The Crash That Never Was

After the “flash crash” on May 6th of this year, many people went out of their way to argue that the intraday melt down was an aberration of sorts.  They implored traders to disregard the massive, high volume 10% spike down that day as something that “does not count.” Even some of the most esteemed technicians, like Louise Yamada, went on television and told traders that if they doubted the validity of the 1065 print on the $SPX, they could simply put their hand over that gap on the chart as though it never occurred. Other traders simply laughed off the event as being a mere game of chicken between Wall Street and Washington, D.C.. They argued that the bull market would continue to march on, going forward from that day.

The problem with those kinds of arguments is that only price gets paid in the stock market.  Unless you engaged in one of the few trades that got cancelled on May 6th, everything else was, and is, completely valid.  Why? Because the market is the ultimate and final arbiter.  To trivialize any price action in the market is reckless and unprofessional.  The market has been telling us for quite some time now that it is sick and unhealthy.  Moreover, that 1065 flash crash low is acting as a price magnet.  Take a step back and ask yourself, with so many people doubting the actual validity of that price, is it possible for us NOT to test it again?

Regardless of your theory about what happened two weeks ago, however, the bottom line for traders is that the demand for equities is being overwhelmed by supply.  Ever since mid April, the charts of both the broad indices and the leading stocks have been telling you to cut your longs.  Price swings, volatility and selling volume picked up well before the “masters of the universe” allegedly turned off the computers on that infamous day.

As I am writing this,  I see that we are off of the lows of the session.  However, we have blasted down through the key 200 day moving average and have spent the entire day below there.  The bulls are running out of time, and even the most steadfast ones who continue to harp on the “May 6th crash that never was” are learning the hard way to always respect Mr. Market, in spite of his temper tantrums.

Market Wrap Up 05/19

For the third time this month, we came perilously close to losing the 200 day moving average, as the $SPX closed down 0.51% to finish at 1115. The 200 day m.a., currently at 1102, is a reference point that is widely viewed as being the line in the sand, helping us to separate bull from bear markets. In fact, on this very website you will find one of the most successful trading systems around–Woodshedder‘s Power Dip System–which relies heavily on whether we are closing above or below the 200 day moving average. Thus, the significance of that reference point cannot be ignored by even the biggest of pocket protector economists.

Although we managed a decent bounce to close above the 200 day m.a., we have yet to see the bulls reenter the market with anywhere close to the same kind of vigor that they showed back in February, when the 150 day moving average was the key support level at the bottom of that correction.  Indeed, the longer we churn around this level, the more likely we are to eventually break below the 200 day moving average, which would likely beget even more selling.  The daily, updated, and annotated chart of the S&P 500 should illustrate these points, seen below.

One common mistake that traders make is to assume that the market will automatically reverse from a downtrend, and subsequently rally, after testing a major moving average.  These misguided traders often place limit buy orders at a given moving average, or aggressively buy via a market order the moment we test it.  I believe that this is a long term money losing strategy.  Keep in mind that moving averages are merely reference points that should be helping you gauge the underlying strength of the market.  Moreover, because major moving averages, such as the 200 day m.a., are being keyed on by so many traders, the more likely scenario is that we will not bottom there.

“When everyone thinks alike, no one is thinking.” -John Wooden.

Over the past week or so, I have shown you various charts of broken stocks and sectors.  So, you would think that shorting here would be a slam dunk.  The problem with that idea is we are oversold.  In fact, being oversold is the best argument that the bulls have right now.  Thus, aggressively short selling is probably not correct here.  At the same time, our rally attempts have been notably impotent. To go long for even a quick one or two day bounce does not seem worth the risk at this point, given the choppy price action.

Above all else, this is still not a market for swing trading.  Anecdotally, I am seeing many people eager to play a bounce, or call a bottom.  This goes back to the point I made yesterday, about the importance of not becoming emotionally attached to either the “this is 2004,” or “this is 2008 redux” camps.  Moreover, many traders had been expecting a pennant or tightening wedge to form in the coming days, as I noted in yesterday’s wrap up.  However, the violent price swings and uncertainty are going to have to abate first, before we can form any kind of constructive chart pattern.

Top Picks: Cash and Patience

Two setups that I am stalking are in the gold and guns space. Both plays have the added bonus of being considered, at various points in time, functions of BOTH strong risk appetite as well as risk aversion.

I have previously traded $SWHC on the long side, and may get involved with that stock again. I sold out of it a few days ago, as I was more or less playing it as a wildly oversold name during the previous months.  Now, though, the stock is threatening to break above the 200 day moving average.  If it can break above–and more importantly hold–that level, I will look to buy back in.

In the interim, $RGR has caught my eye.  Note that it could easily become a short if it breaks down below its flag. However, it should be a bullish setup.

$GLD is pulling back today, as it looks to be a healthy gap fill and shakeout.  “The color” may need to retest $114, though, so taking a full position at this moment is not advisable.  However, it remains at the top of my buy list.

Due to the continued state of WTF??!!! in the market, the above ideas are still just brainstorming at this point.  When an accomplished and respected technician like Brian Shannon says that he has no feel for this market, you should continue to adhere to the house rules at “Gentlemen’s Clubs” in New Jersey—look, but don’t touch (uhh, or so I’ve been told by my friends, that is).

With the recent news driven nature of the market, a wedge has been drawn between various traders, commentators, economists, etc.. There are those who think that we are simply experiencing a healthy pullback that is part of the wall of worry just like we saw in 2004, during that cyclical bull market.  Those people insist that the headlines coming out of Europe and other parts of the world are blown out of proportion, and that investors should show some gumption and buy the dip.  The other school of thought is that everyone has their eyes wide shut at how bad things truly are, and how bad they will soon become. They believe that we are in for another round of a 2008-style deflationary crash…or worse. The wild price swings, increased volatility and selling volume all illustrate the unease and uncertainty with which the market has had in trying to reprice equities commensurate with the risks associated with Europe, China, etc..

Until we find out which group is correct, I believe it is best for individual traders to avoid becoming emotionally attached to either thesis.  The price action, volume, and other indicators have been doing a solid job leading us into holding a large cash position thus far, and there is no reason to expect the charts to betray us now.

The daily, updated and annotated chart of the $SPX illustrates the problem with trying to time an inflection point, as many traders did with the possible bullish hammer printed yesterday.

About the only positives that I see for the bulls are that we are oversold again, and we did not take out yesterday’s low, just south of 1115.  We are also still above the 200 day moving average.  Notice how the 1150 area (pink horizontal line) is turning into heavy resistance again, just as it did in January.

As I said earlier today, I see unfavorable risk/reward profiles to both longs and shorts at this point in time.  One possible scenario is that we narrow our current trading range over the next few days, forming a wedge or pennant that eventually resolves sharply one way or the other. Another scenario is that we will have an imminent test of the 200 day moving average–just above 1100– in the next day or two, which should offer a chance for a tradable bounce.

If we see any kind of dead cat bounce in the next few days, one area that I believe is setting up for a good short trade is the casino sector.  I mentioned $WYNN yesterday as showing a weak chart, and I believe $MGM and $LVS are comparable.

Despite the above short ideas, there is nothing wrong with taking a pass on making any trades right now.  This market is chopping up many overly aggressive and overeager traders, and you can be sure that the brokers are racking up huge commission fees with all of this volatility.

Michael Jordan often used to say that one of his keys to success was that he let the basketball game come to him. In other words, he stopped trying so hard to force good things to happen during the game, and he instead waited for good opportunities to present themselves before asserting himself.  The same can be said now–let the market come to you.

On the back of the hammer that we printed yesterday, you would think we would have seen more enthusiasm from the bulls today. However, so far we are seeing an uninspired effort with no conviction either way.  Seeing as we remain below the 20, 50, and 100 day moving averages, with lots of other tough resistance overhead, this does not bode well for a sharp recovery to the correction.  On the other hand, we are still relatively oversold, so chasing shorts down here is probably not a good idea.  What we are seeing now is as close to no man’s land as you will probably find in the stock market.  The short term chart should illustrate this point, seen below.

As I am writing this, I see that we just gapped lower.  Just as I noted yesterday, trying to anticipate an inflection point is a money losing strategy over the long term, despite short term luck.  Believe me, I am just as anxious to put my 100% cash position to work as anyone else, but I am not seeing good setups. How I feel about that is irrelevant.  Either the trade is there, or it is not.  Try to force it, and you are making a mistake.

With that said, you should not choose to turn off your laptops and walk away. The character of the market can change at any moment, so it is important to watch the action closely, even if you have no vested interest at the moment. Sometimes, being a spectator–and only a spectator–is a necessary part of being a profitable trader.

I am looking at 1128, 1125 and 1115 as key support levels for the rest of the day, with 1142 and 1150 as resistance.

After moving sharply lower into the New York lunch hour today, the bulls managed to stabilize the market and close near the highs at 1136, up 0.11% on the $SPX.  Days like today are interesting from a sentiment standpoint, as many traders are eager to call a bottom.  In fact, the daily updated and annotated chart of the S&P shown below, shows a possible bullish hammer today (long green wick with small body on top).

Note that on February 5th of this year, that hammer did, indeed, mark the bottom of the correction.  However, bullish hammers (as per Japanese Candlestick charting, signifying a day where the bears control the action, before the bulls make a very strong comeback late in the day to recapture the initiative) need confirmation to the upside before you should act on them. As far as resistance and support levels tomorrow are concerned, look for 1142 and 1150 to be resistance, and 1124 and 1115 as support.

As much as I would love to declare today the bottom to our most recent market correction, I remain skeptical for several reasons. For starters, many charts remain broken.  Moreover, the daily price swings and volatility are not healthy, and are not consistent of a market that is on the cusp of a sustained move higher.  Finally, I am not seeing institutions providing an underlying bid to this shaky market, via heavy buying volume.

As noted in an earlier post today, when the S&P dipped below 1120 I decided to take profits in all of my short positions (via inverse ETFs) and move to 100% cash. If you describe yourself as a swing trader, trading in tandem with the primary trend of the market, then I believe you have to step aside here until the market decides where we go next.  For all intents and purposes, we are in no man’s land.

On the one hand, leading stocks like $NFLX and $CREE were up sharply today, but on the other hand, their day to day price swings have been massive.  Violent price swings are particularly concerning after the kind of parabolic moves up that both stocks have enjoyed the past eighteen months, as they signal indecision and a possible reversal.

In addition to those two names, several other leading stocks (over the previous eighteen months) are showing troubling charts: $GMCR, $WPRT and $WYNN.

From my vantage point, these stocks are damaged and need time to repair.  That process is likely to take weeks, not days. I will continue to be skeptical of any bounces that I see, until the charts of the leading stocks offer good setups–and I do not even see decent ones at this point.

Calling any type of bottom (or top) in the market can be a fatal blow to your portfolio, as you are essentially shunning the opinions of millions of the smartest, wealthiest people in the world engaged in rigorous price discovery.  They are often armed with vast resources and information.  To be sure, there are times when it is correct to be a contrarian.  However, for every Warren Buffett who successfully becomes greedy when others are fearful, there are thousands of retail investors who become broke when others get rich off of their hubris to declare an inflection point, before it comes to fruition.

UPDATE: I have changed my daily S&P chart. Originally, I had said the imminent 20/50 day moving average crossover would be bearish.  However, Mr. Woodshedder was kind enough to point out that the data he has suggests that it is actually more bullish than bearish, so long as we continue to close about the 200 day moving average.  You can see it all, just click here.