Written by A.J. Brown

The Bull & the Bear: Where’s the Market Heading?

Last week, most major indexes experienced their worst week in history. The fear was almost palpable as people worried about banks, the economy… and even their retirement funds.

Naturally, after yesterday’s record up day, the average guy on the street is hoping for the best. With all the big down days, people want to believe the markets will now get better.

So, today, the question everybody wants to know is, Have we found a bottom yet? Has the market turned the corner? Well, let’s take an in-depth look at last Friday (10/10/08) and Monday’s (10/13/08) trading day to see what we can learn…

On Friday, the Nasdaq plunged 6% in the opening minutes of the trading session. A powerful rally in the final hour of trading propelled the NASDAQ back into the black, netting a 0.3% gain.

Also on Friday, the NYSE indexes pared their losses and even had gains momentarily, though all three still closed in the red. The NYSE composite shed 1.8%, the Dow industrials 1.5%, the S&P 500 1.2%.

Volume surged across the board. It rose 52% on the NYSE and 41% on the Nasdaq compared with what we had seen on Thursday.

Trading levels on Friday hit their highest point of the year, surpassing even the crazy volume levels that have been logged in the past few weeks. The Nasdaq’s turnover was one of its highest in history.

The trading on Friday capped another historical mile marker: the worst week in the history of the S&P 500.

The market’s benchmark index plunged 18.2% for the week. That crushed the 12.2% drop notched during the week of Black Monday in October 1987, as well as the week after the 9/11 attacks, which produced an 11.1% decline.

The other major indexes also plummeted. The Dow fell 18.1%, nearly matching the S&P 500’s swoon. The NYSE composite tumbled 19.5%, the Nasdaq 15.3%.

That wasn’t all. In dropping nearly 700 points early Friday, the Dow hit its lowest level since March 17, 2003. That was the exact day that the market followed through on a new rally and launched a bull market.

The Dow and other indexes did close above those 2003 levels. Still, this means that almost all of the gains reaped during 4-1/2 years of a bull market have now disappeared, with more than half of those gains evaporating in the past two weeks alone.

Technically, on Friday, the NASDAQ formed a key-reversal up bar-pattern on heavy volume, which typically means momentum in the next trading session will be in the up direction.  Although I don’t have much confidence in bar patterns as primary entry or exit signals, the heavier the volume, I have found the more credible the bar pattern.

Also, technically on Friday, the NASDAQ logged day one of our counting method to determine a market bottom.

Come Monday, prices spiked.

The market’s benchmark S&P 500 index surged 11.6%, topping its second biggest advance, a 9.1% rise on Oct. 21, 1987, by a wide margin.

The Nasdaq soared 11.8%, its second-biggest gain ever.

The Dow Industrials jumped 11.1%, their biggest up day in 65 years (the best since 1932).

The NYSE composite galloped 12.2%.

Monday’s huge rally snapped a string of eight straight down days for the NYSE indexes and seven for the NASDAQ index.

Volume fell 38% on the Nasdaq and 41% on the NYSE compared with Friday, when the Nasdaq reached its highest trading total in history.

So what does that tell us?

Let’s not speculate here.  How about hard facts?  Let’s look at things from a technical perspective.

We had one of the heaviest volume days in history, with very little price movement from open to close, but amazing price movement from high to low.  The bulls and the bears had one of their biggest battles in history with very little being decided at the end.  But, they were both out in full force.  That was Friday.

On Monday, the bulls were victors.  We had historic price gains — but on light volume.  Since volume is the great validator… Monday’s price movement lacked conviction compared to the sell-off days last week.

We already said on Friday we had a significant bar pattern appear on the NASDAQ, but that bar patterns haven’t done well (at least in my experience) as a primary entry signal creator.

At this point our counting method to determine a market bottom, a fairly reliable test that identifies market bottoms, has NOT been satisfied.

The Nasdaq and the NYSE indexes are extremely oversold.  But we know that overbought / oversold oscillators are leading indicators, and leading indicators are only useful predictors when they are paired with a lagging indicator confirmation. I’ve seen stocks, and indexes for that matter, stay extremely oversold for weeks, months, and even years.  Being extremely oversold doesn’t tell us when we’ll not be extremely oversold.

How about we shift away from technical signals and look at what’s happening in the world?

This immense emotional sell off is rooted in an extreme lack of confidence by investors in the world’s economies.  The current steps that world governments are taking to stabilize the world economies are designed as band-aids, stop gap measures, time extenders.

The fundamental problems are not being addressed.  At least not at this point.  Without fixing the fundamental problems at the root of the recent sell off, the current positive investor sentiment will wear thin quickly and more selling will occur.

So, when I look at the technicals and observe world happenings, at this point, we have NOT hit a market bottom.  By the end of the week the technicals may change.  By the end of the week there may be a fix offered up to address the fundamental problems.  But, right now, we have NOT hit a market bottom.

Does that mean I am not riding this momentary rally?  No way!  I’m trading the Q’s long like there is no tomorrow.

Does it mean that I am hedging against a surprise reversal down, an unexpected sell-off?  You bet your rusty duster!

What are your thoughts?  Please comment below.

Best regards always,

A.J. Brown

9 Responses to “The Bull & the Bear: Where’s the Market Heading?”

  1. gerard @ 10:46 am:

    I have no clue and stay on the side line and hold my breath for a while.
    Gerard

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  2. Philip @ 10:47 am:

    I agree with you I’m still in there but very cautious I made some virtual $$ on aapl and still in the $ with dia and cmtl but I am expecting on getting stopped out by my trailing stop.

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  3. Willie Putnam @ 10:52 am:

    I agree that we have not reached bottom yet. Also the fixes to date have not addressed the fundamental problem, which is the sub-prime mortgages. They have only addressed the credit issue of Banks lending to each other. I think they must address the problem of the mortgagee and the original lender; i.e., the current property value(mortage amount), and the adjustable interest rates. Until they do this they have only helped the banks. Even though the mortagee was dumb enough to accept impossible mortage terms(and is partially responsible), the lender is the expert and should have known better than offer such terms. Therefore, the fix must assign some of the loss to the lender as well as the mortagee.

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  4. BobM @ 12:06 pm:

    Given the sheer volume of toxic debt, it will be years before the root cause of this crisis is completely addressed. McCain attempted to address it by simply buying up the bad mortgages but how will he know which one’s are bad until all the derivatives are disassembled to their component parts? It could get ugly. Obama seems content with blaming someone else and expanding the program. After all, it was his ACORN group which was the catalyst in this chain of events. With ample help from Barney Franks, the govt was caught in a damned-if-you-do (too much regulation) damned-if-you-don’t (no regulation) vice which caused this mess. My attitude is: High ‘em all high, wipe the books clean and prevent outside leverages which can distort the market.

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  5. David @ 4:12 pm:

    I agree A.J. I think it was William O’Neill who emphasised the importance of the large volumes coupled with a strong candle to indicate a likely bottom. He also emphasised the importance of a high volume follow through within a week or two as a confirmation.
    I follow price volume relationships with Elders’ Force index, and find that very useful. I don’t see a bottom in the US here in Australia.

    All the best

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  6. RichE @ 9:52 pm:

    Watch the XLF 200MA. Don’t do anything long term until it’s trading above the 200MA. Do small lots in the mean time. Practice whispering. Watch the USD, EUR, and BRIC economies. The strongest is where the money will go. My guess it’ll be between the USD and EUR, but both buy stuff from the BRIC. The USD has to become investor grade. If it doesn’t I don’t know if the globe can stand by its self. Do a credit report on the USD. Would you loan them money? Would you invent? It won’t be over until the majority says yes. Worst case, the Globe will fiddle while Rome burns. Do your part, write your Congressperson and ask for a credit report. It ain’t going to get better until everyone is doing their part to improve the credit score.

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  7. Keith W @ 11:19 pm:

    Hello AJ, it has been a few months since we spoke last. I hope your community is doing well and I may have to stop in and check out the new site when it comes online.

    About the market - the only true thing I KNOW is that I DO NOT KNOW what the market will do at any given time. I have realized that this is an absolutely great time to day trade and the market’s move down has been incredible for gains, recently. Nothing ever moves straight down or straight up in the market, so eventually we may see an absolutely fabulous bull market.

    For those of you adverse to utilizing your edge to the short side, you are missing out. AJ has some great setups to use. Making money consistently is fairly simple technically, hard emotionally. The current market sentiment can have you second guessing, hesitating, jumping the gun - all the things that block your goal of creating wealth. In fact when I trade I do not have CNBC, FBN, or any news on (no TV - no radio). I check my headlines and reports before the market opens and then leave it alone. I trade using equity options and index futures - both day and swing. The secret of success in ANY market? Simple. Develop your market edge (setups). When the market gives you a setup, TAKE it. Develop your entry and exit criteria where there are clear defined rules. Finally, in-my-opinion, the biggest issues are psychological. I can teach 10 different people my edge and guess what, there will be 10 different P&L amounts. You cannot PREDICT, CONTROL, or GET MAD at the market. The market cannot MAKE you right or wrong. The market does nothing but present opportunities, period.

    I have to give AJ credit for helping me start out. AJ has some great setups and he can definitely get most people on the right track. I parted with the community on good terms and have went on to become consistently profitable during the worst time to even try to do this for a living. I utilize my own setups now, but AJ and Trading Trainer helped lay the foundation. For those wondering, I just happened to stop in - I AM NOT A CURRENT MEMBER. I say these things on a whim. I am not ‘plugging’ AJ’s site, but I am stating the facts. The site and AJ helped me get started and I imagine without AJ I may have taken a lot longer, spent more money getting proficient alone.

    Have a good day and for those of you on the sidelines, while I do understand your reasoning, realize that the market produces setups equally in BOTH long and short trends. Don’t let psychology create a barrier to your wealth.

    Keith W

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  8. A.J. Brown @ 2:29 am:

    All amazing perspectives!

    Keith, it has been such a long time. Thank you for posting your thoughts. All I can say is, WOW!

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  9. Cat Cassidy @ 5:47 pm:

    Dear A.J.: I thought that during the Webinair on 10/13/08 you said you thought we had hit the market bottom, and I had actually voted ‘yes.’

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