If the prior week was the important test of the August low, last week's theme was the dark side of what happens when important support breaks. While I wasn't willing to look past the August low as a technical landmark, I knew it had the potential to break. However, there is a difference between trading and gambling. I happen to be in the camp that believes any money manager who banked on the fact the August lows were the 4 year bottom after a correction of only 4 weeks was gambling with his client's money. I also believe that shorts who guaranteed the lows would break weren't doing themselves a service either. I've outlined many instances where there were double bottoms. These are instances where the market is the final arbiter. As we came upon important support, suddenly the p/c dropped with the price action. That was the clue something wasn't right but this condition didn't develop even days ahead of time. The difference in this downtrend is there were no buy signals so anyone who was short required a dose of patience to wait it out and let the market decide.
Had there been a significant bounce at the low that would have been different. Shorts would have been forced to cover. But the whole process of testing the low seemed to have been a slow melt through support by all of the indices until the NDX was left standing alone. I said in this space last week when the NDX was the lone hold out that it didn't really seem like a true positive inter market divergence. Rather, the NDX still had so far to go that the only real reason it didn't take out support was by default. Then we had last Monday. Our markets were closed but the rest of the world melted down. Whatever support was left wiped out by Tuesday morning.
But Tuesday's candle put in a nice reversal attempt as I'm sure there was a certain amount of short covering. If you've been following my work, you know that I'm big on process. One of the prerequisites for even a trading bounce attempt was for smart money shorts to believe there was a valid reason for it and they would start covering. As you know, after a vicious selling wave the first buying always has to be shorts buying back their shares. Where else is buying going to come from? We had a degree of that on Tuesday which was the 55th day of the cycle off the tech high in late October.
My next part of the process is a phrase which may have been coined by Joe DiNapoli, I'm not sure but I've seen him use it in the seminar room. Its called the 'wash and rinse' cycle. This is where a low comes in but is retested fairly quickly. Elliotticians might call it a 5th wave bottom. Whatever it is, the smart money usually waits for the 'other shoe' to drop. That's what happened on Wednesday. That's why we ultimately ended up with the reversal.
So we had some short covering and smart money counter trend activity. We also had the intraday crowd come in to provide liquidity at the relatively low risk to reward ratio. The larger players can't maneuver like that, they need more confirmation. If they come in, you'll have a much larger leg heading north. This is the decision point we are in coming into the new week.
Right now, the situation is tenuous as on Friday morning the NQ topped at 160-5 minute bars and fell for the rest of the day. I don't have the problem with that. The Dow and S&P500 retraced 38% of the bounce with the NDX at 50%. Already, I've heard the 'here we go again' sentiment. What I find interesting is this type of sentiment materializing with half the market only back at the 38% retracement line of the move up. True, tech retraced 50% but I don't get real concerned until a retracement gets beyond 61%. What I find more concerning is the fact we couldn't get beyond the secondary 38% marker on the way up. Across the board, the charts have retraced to the 38% line of the move down off the December 11th high which was the real Santa Claus rally. Part of my strict disciplines is to grade trends and their retracements by the strength of their bounces. Strong trends allow for 38% technical bounces. If a bounce can't take that out, it is not long for this planet.
This week we throw in the wild card with the Fed meeting. Those of you familiar with my work know I don't care much for what the Fed does in the bigger picture, but in the short term, it can create a lot of noise. Then again, for the bigger players to come in, we likely need more than a 'wash and rinse' cycle. What likely has to happen is one of these 'here we go again' legs which retests the low has to hold. Once that happens, we'll likely get a high volume follow through day and a leg that wants to retest the upper end of the range will materialize. The Fed meeting is the 29/30 which means it spills into Wednesday. Tomorrow is day 59 off the October pivot high in tech. Know that what that means? Day 61 is the Fed announcement. Why am I not surprised.
In terms of price, a bigger bounce needs to survive the 38% retracement level. In terms of time, 55-56 day bear leg has to survive the 61 day high to high cycle. Want to see a chart that is challenging both the 38% price and important Fibonacci time resistance at the same point? Look at a chart of the banking index ($BKX). On Friday it hit the 233rd (Fibonacci) day of its trend at the same time it hit a secondary 38% resistance level off an important secondary high made in the middle of September.
Overall, we are in a gray area. The selling was so overextended that it had to bounce. Also consider the fact the selling came all the way down to test the 200 week moving average. If you look at some weekly long term charts you'll see we spend very little time under the 200 wma. But in the times we do fall below it, its very serious. During the old bear, once tech fell below it, we stayed down for well over a year. It is not preordained but if we were to fall below it on decent volume a malaise will set it that will change the mind set not only for traders, but consumers and economists as well. That would be the point of a confirmed long term bear market.
You can see there's a lot at stake this week. Not only are we testing smaller degree 38% levels that are normal happenstance in our technical world but we are also testing whether we go into a deeper bear. We know the Fed is going to cut rates again. We also know that we've been so oversold it would seem that we should have a larger bounce. The lesson we learned from August is when markets get so oversold they usually lead to a trading leg going the other way. However, be cautious and take nothing for granted. Normally, I'd tell you to expect little activity in front of the Fed announcement but I don't think that is going to be the case. People already know what they are going to do. Now we just have to see if this 'here we go again' leg that started on Friday morning can hold the low. If it can, by Wednesday the social mood may improve enough to give us a larger trading bounce.
