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Is Market Pain Worth Any Gain?


The market put up an incredible show last Thursday and Friday, and this action has longer-term and shorter-term repercussions.

In the last week's Bull Market Timer Weekly Update, we shared serious concerns about short-term divergences in an otherwise healthy backdrop, based on several measures.

The market put up an incredible show last Thursday and Friday. This action has longer-term and shorter-term repercussions.

The market has now suffered four 90% downside days very close to its recent highs. The last such cluster in a bull market occurred in July-August 2007.

Click to enlarge

That begs the question of the year: Is the bull market ending?

The way I look at it, the answer would lie in the bounce from here. In Oct 2007, many market health indicators such as Advance-Decline Lines and important indexes failed to reach July 2007 highs, even as S&P 500, Dow, and the NASDAQ made new highs. In that case, the four 90% downside days provided the first signal to the future turmoil.

Bull markets rarely end without warning signals. So, in the intermediate term, we have to be on alert to monitor several indicators and dozens of market indexes to keep a close eye on the health of this cyclical bull.

On a short-term trading-oriented note, there are numerous oversold readings. For instance, at close yesterday, the percentage of stocks above their 10-day moving average slid to 1% (1%). Last time we saw such an occurrence was in October 2008, amidst extreme volatility in the markets. This denotes the extent of sharp decline, and usually acts as a contrarian indicator.

When we turn a page from market history, here are the two important technical observations:

1. First, in 2008, the market was in a defined bear market and there were several reasons to expect such a dismal market action. For some reasons that I outlined, please see my article from September 11, 2008 entitled: How Vicious Will Bear Be on Its Last Legs?

2. Second, as a wise person said, character is much easier kept than recovered. Once trust is violated, it's often quite difficult to regain it right away. This betrayal of trust usually translates into the possibility of rough market conditions.

Applying these observations to the current market, we see that the market remains above its important support area -- the 200-day moving average (currently at 1095). Such support usually puts up a decent fight before crumbling. Most first-time violations are pardoned. See a visual from 2004-2005.

Click to enlarge

The second takeaway from most of such infractions is that the market goes into a choppy trading pattern in the short-term. It usually transforms into a traders market, oscillating between bands of support and resistance. The selling doesn't usually abate for a while. Unless proven otherwise, I'd like to believe that we might face a similar situation this time, too.

My plan is to trade with most exposure in index ETFs. Even though indexes endured a significant decline last week, they still held up better than most popular individual equity names.

Also, it's pertinent to remember the mere presence of oversold conditions isn't an actionable event; the market has to react to these oversold conditions by a healthy bounce in order to corroborate these oversold conditions.

For now, I'm looking for a bounce, given the oversold conditions. But as shared above, I also think that this bounce may have a short shelf life and would probably lead to a choppy trading environment over the next few weeks.

This is a free sample of an update from Smita's Bull Market Timer.
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Position in SPY, QQQQ

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