Sep

Investing Systems Research Lab Blog for Week of September 20th, 2010

Were you long, short or neutral going into this week?

The market is sitting at an extremely critical juncture and next week is crucial. There is severe risk to the downside as we speak and you can almost feel the tension in the air.

Opex was uneventful for the most part, but it almost seems like every one and their “trading buddy” agrees the market is overbought and due for a pullback. The magnitude obviously has yet to be determined, but I have a “zone of risk” indicated below on the chart in red.

The SPY chart shows there is limited upside and a whole lot of downside potential right now. Shorting almost seems too easy, and as I’ve been saying this week, I still wouldn’t rule out a “blowoff top” into the yellow box. The time to get short is with a close or two below the 200-day moving average. It’s not out of the question we get another leg-up into the yellow box, so you don’t want to be so heavily short that you can’t take a move into that area.

I’ve taken the liberty of extending the 200-day MA on the chart below to get an idea of the “confirmation” area, that would indicate the “rollover” has begun. Honestly I have mentioned a few times this week that there should be a good “window of opportunity” to short once it rolls over so there’s no need to “get large” without confirmation.

Personally I think that red box is the most likely destination over the next couple weeks, but I have to see that confirmation before I commit. I also have been watching the 5-day and 8-day moving averages closely on the various indexes and a break to the downside on them will further confirm. We just had 12 days in a row the low on the SPY didn’t even touch the 8-day SMA…whoa.

The Weekly chart below is a little less cluttered and shows how precarious this current level is. Last week was a narrow range bar which indicates exhaustion, and possible trend reversal. The 30-week moving average is in about the same spot as the 200-day, so we will watch carefully for a breach to confirm a pullback is starting. Never underestimate the power of the market to push “just a bit higher”, when it’s so obvious it should immediately reverse. That’s why it’s best to “wait to shoot until we see the whites of their eyes”.

Crack the 5-day, 8-day, 200-day and 30-week moving averages next week and I would say that’s a pretty solid confirmation. The green uptrend line shows the likely “initial” support if this “reversal” transpires as anticipated.

I would normally expect that to take a few weeks, but the way it’s been trading this year, the moves seem to be compressed in time and long range bars are almost the norm. Heck we could touch that trendline next week.

How far can it fall?

I can’t help but think that once the selling starts, it could easily gain momentum and snowball, slicing through support as no one “steps up to the plate” to buy into a falling market.

We’ve been hearing a lot about these new regulations for “halting” stocks and ETF’s when they drop a certain percent in a certain amount of time. That might lead to a situation where the market acts like a slinky marching down the stairs. Limit down, halt, limit down halt, etc.

Imagine the selling in individual stocks if hedge funds and institutions were to start liquidating ETF’s !

Are the HFT’s really going to take the other side of each halted stock?

Or are they going to “pile on” once the selling begins? Who knows, but I can envision a slow-motion flash-crash scenario where everything goes haywire all because everyone’s on the same side of the trade – selling or liquidating.

You remember what a “liquidation environment” feels like right?

Now I’m not saying this is inevitable or highly likely, but never rule it out. DRYS went from 130 to 3 in 2008, and is a good example that anything can happen in the market. Fortunately there will be advance notice if the market were to drop back toward the “danger zone” between the red lines. No one should “freak out” unless we drop below say 1010.

Stepping back even farther, we see the big picture looks tenuous as well. If I gaze at this chart long enough I get the sense that now is “not the time to try and be a hero”. After all, our long term timing indicator is on a sell as of July. Keep in mind that we are looking at Weekly charts and the calamity might not start right away. This is a news driven market and it seems to be running on fumes, but never underestimate the potential it continues to climb the wall of worry.

For individual stocks it’s a trading environment only.

Could the market rocket higher and thwart everyone’s expectations? Sure, but I wouldn’t be afraid of getting left in the dust. Until the market can convincingly trade between the green horizontal lines and actually take out the previous high, the bias will be to the downside. If we do see the market rip higher towards the end of the year, it will most likely be the result short-covering and not genuine buying. Kind of like last week.

I would give the odds of a run-away move higher a very low probability however At 1225 many Bears would be broke and “don’t think they don’t know that”.

It almost seems like some “entity” wants to run this market up, force the shorts to capitulate, suck in as much new money as possible, then pull the rug out from under it. They still might have some tricks up their sleeve.

To sum it up, the risk to the downside far outweighs the reward to the upside at this juncture. Be careful next week and wait for technical confirmations to make decisions.

Down the road, who will be there to buy when everyone wants to sell? That’s what worries me the most. 77 Million Baby Boomers are invested in roughly the same 700 stocks that make up the major indexes. Even worse, the bond market has priced in a Japan style decade going forward and somehow I don’t think it’s going to work out that way due to the eventual inevitable demise of the US dollar. Put another way, there’s only one way out of the black hole “they” have spent us into. Devaluation of the US dollar to meet future obligations. The irony is that eventually it may result in higher stock prices in nominal dollars. But I expect a lot of turmoil between now and then.

IN the near term market is on thin ice along with all incumbent politicians. It will definitely make for an interesting fall..err..autumn.

But don’t forget, the market can indeed rip higher next week and it almost seems like it wants to, just because it’s so obvious it should go down and has been for some time.

Join us Monday morning in the Research Lab Live as we watch the drama unfold.