In two recent posts, Short Term Breadth Pointing to a Bounce, and So We Got the Bounce. Now What, I discussed how to interpret two of the indicators I use and walked the reader through my thinking when interpreting them. You’ll see that the indicators were accurate in predicting the first three days of this week.

The good news is that both indicators are now aligned which means I feel comfortable looking for a tradeable bounce. This means I expect a bounce that will last 3 to 5 days.

Let’s have a look…Click on the chart to enlarge it.

Note that the very short term decline line indicator (green line) is above 99, which means a bounce (or stabilization) is imminent.

The short term “number of stocks above their 5 day moving average” indicator (red line) is also beneath the trigger area of 650 with a reading of 449. This is the lowest reading for this indicator in 2013. The last time we had a reading lower than this was November 14th, 2012, at 388. This date was two days before the absolute low of the Fall 2012 correction.

These indicators do not guarantee a tradeable bounce, but the odds are on our side. Couple the odds with the 50 day average just beneath Wednesday’s close and I’m looking for a bounce.

Last night I wrote about a couple of my indicators, one of which was pointing towards a bounce being imminent.

Well we got the bounce, so now what? Let’s look at the updated indicators, and I’ll walk through my thinking process.

As I mentioned last night, I use the red line indicator, which is a measure of the number of stocks trading above their 5 day moving averages, to gauge how sustainable a bounce might be.  The indicator bottomed out around 900 or so. A glance back through this year shows that tradeable bottoms have occurred much lower than the 900s. In February, it was 501. In April it was 620 and 459. In general, I start getting excited at any reading beneath 650.

So what does this mean for the next few days?

With the decline line indicator reading neutral at 49, the imminent bounce has been had. The red line did not reach a level which makes me get excited about the possibility of a sustainable bounce. Therefore, my thinking is that I wouldn’t be surprised if the bounce continues, what with Ben Bernanke and all, but I’d be less surprised by a lower low.

Another pattern than I’m watching is that $SPY has been touching down on and then bouncing from the 50 day average, every couple of months.

The one caveat is that today’s candle, a hammer, and on good volume, has traditionally been one of the candle patterns that I trust the most to signal a low. It has been such a strong signal for me that I’m tempted to allow it to override my red line indicator. What’s a few hundred stocks that are not beneath their 5 day moving average when the day’s candle is bullish? I don’t know the answer to that. We’ll have to wait and see.

This is not an exact science. We couple our experience with our data by using our previous experience to help us interpret our current data.

And by short term, I mean very very short term. A signal given from this indicator means a bounce is imminent. For this shortest-of-terms measure, I use a bounded decline line indicator, which simply counts the number of declining stocks, compares that number against previous readings over the last 252 days (one trading year), and then ranks this reading against the others in percentage terms. It is bounced because ranking the reading in percentage terms means it is bounded between 0 and 100.

Let’s have a look…Click on the chart to make it bigger.

The decline line indicator (green line, middle pane) is showing a reading of 96.03. Readings in the 90s are typically followed by an immediate bounce, or at the very least, a few days of stabilization. Once the bounce or stabilization occurs, everything resets.

The red indicator in the bottom pane also measures short term breadth but is better for gauging how sustainable a bounce might be. When this indicator gets a reading in the 600s or lower, and the decline line indicator is also indicating a bounce, then I look for bounces that will work for swing trading. In other words, this indicator can help us find bounces that last a few days or more. Since the indicator is currently reading 939, the market has probably not pulled back far enough yet to yield a swing-tradeable bounce.

The bottom line is that I’m looking for a bounce Monday or Tuesday (at the latest) or some stabilization, but expect that this pullback can continue before we get a good tradeable bounce.