Bottom Line: Were certain of only one thing, it's Friday. Thank god it’s Friday!
The dilemma for those who do what we do is figuring out how much of yesterday’s trading was real. Were those actual sellers puking out at the low ($AAPL @ $199?), or not. It's important because it impacts their charts. We’ve seen a lot, but nothing like yesterday's action. The forced margin-call selling likely wiped out more than a hedge fund or two.
Our thought is to judge the action of each sector and name prior to the event. Some of these names (foreign banks and China growth stocks) were heading lower, regardless of the blunders made by fat fingers. How low did they actually go and, more importantly, how fast will they come back are key questions to answer as we form our approach going forward. After a brief rally, our sense is the Specialists will begin unloading their books again. Given all the negative news and fear, you know the short will take another shot or two.
From a wave perspective, yesterday’s hit was either an extended wave 3 or C. If we’re falling in 5 waves, rallies need to be sold into. That’s the beauty of EW, it knows no emotional bias. In either scenario, wave form says we will bounce. How we rally, and how far, will provide the additional clues necessary to determine what the larger-degree labeling will look like.
Near-term, the severity of the oversold condition is intense. The percentage of OEX and NDX components trading above the 20-day MA is at 1 and 0% respectively. There’s only so much it can drop before it has to recover.
After living through what we saw yesterday, nothing should come as a surprise as we try to forecast the future. The psychology couldn’t be more negative, and the wall of worry is probably at an all-time high. Now traders can’t even trust the systems they use to trade. Remember, few were calling for a V-bottom when the lows were reached in March of 2009.
Regardless of the conditions, we continue to rely on what we think makes us special, our tried and true model of analysis. That model, along with our trader instincts, allows us to keep a cool head and prepares us to step up and exploit opportunities, based on a specific risk-reward profile.
The important signs and signals will emerge. They may be well hidden and subtle, but once we spot the important divergences, we will relay them to you.