The Storm Ahead

Tonight, I will have a lengthy post. Market conditions appear very bullish on the surface. The close was higher than the open. Check. The Chaiken Money Flow turned back up. Check. Support @ 1219 on the S&P 500 Index held. Check. So far, so good. My worst fears were not realized for a weak day. Check. If the market lets you off the mark, then there are probably fundamental reasons behind the move. I agree. Check.

And yet I see a storm ahead. Its an unpleasant truth. It is not pleasing to the ear on this bullish evening but my job has been to avoid the drops as well as ride the rallies. Plus I am a natural-born contrarian. So, what am I seeing this evening when all seems sunny and bright?

Signs of an approaching storm:

1. The Bullish Percent Index on the S&P 500 Index stands at 81.00. 81.00!!! Come on, people. There are way too many bulls out there. That reading is not sustainable. I know it. You know it. But we don't want to think about it because the market is going up. It is interesting how herd psychology works. When the market approaches a good time to sell, lopsided readings of bullish sentiment are discounted or ignored.

2. There is negative divergence between the 81.00 reading and the Relative Strength Index (RSI). The RSI has made a lower high and now stands at 79.30. At the same time, the 81.00 reading represents a new high. This divergence portends lower prices ahead. It is a sign of an approaching storm.

3. There is also negative divergence between the MACD lines and the 81.00 reading. The MACD lines have made a lower high and do not support the high 81.00 reading.

4.There is also negative divergence between the MACD Histogram and the 81.00 reading. Once again, we have another sign that the storm is near.

5.Let's look at a daily chart of the S&P 500 Index and what do we see. We see a lower high on the RSI indicator. It is not supporting this recent breakout to new highs on the S&P 500 Index. Negative divergence is also present on the MACD lines.

6. We see an ascending triangle breakout that is paltry. If the market were vibrant and alive, we should be at 1272 levels by now. We are not.

7. Master trader George Angell has documented the existence of a three-day cycle in the financial markets. Actually, the path breaking research was conducted by a little-known grain trader named George Douglas Taylor but Angell expanded upon the idea and made it accessible to the trading community. Taylor observed that there existed a three-day cycle in financial markets. The rallies and declines fooled traders into "buying when they should be selling and vice versa." George Angell, Winning in the Futures Market: A Money-Making Guide to Trading Hedging and Speculating, page 251. The powers that be would create a decline so as to provide a buying opportunity for themselves. And they would create a short-term top three days later so as to provide a selling opportunity. Three days later. Hmmn. Might it be that today's low @ 1219 was a manufactured decline so that the powers that be could buy the S&P on the cheap? And, if so, might this project a short-top three days later this Friday? I wouldn't bet against it.

8.What about a Bull Trap? The market is not a nice place. Everyone is scheming to take money away from everyone else. Did you know that sometimes breakouts fail? And when they do, the declines can be sharp because the bulls who bought the breakout were wrong on the price direction? Bull traps are not announced in advance. You have to watch and observe and assess whether market conditions are supportive of the break out or not.

Listen to Jesse Livermore smoke out a Bear Trap in real time (He was all of 15 years old at the time):

"According to my dope Sugar should have broken 103 by now. The engine wasn't hitting right. I had the feeling that there was a trap in the neighbourhoood. At all events, the telegraph instrument was now going like mad and I noticed that Tom Burnham, the clerk, had left my tickets unmarked where I laid them, and was listening to the clicking as if he were waiting for something. So I yelled at him: "Hey, Tom, what are you waiting for? Mark the price on these tickets--103! Get a gait on!"

Closed at 103, said Tom.

The next quote on Sugar was 108! Livermore just laughed and called over to Tom, "It didn't work that time, did it, old boy?" Edwin Lefevre, Reminiscences of a Stock Operator, pages 18-19.

9. My gut is telling me to sell. Livermore would listen to his instincts. They served him well. Here's an example of market intuition from a successful trader in Market Wizards by Jack D. Schwager:

"In 1980, the year when corn set its record high, I was long the position limit. One night I had the following dream. I'm talking to myself and I say, "Hey Jerry, where is corn going?" "To $4.15.""Where is corn now?" "$4.07." "You mean you are taking all that risk for an extra eight cents? Are you crazy?" I woke up in a flash. I knew I had to get out of my entire corn position as soon as the market opened the next day.

"The next morning, the market opened up a little higher, and I started selling. The market moved a little higher, and I sold more heavily. The market moved up some more. For a minute, I thought the floor broker had executed my order backwards. He hadn't.

"It might have gone up another day, but that was just about the high. Once it started falling, I could never have unloaded a position of my size."

Source: Jack D. Schwager, Market Wizards: Interview with Top Traders, pages 437-38.

Conclusion: There is a storm ahead. I know it. I will act accordingly.

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