Tonight I want to re-examine the S&P. but before that, I need to attend to two matters:

  1. An apology to all readers of this blog for misleading you. I told you that the Nature of Trends was a best seller. In fact it is not. For a full explanation of what I mean and why I made the error, please read the attached doc file. (retraction1.doc). I do thank all who bought the book - sales have still been healthy thanks to your support. I greatly appreciate that you bought and read it.
  2. Friday’s post engendered over twenty questions. Rob Nichols also posed one to the blog. I’ll answer Rob’s first tomorrow (though part of the answer will be in tonight’s post). The rest, I’ll categorise and answer over the course of the week.

S&P ANALYSIS (all figures cash)

The market’s acceptance above 1406 has raised three probabilities

  1. The pullback to 1258 was a correction in an ongoing bull market (5% probability). Figure 1
  2. This is a a second leg correction of a bear market; a correction that will fail to reach the Primary Sell Zone. Figure 2 (35% probability).
  3. This is a second a leg correction of a bear market; a correction that will fail to reach the Primary Sell Zone. Figure 3 (60% probability).

Let’s consider each scenario in turn.

The first is based on the market bouncing off the top of the Value Area (33% Retracement) at 1291 that will lead to new highs and acceptance above the all time high’s maximum extension. [This idea is similar to one I raised when the S&P bounced off 1354 on April 13. I said at the time that the failure of the market to reach the Primary Buy Zone (after selling off April 7) indicated a breach of 1396. I did think the market would hold below 1406].

Let’s take this idea a little further.

On Nov 10 2007, the market formed a high at 1576 and subsequently closed below 1454. This indicated that a sideways market had formed. The market did not trigger an Upthrust Change in Trend because of the rejection extremes at around the 1270 to 1330 zone i.e. we did not see sufficient bearish conviction to warrant stating that a probable change in trend had occurred. On the other hand, we did see enough bearish conviction to say a 12-month sideways market had probably started.

There are a number of factors against this scenario. The most important is the data provided by GannGlobal (http://www.gannglobal.com/) - (my data base is no where as extensive as theirs and this is the reason I subscribe to their service).

The move down from 1576 to 1258 was 20.25% decline. If we view this as a correction in the yearly trend (12-period swing on a monthly chart), we find that it would exceed mean +3, even if we included the 41% decline of Sept 1932. This makes it unlikely the move was merely a correction. On the other hand, if we view it as the first leg down of a bear market, the 20.25% is within normal boundaries. Given this, I rate this latter scenario as the more likely.

The second scenario normally rates as a 50-50 bet when compared to the scenario that calls for a rally to the Primary Sell Zone. I have reduced its probability because of the FED’s actions.

It is difficult to assess what the FED can, and will do, if the markets again tank. At some point the additional money supply will impact the inflation figures. But as the ECRI’s (http://www.businesscycle.com) most recent report shows, while the economy has slipped into recession, there is no sign of inflation upticking. Because the ECRI produces leading indicators, we will have at least a one-month warning before the normal inflation figures start to rise (ECRI indicators lead the normal indicators by one to three months).

Until inflation starts to uptick, we have ‘an unexpected event’ (http://tradingsuccess.com/blog/a-surprise-orunexpected-event-206.html) in the making i.e. traders will continue to believe that the FED will save the markets by increasing liquidity and they can do this with impunity. It’s only when they realize that the inflation bogeyman is alive and well that we’ll start the next leg down.

If this scenario is correct, there are two areas prior to the Primary Sell zone where a rally may end:

  • 1470 to 1475 (most probable)
  • 1487 to 1492.

The target areas are based on stats, ratio projections and Market Profile theory.

The final scenario is the bread and butter Negative Development pattern. Acceptance below a breakout down point followed by re-acceptance above the Primary Buy Zone, indicates either a resumption of the Higher Time Frame Trend or the formation of sideways market (even if that sideways market eventually leads to a change in trend).

OK, we have looked at the three scenarios; let’s accept for the moment that we will see a rally to at least 1470, what can I see for today?

The most recent leg of the rally since the 1258 has shown 22% lower average volume than the first leg (Figure 4). For this reason, I expect that the market will retest the breakout 1396 to 1404 but hold above 1384. I rate the probability of closing below 1384 at 25% i.e. the pullback is a buying opportunity for a run to 1470s.

Why would these levels produce a pullback? Because the 1422 to 1427 area is the first area of resistance after 1404 (Top of larger Primary Buy Zone). It’s the maximum extension of the smaller sideways pattern and there are some ratio projections in this area. However given the context, I doubt if the market is ready to resume the downtrend.

That’s the S&P for tonight. Tomorrow and the days following, I’ll reply to the questions sent in.

05-05-2008-12m.jpg

Figure 1 12-M Swing

05-05-2008-18d-mkt-profile-f2.jpg

Figure 2 Market Profile PSZ 35% Prob

05-05-2008-18d-mkt-profile-f3.jpg

Figure 3 Market Profile PSZ 60% Prob

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Figure 4 Volume Comparison

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