THE MIND-BENDING CONFLICTS THAT TRADERS FACE IN THE WEEKS AHEAD
You want mind-bending levels of difficulty in a complex, volatile structure? The current state of the financial markets is handing it to you, gift-wrapped in a fancy box for your holiday enjoyment.
The fundamental problems we face are strewn throughout the financial media. There is no need for me to regurgitate what has already been dissected a million times over recently. If it's not Europe, it's China. If it's not a recession in 2012, it's a collapse of a significant member of the banking community. The list goes on. The fundamentals are impossible to interpret accurately, much less initiate a trade through whatever insight can be gleaned from such data.
That leaves us with technical data, seasonal data, and the various pieces of anecdotal evidence that we tend to use in an effort to profit. Problems arise when these pieces of data begin to conflict with each other to no end.
Here are the conflicts as I see them:
1. Captain Obvious time: Seasonals. This has been discussed more than the crisis in the EU recently. You all know the story. It's Q4. A seasonally strong period. What I should add that isn't discussed nearly as much is that we are in a Q4 following a double digit decline in Q3. That fact changes everything and in fact, makes the bull case as solid as a rock. Here are the results:
When the market has fallen by more than 10% during the 3rd quarter, a rally in the 4th quarter has not failed since 1957. The last seven instances were:
1974 Q3 -26.12% Q4 +7.9%
1975 Q3 -12.21% Q4 +7.54%
1981 Q3 -11.45% Q4 +5.74%
1990 Q3 – 14.52% Q4 +7.83%
1998 Q3 – 10.32% Q4 +20.85%
2001 Q3 – 15.03% Q4 +10.38%
2002 Q3 – 17.68% Q4 +7.98%
2011 Q3 – 14.38% Q4 +2.48% to date
Needless to say, we're sitting at the very low end of the expected results at present. No study is infallible. Just like every other statistic with respect to the market, the death of this one is inevitable. Will 2011 be the outlier? Answer that question and December will be yours.
2. Verbal and Psychological Sentiment: Negative. It's ugly out there. I am seeing it in the blogosphere. I am seeing it in the anger with which anything bullish is shredded into confetti. Anything having to do with economic infrastructure, whether in the form of banks, Wall Street, government agencies, guys with suits and lots of hair gel is hated to the point of vitriolic nausea that I haven't witnessed since Steve Bartman ruined the Cubs chances of making it to the World Series 2003. Suddenly the whole world is Chicago and Wall Street is Steve Bartman.
3. Positional Sentiment: Here's the canary in the coal mine...pay attention to this one. There is a difference between saying you are bearish and positioning yourself in a bearish manner. For all the talk of bearish Armageddon that exists, how many traders do you who are getting short here? How many traders do you know who are looking to play the much anticipated bounce in the market? All I see are traders looking to get long in fear of missing the bounce. I don't see anybody looking to get short here. That's a problem.
From a positional sentiment angle, it seems that the most difficult position to take here is to sell, not get long. After all, countless oversold indicators are flashing near record readings. Everybody seems bearish, which from a contrarian angle is, in fact, bullish. And the Q4 bounce just has to come.
Most traders and investor seem to be either cautiously long or in cash. That's not nearly as bearish as the verbal sentiment makes things out to be.
The markets will bounce. I promise you this, however: The bounce won't be a first or even second bounce bottom. The mystic of Q4 will insure that too many people hop on the rally train much too quickly in order for the rally to provide stability.
4. Technicals: Price action may be the only truth out there. In complete honesty, I would be having a much better year if I filtered out everything else but price action this year. It has been tremendously accurate, as usual.
If I was locked in an analytical prison of sorts, where the warden only allowed me access to price action without looking or having knowledge of any other tools, I would look at the current technical structure of the market and KNOW that we are headed lower.
This past week, from a price action perspective, was the nail in the coffin. Oversold indicators be damned. Sentiment indicators be damned. Seasonals be damned.
In terms of support levels, 1120 on the S&P 500 is crucial. 2340 on the Nasdaq Composite is huge. And interestingly enough, I have Dow 11,150 as being pretty significant. We could see the Dow level tested on Monday.
For those seeking peace and happiness during this holiday season, may I suggest finding a large area of sand and burying your head in it. Ignorance is indeed bliss.
