Is This a Low?
We have not yet qualified a break of 777, which is critical to the bullish case.
Lou Reed, "Perfect Day"
Well, that may be a perfect day for Lou, but for the rest of us it involved sitting around watching the S&P 500 and wondering what it all means? Is this, finally, the bottom?
Recall that we first made our case against the low in October of last year in this piece, "The Case Against the Low." At that time, with the S&P 500 (SPX), (SPY) at 910, I was looking for potential signs of exhaustion at 777: "The longer-term time frames remain dominant, and the initial downside target of 777 for the S&P 500 (SPX) looks likely, with potentially even lower prices later in 2009."
Fast forward a little over four months and here we are below 777 with the market nearing some important potential exhaustion points according to several DeMark indicators.
Before we get into where we are today, here's a brief refresher course on the DeMark TD Sequential indicator. If you have no interest in this, feel free to skip ahead to the conclusion below this refresher.
TD Sequential Refresher
TD-Sequential consists of two components, a setup and a countdown period. Numerically, the setup is complete at 9, the countdown at 13. These patterns help identify potential selling or buying exhaustion points. They are probabilistic and dynamic, because markets themselves are probabilistic and dynamic.
Now, what do these 9s and 13s really mean? Because we are looking for a market low, let's focus on TD-Sequential Buy Setup and TD-Sequential Buy Countdown.
The TD-Sequential Buy Setup consists of 9 consecutive closes that are lower than the close four price bars earlier. The criteria for "perfecting" the sell setup is that the LOW of price bar 8 OR 9 be below the low of BOTH bars 6 AND 7.Typically, after a Buy Setup records, a reaction consisting of 1-4 bars takes place before the larger trend resumes.
Once a Buy Setup is in place, the TD-Sequential Buy Countdown can then begin. The difference between Buy Setup and Buy Countdown is that Buy Setup compares the current bar's close with the close of the bar four bars earlier, while Buy Countdown compares the current bar's close with the LOW two price bars earlier. Also, unlike Buy Setup, Buy Countdown need not occur on CONSECUTIVE bars.
That is the quick and dirty overview of TD-Sequential.
On the monthly chart of the S&P 500, we have been monitoring a potential TD Sequential Buy Setup unfolding. February did produce a 9 Buy Setup count, but in order to "perfect" the buy setup, we needed to exceed the low of bars 6 and 7, which was 741.02. Today, the final trading day of the month, the Buy Setup was perfected.
Of course, timing is everything, and it's not as simple as just buying today and hoping for the best. There are a couple of things to consider going forward.
First, the reason 777 was able to be identified as an initial downside target last year was not by some magical formula on my part, but simply arrived at by looking at TD Absolute Retracement levels for the S&P 500.
Last November we were concerned that the 777 retracement level on the S&P 500 would be broken in a "qualified' manner. What does this mean? Simple, in order for a breakdown to be "qualified" the following must happen:
RULES FOR QUALIFICATION
Step 1: The close prior to the breakdown close must be an up close versus the prior bar's close. (i.e. the close 1 price bar ago must be greater than the close 2 price bars ago)
Step 2: The current breakdown price bar's close must be less than the breakdown level
Step 3: The current breakdown price bar's close must be less than the close 1 ago
Step 4: The current breakdown price bar's low must be less than its open
Open Restriction -- The NEXT price bar's open (the bar immediately after the breakdown) must open lower than the 'current' close , and then it must trade lower than its open.
Why such strange rules? Traders have a tendency to extrapolate from the immediate past into the future. Specifically, for a possible downside breakout, if today's close was a down close, a trader typically assumes if there is apparent nearby price support the next day, it will be challenged and exceeded because the market was showing downside momentum by closing lower.
This reasoning is flawed. If the market is already trending down, many trend following traders are, by definition, already invested in the market. So, if everyone, figuratively speaking, has already sold his positions (and gone short), who is left to sell below the support level, maintain a close below it, and insure the next day's open will be below that level, as well?
Consequently, it is more likely a market will follow through on a downside breakout if the preceding close is an up close. In such a situation, it is more than likely the trading community is positioned to the upside on a short term basis and, that implies that most traders believe the trend is up and inclination once a level is broken downside is to dismiss the move. if the close bar before a downside break is a down close then the likely conclusion is that most traders are already short and who is left to perpetuate the move downside. in particular instead of selling the breakdown the market is more likely to rally from that level.
So far, even though we have perfected the monthly TD Sequential Buy Setup by exceeding 741.02 on the downside, we have not yet qualified a break of 777, which is critical to the bullish case. As long as that level remains disqualified as a break, the more likely the market is to recapture it and use it as a springboard to move forward. What we are looking for on the daily chart is a close greater than the close four price bars earlier, followed by a higher high the next day.
And what happens if that level is qualified as a break? The market's next area of attraction is 593, as seen in this chart.
Finally, remember that the buy setup we are currently working on is a monthly buy setup and monthly bars can have extreme ranges and take (obviously) many weeks to unfold in a positive manner. Do not base short-term trades on long-term monthly charts, just as you would not base longer-term positions on hourly or 30-minute charts.
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