Amid extreme market action: A recovery report

Given that the S&P has been positive annually in 75% of the previous 50 years, I will occasionally run across a 27-3 twelve month signal in my daily pattern recognition studies, but it is almost impossible to get such a read on a one day outlook, which has closer to coin toss outcome probability. On Monday's (August 8) Close and Wednesday's (August 10) Close I got the identical unprecedented 29-1 one day (99.7) rating on the daily Volume analysis study, which both preceded 4% daily advances.

Given such an angle, I wanted very much to be significantly long for Thursday, Aug. 11, but was thrown for a loop when the S&P made an assault on the Low at the Bell on Wednesday. It momentarily threw me out of my game plan and the commentary I sent out yesterday occurred while I was still blinded by the headlights thrust upon at the Bell. There were several factors which went into my conclusion over the course of the evening that Long was likely the right side to be on for Thursday.

  1. Although you are not supposed to 'violate' the Low on Day 2 off the bottom, I noticed through manual inspection there were a few occasions where you had similarly 'broached' it within a couple of days of the candidate bottom.
  2. For example, I visually observed that in October of 87, we had one strong up day off the bottom and then 3 consecutive small down days that 'broached' the Low before reversing sharply to the upside. If you could convince yourself that condensing those 3 small candles into one was plausible, they looked identical to what we had today, provided this morning's positive opening. The official retest in 1987 came 6 weeks later.
  3. Also in July 2002, there was a 'broaching' of the intraday Low after two days that sent you sharply higher on Day 3, before an official retest two months later.
  4. The fact that Monday's intraday Low of 1101.50 was not violated over night and we were able to open higher this morning gave me cause to speculate that the 1987 and 2002 scenarios were likely in play again.

It is now my opinion,

  1. We still have not had an 'official' retest of the Low, which should occur sometime 10 to 30 days from now.
  2. If that retest occurs 'successfully' in the time frame expected, we should have a meaningful rally into the end of the year.
  3. If we violate the Low (1101.50) in the next three days, we trade significantly lower.
  4. The past market cracks I have studied, suggest you are well served to fade the 5% moves in either direction until a successful retest occurs.

If you are a trend follower, you would have been well advised to go on vacation for a couple of weeks. If you failed to take some time off from the screen, then make a note to overrule trend following systems for a month after any 5% down day in the S&Ps as gyration is in order.

I am still of the opinion that a year from now, odds favor regret at passing up the opportunity to buy the market at a 5-7% (Earnings yld - 5 Yr Note yld) spread in August of 2011. I say 5-7 to allow for the difference between actual trailing and forecast earnings.

It is my sense the crack psychology technicals dominate trading for the next 3-6 weeks and seasonal, sentiment, and short-term tape studies take a back seat, so view the following seasonal study with that disclosure made. I have an interesting NHNL study, which is a day from developing.

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