Bringing Common Sense to Trading Part II

[PristineTrading 10]

In last week's Chart of the Week (COTW), I explained why there would not be a severe market correction any time soon. However, I did tell you short term the odds are that a minor correction is not that far off as we are coming into what is historically the most bearish time of the year. That being said, we need a common sense way of measuring the likelihood of a historical cycle repeating, rather than blinding following history. Let's look.

 

For a short-term correction to occur there has to be a reason for that to happen, other than just the time of year. Many seasonal periods have failed to produce the expected based on the past. Here is what else has to be in alignment with this time of year.

 

First, in an uptrend, the Void of price resistance has to be closed. Without an area of price supply to the left, prices aren't likely to pullback much. Second, the majorities have to be willing to take on a historical high level of risk with bets that the trend will continue after having doubting it. This is seen through an acceleration of prices moving higher and an increase in speculative leveraged bets. In other words, the trend is now obvious to the latecomers and they are entering close to the worst possible time. This started happening last week.

 

 

In the chart above, prices of the S&P 500 measure by the ETF symbol SPY began accelerating higher the week before last and are nearing resistance. This resistance is also the all-time highs from 2007, so this area will be an obvious point that all will focus on. So why are so many increasing their buying into an area where selling will show up? It always happens that way and I believe that it's just human nature to ignore the obvious risk when greed kicks in. There is also the fear on the part of money managers that they have missed the move and are jumping in.

 

 

The second component needed is speculative leveraged betting and there is no place better to measure that than with the activity of options traders. The chart above displays the number of put options traded verses call options in equities on each day and a 5-day moving average of those daily closes. The 5-day moving average and the daily close have reached a historical level where short-term corrections are not far off. Combined with the upward momentum into prices resistance it tells us that the odds of a short-term correction are high during this bearish yearly time.

 

Historical cycles in the market can be a good guide to timing change, but alone they are not enough. It's the combination of technical concepts and market internals with historical cycles that make them valuable information.

 

All the best,

 

Greg Capra

President & CEO

Pristine Capital Holdings, Inc.