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How Bearish Should We Get?


While lower prices appear likely, the bigger question is: How much lower?

The market's job is to get you looking the wrong way, and to try to get you to do the exact wrong thing at the exact wrong time. It wants you to short when you should go long, and it wants you to go long when you should be shorting. Back in November, I began leaning bullish, but hesitated to commit to a long-term bull outlook until January, when I became exceptionally bullish -- probability the most long-term bullish I've ever been publicly. My updates were all about the rally continuing to new highs -- and the signs of strength I was seeing. Nobody read the darn things.

I started trying to throw in some bearish stuff so as not to lose readers completely, since most everyone thought I was nuts talking about the S&P 500 (INDEXSP:.INX) rocketing upwards in a "nested third wave rally" to the 1500s and 1600s, and possibly even the 1700s. "What are ya, stupid? The world is a mess, dontchaknow." Believe me, I know. I've been fundamentally bearish for years. But I don't trade my fundamental bias -- my fundamental bias underpins my understanding, but it doesn't help me time the market.

Near the end of May, after the SPX had rallied more than 200 points from January's prices, the mass psychology has reversed. Everyone "knew" it was stupid to ever take on a short position, just like everyone "knew" it was stupid to go long back in January. I assume most thought I was nuts when, on May 28, I suggested it might be Time to Sell the Bounce. I myself thought I might be nuts (and I said as much), especially after the SPX had reversed directly in the middle of May's target zone of 1680-1690. Unlike most people who become more confident after a string of good calls, I become more cautious and start challenging my assumptions all the more rigorously.

I take this approach because the market will eventually rip your face off if you start assuming you are way smarter than it is. I learned that the hard way -- in fact, I'm not ashamed to admit that a little more than a decade ago, I all but completely wiped out my trading account by going "max leverage short" at exactly the wrong time, after a string of good calls. I started thinking I had it all figured out, and decided (since I could do no wrong!) that it was time to knock one out of the park with a massive put options trade. When the trade started going against me, I stubbornly held to my previous views in the face of evidence to the contrary... and I clung to the trade until it was too late. It was an incredibly painful experience. This taught me that we always have to see both sides of the trade -- at least, if we want to survive.

This is why I offer my preferred interpretation, but also try to see the other possibilities and provide levels that hopefully act as waypoints to indicate when the market is breaking from my projections and onto one of the alternate routes. I probably tend to caveat too much sometimes, but I feel this is a better approach than the alternative. People who've read me for a while eventually learn my language and grasp where I feel we're headed through all my "but watch out for this and that" warnings. I don't present alternate counts so that the outlook is "always right" -- in my mind when an alternate plays out over the preferred count, then that means I assigned my probabilities wrong -- I present alternate counts so readers can adjust on the fly and protect themselves where appropriate.

A few times over the past couple months, I've talked in brief about the fact that the recent rally has shown some of the characteristics of an extended fifth wave. I haven't focused on that option however, because up until May 23, the larger wave structure had (in my opinion) remained pointed upwards for the most part. Sometimes it's hard to sort out the options too far in advance, which is one reason I'm a firm believer in staying nimble, and recognizing when the environment may be changing. For reasons discussed above, getting married to a long-term outlook can be an account killer. Everyone can see how the "let's marry our convictions" approach has killed the bears this year, as many kept shorting all the way up, convinced that the rally was "just about to end!"
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