Friday, July 27, 2012

SPX and INDU Updates: Are You a Bull or a Bear?

"Are you a bull or a bear?"  In today's modern world of lightning finance, where stocks are more widely-owned than at any prior time in history, a person's answer to that question is probably even more fundamentally revealing than his or her political affiliation.

But it's a loaded question.  When it comes to investing, trading, charting, and analysis, there are at least two psychological factors which all humans share, but which both need to be controlled and minimized as much as possible in the bull/bear equation:

1.  We all tend to see what we want to see.  In charts (and in life, for that matter), we often find whatever it is we're expecting to find.  This tendency is linked to:

2.  Our desire to be right.  The more consistently we're right about things, the more we feel smart, successful, and valuable.  This is such a deep-seated need that we actually go around the block at times to blind ourselves to anything which could prove us wrong.  Anyone who's married knows that their spouse has weaknesses that he or she refuses to see as true; and so do you and I.

We all have some degree of bias, that's unavoidable.  But as a result of the factors above, we tend to give additional weight and credence to data which supports our underlying bias, because that data actually rewards us emotionally (it appears to prove us "right").  For the same reason, we sometimes discount data or evidence that runs contrary to our bias (it would, heaven forbid, make us "wrong"!).  Most do this without conscious awareness; it actually requires conscious effort to do the opposite -- to suspend bias and "turn the charts upside down," so to speak.

The further emotional challenge is that questioning our bias creates uncertainty.  And as humans, we strongly dislike uncertainty -- we crave a sense of consistency, stability, finality, and resolution.  We want security; we want guarantees and insurance policies; we want our answers simple, straightforward, and easy to comprehend.  Then we want to stop thinking about it.

A quote I've always liked comes from F. Scott Fitzgerald:  "The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function."

There's a simple reason that a fair number of analysts seem to be either perma-bears or perma-bulls, and I can tell you, from my own experience, exactly what I think that reason is: it's simply because it's a heckuva lot easier to operate that way.  Pick a side and stick to it forever, and you save yourself an unimaginable amount of work and stress.  Plus you attract a core group of die-hards who are also "perma" somethings, and everyone is happy, even if they miss a decade of profits because the market went the other way.  Don't get me wrong: this group isn't happy from a financial standpoint (obviously) -- but they are happy on a far more important emotional and psychological level.  The perma-analyst is feeding their basic human need for acceptance, and makes them feel reassured that they are "right."

I bring this up because when I look at the present pattern in, say, the S&P 500 (SPX) chart, I think of a Rorschach ink blot.  I can imagine a psychiatrist asking, "Tell me what you see in this chart," and then passing it around a room full of traders:
"I see a bull!"
"I see a bear!"
"I see my father yelling at me for getting an F in math!"

What do you see?  (Also, to that last trader: it's time to let it go about your father. You're an adult now; take responsibility for your own life!)

I'm sticking with the bearish intermediate outlook (aka: the preferred count) for the time being, because the risk/reward is good, and the count has played out amazingly well, going all the way back to April (it hasn't performed flawlessly, of course, there have been a few minor miscues, but that goes with the territory).  For July, it has performed exceptionally well, and here's a quick review of the preferred count's July performance: 

-- Hit the 1325 bottom within 8 points
-- Hit the 1380 top within 11 points
-- Hit the recent 1329 bottom within 6 points
-- Captured yesterday's rally to 1362

The resounding message of this market has been "don't get greedy on either side of the trade."  Has that changed yet?  I'm not sure.

And the bottom line message I'm trying to convey is: I'm not married to my prior analysis.  Everything is based on the best information available at the time, but the market is a dynamic mechanism and reserves the right to alter its appearance -- so if the picture seems to be changing into something more bullish for the intermediate term, then I'm going to do my best to change footing accordingly.

The short-term picture is muddy as of Thursday's close, and I think new swing highs (above 1380) aren't completely out of the question here; in fact, I'm now roughly neutral on the odds.

Let's take a look at the Rorschach charts and see what we can come up with...

The first chart's focus isn't price; it's a chart I've already shared twice this month.  Now, for the third time in July, the market experienced a huge up-day with somewhat weak internals.  The chart below shows the ratio of advancing volume to declining volume.  Since it's a ratio, it's always relative to the total volume of the day, so it's not seasonally impacted by high or low volume days.  And yet again, Thursday's ratio shows that the accumulation levels were minimal. 

Bulls haven't really committed to these rallies; the rallies appear to be mostly short-covering.  Despite this, on the prior two occurrences this month, bulls have still managed to squeak in some new swing highs, so this indicator doesn't preclude short-term rallies.  It doesn't even preclude intermediate rallies -- it's just one more statistic that gives the bears better odds.

The next chart is the big picture SPX, and discusses the most likely short-term options -- again, it is unclear if the rally has peaked or will continue, but the 62% retrace level we've reached is a higher-than-average spot for a turn to occur, if it's going to. 

The very bullish big picture alternate count is still lurking out there as a potential, and I'm watching for signs that might suggest its appearance, in which case I'll shift intermediate footing.  Based on all the current evidence, that count still appears to be the underdog.

The short-term SPX chart is below, and discusses some key levels that will swing the short-term odds in favor of bulls or bears.  Note that micro wave 4 (small blue label "or 4?) could become more complex and simply chop sideways for a session or three.

Next is the Dow Jones Industrial Average (INDU), which has already exceeded its 62% retrace.  I have labeled this chart with the short-term bullish (still intermediate bearish) potential, which sees a new swing high coming in the area of the "C/(y)" label.  There are more bullish potentials in the present pattern, but they are not currently shown on the chart.

Finally, a short-term Russell 2000 (RUT) chart that suggests a pending bullish buy trigger.  The target, should the trigger become active, is conservative.  There is an aspect of this chart that disturbs me for the bear case, but it's only a potential at present, so I'll discuss it next week if it becomes appropriate to do so.

In conclusion, as I've said for some time, as long as the market stays range-bound, there's not much information being conveyed, and neither the bulls nor bears have crossed any of the key intermediate levels to confirm a more solid outlook.  A few days ago, bears were quite excited -- but at the time, I warned that the bears would accomplish nothing if they couldn't reclaim 1306 (which they didn't do).  So it still appears to be an undecided market. 

The intermediate odds still seem to favor the bears, but to date, there's been nothing in the price action to confirm the indicators -- and price is always the final arbiter.  One more new swing high (marginally higher than 1380) would remain within the tolerance of the intermediate bear outlook.    

Neither side has been able to get anything done in two months, and in the meantime, the pattern has built up a lot of potential energy -- so when it eventually starts breaking more decisively, it should have fuel to run for a while.  Until then, all we can do is take it day by day (which has worked pretty darn well all month) -- and try to shift intermediate footing if and when appropriate.  Trade safe.


  1. I've been following your comments for about 6 months now, and I find them informative, thank you. But, I'm having difficulty in trying to figure out the charts you present. How do I learn how to read your charts Pretzel Logic. Muddling through the S&P charts you present I've sort of gotten through, to a point. But, I would like to understand your explanations of things better than I do. How can I?  I'm having difficulty in finding the red/blue bearish count you explain.   

  2. This article might help: