Here Is The Oversold Bounce I Was Talking About; Intraday Reversal On Huge Volume Ends The Vicious Downtrend

January 23, 2008

When I woke up today, which was an hour later than usual, I witnessed something I was not quite expecting to see: the Nasdaq was down 65 points which, I believe, was almost a 4% loss. It was something I just didn’t expect as I thought a rally was due. My first natural reaction was disappointment as I covered quiet a few shorts.

But then the bottom was put in almost immediately after I woke up. I woke up and I saw the lows and that was it. The market took off and never looked back as a stunning reversal left stock indexes up across the board on huge volume. That kind of reversal, on top of the intraday action and Fed rate cuts, is something that we can not ignore on the short term. To think that stocks should continue to move lower here is just silly, as the market has been moving straight down, falling at one point, intraday, down 16% from the December 27 selloff. It is time to stand aside and let this market get nuts, after that kind of downtrend.

A lot of people, today, have been very quick to call a bottom and I had some close personal friends ask me if the stock market bottomed today. My first reaction is where did my friends here this market news? After getting over that, I then thought to myself that if new traders are calling a bottom, my friends are asking if the market has bottomed, the Fed is still cutting interest rates, and the retail crowd is saying that they are not selling, then we can’t possibly be bottoming here.

To reaffirm this, on my Telechart software, I went back to early 2000 and went day by day through each day of the bear market that ended in October of 2002. The first thing I noticed is that on EVERY initial rally after a lot of selling that came on heavy volume, the gains would be very large on day one along with volume being very impressive. How impressive were the rallies and volume? The nine biggest up days in stock market history all came during this time frame. So one of the worst bear markets we have ever had had the nine biggest up days in the stock market’s history. If that doesn’t seem a bit shocking to you, not much else will.

Today wasn’t one of the biggest up days ever but if you took the Nasdaq’s total move today you still get a very impressive 4%. With this up day I have to remind everyone to not get carried away and call a bottom just yet. This is simply a first day of a rally attempt and should be taken as nothing more or anything less.

What we need to start looking for to get bullish again is for a follow-through day which is the third day the market puts in solid gains on much heavier volume than the day before. The solid gains can range anywhere from 1% to 2% and if it comes on bigger gains then you know you have a very strong market. But the most important thing to do is not get too bullish off of day one.

There was something that I noticed about all the follow through days that did not work, from 2000-2003, compared to the one that launched the big-and-bear bull market from 2002-2007. The bottom came in October of 2002 but the stock market really did not get moving until the March 2003 follow-through. The key to that follow-through day, unlike the rest that came during that bear, is that the selloff that came before the rally came on very low volume.

So what it appears to me is that when you have a heavy volume selloff, in a bear market, if you get a follow-through day, you can pretty much guarantee that you are not going to get a rally that last for more than a few months. But during those few months of a rally, there are always a few gems that end up working that produce some OK gains. You can see them on my ‘past big winners’ section where I am posting all of my best and PRETTIEST (if the uptrend is not green it is not posted) charts, there are always some great stocks out there no matter what the market is doing. Even in this market, there are some stocks I am long that show no signs of any problems and are doing very well.

Going back to the follow-through days, I must remind readers of this blog that do not know about them how they work. Not all follow-through days guarantee a bull market. In fact, during a downtrend, they will all fail…until it does not. In bull markets, as the rally goes along, when these show up after short pullbacks, they usually work. So the first thing to remember is that not all follow-through days launch a big bull market.

But the most important reason that we watch for them is for the simple fact that NO (none, nill, zero, zilch) bull market has EVER started without one. If there is any bull market that you see via your research in any market, you will find a follow-through day.

So to review the follow-through day one more time, remember that no new bull market has ever started without one, not all follow-through days work, follow-through days in an uptrending market normally work no matter what, and follow-through days normally fail in downtrending markets until the selloff that precedes it comes on low volume. Now that you have that down, we can move on.

After the closing bell, I reviewed my positions and am now very disappointed I did not cover more of my shorts yesterday than what I ended up doing. Some of my largest shorts, OF COURSE, reversed hard and many large gains were turned into mediocre to small gains. It was kind of sad, but at the same time, when I compare my trading to the retail crowd that is not doing so well and to certain traders on youtube, I have to say that things are not great but they sure are a lot better than the schmucks that think this business is easy. This is one of the most difficult mental challenges you can ever pursue.

I am still going to stay short some stocks that show know signs of suport. But for the stocks that I want to load up on like GRMN, AAPL, GOOG, RIMM, BIDU, and FSLR, I am going to have to take profits in the four I am already short. The shorts are not big to begin with but the gains are so large and seem like a gift in such a short time that I believe I have to cut them down. However, by keeping a little bit, I will be able to monitor them. It is just a shame that the volume was so large on today’s support. The only thing that would make me excited about shorting these past leaders again is that if today was the only large volume day to the upside. If the stock market does rally, it would be perfect to do it on low volume, so that we can short these stocks at their 50 and 200 day moving averages.

The problem with this is that the vicious selloff has come so far so fast that some of the angles of decent for the ex-leaders are going to be very steep That isn’t necessarily that bad but it is a better setup if the rally last at least a few weeks on low volume to touch the line. Instead the 50 DMA should be rolling over and touching the stock price quite fast. If that is the case, what will probably happen is what happened to stocks like ORCL, INTC and CSCO where they topped, fell too fast, and then had to spend the next three to four months chopping around the 50 day moving average until the 200 DMA setup with the 50 DMA and the stock price to act as a resistance. Once the oversold condition wore off and once the consolidation convinced everyone that these leaders were setting up in new bases, the stocks could finally rollover and start there real selloff.

CSCO started its biggest selloff six months after its top in March 2000, INTC started its biggest selloff five months after the first top–the second top was followed by HUGE selling, and ORCL put in a double top and sold off five months after the Nasdaq topped. Before all of these leaders cracked the more speculative stocks were already cracking and selling off. BIDU, RIMM, GRMN, AMZN, AAPL, FSLR, and GOOG are all a bit different as I do not believe they have bubbles. These stocks do not show signs of being in a tech bubble. They appeared to be wrapped up in the credit bubble that occurred in a ton of industries that then spread over. But there is no doubt they have had exponential moves recently. Another key is that besides GRMN last year and RIMM this year, I don’t think that there were any other splits trying to get these prices down so the retail crowd could buy more. Back in 2000, the name of the game was getting high priced stocks lower so that the general public could buy and help push the prices higher. CSCO split in 92, 93, 94, 96, 97, 98, 99, and 00, ORCL split in 96, 97, 99, and twice in 00, and INTC split in 95, 97, 99, and 00. It was like this for many other high priced stocks.

So it is hard to say these stocks are in a bubble but I still believe they have topped and when the time is right–which should be soon–they will all make great shorts.

Now, I know I am a bit all over the place tonight but that is normally how I always am. The biggest thing I really want you all to be excited about it knowing that when this market is done selling off, rather if it was Wednesday or if it is two years from now, the bull market that will be leashed will give us a fresh new batch of leading stocks to get long. Besides these high quality stocks, there are also going to be max green BOP filled speculative stocks that will break out of BEAUTIFUL bases and go on to make big gains. A replay of 2003 (using it as an example as it was our most recent “perfect” bull market) will happen and there will be more TASR, FMDAY, and IST stocks. I LOADED up on them then and I will load up on them again. Perfect charts always work in fresh brand new bull markets. It is years like 2007 when things fail 75% of the time.

Something to appreciate about the failures of the near-perfect to perfect charts, besides AFSI TESO OIIM and APPY, is that they all started to happen in the last year of our bull run. More near-perfect to perfect charts showed up in 2007 than 2006 which is weird considering the poor months we had last year but the fact that they failed so much was our clue that the market was nearing its end. That can be used as a lesson later on. The next time you are going through a bull market that looks too good to be true and all of a sudden your breakouts are failing then you will know, before it is too late, that it is time to ease up off of margin, be careful about initiating new longs, and selloff stocks that are not moving higher immediately.

So to end this long post remember that we some short term panic in the air today in the big-cap high tech growth stocks but according to the VIX’s lower high today when the market was down almost 4% shows that this market STILL HAS NOT SEEN A TRUE PANIC LOW. YOU CAN NOT HAVE A PANIC BOTTOM, like the schmucks on TV said we did, WHEN THE VIX AND PUT/CALL RATIO IS NOT HITTING NEW HIGHS WHILE THE MARKET IS HITTING A NEW LOW. Besides that the bulls came in today at 41% and bears came in at 31% on the investors intelligence survey which still shows that there is no fear. The bulls must be lower than the bulls before we can start to look for a real bottom. So that makes us 0 for 3 in the fear indicators. So it doesn’t look like nothing more than a bear market spike.

Be careful of the Doug Kass talking heads out there who declared a bottom two weeks ago that are now heavily in the red yet telling us that “here is the bounce.” Yep, nice job, you are only down 5% on the Nasdaq since then with the stocks down even more. If you can watch out for those guys and keep your cash level high, you can escape this bear market with minimum damage. And, one more thing, before yelling and screaming to your friends that “this is the bottom,” remember that MSFT reports its earnings after Thursday’s stock market session at 5:30pm. That is sure to rile the market and if you take a look at its chart and are a believer that objects in motion stay in motion then MSFT should continue lower. However, it is on its 200 DMA so that combined with the bounce could take us higher. Do you see all the different possibilities? This is how you are supposed to view the market.

BE PREPARED FOR EVERYTHING IN A MARKET LIKE THIS AND KEEP YOUR CASH LEVEL HIGH. I AM ALMOST AT 50% CASH NOW AFTER TAKING IN MORE OF MY SHORTS.

Aloha and I will see you in the chat room!!

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