Friday, January 12, 2018

SPX and COMPQ: Why There's No Such Thing as an "Overextended" Market

Before we get to the charts, let's talk about the concept of "overextended" as it relates to moves within a market, because this is a term we've been hearing from the talking heads with increasing frequency (as in: "This rally is getting really overextended.").

"Overextended" is one of those terms that sounds meaningful, but which is actually somewhat arbitrary in the grand scheme of things. Terms like this can be misleading to traders, because they really can only be used subjectively, but they are often portrayed as being objective measures.  More on this in a moment.

First, let's define the term:  Typically when someone says a move is “overextended,” they mean it has run beyond what an “average” move would, and they may or may not factor in standard deviations in those calculations.  Thus what is NOT said is that: “the move is overextended in their opinion, according to the rather arbitrary metric of mean or ‘average’ movements and/or standard deviations.”

While “average” movement seems wholly reasonable on a superficial level, one glance at a long-term chart will show you that stocks rarely move in an “average” manner. Instead, they tend to move in somewhat violent fits and starts.

A $10 stock, for example, might rally to $14 in a month, then trade sideways for 3 months. You would be completely correct to look at that sample and say that the “average” gain of that stock over the past 4 months has been $1 per month.  That's true -- but it's irrelevant.  And misleading.  Because in actuality, virtually no stock moves in a steady upwards or downwards manner for long -- so it’s a mistake to look at an average and then judge that anything that falls outside of that average is "unusual" (i.e. — “overextended”).

One only needs to look backwards to understand why: Using our hypothetical stock, our trader has correctly determined that the “average” move of this stock is $1 per month. Let’s rewind him, though, and put him in the real-world past, attempting to actually use his correct average while trading:

We're four months in the past, and the stock is still $10.  Our trader goes long, and the $10 stock starts rallying. It hits $11 in a week. Our trader says, “Well, that’s the ‘average’ move for this whole month already, so I’m getting out of my longs!” He exits.

The stock continues to rally to $12 the next week. Now our trader says, “Whoa, this move is overextended! The average move is only $1/month, and it’s moved twice that much in only two weeks! I’m going short!”  He goes short.

The stock rallies to $13 the next week.  Now our trader says, "Holy cow, this stock has moved TRIPLE its average month already!  This move is now REALLY overextended."  He adds to his underwater shorts.  But now he's rather nervous, so he sets a tight stop (which he probably should have done earlier).

The stock rallies to $14 the next week and our trader is stopped out for a decent loss.  At that point, the stock finally starts correcting.  After a month, it's back to $12.50.  Our trader now realizes that the recent "average" gain of this issue (recency bias) is $1/month, so he "buys the first dip," expecting to see $13.50 next month.  Instead, the correction continues and he is stopped out of those longs for another loss.

So, what happened?  Well, our trader was 100% correct about the $1/month average, yet he still closed his longs far too early, entered short way too soon, went long again at the wrong time, and ultimately exited the total trade for a significant loss.  Why?

Because, as I said at the start:  Stocks don't move in "average" ways; they move in fits and starts.  Indictors often also use standard deviations, but using standard deviations on a mean doesn't eliminate the problems inherent in the base thinking that causes one to arrive at a conclusion of "overextended" in the first place. Standard deviations are still based around a mean.  If means and averages don't work for timing the market (which they don't), then standard deviations above or below these means will likewise not work. 

Indicators such as RSI can move deep into overbought territory and stay pegged there for weeks or months.  If the calculations that underpin these indicators actually worked to tell you when a market was truly "overextended," then that type of thing would never happen.  This is why indicators such as RSI are often more useful during oscillating moves than they are during trending moves.

In truth, moves that fall outside the average are the norm, not the exception.  And that means there really is no such thing as a move that is "overextended."  Except in our minds. 

We can bring in the concept of revisions to the mean over time, but that doesn't help you trade tomorrow.  It may hurt you, in fact, because it can lead to looking down when you should be looking up, and vice-versa.  I myself am even guilty of occasionally using variations of the "overextended" term, but I do understand their relevant priority when I use them -- which is why I have never written anything such as, "This move is due to correct because it's overextended."  I may note it for other reasons (typically I note it in terms of relative strength of a move, and that strong moves tend to beget more strong moves), but I've never once attempt to predict a reversal based on this metric. 

This is why I say that "overextended" is more of a subjective term than an objective one.  Because, really, the measure is rather worthless objectively, at least in terms of how it's so often used, which is to say the move is "due" to reverseThus what's truly being said when someone says, "This rally can't run much farther because it's overextended," is instead more akin to: "I feel this move has run long enough, therefore I will label it 'overextended.'"

As I've said before: "Overbought can always become 'more overbought.'"

I've made the next statement previously many times over the years, but perhaps the explanation above finally sheds light on why I've often said:  There is no such thing as "oversold" in a bear market, and there is no such thing as "overbought" in a bull market.  In other words:  There really is no such thing as objectively "overextended" -- so the sooner you stop prioritizing that concept, the better you'll be equipped to ride a trend for the appropriate amount of time (which is: until the market says you shouldn't).

Anyway, I felt that might be a helpful discussion to have, in light of how often we're hearing the term recently, and how the very concept can be a thorn in people's sides, as opposed to being helpful.

Moving on:  Last update discussed the speculative potential of a correction, but emphasized that unless and until we saw an impulsive decline, we had no reason to actually turn bearish yet.  As it turned out, the decline developed into a clean ABC down, indicating that the rally would continue.

I would like to reiterate that this does not mean we won't, at some point this year, see a larger double-retrace correction as shown in that update, but we simply have to await an impulsive decline before we try to game such a correction.  I tend to think we will see such a correction at some point in 2018 -- but I am aware that such a move could begin from higher prices, potentially from much higher prices.  The reason I'm alert to such a move is because it's in the nature of extended fifths to produce such moves -- but one has to await confirmation, because it's also in the nature of extended fifths to tack on extensions upon extensions beforehand.

As I've tried to assure bears previously, the upshot of this is that there should be a clean retest of the high prior to the BIG leg of any such correction.  So there's really no reason at all to front-run a move like that, because almost nothing good can come of it.  We will likely know it when it's actually here, and I will not be calling it "speculative" after a clean impulse down, I will be calling it "probable."

There's not much to add, chart-wise, as I'm simply taking this as it comes at this point, which I think is the only rational approach.  So far, we've yet to see anything that points the market in the downwards direction for more than a near-term correction -- which is why I've remained "bullish until the market says we shouldn't be" for a long time now.

We'll take a look at COMPQ, because this is the only chart that's worth looking at right now.  COMPQ is continuing to close in on its next upside target.  Even if/when we reach this target, we're going to have to await an impulsive decline before getting too bearish, though -- because that's what this environment dictates.

In conclusion, bears never received confirmation of a pending correction, so it's back to "watch and wait" mode for them.  There is presently potential for another extension (if the market wants one) to reach as high as SPX 2870-90, so we will continue awaiting an impulsive decline before shifting footing.  Trade safe.

Wednesday, January 10, 2018

INDU Update: INDU Captures Next Target and Asks, "Does 2018 Rhyme with 1987?"

It's been an interesting year so far.  SPX has not notched 6 consecutive records this year, something it hasn't done since 1964.  There is also some present similarity to 1987 -- a year which saw a crash, but saw that crash come within the context of a larger bull market.  Most interestingly, the blue chips have created the perfect setup for a very similar situation this year. 

And it might not be too far off, relatively speaking.

Let's focus on just one chart today, but we need to caveat that we do not yet have impulsive declines in any major index, so this must be considered as purely speculative until we do.  As we've seen so many times already, fifth wave extensions love to tack on more fifth wave extensions, so we need to see an impulsive decline to finally signal at least a temporary cap to that trend.

So for right now, let's just mull over the possibilities in the chart below:

If you're wondering where the captured target came from, it was published on 12/29 via the chart below:

Referring back to the first chart (weekly), there would be a certain beauty to an extended fifth wave and a double retrace here, inasmuch as the textbook retrace would almost perfectly back-test the breakout over the long-term trend channel.  That gives the potential some harmony in my mind, and the fact that it fits the wave count to the letter makes me think there's a real possibility for this outcome to occur.

Again, I don't want to get too excited until we see an impulsive decline, but it sure is tantalizing to consider.

Back above the all-time high, of course, and bear possibilities for the first impulsive decline will be dead for the moment.  Amazingly, the last time I spotted an impulsive decline in SPX was back at the very end of November, so it's somewhat mind-boggling that we've gone this long without another one.  Do keep in mind that another new high here would rule out the options for an immediate impulsive decline, but would not entirely negate the potential of the larger correction.

In conclusion, we've reached a big inflection point with some significant bearish potential if (and I cannot overstress the "if/then" nature of this equation) the market forms an impulsive decline here.  For the moment, all we can do from a predictive standpoint is tread water while we await confirmation or negation.  Trade safe.

Monday, January 8, 2018

SPX and RUT: Near-term Inflection Point

Bears want to know "Are we there yet?"  The problem now is, the beginning of this year has been so strong that it historically suggests the odds are quite good for 2018 to end on a high note.  Of course, history is littered with "broken market rules," which is why brokers love to tell you that Past Performance is No Guarantee of Future Results

Accordingly, I never make decisions or predictions based solely on "historical rules."  But by the same token, we'd be idiots to completely ignore historical signals that seem to point strongly in one direction or other.

From a structural standpoint, SPX has reached at least a near-term inflection point, but one that does not currently lend itself to being predictable.  There is potential for a correction to begin here, but we've been avoiding front-running for a reason, so we'll just have to see how the market reacts next:

RUT may actually be more helpful in terms of pending clues, because it has reached a more clearly-defined inflection point than SPX has:

In conclusion, we've reached at least a near-term inflection point in several markets -- but I'm quite pleased with the results of "not front-running" against a potential extended fifth, and that approach has served us very well.  In fact, the only "top" I've called unequivocally in the past few months was at the beginning of December, on the same day that SPX dropped 45 points in an hour, and I called that top only after we saw our first impulsive leg down.  Thus, we'll continue awaiting a similar setup before getting to married to anything bearish, even over the near term.  Trade safe.

Friday, January 5, 2018

SPX and COMPQ Updates

Last update we looked at a detailed micro count, and I very slightly leaned toward the interpretation that we might have a more complex flat (ultimately still due to resolve higher), but while the micro count was correct, the interpretation of it as a flat was not.  It was instead the noted WXY.  Luckily, that was obvious immediately upon the open (as I noted live in our forums).

On the bright side, I'm happy that I did have the micro count correct, which was no easy task in itself.  WXY's are always a pain, because the double-three nature means they can mimic many other patterns:

Bigger picture, we're getting closer to the long-term target in COMPQ, and again, we'd expect all markets to (more or less) "rally together" or "decline together."

SPX is about to tag another channel line:

In conclusion, the larger wave structure is finally reaching the inflection point of a potentially complete fractal, but -- due to the potential for continued fifth wave extensions -- we will continue awaiting a larger impulsive decline before trying to call a top, which is an approach that has served us well for a while.  Trade safe.

Wednesday, January 3, 2018

SPX Update: One More Trick Up Its Sleeve?

So, we've been anticipating another new all-time-high in SPX was still due, and we finally got it... but the market may yet have another trick up its sleeve.

Let's get right to the near-term SPX chart to understand why I say this:

Due to the complexity of the prior wave, I cannot rule out the possibility that wave v of 5 has already begun, but I am a bit more inclined to lean toward the increasingly-complex flat (red ABC) on the chart above.  Thus if the market sustains its breakout, we'll assume the fifth wave is underway; if it doesn't, we'll assume the more complex flat is underway.

Bigger picture, we should be approaching the final fifth before a correction, but please understand that this approach is only structural at this exact moment.  If this fifth wave extends like the last one did, then the price high could still be a ways off.  We'll just have to track it in real-time to determine that.

In conclusion, we did get a new ATH as expected, but, to paraphrase the first Star Wars, "this may not be the fifth wave you're looking for."  Due to complexity, though, it's far from clear (especially since it's basically the same structure we'd have for a WXY), but we should have an answer to that question fairly directly.  Trade safe.

Friday, December 29, 2017

SPX and INDU Updates

Not much has happened in recent sessions, but in the prior update we decided to focus on INDU as our near-term barometer, and it appears that the blue iv correction panned out -- though there's nothing that says it can't grow even more complex:

As usual, we would expect SPX to be in a similar count to INDU.  Bigger picture, it does appear that we're close to wrapping up a larger fifth wave.  Of course, it's always possible we'll see another fifth wave extension -- but the last time that happened, we spotted that extension in real-time just before it unfolded, and adjusted our views higher in tune with the market.  Thus I presume that if this wave shows signs of extending, we will likewise be able to adjust in real-time. 

For this reason, though, it is probably wise for bears to await the first impulsive decline before getting too committed (as has so often been the case during this bull market).

In conclusion, the preferred count has been anticipating that another wave higher was most likely in the cards, and if the rally in futures sticks, then that expectation will pan out.  INDU looks like a possible micro bull nest, so in the event we gap up and reverse immediately, then we might be dealing with a more complex flat.  If we don't reverse immediately, then we probably have a few micro fourth and fifth waves to unwind, and would thus trend higher throughout most of the session.

Since the market is closed on Monday for New Year's Day, I won't be doing another update until Wednesday of next year, at which point I will have trouble remembering to change the dates to "18" instead of "17," so bear with me if the updates seem to be going back in time at some points in January. 

I wish all my readers as safe, healthy, and prosperous New Year.  Trade safe.

Friday, December 22, 2017

INDU Update: Near-term Holiday Fun

There's nothing much to add since the prior update, except to note that it appears we may be undergoing a more complex near-term wave at the moment.  The challenge is that this wave suggests more downside over at least the near-term, but there are at least three different wave degrees which could be impacted, and I'm not certain which one to focus on.

Accordingly, we're just going to look at INDU's chart and let that lead the way for the rest of the market (as INDU often does):

We can see that the most likely outcome is further near-term downside.  Sustained trade north of the ATH would, of course, call that into question and thus nullify the rest of this discussion -- but presuming that doesn't happen, the question (if we break the blue a-wave low) will be:  Which wave degree are we correcting here?  If we sustain a breakdown at the blue i peak, then we're probably in red 4, though it does not need to stretch as low (or remain as high!) as shown -- the area shown is simply the most common zone for a fourth wave at that degree.

If we do continue lower (as I'm leaning toward over the near-term), then bears will be able to hope that ALL OF 5 completed at the most recent all-time high -- but if that's the case, it probably won't be readily apparent.  Nevertheless, it's a possibility to consider.

In conclusion, the near-term now suggests at least a bit more downside is in the cards, with the possibility of more than "a bit."

In other news, the Christmas holiday is upon us, which means the market will be closed on Monday the 25th.  As the result of some family travel issues, it's unlikely I will be able to publish an update on Wednesday the 27th, but I will if I can.

Beyond that, due to certain life-altering events that transpired in my life on Christmas Eve many years ago, Christmas is always a time of contemplation for me personally, and it's become something of "a blog Christmas tradition" to link to a piece I published in 2013, titled:  A Christmas Story -- Reflections on What Matters.

I wish everyone a safe and happy holiday, and whether you read the above linked piece or not, I would encourage everyone to take a moment to consider something my late father once told me, dozens of years ago:  "People are really all there is in this life."  Sometimes in the seemingly-endless quest to maintain "stuff, security, and sanity," it's easy to forget what's important -- especially in that people are both "all there is," and often our greatest source of challenges in life. 

Merry Christmas to all.  Trade, and be, safe.