Worrisome

A downtrending day with a higher close has put the “Supply & Demand System” in a long position from yesterdays open. Hopefully you saw yesterday’s typo and saw that 15 “contracts” were being used in the sample money management section; 500/32.78 = 15.25. Anyway, the practical question now revolves around trade management, specifically, where to place the stop.

In the current environment we do not have much room for error; and, for what it is worth, I don’t have a good feeling about this trade. We did make a new low yesterday and the ADX continues to rise indicating the down trend is still in force. More importantly for my immediate purposes, the current “support” line is right underneath the market. A break of that line would nullify the current bullishness and should be used as a Stop Loss level or a “Stop and Reverse (SAR)” point. This morning the support line sits at 1240.80.

Educational use only. Never intended as investment advice.

Step Right Up and Take a Chance

After tip-toeing higher at the open the cash S&P500 tripped and fell heavily, making a new low (closing basis) for the decline that started last autumn. This price action led to an uptrending bar with a lower close on the daily chart that leaves the market delicately poised between support (green line on chart) and resistance (red line on chart).

Although the downward trend is still in force (as shown by the fact that the ADX continues to rise), there are bullish divergences forming here between price and the technical indicators I use. In fact, if we can rally strongly the next two days the weekly chart would confirm the price action by triggering a bullish technical signal itself. But that is a “what-if” scenario. What does the objectively based plan dictate?

Perhaps surprisingly it says the following:

IF we OPEN at 1240.76 or below go SHORT with a stop at 1273.55.

IF we TRADE at or above 1240.19 go LONG (unless you are already short) with a stop at 1207.41.

Stop loss levels “drive” position size and money management rules allow a risk of no more than 0.5% of account equity. For example, on the theoretical long trade above, the risk is set at 32.78 points. If the account was worth $100,000 we have a situation where $100,000 x 0.005 yields a maximum loss of $500 allowed on the trade. $500.00 / 32.78 stop = 174.3; rounded to 15 share maximum. The practical result is that 18.6% of the account is used to “bet”.

An Oversold Bounce

The cash S&P500 rallied yesterday to make an uptrending price bar on the daily chart. Not only has this bounce alleviated the severely oversold condition we’ve had over the past few sessions, but it has displayed two other “bullish” aspects:

1) A technical “buy” signal was generated as bullish divergence formed between the RSI (top pane) and Composite indicators (middle pane);
2) The active “Resistance” line (see chart) was validly broken.

In the past that “buy” signal would have swayed me to bullish action – even though the weekly chart is still on a “sell” signal. Of late I have become more reactive to market action and less “proactive”. This includes considering the Tom DeMark idea of not moving into a severely oversold market. That constraint has had the practical effect of passing up yesterday’s bullishness and to not take any action regardless of today’s price action.

So what am I waiting for? The “next” opportunity, and this is not necessarily on the long side. It will be what the price action gives me. The next steps in this process are to see which price fractals and support/resistance lines form next. If Monday’s low of 1240.68 can hold through today then that price bar’s low will be a price fractal (lower than the lows of the two price bars immediately before and after it). This occurrence would establish a new support line below the market and delineate where a shorting opportunity may lie. For a long trade I will wait for the market to close back below the active resistance line or for that line to adjust to a new supply/demand equilibrium should a new high fractal form.

Finally, a quick note on the Directional Movement System that has been mentioned over the past few postings: the ADX has still not turned down.

Oversold Can Become More Oversold

Yesterday saw an “outside” price bar on the cash S&P500 index and prices are now at their lowest levels since July of 2006. The steep downtrend with severely oversold conditions continues and the ADX line (shown in the last posting) has risen further above both Directional Index (DI) lines. The RSI is now at its lowest level on the daily chart since July of 2002.

Of course, what is oversold can always become more oversold. That truism has me unwilling to touch this market right now. Before my work can become positive on the S&P’s I must see a bounce (to relieve the oversold condition) and then another oversold (less than 32) reading.
Looking at my database (from 1983) the RSI has been as low as it is now just eleven times, and only did three of those instances occur at “the” bottom: the 1987 crash, 1994 and 1996. Significantly, none of those three cases saw the market reach an extremely oversold condition (RSI less than 32 for six or more days) as it has now. Conclusion: This is not "the" bottom.

Here are the support levels to watch today:
1234-38
1220-25
1200-05
1187-93

Just the Facts Ma'am ...

One of the benefits of writing this blog is that I am learning that I won’t make progress by trying to forecast or anticipate the market’s path. This may be intuitively obvious but is a hard lesson to personalize. I have to continue to become more objectively-oriented and make decisions based on factual evidence. Here are the facts:

1. The cash S&P500 is in a bear market. This is shown, for example, by prices being below support and resistance lines.
2. Prices are trending downwards. This is shown by the current ADX value being at 36.
3. The market is severely oversold as indicated by the RSI being less than 32 for six or more consecutive trading sessions.
4. The monthly chart is on a technical “sell” signal.
5. The weekly chart is on a technical “sell” signal.
6. The daily chart is on a technical “sell” signal.

All I can conclude based on these facts is that a bearish view is warranted. But, it is also the time to look for a long position. However, I will implement one of Tom DeMark’s ideas here and wait for the oversold condition to “recycle” before taking action. No trading action will be taken Monday.

In a trending market we also want to watch for “… significant interaction between lines made by +DI(14) and –DI(14) and the ADX when plotted on a bar chart” (Page 47 of New Concepts in Technical Trading Systems by J. Welles Wilder Jr.). Mr. Wilder states “The turning point often occurs concurrent with the first down turn of the ADX line after the ADX has crossed above both the DI(14) lines.” On today’s chart the ADX line is in black, +DI in green and –DI in red. The ADX line has now gone above both DI lines. Let’s see when it turns down.