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Interpreting DeMark Indicators: All Trends Must End, But the When Is Key


What the DeMark counts suggest is that regardless of your time frame, the upside move in equities is extremely powerful, but it has also used up a lot of buying power.

Is this the end of the party? Again, given how powerful this move has been, it is prudent to wait for a price flip and/or a TD RefClose Down signal. These are objective signs that show that it is more likely than not that the trend has in fact exhausted itself. Within trends not as strong, I may be more inclined to step into a short position without waiting for confirmation; that's a matter of risk appetite.

With daily and weekly trends seemingly exhausted, and to avoid the kind of pitfalls encountered by not looking at the daily counts in the context of the weekly chart, let's take a look at where we stand on a monthly time frame.

Click to enlarge

Here you can see that the TD Buy Setup printed pretty close to the 2008 panic bottom and price flips and TD RefClose Up confirmation registered three months later (white circle). That began the Sell Setup, which completed in the red circle, and was followed by a period of consolidation. The concurrent Combo Sell count was never cancelled and concluded just about simultaneously with a new Sell Setup (green circle). Buying was exhausted at that point, and the SPX corrected about 20%. Because of the way counts are measured, there can be overlapping Combo counts working at the same time, so currently we are on Bar 11 of the latest Combo Sell and on Bar 7 of a Sell Setup. This suggests that we may have a couple more months of higher highs before the Combo Sell and the Sell Setup print simultaneously.

Now that I have you all confused, I'll go back to Minyan Sol's question and see if I can tie the above DeMark primer with an answer.

What the DeMark counts suggest is that regardless of your time frame, the upside move in equities is extremely powerful, but it has also used up a lot of buying power. This buying power has been mostly a function of the re-opening of the corporate bond market back in early 2009. (Read Corporate Bonds, Derivatives, and How They Wag the Equity Markets for an explanation of how and why). While the corporate bond market continues on a buying frenzy, there are times when it too must rest, and there is growing evidence that bond prices have reached exceedingly pricey levels. Exhaustion in multiple asset classes increases the chance of a negative feedback loop if one asset class breaks. So yes, I do believe that we are at levels where risk assets are way overextended and dangerous.

It is somewhat difficult to forecast the breadth of a downward move before the trend even changes, but what was previously resistance on the SPX monthly chart (the TDST Level Up at 1395.29) can now be seen as support, so a move back to that range (if it holds) would not dent the longer term trend for stocks. As for the timing of a trend change, again I am letting price flips and TD RefClose levels be my guide, particularly in light of the power of the current move.

Once/if we get a correction down to the 1395 area, we should have better clues as to its nature. My key "tell" will remain the corporate bond market. Have spreads widened dramatically? Is there new issuance when the price is right? Are late vintage bonds breaking par? What does the credit derivatives market look like? If things remain generally healthy in the corporate bond market, we can ultimately expect another ramp higher. Otherwise, we may have to consider the possibility of a more serious bear market.

Lastly on Clayton Williams and my SPX position: My guru analyst turned cautious on the stock many moons ago when management reverted to its old risky wild-catting ways and stretched its balance sheet too thin. With many other candidates to pick from, I never revisited the story, so at this point I can't offer much more than that. My SPX position is in fact short, but purely as a modest hedge.
Position in SPX.
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