Market Analysis

Weekend Charts: Optical Illusion

Spinning-Optical-IllusionNo matter how good a trading set-up you identify, it is only a set-up until it is confirmed by actual price action. This is the basic risk/reward challenge all of us traders are confronted with every time we identify a trade. The particulars of when you enter/exit a trade, with how much capital, and with what trade vehicle are driven by your trading process. This week again highlighted how enormously complex and counterintuitive the data can be that gets thrown at traders. From Janet Yellen and extreme currency volatility, to Scotland voting, quarterly OPEX and the largest IPO in history, there was a lot to digest and to make fun of (see trading memes).

Our trade plan had us trading long earlier in the week, but we were already mindful that we wanted to sell strength later in the week, specifically into Friday. While some markets made new highs this latest push to new highs is setting up to be a major optical illusion. In fact, the set-up is increasingly pointing toward a major sell signal. Remember it’s a set-up only until confirmed, but let me walk you through the major data points.

APPLEFirstly the $BABA IPO was as clear expression of sentiment as I’ve seen in a long time. Greed, chase, giddiness. Originally priced at $68 within mere minutes of open the stock pushed toward $99.70 giving the company a market cap of close to $250B. That was heading toward a Price to SALES ratio of almost 20. Granted $BABA has great margins and a great story, but it was the ferocity with which people stormed into the stock that made one wonder. Word was that buy orders of $199 existed, people wanted IN. As the stock settled market cap was closer to $230B. We live in an age where numbers in the trillions and billions seem no longer to register or compute. $BABA’s valuation ranged from $150B-$250B within a time period of 24 hours. Now markets can determine fair value anyway they like I suppose, but when the culture exhibits signs of rushing into something at all cost it speaks of irrationality.

Hence I felt compelled to make this comment:

While Janet Yellen propelled stocks higher for the umpteenth time using the same “considerable” language yet again more voices of caution began to emerge, this time from the IMF. Marketwatch kindly included my comments in their source article:

So at least some of us are speaking out amongst the hype. But the charts reveal the hype to be an illusion.

One of the big factors that got us initiating short by the end of the week were the various analog structure I have been pointing out in Action Replay. Now as it turns out these structures do matter:

SPX daily

Another fake high with a false break-out above the upper trend line. Now note this week the low was made Sunday night during the first seconds of futures open and the high was made Friday morning also during futures trading. Regular trading hours have little to do with price discovery these days. That happens in the dark with hardly anyone participating. In the chart above you will note negative divergences. Let me crystalize how extremely divergent the market has become on this latest push up:

Firstly the RSI on the $NDX is horrid with cumulative advancers completely lagging:


The highs/lows on the overall market are as divergent as they have been and weakening to a new extreme:


The $NASI remains on a sell signal:


The $NYMO wasn’t even playing along this week:


And the trend in $NYAD continues to weaken even with new index highs:


Even the $NYSI put in a negative divergence:


So let’s put this in context with this 6 year chart:

SPX weekly

This unprecedented rally is internally weakening as it approaches an ever narrowing field of trend lines, one of which is already broken and is desperately trying to recapture its slope. Now one can choose to believe this trend will continue forever, but someone is clearly not. Some asset managers are reallocating and quickly so:

ASSET ratio

And this comes right on the heels of the most bullish asset allocation ever, the most bullish Rydex ratio since 2000 and historic high money flows. Now I hear plenty of people raise their price targets here, but from a risk/reward perspective is this really the best spot to trade long? The analytical answer is no. The hype answer may be yes. But while they have kept up the illusion and sold tons of $BABA supply my premise is that this latest high was an illusion.

Note on Friday small caps were crushed again. These internals are telling a story and both the weekly and monthly charts of the $RUT tell a tale and it is of a trickster who suckers retail in to buy more shares:

IWM weekly

The monthly chart points to significant more downside to come:

$RUT monthly

So I’ll leave you with a little thought experiment. Corrections no longer happen right? They used to and they have some basic percentages associated with them. In a world that has lost connection to numbers and has forgotten corrections let’s run through some basic corrective numbers on the $SPX. Just for giggles, and ask yourself who is prepared or is even contemplating a market hitting basic corrective $SPX targets such as these:

5% – 1892

8% – 1849

10% – 1809

12% – 1768

15% – 1708

20% – 1608

The very fact you are probably thinking I sound like a complete lunatic for even mentioning basic corrective figures like these in the current environment would highlight how extremely distorted these markets & sentiment have become. But these are just speculative possibilities. As with this week, we trade them long and short as we see them. For now we see risk to the downside. Good luck.

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