The Fade

On Friday the SPY rose slightly out of a pullback pattern, but on shrinking volume.

Scans don’t give us a large indication what to expect on Monday. However, watch for a potential price spike this week that gets quickly faded. A gap up on Monday would offer a good shorting opportunity.

Financials

While it seems most traders consider the weakness over the past two days to be merely just a light pullback in a near term uptrend, we see ominous clouds on the horizon.

US law is a funny thing. If you are just an average Joe you are held to a very strict standard and the rule of law is considered quite rigid. For example, commit a minor traffic violation and few are let off with a warning. Instead, heavy fines are meted out, points get put on the record and insurance rates rise.

Things work differently in the financial world though. If you are a member of society we like to refer to as big money, laws are more flexible and as often as not, violations are merely winked at.

In fact, there are instances where breaking the rule of law is openly not enforced.

After the financials were down too much for the government's sensibilities a couple of months back they announced emergency measures wherein they planned to actually enforce the rule of law already on the books and forced traders to cover their illegal naked shorts.

Today they lifted these emergency measures and low and behold, the financials were once again taken apart.

The logic in this measure is hard to find, but nonetheless the financials threaten to take apart the latest market rally, as does a potential ongoing bounce in oil.

Keep an Eye On Transports

The SPY pulled back to its breakout point today and found a few buyers at the close. Nevertheless, our scans today found very few reasonable long set ups. Generally when we find so few long set ups the market is projecting another negative upcoming session.

On Friday the SPY broke its trading range so we could arguably say the near term trend has moved from a sideways trend to an uptrend. Yet, with today’s lack of follow through we hesitate to make the switch in our Risk Assessment Meter. If buyers come back in tomorrow then it would be more reasonable to adjust the meter and call an uptrend. The proof is in the pudding though and as of today’s close the evidence is just not in.

Oil has been the tail wagging the dog and USO, while still in a steep downtrend, is in an area where buyers may indeed show up. The transports appear to be projecting a turn around in the oil trend as false breakouts in the sector are legion. From failed moves come fast moves so the failed breakouts in the transports may be sending us a clue as to what to expect from the market this week.

Time will tell.

Let's Be Careful Out There

The near term trend closed out the week with a bullish bias. Nevertheless, there are reasons to exercise continued caution here. The SPY closed right at its 50-day average and near term sentiment is reaching the overly bullish area.

These reasons for caution do not mean that the market is going to reverse here but they do mean that the market still needs to prove itself. Friday’s volume gives us no clues as to what to expect next week either.

Bullish Set Up Emerging

The market remains range bound but is showing some bullish signs on a daily basis.

The SPY is back at the 200-week average, where it has continued to find resistance. That said, if it can break out above this level then the scenario we pointed out last week which has the market launching a multi week rally would then seem to be the most likely probability.

In addition to the 200-week average, the SPY is faced with its 50-day average just overhead. Today’s volume was weak today so we are looking for a bit of backing and filling in this area. There’s no denying, however, that the set up looks very bullish here. At a minimum we expect a breakout. Whether the breakout is for real or fails is a whole other question entirely.

Market Tries to Digest Meaning of Fed

The SPY moved back up to the area where it has been finding resistance over the past two weeks; the 200-week average mentioned in our last update. It has been trading in a bullish continuation pattern on its daily charts, but keep in mind that the broader market remains in a long term downtrend, so bullish patterns like this are a lot less trustworthy as the longer term path of least resistance is down.

The Fed left rates unchanged today and the market responded with mild enthusiasm. But again, keep in mind that it usually takes a few days before the market fully digests the Fed statement and as often as not gains made on Fed day get faded within the next day or two of trading.

Right now this market is still indecisive and it needs to prove itself one way or the other before it can be traded aggressively. Proof will come either in the form of a breakout from the trading range or a breakdown. We would tend to get more aggressive with a breakdown than we would a breakout as once again, the long term path of least resistance remains down.