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Extracted from the Early Dec 2007 market update.
"The person who seeks all their applause from outside has their happiness in another's keeping." ~ Claudius Claudianus 340-410, Egyptian Latin Poet
|Moving average||New Highs||New lows|
Looks like our outlook last week proved to be accurate. However note that despite today's impressive rally, all 3 moving averages of new lows continued to lead the moving averages of new highs. This suggests that there could be one more massive selling wave in store before things calm down and the market is ready to rally. Market update Nov 27. 2007
It appears that the markets might be preparing for another rapid pull back and this pull back could be the one that launches the entire US market into a massive rally but this pull back could be circumvented by the lowering or the hint of lowering of interest rates. We would not hold our breadths for this pull back but if it does occur then risk takers can go out and buy even more calls on the Dow, QQQQ, SPX and futures players can go long Dow or SP500 futures. Option players make sure your options have at least 6 months of time on them and do go too far out of the money. In other words don't start to buy Dow 15200 options right now.
Standard Deviation Analysis
The premise here is simple. When either the +3sd band or negative -3Sd bands are hit; it suggests that an oversold or overbought condition is in the works. Example if the market is topping and the +3SD band has been hit, then it would indicate that there is a pretty good chance of rather sharp downward move occurring and vice versa. If we are in an up trend, meaning that the +3Sd band was hit and the markets have pulled back. A test and the ability to hold above the 18 or 30 day moving average would indicate that the markets will most likely rally to test the +3Sd bands again. This tool should be used in conjunction with 2-3 other TA tools or simple trend analysis. One should never make a judgement based on this tool alone or any other individual tool; always use 2-3 tools. The more TA tools you familiarize yourself with the better. However one should not exceed 6 tools as you will most likely overwhelm yourself. Ideally 3-5 tools should suffice.
|18 day SD moving average||13117||2622|
Difference between -3Sd and +3Sd bands
(15 weeks worth of data provided below; updated on a weekly basis)
Highest value between the -3Sd and +3Sd band for Dow = 1964 (Nov
Highest value between the -3Sd and +3Sd for NASDAQ= 583 (Nov 20th, 2007)
Rapid contractions in both bands especially in those of the NASDAQ (50% contraction); this could be a sign that another fast and hard pull back could be in the works.
We know that right now things feel rough but we have been here before; indeed at one point in 2005 our entire portfolio was in the red but then there was a massive turn around and we started booking triple digit gains left right and centre. What has happened this time around is that the small investor has been scared out of his wits by the constant barrage of bad news from the credit, mortgage and housing sector. This fear has reached such heights that it has now even scared some of the big speculators and some of the lower echelons that make up the smart money. One can see the effects of this on the whopping jump in the short interest ratio on the NYSE. Understand that no bear market has ever begun when the short interest ratio is high especially when it is trading in record high territory. It will take time for the fear to move out and the first chaps to gain will be the large cap stocks but when the masses race into the markets the small caps will play catch up with a fury; it's only in the small cap arena that you can constantly lock in gains of 60-100% on a yearly basis. Right now its time to be patient, prudent and disciplined as the time for rewards is not to far off. Those that took part in the higher risk option plays are already sitting on massive gains as they got in the 12700-12800 ranges. Futures players are sitting on open gains of close to 7000 dollars a contract. They could easily pay for 10 years worth of market update service and one would still have plenty of change to spare.
It seems that we are not alone when it comes to being sceptical about the Dow Theory. Mr Droke used information provided by old Dow Theory experts (Rhea, etc) to prove that for the most part that today's Dow theorists are actually abusing this theory http://www.safehaven.com/showarticle.cfm?id=8935. He also uses information provided by these old experts which illustrates that the Dow Theory was never supposed to be used as a stand alone system. The truth is that no theory can work forever and if we had to come up with one and call it the "Tactical Investor Theory" we can quite confidently state that it would fail sooner than later. The only tools that work are ones that employ pattern analysis and the reason they work is because they are adaptive and not static. This is another reason why TA works but one must learn to use these tools in a personal manner; in other words one should not always use them in the way so called experts state that they should be used. One way to do this is to always adjust the settings and select tools that personally appeal to you and not ones that are hyped or are popular at that point in time. Finally one must remember that no tool or tools work forever; in other words there are going to be times when they and everything else fail; this is called life for nothing in life is guaranteed. Most people give up when this happens or start looking for excuses instead of simply admitting to the fact that failing or losing every now and then is part of life. Without experiencing loss one can never truly experience what it feels like to win; the pain caused by the loss creates even more joy when you win. The same goes for love you can only truly appreciate what love is when you have lost it or are in deep pain. So losing, just like winning is part of life and no one can win all the time for if they did they would fail to appreciate it. The laws of the cosmos are truly wonderful if people take time to understand the benefits they provide but sadly most always focus on the negative aspect. Fear not when you have fallen but understand why you have fallen; rise up and use the pain to drive you even further up the ladder of life.
The Utilities have put in two clusters of new highs (green boxes) and thus this powerful indicator that we discovered roughly 2 years ago is predicting that the markets are ready to go and put in new highs. The last high was set on May 22 2007 when the utilities put in an intra day high of 537.12 and closed the day at 533.70. If they can remain above 540 for 9 days in a row they definitely have a very good chance of testing the 600 mark. According to the pattern we discovered the next one to follow should be the Dow transports but occasionally the Dow industrials and transports break out together or the Dow industrials could lead.
The transports appear to have already put in a bottom and in doing so flashed a rather strong positive divergence signal. They need to hold above 4346 on a closing basis to indicate that a bottom is in. Thus based on this pattern that we have spoken of several times in the last few months; the Transports should be the next in line to put in a new high and the Dow industrials should be the last to join. Now we never rely on just one indicator as to do so would be extremely fool hardy. We have no sell signals on any of our tools and so when we combine this with the above pattern its seems almost a given that the Dow is going to go on to put in a new true all time high by blasting past the 14500 mark.
In the short term though there is one negative and that is our smart money indicator; last week when the Dow dropped instead of diverging it confirmed the drop and thus it appears that the Dow could test its lows (12700-12800) once again before embarking on a very strong rally.
As stated before the short interest in the NYSE is still in record territory; clearly the dumb money is betting the markets are going to crash. The smart money on the other hand has one of the smallest short positions in history again and this time the commercial hedgers have joined the party too. The last time they held such a record low number of short positions was in the year of 1995, just before the markets embarked on one of the most explosive bull runs ever.
One other major factor deserves mentioning here; when the US markets are adjusted for the lower dollar they are actually one of the cheapest markets in the developed world and smart money on a global basis has noticed this. Therefore it comes as no surprise to us that the Abu Dhabi Investment Authority said it would invest $7.5 billion in Citigroup. Note also that Air bus is considering building new factories in the US; this is another form of ploughing money into the United States.
The utilities have flashed a new buy signal by putting in two new 52 week highs one after the other. This buy is confirmed by the lack of sell signals on any of our indicators. The only negative that we have right now is that our smart money indicator validated the lows the Dow put in last week and in doing so they are indicating that there is a chance that the markets could test the lows once more. It would be incredibly bullish if this indicator flashed a buy or at the very least, a strong positive divergences signal on the daily charts. We cannot force this indicator to do anything and as disciplined traders we have to simply sit and wait for it to generate a signal. As of right now we are even more bullish given the fact that the utilities have put in two 52 week highs one after the other.
Risk takers that took our advice and bought calls in the 12700-12800 ranges are sitting on very lovely gains right now. Half of these calls should have been sold for roughly 150% in gains and thus the remaining half of the position basically is being held at a zero cost.
"Accuracy is to a newspaper what virtue is to a lady, but a newspaper can always print a retraction." ~ Adlai E. Stevenson 1900-1965, American Lawyer, Politician