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Friday, October 14, 2011 - Short Term Update

|Includes: DIA, QQQ, SPDR S&P 500 Trust ETF (SPY)
Indicators are extreme and possibly starting to show divergences while cycle studies are peaking; the market appears to be topping.

The market moved back up to resistance lead by tech after Google's beat. What was a major drag on equities was the entire financial sector. Frankly, my opinion is that the financial sector is more important than Google's impressive earnings. Essentially, Google is a media company. The financials are the circulatory system of the entire economy. In fact, even though the market closed at the highs of the day, the $BKX could not even reclaim the highs it set in the opening hour of trading.

Little has changed since Wednesday's read; trading indicators are near +1stdev extremes and cycle studies appear to be peaking. Greater than one standard deviation means that 85%-95% of the time, these indicators will close below where they are now. This does not guarantee the market will go down, but it does mean that buying stocks here for a trade is very risky, and unlikely to be profitable. This also means that shorting stocks, once we get a breakdown, is the statistically smart trade. With a risk management method in place, we are playing the high probability trade, and limiting our losses should we be incorrect.

What has changed in my view is the short term sentiment. CNCB has been throwing a daily party at the close for a few days now, enticing viewers with the "news" that the market's performance has been the best in months. Just like the false breakdown last week immediately started chatter of $SPX 1000, prices near the highs of the range have started chatter about going long to catch the impending breakout. Not that it isn't possible, from my view, it just doesn't seem probable.

Trading Indicators:

Notes: The one day close lies at 1.5 standard deviations from the mean: that means that 93.32% of the time, the advance decline line closes lower than current levels, and only closes higher 6.681% of the time.


Notes: The 3 DMA appears to be producing a bearish divergence. The one day close is 1 standard deviation from the mean. This means that 84.13% of the time the $NYUD closes lower than where is closed today, and only closes higher 15.87% of the time.


Notes: The 3 DMA appears to be producing a bearish divergence. The today's close was 1.25 standard deviation above the mean. That means that on average, the $TICK closes lower 89.44% of the time, and only closes higher 10.56% of the time.


Notes: The short term trading ARMS index again is showing an extreme reading, as well as a bearish divergence.

Swing Indicators:

Notes: The 3 & 5 DMA are both above 1 standard deviation from the mean, indicating that the next big swing will most likely be to the downside. The McClellan Oscillator closed at 2 standard deviations from the mean. That means that 97.72% of the time, the McClellan Oscillator closes lower than where it ended today, and only close higher 2.275% of the time.

The trading indicators I follow remain very elevated. While it can be slightly frustrating to "miss out" on a good rally, playing the long side here is simply not the smart trade as far as my methodology is concerned. I know from experience that while this trend feels unstoppable, it is only a matter of time before it ends. According to the indicators I watch, that time is sooner rather than later.

The sell setup is here, I am just waiting for a convincing reversal in price. Owning stocks while everyone is celebrating may feel good, but probability dictates that this is actually the very high risk play. Ironically, the low risk time to buy was the buy setup I pointed out last week, when everyone thought the world was ending. 

Rallying did not surprise me, but the size and speed of the rally certainly has. That said, my Long Term Trend Model is indicating we are in a bear market. We are simply seeing far to much volatility and huge price swings to be in a bull market. Use this fantastic rally to lighten up on remaining equity positions. In the next few months, long term investors will most likely be very glad they are sitting in cash.

We will tak again Monday,
Have a great weekend!
-Bill L.