Joined Oct 26, 2011
153 Blog Posts

The Unconfirmed Top

I believe the market provides superior risk/reward for the bears than the bulls at this time, even if the current momentum is in the bull’s favor, and even if there is no confirmed bear market yet. The IWM shows about $25 potential reward to $5 risk. I don’t think the full $25 potential will materialize, but even if you only get $10, the trade has profitable expected value as long if the market produces a win more than 1/3rd of the time.



On an intermediate time horizon, the trendline starting from the 2011 low created a 1-2-3 topping signal which set up sometime around November 2015. This was also a retest of a triangle top which probably moved too fast for most to react to.

Unfortunately, the decline failed to take out the prior low in every market, on both a weekly and daily closing basis, so there’s some confusion as to whether we have entered bear market or bull market.

For now we actually have a couple bearish trend channels that have begun to form and either remains a viable sign of a bear market. However, the more conservative bullish trend channel has not been breached, nor has the trendline starting from the 2009 low. Additionally, the other possible bullish channel was breached briefly, however in the rally we have regained support.

So that leaves us caught between a rock and a hard place as far as predicting price goes. Fortunately, there are still clear areas from which the risk reward favors one side over the other, and risk/reward is the name of the game.

Right now we are overbought entering supply zones where the bears who sold will defend the break even and the bulls may look to sell while they have a buyer in positions that are underwater.

The areas of supply are at 205-212 range in the SPY, 110-117 in the IWM, 107-110 in the QQQ (not top heavy) and the 175-180 range in the DIA.

The QQQ actually has a more bullish volume profile in that it has history of volume from 101-106 where the bulls directly below seem to outnumber the bears directly above. Nevertheless, with the other markets suggesting greater risk of running into resistance and selling off, the nasdaq bulls could quickly end up under water and the bulls could pile on and if prices move below the 101 level things could very quickly shift to where the sellers are in control.

The overhead supply provides an easy out for sellers to get back there shares at a slightly higher price while the gap below provides potential for gains. Past price history and volume suggest the amount of future transactions that take place as well as the speed of the price movement away from volume clusters and towards price discovery through volume pockets until new transactions are found.

Apply this principal to the IWM.iwm

You can see there is risk of a fast move below. There was very few transactions as the IWM rose above 85 to 110.. There are enough transactions at and above 110 that are underwater and bears that may look to reinitiate at similar prices. This creates the conditions for selling, and without much history of transaction below, prices move until it finds new buyers. The volume profile suggest that unless new money that wasn’t interested in buying on the way up in the 85-110 range suddenly decides to on the way down, or unless short sellers begin to take profits and establish a bid, you could see the market continue to move downwards as there will likely be more selling supply than buying demand.

Even if the profile won’t tell us what will happen, it can establish an objective measurement of risk and reward locations. For selling to be a bad idea, you’d have to be wrong a much larger percentage of the time than 50/50 if you manage risk so that you have the markets moving as much as $25 down when you’re right and no more than $5 upwards when you’re wrong. Certainly it’s possible that the market catches a bid and you have to close out your gains short of the $25 reward at the $5 risk, and certainly you may be right less than 50% of the time, but the odds are in your favor that you have a profitable trade on the bearish side.

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