Equity markets continued their losing streak today with the DOW dropping over 500 points by mid-day before recovering a bit and closing with a 249 point loss. The S&P 500 lost 22 points. The DOW is now down about 12% from last year's Nov.3 high in what is the worst start to the new year in the history of the U.S. stock market. Pessimism, fear and panic is clearly driving this market. Could this be the start of a full blown "crash" similar to
2008 -2009 ? It is possible. We need to look closely at our technical, cycle, and timing parameters to gauge our trading strategy now.
We are now nearing the end of a medium-term cycle in all three of the major broad stock market indices (DOW, S&P 500 and NASDAQ). What this means is that a normal corrective bottom is due in all three indices now or over the next several weeks from which new cycles and new rallies will start. New cycles usually rally strongly for at least two weeks (longer if the market's trend is strongly bullish) so we try to buy as close as possible to the bottom of an old cycle/start of a new one. Today all three indices dropped sharply, made new monthly lows and then snapped back up and recovered nearly half of their losses. This is a bullish signal and could be the sign of an imminent reversal especially since the timing is right for the start of a new cycle. Another bullish sign is that the S&P 500 has taken out its low of Aug. 24 (the start of the cycle) but the DOW has not (yet) taken out its Aug. 24 low (it came very close today). This gives us a case of bullish intermarket divergence and supports the idea of a reversal now.
In a normal market the above analysis would make a good case for going long now in equities for at least a short-term rally; however, this is not a normal market. Its sharp plunge over the last two weeks has been unusually strong and, indeed, directional momentum for all three indices is now 100% bearish. Buying here may be like standing in front of a freight train or trying to catch a bowling ball dropped from the roof of a tall building - not a good idea. If this market drops lower over the next day or two and the DOW breaks below its Aug. 24 low (at 15,370), we could see more downside into the first two weeks of February before the final cycle bottoms are in. We especially don't want to see a strong break and close below 1800 in the S&P 500 as this would mean big trouble for equities and could be the start of a major crash. (The S&P got down to 1812 today but fortunately snapped back up and closed at 1859.)
We need a cautious approach in our trading now because of this market's high volatility and strong downward momentum. If today's lows hold, and the market starts to rally over the next two days, we will consider a long position and will watch for the DOW to exceed and close above 16,100. This would be a sign that a new cycle has started and a rally could get up into a range between 16,600 and 17,200 in the first half of February. If market momentum starts to turn bullish, the rally could go even higher, but right now it looks more likely that such a rally towards 17,000 would soon turn down again, and we would probably be looking to sell short the peak of any surge into the second week of February.
The bottom line here is that we will be watching for the start of a new cycle in the broad stock market over the next few days and an opportunity to ride a significant rally up into the first two weeks of February (and possibly longer). If instead the DOW breaks and closes below 15,370 (and especially if the S&P 500 closes below 1800) we will abandon the idea of a rally and will instead focus on short selling strategies as the market will likely fall much lower.
Still on the sidelines of this market.