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Complexity Analysis



Editor's Note: The following analysis was offered this morning via Scott Reamer's technical service. We share this vibe with educational intentions only. For more information regarding Scott's unique approach, please click here.

Funny how one day can change everything. Yesterday was a very important day to our models: breadth, ticks, down vs. up volume, volatility, total volume, momentum: all confirmed the sharp decline. Furthermore (and most importantly), the fractal pattern looks impulsive and price support levels that SHOULD have held if a larger bullish trend (to new annual peaks) did not: they gave way meaningfully. Add to that the bearish confirmation by the transports, and you have a meaningful probability that the bifurcation point recently reached in the markets could have been very large and very important.

Our confidence rating in our assessment goes from medium to high. Of course, we'll try to make sure that further price action confirms our bearish stance (decline should be impulsive and bounce should be labored and corrective) but so far the data coming in is highly supportive of a significant bear trend now, that indeed the March peaks were a large degree peak that should remain for many years.

Recently, with so little to actually write about with respect to our models, we digressed into some background theory on complex systems; specifically writing about heart attacks. Little did we know how appropriate that would be. Recall: "You might be interested to know that the human heart is the same way: the human heart actually beats irregularly - almost chaotically. It's too small a difference in beats per minute for you or I to notice but it happens, and it happens all the time. The interesting part is that on rare occasions, the human heart will beat perfectly regularly - with no change whatsoever in beat cycles. When does this happen? In the few minutes before a heart attack."

Time will tell if something as serious as a market heart attack is taking place, but the sharp decline that we saw yesterday provides strong anecdotal support for the view that negotiated financial markets are in fact complex systems. They are decidedly NOT linear, or driven by econometric, causal relationships. After all, what could have made the DOW swoon 265 points (as I write) when the past 20+ days saw its range become more and more narrow? FedEx's (FDX) results? $60 oil? Of course not (and that statement is mathematically provable). The larger point is this: negotiated financial markets are complex systems that are governed by much larger and much more - well - complex relationships than what, say, the price of oil is. Don't believe what you hear. The market has an internal order all its own. We're still trying to figure that order out, but at least we - and hopefully you - accept the notion that traditional asset pricing models are deeply flawed.

Short term, we'll look for this significant swoon to bounce at some point (probably next week). We will be watching for a move higher to setup positive risk/reward looking for a move below DOW 10,000 if our larger bearish interpretation is correct. Be patient; just like Mr. Market gave longs plenty of time to get out (26 days), he is likely to give patient shorts another good opportunity to get positioned for more declines. Hope floats, after all.

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No positions in stocks mentioned.

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