Something for the Trolls to Choke On -- Back-testing Pretzel's Calls

Every now and then, when they run out of gravel to chew on, trolls stop by and harass me about random things.  As a result, I’ve decided to put together an unbiased back-test of my calls going back to when I first launched this site, in early September of 2011. 

Now, this summary makes one assumption: it assumes that the person reading the projections is making good trade decisions.  For example: taking profit in a target zone when the potential exists for a big move against one's position, as opposed to just holding and (greedily?) hoping for more profit.  It also assumes that stop losses are being used, as suggested by KO levels, or in the body of the articles.

It also assumes that the reader is not abusing leverage and trading instruments like OTM (out of the money) options, which, for many traders, are the equivalent of playing the lottery.  Triple inverse funds would be a close second, and both these vehicles should only be utilized by expert traders.  The majority of traders using instruments like these will lose money, it's just a question of how much and when.

To summarize results, I assumed an active trading style and a $10,000 “hypothetical account,” using one ES (E-mini S&P 500) futures contract at $50 per point.

In each case, I chose the least aggressive target for profit taking.  For example, on a short trade, if the short was suggested at SPX 1200 and the target zone was 1140-1160, I used 1160 as the point of profit taking, regardless of whether the market went lower into the zone (for more theoretical profit) or not.  I used KO levels (knockout levels for the preferred count) as the stop loss levels.

In several instances, I did not use all the “in-between” trading which, for an active trader, could have yielded a higher return.  For example, during the December decline, an active trader could have picked up additional profit by jumping in and out as target zones were reached. I have also not bothered to include things like the DAX and BKX profits in the results summary, though some are mentioned.  These would add additional profits, but the results don’t need the additions.

I'm also skipping a lot of the daily commentary between the big swings, largely in the interest of time.  I'm quite certain without even checking that I didn't get every single daily call correct in the interim between bottoms and tops, and vice-versa.  I'm assuming neutrality of hits and misses for purposes of these numbers, and mainly tracking the bigger swings -- except for September, because September traded within a pretty narrow range.  

For documentation, I have provided links to each article, and a brief summary of the projections and their outcomes.  Below is the cumulative summary of all listed "hypothetical" trades combined:

620 points of profit
97 points of loss 

Over the course of less than 5 months, that’s a net of 523 points of profit. 

This equates to a return of $62,760 per year for $10,000 invested -- or 628% per year. 

So, all I have to say is… Troll THAT, buddy.  ;)  The results stand on their own. 

Especially when one considers that this hasn't been a trending market, but an up and down whipsaw market which has broken a lot of backs.

And now, of course, the obligatory disclaimer:

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including, but not limited to: forum comments by the author or other posters, articles and charts, advertisements, and everything else on this site, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment advisor before making any investment decisions. Past performance does not guarantee future results.

The Calls:

September, 2011 

(Starting with September 4, 2011)
Predicted short term decline from 1177 to 1150.
HIT for 27 points profit
http://pretzelcharts.blogspot.com/2011/09/possible-count-on-es-futures.html

predicted DAX would head to 5100 from current level of 5319 HIT  219 points profit
http://pretzelcharts.blogspot.com/2011/09/can-dax-shed-light-on-spx.html

Predicted bounce from 1150 to 1185-1210 target zone target 1195 HIT 45 points profit
http://pretzelcharts.blogspot.com/2011/09/looks-like-possible-short-term-count.html

Two articles, which have to be taken together --predicted move from 1195 to 1101:
http://pretzelcharts.blogspot.com/2011/09/update-as-of-9-7-close.html
then at 1154, suggested market would bounce to 1174-1187: 
http://pretzelcharts.blogspot.com/2011/09/weekend-update-to-short-term-elliott.html
1195 to 1154 HIT = 41 points profit
1154 to 1174 HIT = 20 points profit

Suggested current wave may have more room to run on upside.  Position = flat
http://pretzelcharts.blogspot.com/2011/09/update-as-of-9-13-close.html

Suggested move from 1166 to 1145.  HIT = 21 point profit
http://pretzelcharts.blogspot.com/2011/09/cmon-bennie-lets-do-twist.html

1129-1140 HIT = 11 points profit.
http://pretzelcharts.blogspot.com/2011/09/elliott-wave-update-9-22-11.html

1142-1155 HIT = 13 points profit.
http://pretzelcharts.blogspot.com/2011/09/weekend-update-without-dennis-miller.html

1162-1101 HIT = 61 points profit.
http://pretzelcharts.blogspot.com/2011/09/spx-update-9-26-11.html


Calling the October Bottom:

Nailed the October low, before and after it happened.  Instructed readers on what to watch for before hand.
http://pretzelcharts.blogspot.com/2011/10/spx-update-10-3-11.html
http://pretzelcharts.blogspot.com/2011/10/spx-update-multi-month-counter-trend.html

I’m going to use the same qualifier of "what to watch for" described in the article above as the entry point – a move below and subsequent whipsaw back into the diagonal (that’s how I traded it, as well).  Thus, long positions taken at 1100 for ride to 1265 target HIT for 165 points.

Calling the October top:

Suggested rally would end shy of 1280 - MISS.  Suggested short entry at 1270 per chart… 1280 stop.  LOSS = 10 points.
http://pretzelcharts.blogspot.com/2011/10/spx-and-ndx-updates-last-call-for-bears.html

Favored view that top was in, suggested using 1256 as key pivot for shorts.
Assuming 1256 short entry going forward.
http://pretzelcharts.blogspot.com/2011/10/spx-and-ndx-update-new-key-levels-which.html

First target zone of 1196-1225 HIT.  Profit = 31 points.
http://pretzelcharts.blogspot.com/2011/11/spx-and-ndx-update-bulls-running-out-of.html

Unsure on whether current wave was 2^nd or 4^th wave.  SPX at 1218.  Suggested target for 4^th wave 1235-1254.  HIT = 17 point profit.  Suggested target for 2^nd wave 1253-1277
http://pretzelcharts.blogspot.com/2011/11/spx-and-ndx-update-so-far-so-good-what.html

Preferred view became that the rally was a second wave, with a target of 1253-1277.  SPX trading at 1238, stop at 1226.97.  HIT for 15 points profit.
http://pretzelcharts.blogspot.com/2011/11/spx-update-bulls-in-control-for-short.html

Suggested market was in topping/reversal zone, short SPX at 1261, stop loss at 1292.  Preliminary target for first leg of decline was 1140, later revised to 1140-1160.
http://pretzelcharts.blogspot.com/2011/11/spx-and-ndx-update-retracement-rally.html


From that point there was a lot of up and down and hemming and hawing on the part of the market.  Nimble traders could have picked up additional points during all this, as new waves became apparent and target zones were posted.  For the sake of time, I’m going to skip ahead, though there was certainly more profit to be gained in the interim period that I’m skipping.

I'm going to post one article from that interim period, because I was particularly proud of this call.  This was back during the November “triangle” that every analyst on the planet was convinced was forming and thought that the market was soon to head higher.  To my knowledge, I was the only one calling for a reversal of the prior trend and a move lower out of the triangle (I’m sure I wasn’t the only one – the key phrase is “to my knowledge”).

How many other technicians convinced their readers to take long positions during that triangle?  Where do you think they sold those longs -- no doubt at the point of max pain.  How much loss did they take?  One never knows, but think about it next time I blow a call.  ;)

http://pretzelcharts.blogspot.com/2011/11/spx-and-bkx-update-next-move-out-of.html

Article above also had a BKX chart, with a suggested target of 34.5-36.25 HIT.  BKX was at 38.01.  Additional profit not included in figures = 5%.

The November bottom:

Suggested first target for wave of November decline was 1140-1160 HIT for 101 points.  Article below also warned readers not to become complacent:

Now, that said, here's where things start to get interesting. Despite the fact that price has performed exactly as I've been predicting, my indicators are now giving some conflicting signals. I'll come back to that in a moment, but first: it's human nature to get complacent when things go perfectly according to plan, as they have for my readers. However, the stock market is no place for complacency. Please don't be tempted to get lazy here; I'd hate to see anyone give up their 100+ points of SPX profit at this point.

http://pretzelcharts.blogspot.com/2011/11/spx-update-crash-1-seasonality-0.html

Then a second time, on November 27^th, the Sunday prior to the rally, I warned of several things, including the fact that the bullish count had reached the bottoming window.  (This bullish chart was originally published in the comments section.)  Some quotes from that article:

One tendency I've observed in many traders over the years is to continue "looking" for things after they've already occurred. Here's an example. Back on Nov. 18, I wrote:

"Assuming my preferred count is correct, market surprises going forward should be to the downside. In third waves, momentum indicators reach oversold and stay there. Bounces that should materialize, often don't."

That has already happened, as indicators have been quite oversold for some time now, and expected bounces have been non-existent to this point. But as I wrote this past Friday, now is the time when I'm finally starting to look for a bounce, because the charts are finally justifying it.

Besides the chart potential, another argument in favor of a bullish move occurring is the fact that everything's gotten so bearish. Something has to give. The market is now like a rubber band that has been stretched to its limit: either it snaps back soon... or it breaks.

But after Thursday's action, I tried to convey on Friday that a bounce definitely became something to be cautious of if you're holding short positions. If we do see a bounce here, I expect it will simply be a snap-back rally, though it could retrace as high as 1220.

I blew the snap-back call.  But I gave readers ample warning of the potential of a 60 point move against their positions with the 1220 target.  I had also given this same warning in Friday's article.  If that's not enough to cause one to cover in the target zone (as I did), I don't know what is.
http://pretzelcharts.blogspot.com/2011/11/spx-update-bounce-or-die.html

I blew the next call (the same as above, the snap-back call).  I told everyone to “sell the bounce.”  Stops should have been placed at 1225, as per the article:

Sustained trade above 1225 would call this count into question, and would lend credence to the bullish alternate count shown yesterday.

SPX was at 1192.  LOSS of 33 points.  Keep in mind that even if one was trading very passively and didn’t capture points in the target zone of 1140-1160, then one should have stopped out at 1225 from the shorts taken in October at 1261.  This is still 36 points of profit for the most passive swing trader.
http://pretzelcharts.blogspot.com/2011/11/spx-update-sell-bounce.html

Once 1225 was violated, I began giving serious weight to the bullish alternate count:

The bullish alternate count has of course, roared into the spotlight, and could in the end prove to be the correct count.
http://pretzelcharts.blogspot.com/2011/12/spx-update-uncle-ben-saves-world.html

The December Top:

On December 2, I began suggesting that the market was in the process of topping again, regardless of whether the bull or bear count was in play.  Suggested target zone for the top was 1260-1280.  We’ll use the low end of 1260 as the short entry.
http://pretzelcharts.blogspot.com/2011/12/spx-update-topping-again.html

There was also a series of articles that followed the article above, and in each one I presented more evidence that a top was forming.


The December Bottom:

On December 18, I suggested active traders may want to take profits in the “safe” 1190-1208 zone.  Profit from 1260 entry = 52 points. From the article:

The blue "Alt: B" target zone is the safer and more conservative target.

Below is only a small excerpt, but in this article I also warned at length about the potential for the more bullish counts to play out.

There are several ways to label the current decline, and if it is indeed the impulse wave the preferred count thinks it is, then it needs to show some acceleration lower soon. There are only so many first and second waves that seem "reasonable" -- after a time, one has to start considering that the whole structure may just be a corrective wave instead.

I do feel that the market is in an area where shorts need to remain aware of a potential rally; bearish sentiment is also reaching levels that have generated rallies in the recent past.
http://pretzelcharts.blogspot.com/2011/12/spx-and-dow-update-critical-week-for.html

On the next day, I warned even further about the bullish rally potential, and suggested a stop loss level of 1231.47.  Once again, even passive swing traders should have profitted over 28 points on the December top.

trade above 1231.47 SPX would indicate that my favored interpretation is incorrect

http://pretzelcharts.blogspot.com/2011/12/spx-and-ndx-update-rally-or-just-blip.html

Then two misses. 

Here I suggested the rally would top at 1254, with a stop at 1267.  LOSS of 13 points.
http://pretzelcharts.blogspot.com/2011/12/spx-and-vix-update-indications-rally.html

Here I suggested the rally would top in the 1269-1310 zone.  Wherever one’s short entry, it should be readily apparent from the articles that followed that above 1310 would be dangerous for bears and thus used as a stop level.  Even though this article suggested that the rally was due to move higher than 1269, we’ll use that as the entry and 1310 as the stop, for a total loss of 41 points.
http://pretzelcharts.blogspot.com/2011/12/spx-euro-and-dollar-update-are-bulls.html

In conclusion, emotions of hope and greed and fear are all trade killers.   Trade safe.

Further Disclaimer:  These results are based on hypothetical or simulated performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under-or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Hypothetical or simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown.

SPX Update: Using Elliott Wave Theory to Choose Entries and Stop Losses

Yesterday the market formed a bearish reversal bar: it gapped higher at the open, but closed solidly in the red.  These types of bars sometimes indicate buying exhaustion.

The market is now as overbought as I've seen it, and if this is still a bear market, then this is a dangerous condition ripe for a serious decline.  If this is a new bull market, then it's par for the course, and the indicators could get even more overbought from here.  Materially, there isn't much to add to the last couple weeks of updates, so I'm going to discuss some of the ways I use Elliott Wave Theory for trading.

The market tagged my target zone yesterday before reversing, and there are now two ways to view the current structure.  I'm going to present both of them -- and then I'm going to talk a little bit about how one can use Elliott Waves to pick entries and exits for a trade, using the the current charts as examples.  This is not going to cover it exhaustively, by any means, but it could serve as a quick primer.  The disclaimer, of course being that none of this is to be taken as trading advice, and you should always consult your investment advisor, your spouse, your lawyer, your doctor, your priest, and a Magic 8 Ball before making any trading or investment decisions, etc..

Anyway, the charts below are the same time frame for the S&P 500 (SPX), but are each labeled slightly differently.  Both interpretations are viable.  So what does one do with this information, when the market "could go up or down"? 

Let's start with the bearish interpretation.  The bearish interpretation would view this as a complete five-wave rally, which would mean a larger decline is due. 

On the bearish chart below, the "c" label marks the potential end of the wave.  Obviously, any trade above that price point indicates that the wave isn't complete, so that becomes one's stop loss level for shorts.  On my charts, I label these as "KO" levels, meaning, in this case, that trade above that level knocks out (invalidates) that interpretation. 

In this particular instance, if one was inclined to go short, as I did yesterday when the rally reached the target zone, then the bullish interpretation (next chart) shows why you don't want to chase the decline and go short at random (you really never want to do anything at random as a trader, but the chart after this one emphasizes that point).

So, one would either wait for a bounce and short from higher levels, where one's stop loss is closer and manageable -- or one would stand aside and wait for the bullish interpretation to get knocked out entirely, since that should act as confirmation that the rally is indeed over.

The chart below shows the bullish interpretation and the knockout level.  If one was undisciplined and shorted at random -- say at a really dumb spot, like 1310 -- then one would be risking 23 points (from 1310 to the 1333 bearish knockout) to gain 14.  Why 14?  Well, because the bullish knockout level is only 14 points lower, at 1296.  If one missed going short near the top and can't get a better entry than our hypothetical dumb trader at 1310, then it's really much smarter to either:

1) Stand aside and wait for the bull count to get knocked out (1296) before considering taking any action on the short side. 
2)  Wait for a bounce back up toward the bearish knockout level (1333), where one can get a lower-risk short entry.

Is this starting to make sense?  There's a method to this madness.

Conversely, if one wanted to play the move from the long side, one could go long near the 1310 support zone and use the 1296 KO as a stop loss level. 

If one was already short, the 1310 zone is a good area to consider taking profits, since it seems almost certain that some type of bounce will develop there -- either a small bounce, or a stronger bounce to brand-new highs.  Needless to say, if the brand-new high scenario plays out, one gives back all of one's short profits and then some.  That's why I take profits often.  Bears can still make money in a bull run; they just have to be smart and nimble, and not turn into pigs (greedy). 

Once one is safely back in cash, one has several options, including the following:

1)  If one is still bearish, one can always short again from higher levels after a bounce. 
2)  Still using the hypothetical 1310 profit-taking level, if no bounce develops -- then worst case, one misses out on 14 points between 1310 and the bull count KO level.  Once the bull count is KO'd, one can always consider fresh shorts, since that should validate the bear case.
3)  If one is bullish, long positions could be taken for a ride up into the bull count target zone.  1296 becomes the SAR level (stop and reverse) for that trade.

Going back to the first chart, I personally wouldn't use the bear count's KO as a SAR level to go long, because it appears that even if the bullish count is playing out, then the rally is entering its final leg -- and with the KO level at 1333 and the lower portion of the target zone only a couple points above, at 1335, the risk/reward seems marginal.

Those are a few basic concepts.  As I said, it's by no means exhaustive.

So, which of the two counts am I favoring?  I thought you'd never ask!  (Yeah, right.)  Well, currently the decline is only three waves, which -- if it stays that way -- indicates it's corrective, which means it's just what it sounds like: a correction to the next larger trend -- which is up.  Tomorrow's action could change that -- if it adds another wave down in a proper Elliott way and turns the decline into a five-wave move, then that could be an indication of a trend change.  But at this exact moment, there's nothing to indicate that the trend has reversed.

If the bullish count is unfolding, then what would usually play out in this type of wave would be a bounce back up toward the mid-1320s and a subsequent decline to roughly 1310, before rallying up into the target zone.  It's also possible that the three wave decline the market formed yesterday was it, in which case all my talk about 1310 is meaningless, because the market is on its way to immediate new highs. 

If the bear count is unfolding instead, then ideally the market needs to keep the bounce that started just before yesterday's close below 1325.30 to keep open the bearish possibility of a nested series of first and second waves, or it needs to head down off the open to create a five wave move.  Note that the bull count could clear 1325.30 and then decline to 1310 without creating any rule violations.  Trade safe! 

The original article, and many more, can be found at http://PretzelCharts.blogspot.com

SPX and VIX Updates: Bears Running Out of Real Estate

Yesterday, the Fed announced that it will continue to keep interest rates low "until late 2014 or until we all get fired, whichever comes first."  The market immediately rallied, as hopeful investors cheered the news that the Fed could get fired.  As I predicted, there was no announcement of QE3, however the Fed has effectively stated that they're going to keep juicing the money supply as much as they feel is necessary to continue driving inflation higher.  Inflation creates higher prices in all asset classes, including of course, stocks and commodities.

It seems to me that the Fed realized some time ago that the scenario they face now is basically "inflate or die."  The practical difficulty they are challenged with is outlined in the quote below (from Paul Samuelson's 1948 Economics textbook):

By increasing the volume of their government securities and loans and by lowering Member Bank legal reserve requirements, the Reserve Banks can encourage an increase in the supply of money and bank deposits. They can encourage but, without taking drastic action, they cannot compel. For in the middle of a deep depression just when we want Reserve policy to be most effective, the Member Banks are likely to be timid about buying new investments or making loans. If the Reserve authorities buy government bonds in the open market and thereby swell bank reserves, the banks will not put these funds to work but will simply hold reserves. Result: no 5 for 1, "no nothing," simply a substitution on the bank's balance sheet of idle cash for old government bonds.

Their hope seems to be that they can keep everything afloat just long enough to move into a recovery period, at which time the economy will pick up and the banks should start lending again.  So far, it's been a pretty tepid recovery, and it's difficult to see what, if anything, has changed since 2011.  The market sure seems to have gotten ahead of itself -- but since the money the Fed pumps to its primary dealers ends up in stocks and bonds, which drives higher prices, reality isn't much of a factor in the market these days.  If you want some illustration of that fact, consider that the Dow is currently at the same price level it was at in early 2007 -- and then compare the fundamentals between then and now.

Fundamentals don't drive the market; liquidity does.

So, fundamentals aside, there's a cardinal rule to Elliott Wave Theory that wave 2 cannot exceed the start of wave 1.  Several indices are still some distance away from violating that rule, however, the Dow Jones Industrial Average (INDU) is only 120 points away from its 2011 high.  12,876 would be the line in the sand for the bear count in the INDU.  And since the Dow leads, it is probably safe to assume that if the Dow knocks out its bear count, the S&P 500 (SPX) would follow soon after.

We're not quite there yet, but it's an awfully close shave for bears right now.  As such, today I'm going to present an alternate long-term bull count alongside the bear count.  If the Dow knocks out its bear count, this bull count is likely to become my preferred view, though I'll have to do a lot more cross-market studies before committing fully to a new preferred count.  I'll need to see what form the knockout takes.  However, I'm getting a bit ahead of myself here, since the market still hasn't knocked out the bear count.  In any case, I wanted readers to get an idea of one possibility (chart below).

There are of course, always other possibilities, but we'll burn that bridge if and when we come to it.  First things first, though. 

Part of the reason I'm giving serious consideration to the bull counts at this stage is that numerous overbought indicators have been failing to generate any sort of meaningful pull-backs in the rally.  This is usually a hallmark of bull markets.  But price is the ultimate indicator, so let's see whether the bear counts get knocked-out or not.

Speaking of indicators, below is yet another top indicator that triggered recently.  This indicator uses the ratio of the Volatility Index (VIX), which measures one-month volatility, to the VXV, which measures three-month volatility.  The VXV is generally more stable, so low readings in this ratio indicate investors have become complacent quite rapidly, which is often a recipe for disaster for equities.  It's not my best "top" indicator, with roughly a 64% win ratio over the prior four years -- but it is yet another addition to a long list of recently-triggered top indicators.

Note the current development of this second signal trigger, about a month after the last one.  The last time this happened at a one month interval is highlighted on the chart, and in that prior instance, the second signal did nail the top.  I've also noted the bullish falling wedge in the VIX (bottom panel), mainly to point out that it might not mean anything.  Recall that the VIX acting bullishly is actually bearish for the broad market, as the VIX rises when the market goes down... however, I recall similar talk of these VIX patterns in the past, and indeed you can see on the chart that the prior two falling wedges both failed.  It seems that VIX traces out falling wedges with some regularity, and I think it's an error to read too much into that pattern on VIX.

But maybe in concurrence with the sell signal trigger, this time will be different.  We'll find out soon enough.

Last but not least, the SPX short term count.  Once again, my alternate count is the one that played out yesterday.  I keep favoring the bearish counts based on the indicators, and as the indicators fail, the bear counts fail with them.  Be that as it may, the current preferred count appeals to me a great deal.  I continue to feel that the first portion of the rally counts best as a leading diagonal first wave, and that suggests the market is now in the final stage of this leg upwards.  This might be the last hope for bears over the intermediate term.  However, until the market knocks out the long-term bear case as outlined earlier, I will continue to play this rally as a bear.

The count below suggests that the market is due one final gasp into the target zone.  If that count is correct, then the rally is finally getting ready to roll over.  Yesterday did have some hallmarks of an exhaustion day.  If that count's not correct and the rally keeps going, then it's likely the INDU will knockout its bear count.

     
In conclusion, if the bear case still holds water, then it's time for the bears to make a stand.  The indicators continue to signal a top -- but if this is no longer a bear market, it would not be uncommon for these indicators to fail.  The price action over the next few sessions is key.  Trade safe.

The original article, and many more, can be found at http://PretzelCharts.blogspot.com

SPX Update: Giving the Bulls Some Airtime

"Everybody knows that the dice are loaded, everybody rolls with their fingers crossed.
Everybody knows the war is over, everybody knows the good guys lost.

Everybody knows the fight was fixed, the poor stay poor and the rich get rich.
That's how it goes... and everybody knows.

Everybody knows that the boat is leaking, everybody knows that the captain lied,
Everybody got this broken feeling, like their father or their dog just died..."

- Leonard Cohen, Everybody Knows

Bears need a game changer.  On Tuesday, the market tested, and held, the critical 1300-1310 zone.  If the bears can't get something going pretty soon here, it's going to turn my system long-term bullish.  The next week or two could become critical.

As I've said before, I'm not a perma-bear.  My system turned long-term bearish some time ago, and it currently remains bearish -- but it's now very, very close to flipping to long-term bullish.  This is as opposed to October 4, when it turned intermediate-term bullish, but remained long-term bearish.

Lest people read this wrong, we're not there yet.  But it seems appropriate to give some thought to the possibility.

While "everybody knows" that the world is in long-term trouble with its mountains of debt and contracting economies, these lousy fundamentals do not preclude a bull market.  The market is driven solely by liquidity -- and if the central banks of the world keep flooding the market with liquidity, then stocks can continue to rally.  This doesn't necessarily mean stocks will be increasing in value in real dollar terms, but it doesn't really matter from a chartist's perspective.  A rally is a rally.   

With Europe now doing its own form of QE, the interesting dynamic at play is that the U.S. equities markets could rally in lock-step with the dollar as Europe floods the system and devalues the Euro.  So for a time, stocks could actually increase in terms of real U.S. dollars as well. 

It seems to me that this gigantic central bank shell game must end eventually; and when it does, it will end very badly.  The governments of the world have been eating all the economic bubbles they themselves created... and as a result, the governments have now become the final massive bubble in this grand economic experiment.  You are what you eat.  They're a bit like the Blob in that old Steve McQueen movie, consuming everything in their path and growing ever more massive -- except the Blob was somewhat more discerning about what it consumed. 

When this massive government bubble does finally burst, as it inevitably must, then there will be nothing and no one left to back-stop it.  And that, my friends, will be a very dark time -- and one that none of us should look forward to. 

Personally, I don't look forward to it; however, I do believe it to be necessary for things to become healthy.  Things can't last when built on a faulty foundation.  The writing on this wall has been pretty obvious since the late 90's, but each time the markets have tried to move back in line with reality, the government steps in and creates more pretend money.  That's how the internet bubble came about; how the housing bubble came about; how the mortgage-backed security mess came about; and why the national debt now borders on being completely unmanageable.

So here we sit, unable to create anything of real value, and unable to produce anything other than greater and greater quantities of pretend money.

But in the meantime, the question on my mind is whether the can has been successfully kicked yet again.  The answer to that question should be revealed by the signals the market sends over the next couple weeks. 

The bullish interpretation of the charts reeks of massive inflation.  I view that as perhaps a scarier resolution to the current ongoing and unresolved crises, because it will ultimately be that much farther to fall.  In any case, I'm watching these things carefully, and if my system flips to long term bullish, then that's how I'll play it going forward.

Let's see if the FOMC meeting can have any impact on the market.  As I've stated, I don't believe there's even a remote chance that QE3 is coming out of this meeting, so it will be interesting to see how the market reacts to that (assuming I'm right, of course).

I'm only going to present one chart tonight, because there's simply not much to add over the last couple weeks-worth of data.  There are two ways to look at the recent decline from the 1322 high.  The bullish view counts the decline as an a-b-c down to a fourth wave bottom, although fourth waves can be quite complex, and as such it could bounce around in a sideways fashion a few more times before rallying again.  If that interpretation is playing out, then the S&P 500 (SPX) is ultimately on its way to 1330 as its next test. 

The bearish count would view the decline as two sets of first and second waves.  If that's correct, then the move lower should accelerate if the recent lows are broken.  If the recent lows are broken, but the move fails to accelerate, then suspect that a more complex correction is playing out, which should ultimately resolve with higher prices. 

On the chart below, I have highlighted some key levels for the bull and bear counts, and also drawn an upside target box in the event the bull count is in play.  I'm hesitant to suggest a target for the bearish possibility at this juncture.  If there's downside follow-through, then I'll add some downside targets in the future.

In conclusion, the market appears to be at an important pivot point for the big picture.  My system remains on a long-term bearish signal, but it's on the cusp of turning bullish.  The next week or two are potentially critical to the bear case.  Trade safe. 

The original article, and many more, can be found at http://PretzelCharts.blogspot.com

SPX Update: Bears' Turn Now?

On Monday, the S&P 500 (SPX) made it into the 1320-1325 target zone I suggested on Friday and reversed; so hopefully the short term wave structures are finally starting to clear up again.  There's been no material change in the counts, however there's now enough structure to target some key price markers for the bulls and bears.

The preferred count believes the rally completed in the target zone yesterday, so the bears' line of defense is fairly obvious: the recent 1322 print high.  If the market moves above 1322.28, then 1330 becomes the next target; and if that falls, then 1345-1350 becomes the target.  The preferred and alternate counts are both reflected on the chart below.

The first alternate count would see yesterday as the completion of wave 3 of c, with 4 down and 5 up still to come -- to rule out that possibility, the bears need to take control of 1296.46.  If the downward movement (assuming we continue down after yesterday's reversal) looks tepid and overlaps the same price territory repeatedly, then I would suspect that this alternate count is in play.

A number of markets ran into resistance yesterday, including the NYSE Composite (NYA) and Dow Jones Industrials (INDU), so this seems like a natural area for bulls to take some profits, and for the remaining sixteen bears to make a stand.  Below is a daily chart of the INDU; the horizontal resistance faced by the INDU yesterday goes back to the 2007 top.

Yet another top indicator triggered on Monday, as the put/call ratio reversed its downtrend from near-historic lows.  This reversal is (yet another) bearish signal.  I'd like to quickly rehash the numerous other top indicators we've covered over the past couple weeks, counting backwards from the most recent:

1) VIX:TNX closed outside its lower Bollinger band, while COMPQ closed above its upper band.
2) Nasdaq volume as a ratio to NYSE volume reached unusual highs.
3) The NYA has formed (and continued) a negative price divergence with the SPX.
4) Daily RSI is in the upper "bear-market bounce, heavily over-bought" zone.
5) Daily MACD remains on the cusp of forming a bearish divergence.
6) My 12-year study on investor sentiment suggests that the current and severe lack of bearish investors is virtually always consistent with a top of some kind.
7) SPY has 4 unfilled gaps below the current market, all within the prior 100 trading days.  History suggests that these gaps will be filled 90% of the time.

These are some of the statistics and indicators which have kept me bearish recently while the bulls ran amok.  Granted, some of these indicators began triggering early, and have kept me from participating on the long side of the market since roughly the 1269 area.  Even if an indicator works 90% of the time, there will always be that 10% of the time when it fails.  I can live with that.  I don't need to trade every move, and when things start to look dicey, then it seems to me that being cautious and patient is not unreasonable.  I'll happily take the 90% odds all day long.

To reiterate another factor, I am virtually certain that QE3 will not be announced this time around.  Currently, my "no QE3 today" record is flawless, and I'd like to keep it that way if possible.  Given all the liquidity flowing into the U.S. from Europe, I would be absolutely shocked if the Fed decided to flood the system further.  In fact, indications suggest that the Fed has quietly been taking steps to contract liquidity.  So they'll probably give more jaw-boning to the numerous "tools" they have available to continue ruling the world, but I strongly doubt they'll take any significant action at this time. 

In conclusion, with several rare, once-a-year (and some even less frequent) top indictors triggering recently, I have to continue to stay with the odds here. I believe there's a very reasonable chance that the top is now in place.  Ultimately, however, top calling is the toughest racket in trading, and this one has been less-than-kind to me -- so until bears can break the rally channel and begin taking over some key price levels, conservative traders may want to give the uptrend the benefit of the doubt.  Trade safe.    

The original article, and many more, can be found at http://PretzelCharts.blogspot.com

SPX and BKX Updates: Rare Top Indicator Triggered on Friday

Before I get to the indicators and market charts, I want to do a quick update about domestic mutual fund flows, with some new data that has come to my attention.

Last week, we discussed the high number of mutual fund outflows which have been ongoing for several months.  Let's take a look at the updated mutual fund flow chart, courtesy of Lee Adler at the Wall Street Examiner, and then the new data I want to discuss.  Here are Lee's comments regarding the chart which follows:

Domestic equity mutual funds had $0.7 billion of net inflows in the week ended 1/1/12, up from $7.1 billion in net outflows the week before, which was the highest level of weekly outflows since August.  This was the first week of inflows since last April, which was nearly coincident with the top of the market at that time.  Total outflows for November were $14.3 billion and for December are estimated at $18.2 billion based on the weekly data. The projection for January based on the first two weeks is for outflows of $13-14 billion. That would continue a bearish signal on the chart.  A continuation of heavy outflows could eventually take a toll on stock prices.

Some analysts are taking the large outflows as a sign that the public is bearish.  I have a different theory, and feel that the recent outflows have little to do with sentiment.  Before I outline my theory, let's first look at some facts:

1)  The personal savings rate in the U.S. has fallen to its lowest level since December 2007 (the early stages of the last bear).

2)  Loans taken against individual retirement savings accounts rose 20% in 2011.

3)  According to Aon Hewitt, nearly one-third of all people with retirement savings accounts have outstanding loans against those accounts.

These facts underpin why I don't think the huge mutual outflows are primarily due to a bearish public, although certainly some are.  Based on the above statistics, it seems to me that a good chunk of these outflows are happening because people actually need the money.  Certainly, demographics are at play as well, since the over-sized baby-boomer generation is gradually retiring and turning from net savers to net spenders; but that's akin to "needing the money."  In any case, I think to just write off the outflows as being symptomatic of a "bearish public" ignores the supporting facts.  The public outflows appear to be a sign that the economy is still quite sick.

That said, we still have the ongoing flood of cash fleeing Europe to give the bulls more firepower.  I'm not going to re-hash this point, as it was already covered in last Wednesday's update, but Europe remains the X-factor in this market, and could be the reason that numerous top signal indicators have failed. 

Speaking of, there was another topping signal triggered late last week.  This is a pretty rare signal, which has only occurred three times in the prior 4 years.  The signal triggers when VIX:TNX closes outside its lower Bollinger band concurrent with a major index closing outside its upper band.  It's a sign the market has become quite overbought and over-confident (complacent).  Compare the current market position with the last two times this signal triggered on the chart below.  The S&P 500 is shown in the top panel.

 
Can Europe blow-up this indicator too?  We'll find out soon enough, I suppose.

The next chart is another top indicator, which has fallen just shy of where I like to place the signal line.  However, last week it reached levels which also frequently coincide with tops.  The indicator compares the volume on the Nasdaq as a ratio of volume to the New York Stock Exchange.  When the ratio meets or exceeds 2.6, it indicates excessive speculation in the "riskier" Nasdaq stocks, complacency, and "rally chasing" by investors.  The ratio recently fell just shy of the 2.6 level, which still indicates a high degree of optimism and complacency.

Again, I ask:  Can Europe blow-up this indicator too?  

In case they do, I have spent some time looking for alternate long-term counts.  Elliotticians seem to be mainly divided down the middle as to what's happening next for the market: some are expecting a top soon, as I am -- others are expecting a massive nose-bleed rally to new all-time highs.  I don't view that as likely, but I suppose if the flood of money from Europe intensifies, it might become conceivable. However, I wanted to see if there was something in-between these two extremes which might be viable, and I think there is.

Now, keep in mind that this chart below is my alternate count, not my preferred view of the long-term -- largely because I continue to believe that the wave off the 2011 highs is an impulse wave, which means new lows are still needed.  However, depending on what happens over the next week or two, the market may give new input that requires me to shift my viewpoint.

This chart also adds another, slightly humorous, top indicator (or bottom indicator, for that matter) to the dozen other ones: 8 out of 10 times when I start giving serious consideration to an count that is markedly more bullish or bearish than my preferred big picture count, a reversal is very nearby.  A little more anecdotal than objective, but maybe publishing this chart will finally trigger the reversal. 

The next chart is the short term SPX wave count.  I can see two likely possibilities in this chart, and I'm pretty torn as to which I'm favoring.  The first is the same count that was shown on Friday, which suggests this wave up still wants to head a little higher, into the 1320's. 

The second (black alternate) has some appealing characteristics, however.  Readers will recall that I previously believed the rally to be part of an ending diagonal;  this black count explains the a-b-c appearance of the rally as being part of a leading diagonal first wave.  This would account for the overall form of the structure, and the fact that the rally has continued despite its presumed completion.

The last chart is the Philadelphia Banking Index (BKX), which also shows a wave structure that appears to be nearing completion. 

In conclusion, there are many indicators, both common and esoteric, which are suggesting that the rally is massively overbought and due for a correction at the minimum -- or a serious decline if my long-term view is correct.  The caveat, of course, is that past performance is never a guarantee of future results, and maybe the goings-on in Europe are temporarily distorting the accuracy of these indicators and wave structures.  Is this time really different after all?  We simply have no way of knowing, so I have to continue to give the benefit of the doubt to the odds... and the odds still favor a top very soon.  Trade safe.

The original article, and many more, can be found at http://PretzelCharts.blogspot.com 

SPX Update: A Discussion on QE3 and the Market's Potential for Disappointment

Since "to QE3 or not to QE3" is once again the big question on investors minds, I'm going to share my thoughts on this before we get to the charts.

The Federal Reserve Board meets next week, and as has become something of a tradition over the past several months, there's been even more QE3 talk lately.  The Fed is starting to sound like the little shepherd boy in that old Aesop's Fable, The Boy Who Cried QE3.  How many more times will this Virtual QE talk work?

Several top economists (I realize this is a bit like saying "several of the world's tallest midgets") are now predicting that the Fed will launch QE3 in the very near future.  Many seem to be predicting this based on the still-abysmal housing market, as recent statistics show that the ratio of homeowner equity to disposable income has fallen to an unprecedented low of 54%.  How more QE would help the housing market is beyond me... if 30-year mortgage rates get any lower, the banks will have to start paying us interest.  Call me old-fashioned, but the housing market's woes seem to be caused by the archaic principle of supply and demand.  Too much supply and too little demand are not going to be solved by the Fed firing up the printing presses again. 

Perhaps the theory is to keep inflation going up, thereby driving housing prices up, thereby bringing current underwater homeowners back to even.  But, my word, at what cost?  If that's their thinking, we're in even worse trouble than we thought with this bunch.  To achieve that level of inflation... homeowners wouldn't be underwater on their mortgages anymore, but gas would be $15 a gallon.  So we'd cure the equity problem, but we'd have the slight new problem that homeowners wouldn't actually be able to afford to heat their homes.  As Robert Heinlein said: "TANSTAAFL: there ain't no such thing as a free lunch."  I'm hoping the Fed has figured this out.    

In any case, I continue to believe that the Fed will not announce QE3 at this time, especially in light of the recent stock market rally.  There are two main reasons I believe this. The first is: why launch QE3 when you can accomplish the same thing just by talking about it?  I don't think it's coincidental that the Fed tries to make a very convincing case before each and every meeting about why they're going to launch QE3 any minute now.  But then Ben comes out of the meeting saying, "Eh, not today.  But we could!  Don't tempt us!" and shakes his finger at the camera.  These guys aren't idiots -- at least, not in regard to the PR department.

The second reason is that in observing the current board, this Fed does not strike me as a proactive body.  Virtually every major action they've taken, including both prior QE's, has been a reaction to the stock market and/or other factors.  There presently seems to be no blatant crisis to react to, since we all know that Europe is fixed for at least a few more minutes; the latest massaged economic numbers aren't horrible by any stretch; and everything has been coming up roses for the market lately -- potentially because institutions are front-running QE3.  The irony is that maybe in front-running QE3, institutional investors are preventing the very situation that needs to occur for the Fed to feel mandated to announce QE3 in the first place.  It may create something of a Catch 22... then again, maybe they just have more information than I do.  We'll find out next week.  

What really steams my boat about the whole thing is that the Fed created most of this mess in the first place -- and then completely failed to anticipate the backlash of their prior actions.  People can blame subprime mortgages and sleazy lenders all they want, but the Fed created that situation.  It's a bit like blaming the punk street dealers for your city's drug problem; the punks are just the pawns, and while they're far from innocent, in order to address the problem one really needs to blame the kingpin distributor.  Now somehow the kingpin Fed is going to "fix everything" by doing what the government always does when it attempts to fix the problems it's created:  it throws even more money at them.  (I'm aware that, technically, the Federal Reserve is not part of the government.  I'm also aware that back in 1995, technically, O.J. Simpson was innocent.) 

In my view, the problems are not going to go away even if the Fed does print more money.  This "hair of the dog" fix may continue to work temporarily, but it seems to me that digging the hole deeper isn't actually a solution.  As Albert Einstein said, "We can't solve problems by using the same kind of thinking we used when we created them."

Alright, off my soapbox and onto the charts.  The market broke through the key resistance level of 1300-1310, and the bears now need to reverse this move quickly, or risk an accelerating melt-up.  The 1300-1310 level hasn't truly been back-tested yet, but if it holds as support, the market could make a fast run to 1350.  Conversely, if it fails as support, the bears have a potentially powerful whipsaw to run with.  While there are numerous indications that the market is overbought, prior melt-ups have sometimes occurred from such levels. 

Today is options expiration, and as I mentioned last weekend, January's OpEx Friday has been solidly negative in 10 of the prior 13 years -- so maybe the bears will get some help there.  A good reversal back under some key levels would make the breakout a whipsaw, and whipsaws usually lead to strong moves in the opposite direction of the prior trend.

If this is indeed Minor Wave (2), it is allowed to retrace up to 100% of the prior wave without violating any structural rules.  However, this weekend I intend on revisiting the long-term charts in depth and doing my best to determine if that scenario still appears to be the most likely (usually this type of decision on my part is a signal for the market to decline immediately). 

Sentiment still seems to indicate that a decline is probable -- since bullish sentiment as measured by the latest surveys is quite elevated, and the put/call ratio is reaching unusual extremes.  There are a lot of investors looking for more rally here, which means there's a big chunk of money already committed to that rally, which means there are less buyers to actually drive that rally.  It would be unusual for a melt-up rally to start with investors as bullish as they are, because the market rarely rewards a crowded trade -- but past performance doesn't guarantee future results and all that.

The short term charts depict essentially the same counts as yesterday.  Both counts were expecting some further upside, which the market provided.  This wave remains one of the more difficult structures I've faced in the past few months.  The challenge is that the entire wave leaves a great deal to interpretation and there has been little in the way of clarity.  The blue wave 1 (below) could conceivably be 1-2, i-ii (see second chart).  The entire third wave is a mess of structures that look more like a-b-c's than impulse waves. As a result, I have simply felt unable to nail down the short-term with much confidence. 

The first chart shows that there are enough squiggles to count this as a complete 5-wave move, although the one-minute chart suggests 1320-25 could still be in the cards for this wave.  1315 could possibly be the top -- but if this wave were behaving normally, I would be more inclined to think 1320ish.  Not surprisingly, it's very unclear. Below 1302, and I would no longer consider 1320 probable over the very short term. 

The second chart is the more bullish interpretation.  The count below suggests that the rally is moving into an acceleration upwards.  I have a hard time wrapping my head around this possibility, because of the ridiculously bullish sentiment and all the bearish secondary evidence.  But I'm trying not to let that evidence blind me to other possibilities, because as I said yesterday, price action always rules.

I think there's a dangerous tendency bears have to look at a rising market and say, "Are these people clueless as to what's actually going on in the world?"  Maybe. Maybe not.  The market doesn't generally do a very good job of pricing reality into the equation, otherwise there would never be crashes in the first place.  For example, the problems of 2008 (and beyond) were all written on the wall in 2007 and earlier -- but the market kept going up anyway, because the majority was simply oblivious. 

To draw another example, the housing market was quite obviously in a bubble for years, but prices kept going up anyway.  It usually takes the majority a long time to catch on, and while you did well to sell your house and walk away in 2005, had you somehow been able to "short" houses and started doing so in early 2005, you would probably have been hurting by the time the housing crash actually got rolling. 

Conversely, the problem with ignoring reality is that the masses tend to catch on all at the same time, and the exits suddenly get crowded fast.  Traders have to walk a fine line in both regards.

Objectively, the action yesterday was bullish.  Price broke out of the bearish "three drives to a top" type pattern that the market was in, and MACD also broke out to the upside.  Bears really need this to be a blow-off head fake, because the market was signaling strength yesterday.

In conclusion, the bottom line is that bears need a quick whipsaw to stay in the game over the short term.  Based on all the evidence, I'm inclined to think the bears will pull out an upset soon.  If indeed institutions are front-running QE3, and no QE3 comes, perhaps that will be the catalyst bears need.  In any case, theories, sentiment, and indicators aside, the current price charts have to be respected.  Trade safe.

The original article, and many more, can be found at http://PretzelCharts.blogspot.com