Market Stats

After yesterday's relatively strong bounce off the spike down in the morning it was looking like we had a market save. Today's decline likely dashed the hopes of many. By the looks of the put/call ratio today there was a lot of put buying going on. The VIX spiked up nearly 21% and poked above 30 and closed at 29.40. Fear is back.

Whenever we've seen the VIX spike and the put/call ratio spike suddenly (indicating a lot more puts than calls being bought) it's been a good time to fade the selling (buy the dip). It has worked in the past and by the looks of this afternoon's strong v-bottom it looks like more than a few stepped into the fray and bought it, hoping they're not just catching a falling knife that leaves one less digit on their hand. The one thing I will caution dip buyers about right now -- if the market has truly turned down we will see oversold conditions stay oversold (indicating a strong trend) just as the rally stayed overbought and drove the bears nuts. Don't be a hero and try to nail the bottom since oftentimes you're the one that will get nailed instead. And in a decline the market takes no prisoners.

So the big question after this week's selling is whether or not the decline is a pullback correction to the larger rally or has the market made a more significant turn. The answer to that question lies in the future and unfortunately none of us has the perfect crystal ball. I have some ideas (naturally) and will show you what levels and price pattern will help us along the way.

As I noted in the table above, the selling today was on very high volume, the highest we've seen since last summer. It might have been another 90% downside day (90% of the volume on the selling side, an indication of strong liquidation of stocks). When you think about the money managers and the profits they're sitting on, and especially as we head for the end of the quarter (not to mention the influence of opex week), it's not surprising to think about the amount of selling that will take place to protect profits. When you have a market with excessively high bullish sentiment, meaning those who want to be long the market are already long and there's a dearth of bears (shorts), there's significant downside risk as all those longs turn into sellers and there are very few shorts to help do some buying in a decline. It's why excessive bullishness is bearish in a contrarian sense.

The result of the selling since the February 18th high is that the S&P 500 and the Nasdaq have now closed below the level at the start of the year (1257.64 and 2652.87, respectively), which will only frighten retail investors further. Since the bounce high on March 3rd, which was a high test of the February high, the market gave up a two-month rally in 9 trading sessions. Playing the short side has been incredibly difficult but the ride is profitable quickly if you can catch it. Unfortunately it often takes a lot of paper cuts before you're allowed to take that ride.

One thing to be cautious about is blaming the selling on whatever news happens to be hitting the wires at the time. Usually you can go back and see how the price pattern was developing the move before the news hit. The news simply became the catalyst. It's not so much the news that's important but instead it's the reaction to the news. Many are saying the selling is overdone and an overreaction to the news. That's exactly the point. Why did it overreact? Perhaps because the market is on pins and needles waiting for an excuse to sell? And why is that? Because the market has had excessive bullish sentiment which means the majority of traders who want to be long the market are already long and bears have become nearly extinct. That makes the market very vulnerable to "overreacting". When the selling starts there's little to stop it (very few shorts to start the buying but lots of stock to be sold). That's why it's important to watch how the market reacts rather than why or what the news is.

The same holds true in reverse when the bearish sentiment is so thick you can cut it with a knife and then the market starts to rally even on bad news. Throw in some good news in that situation and it's like throwing gasoline on a fire as the shorts, of which there are many when bearish sentiment is extreme, run for cover all at once. Yet we never hear the market is "overreacting" to the upside. So be careful that you don't get caught up listening to the TV pundits talking about how the market is not reacting rationally and that we will therefore see the buying return. T'ain't necessarily so. And so it is with the news out of Japan.

One thing I want to be careful about is making light of the situation in Japan, and in fact I have a link below to show the devastation, but I also think it's important to always maintain your sense of humor. Too many bad things happen around us, both personally and professionally, and it will be your sense of humor that gets you through the tough times. So with that in mind, I found the following comic both humorous and telling (what do you think Wall Street is most interested in?).

Stock market reacts to Japan's news, courtesy

On the serious side of what's happened in Japan, John Gray found the link below at NYTimes and posted it today on the Market Monitor. It shows before and after pictures of the devastation from the tsunami (after it finishes loading you can slide the vertical bar back and forth to see the before and after). My heart and prayers go out to all those who have suffered loss from this. It's yet another reminder to keep the market in perspective and to remember what's really important in our lives. Give your loved ones a hug and tell them you love them. Tsunami Damage

Last week I reviewed on the SPX weekly chart the possibility for this week to mark a low and that remains a possibility. The time projections shown on the chart are Fib projections based on the time it took for the March 2009-April 2010 rally and then projected from the July 2010 low. The 38% time projection marked the November low, 50% at the January low and now this week marks the 62% projection. So remain aware of that possibility if you're starting to feel too bearish about this market (there's reason to but don't get complacent). SPX has also dropped down (a little below) its uptrend line from 2009 drawn through the July 2010 low, which is currently near 1262 (log price scale). It's where yesterday's decline found support (did you wonder why it stopped where it did?).

S&P 500, SPX, Weekly chart

Below 1262 is the uptrend line from 2009 drawn through the August low, currently near 1225. That also happens to be the November high and the top of the downside target range I've been showing on the daily chart. As depicted on the daily chart below, the wave pattern and price relationships between the waves would look good with a drop down to 1225 this week and then a bounce/consolidation next week before heading lower again.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1323
- bearish below 1294

The price projection at 1251.69 is the 162% projection for the 2nd leg down in the decline from February, a typical target. The bounce off that level today (slight undercut) and close above says we might see a 4th wave consolidation from here, one that should last a week or more before heading lower again(red dashed line). Keep that in mind since it would make for terrible trading conditions over the next week or so (feed your broker time). There is also the risk, shown with the other dashed red line pointing lower, for the decline to pick up speed. And not to forget about the bullish possibility, although I think it has a much lower probability now, the green dashed line shows the resumption of the rally from here (the key level for that scenario is up at 1323 although a rally above 1294 would be a bullish heads up).

Since last week's update, which had SPX consolidating around its uptrend line from August-November, we've had a clean break of that uptrend line now. The break below 1294 put the bears on offense and the bulls have been playing defense for the past week (and giving up ground). This requires an update to the analog chart showing the comparison between 1987 and today. I'll say it again that I don't like predicting market crashes and I'm not predicting one now but I would be remiss (if not downright negligent) if I did not point out the risk of one occurring, especially given the vulnerability due to the excessive bullishness and the false propping of the market during the past year. Crashes come out of oversold, not overbought, and we're now oversold.

As pointed out last week, in September 1987 the rally tested its uptrend line from January (the 2nd test made a slight break of the uptrend line but recovered quickly), made a 3-wave bounce to a lower high in October and then broke its uptrend line in early October. It then tested its September low, made a smaller bounce and then when the September low was broken the bottom fell out. What I just described, up until the bottom falling out, is price action since the recent February high and the break of the February 24th low near 1294 has so far resulted in a stronger selloff. Whether it will lead to another 1987-style crash is anyone's guess. The analog says yes even if we have a hard time believing it (myself included). If Friday closes strongly down I would not want to be long going into the weekend. I might not want to play the short side expecting a market crash but I sure as hell would be reluctant to be long right now.

SPX 1987 and 2011

So the risk is for a big downside disconnect and if I was long the market I'd want some stops in place (or hedges). Remember that morning gaps can jump right over your stops. If you're looking to play the downside, it's always risky playing for a crash. Play it small and if you're in some short positions and it happens you'll at least participate a little (a small position with a big move is the same as a big position with a small move). In the meantime I'll continue to show a "normal" declining pattern and levels to watch for support.

The 60-min chart below shows the steepening downtrend lines (waterfall decline) and the break below the original parallel down-channel for the pullback from the February high. That's a bearish break and signals the pullback is likely something more than just a correction. It will be interesting to see if the bottom of the channel, currently near 1274, acts as resistance (which it was not during yesterday's bounce) for the next bounce. I'm depicting a bounce/consolidation into the end of next week (for wave (iv)) but that's just a guess at the moment.

S&P 500, SPX, 60-min chart

If it does start a corrective bounce, as depicted in bold red, stay aware of the fact that it will likely be very choppy and full of whipsaws (feed your broker time) before it sets up the next leg down. The price projection for the pattern shown on the 60-min chart points to a downside target near 1225 before launching a much bigger bounce into April. That happens to be the top of the target range shown on the daily chart.

Until yesterday's decline I was wondering if we were getting a bullish descending wedge for the decline in March, the bottom of which is shown on the above chart along the lows from March 7th to March 14th. After price broke down through the bottom of the wedge yesterday (a bearish move) I was pointing out on the Market Monitor to watch for possible resistance at the trend line on a subsequent bounce since it's most often a very good short entry. It did not act as resistance yesterday (the rally off the low popped back above it) but once it broke again this morning (this morning gapped down below it) it was time for the 2nd mouse to pick up the cheese when it was retested again on the morning bounce.

It's always nice to hear readers who take advantage of these technical setups and get a nice trade. This from John and the chart he sent to me:

"Thanks for the chart ideas. Perfect entry this morning for puts. Convergence of support turned resistance doesn't get much better than this. These are the times you can enter with confidence. Bought SPY 120 April puts @ 1.16, sold them too soon for 2.20 [almost a double]. I wait for these types of setups and don't rush into trades."

John is the kind of patient trader that waits for the market to come to him. If the bus doesn't stop to pick him up he simply waits for the next one. Forcing trades is usually how one loses money in this game. John saw the break of the bear flag pattern from yesterday and a bounce back up to the bottom of it where it crossed the bottom of the descending wedge and recognized that it was too sweet a setup to ignore. It's the kind of trade I'll take every time. Nicely done John (especially selling too soon, the hardest part of the trade).

SPX 30-min chart from John

Once the DOW broke its uptrend line from August-November, and especially its 50-dma at 12011 on Monday it's been a flush to the downside the past two days, despite big rally attempts. The 2nd leg down for the decline from February has achieved 162% of the 1st leg down, at 11622, which is the projection I'm showing the daily chart below (today's low was 11555 so it was a "minor" break but it closed very close to this projection). Today might have completed the 2nd leg down (labeled wave iii on the chart) which would set us up for the 4th wave correction into next week before heading lower again into the end of the month. I'm showing a downside projection for the next leg down into the end of the month to about 11420 based on the 5th wave being the same size as the 1st wave and guessing the 4th wave will finish around 11830 (38% retracement of the decline from the March 3rd high). Obviously all those numbers change if the market continues lower tomorrow before starting its consolidation (dashed line).

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 12,800
- bearish below 11,980

The techs are in the worst shape of the primary indexes. Even the small caps are holding up much better. NDX has now dropped below its December 31st low, which if it were the DOW it would now be below 11K. I'm showing a downside projection at 2178 where it would meet its H&S top objective, a bounce into next week and then lower into the end of the month to its uptrend line from 2009 (log scale). If the selling continues this week, perhaps exacerbated by opex, look for a move down to its downtrend line located near 2125 by Friday.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 2306
- bearish below 2217

Who would have thought the RUT would be the go-to index in a downturn? Or if not the go-to index it at least it hasn't been the gotta-get-out-now index. The 2nd leg of its decline hasn't even approached the downside projection near 760 (162% of the 1st leg down) while the blue chips and tech indexes have done that and then some. I can't explain its relative strength and if it manages to climb back above 794, its February 23rd low, it would be a bullish statement for the rest of the market. In the meantime I'm showing the same expectation for it to make it lower into the end of the month.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 828
- bearish below 794

The bonds might have peaked today for the leg up from March 8th, having reached the level for two equal legs up, at 94.03, from February's low. It should get a larger bounce at a minimum before potentially ready to reverse back down but as depicted in bold green, we could fist see a pullback before heading higher again. We should see at a minimum a Fib retracement of the decline from August 2010, the levels for which are shown on the chart below. A bounce back up to its 200-dma, currently at 97.57, makes for a good upside target in April/May. If the stock market continues to sell off hard then we might see bonds continue higher from here as money rotates into bonds as part of the flight to safety.

20+ Year Treasury ETF, TLT, Daily chart

Last week I pointed out the neckline of a H&S topping pattern on BIX and today it was firmly broken, with a close below it at 148.29. A one-day break is not significant so a recovery back above it tomorrow would be bullish otherwise it becomes resistance on any bounce/test. The downside objective out of the pattern is slightly below its 200-dma at 137.75.

Banking index, BIX, Daily chart

The transports have been relatively strong, like the RUT. Why those two trade so much alike is a question I don't have the answer to. In any case, the multiple tests of the broken uptrend line from November and its broken 50-dma finally resulted in selling but it still hasn't broken its February low, one of the last holdouts to do so. I suspect it will follow tomorrow if the selling continues otherwise another bounce to who knows how high before heading lower. This one could have another H&S top with a down-sloping neckline.

Transportation Index, TRAN, Daily chart

The U.S. dollar continues to struggle inside its bullish descending wedge (with the supporting bullish divergences) and I'd be surprised to see the dollar break down. I think it's just a matter of time before the dollar starts to rally strong out of this pattern.

U.S. Dollar contract, DX, Daily chart

One reason the dollar will likely rally strong is because of the high percentage of bears in the dollar. Short the dollar is a favorite trade amongst the hedge funds and when they start covering, and they will, the dollar will likely smoke to the upside. I found an interesting chart that shows the dollar vs. the COT (Commitment of Traders) report, with the COT plotted upside down for visual effect. Even though the dollar has been making higher lows since 2008 traders have been getting more and more net short (which goes along with the very bearish sentiment) and when they start covering look out above. This chart shows why many use the COT reports as a contrarian sign -- the dollar highs were marked with very low levels of short contracts whereas the dollar lows have been accompanied with high numbers of short contracts. It could soon get interesting for the dollar, which will likely entail the selling of other assets (short the dollar, long everything else with the money).

U.S. Dollar vs. COT, Daily chart, courtesy

It's not clear yet whether gold has topped out. On the weekly chart below I see the possibility for it to continue higher to the top of its parallel channel from 2005 and get pinched a little more inside its rising wedge pattern from 2009. A break of the uptrend line from April 2009, near 1340, confirmed with a break below the January low near 1309, would suggest gold has started what will be a much deeper pullback than we've seen in years. It's possible gold has already topped but proof will be the break below those levels.

Gold continuous contract, GC, Weekly chart

After hitting the trend line along the highs since June 2009-January 2010, with a quick throw-over finish, oil has sold off hard. It also retraced 62% of its 2008-2009 decline. The rally had all the oil analysts predicting $220+ oil but since the selloff started they've been silent. They could be right but I don't think so. I see much lower prices this year (back below $85 for starters).

Oil continuous contract, CL, Daily chart

Copper is another commodity that I like to watch because of its value in telling us how the economy is doing. It is of course affected by speculation, the dollar and other factors but the industrial demand for copper is an important gauge of global economic health. I received the following question from Matt: "I've been reading an EW forum on copper and one of the analysts sees a "bull slaughter" ahead and his weekly chart shows the latest peak as the top of a Wave 5 from which he expects copper to drop significantly. Can you provide an opinion on this especially given the importance copper plays as an economic indicator?"

Copper topped in February, the same as the stock market. The rally did a throw-over above a trend line along the highs from 2006 and 2008 and has now broken its uptrend line from June 2010. I think copper has either finished its bounce off the 2008 low or is in a 4th wave pullback which will lead to another new high (the same possibility for the stock market). With only a 3-wave pullback from the February high so far there remains the possibility for another leg up.

The bearish view of copper is very bearish because of the larger A-B-C pattern from 2006. The b-wave (the rally from 2008) achieved 113% of the a-wave (the 2006-2008 pullback) at 453.76, which is a common level for a double-top pattern (1.13 is the square root of 1.27, the other common Fib extension and reversal level, which is the square root of 1.618). So the reversal potential from here is high. The larger A-B-C pattern playing out from 2006 suggests a sharp decline (but still taking a couple of years) to below the 1999 and 2002 lows near $60. Obviously that would be quite a drop from the recent $460. Copper needs to rally back above its March 4th high at 455.40 to negate the bearish pattern and point to a new high instead. The bearish projection clearly points to significant weakening in the global economy, especially China.

Copper contract, HG, Monthly chart

This morning's economic reports were largely ignored although the weak housing numbers certainly didn't help the bull's cause. And regardless of what the inflation numbers show us the Fed will continue to tell us we don't have any inflation. Ignore that man behind the curtain. Tomorrow's reports include the normal can't-believe unemployment numbers and some more ignore-commodity-inflation reports. The capacity utilization and LEI report is not expected to move the market and while the Philly Fed report in the afternoon could move the market I think it's got greater worries at the moment.

Economic reports, summary and Key Trading Levels

I turned very bearish last week and I remain bearish this week. That's not to say we won't get a bounce into next week but the larger pattern points lower and therefore any bounce that we get from here (as long as it stays below the key levels identified on my charts) will be another shorting opportunity. I think it's too early to be looking to buy the dip but that opportunity will come. If we get a clean 5-wave move down into early April as I've depicted on the charts we'll get a beautiful setup to play the long side for most of April. It could get ugly after the bounce but we'll worry about that when the time comes.

If we do get the bounce/consolidation into next week I would be very careful about trading it. If it's to be a 4th wave correction they're horrible to trade -- lots of chop and whipsaw. Throw in the higher volatility and the whipsaws could be large. If the market continues to head south from here then watch the support levels I've identified since we should be getting close to finishing the leg down from March 3rd. If the market is setting up for a crash instead there will be no mistaking it, in which case step away from the computer and don't try trading it. If you're short that's one thing but getting short and having it fly back in your face with a couple hundred point run back up on the DOW before falling back over is not something you want to play with.

If you're long the market and simply hoping nothing bad happens, that's not a trading strategy. Well, I guess it is but it's a losing one. Decide now where and when you'll get out and ask no questions when your stop is hit. Stay disciplined and that of course goes for both sides. Volatility is increasing and that means being on the wrong side of a trade and not exiting is going to be a painful experience. Trust me on that one.

Good luck and I'll be back with you next Wednesday.

Key Levels for SPX:
- bullish above 1323
- bearish below 1294

Key Levels for DOW:
- bullish above 12,800
- bearish below 11,980

Key Levels for NDX:
- bullish above 2306
- bearish below 2217

Key Levels for RUT:
- bullish above 828
- bearish below 794

Keene H. Little, CMT