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Technical Tuesday: Tale of 2 Coiled Springs

By Chris Rowe September 17, 2013 Facebook Logo Twitter Logo Email Logo LinkedIn Logo

The market is strong and the market is weak -- what the heck should you do?

I'll tell you why I'm saying this, and explain the title of the article, in a sec.  But first...

One easy answer is:  Lighten your load until Thursday at noon.  By then we should have our answer on what to do - what to do - what to do.  You can just step out of the way for a few days or reduce your risk exposure for that time frame. 

If you have long-term positions that you don't want to exit and reenter in a few days (for tax reasons), then you can totally hedge your positions with options contracts.  I can't teach you how to do it in this article, but there will be plenty of future events for which you'll need to have this understanding, so if you don't know how, it's not too late to check out our Options GPS course.  Or sign up for one of my future webinars.

But in the meantime, what I just mentioned is one way to neutralize your portfolio, at least to some degree.  Remember, you can hedge or exit 1/2 of your positions, 1/3 of your positions or 1/4 of your positions.  It doesn't have to be all or none.

Be a good, responsible trader/investor and look that dangerous emotional blockade right in the eye and say "not today!".  Half the people reading this right now are imagining exiting their positions and then having the market run in the direction they had originally assumed it was going in -- thus creating the fear of a missed opportunity

1.  There's no such thing as missed opportunity.  That's your mind playing tricks on you.  There's always another opportunity tomorrow, and there are a million opportunities that you missed yesterday (that you just didn't see). 

2.  Why are you still reading?  It's because you also have that fear that you'll get caught on the wrong side of the market's price trend.  So there you have it.  Since that possibility exists in a pretty important way right now (I'll explain), we have to make that a part of our risk calculation.  And we should act accordingly. 

As I've said in recent articles, the way I'm playing this is by using bullish/bearish relative strength strategies.  I just recently slightly decreased my bearish position and slightly increased my bullish position.  You might remember last week's article where I explained how the short-term trend is likely bullish with more fuel to burn, but the longer-term trend shows deterioration. 

... which brings me to the explanation of the title of this article...

"Tale of 2 Coiled Springs"

The short-term trend has some more fuel to it.  In other words, as I described last week, the short-term trend has been a coiled spring (sending prices higher with more fuel to go).  It was certainly not a "crowded trade" that was on the verge of a bearish reversal. 

That short-term strength has been playing out and STILL has more room for short-term upside.  But that might all change based on the Fed meeting, announcement, and forecasts tomorrow, beginning at 2:00pm.  (I said it pays to wait until Thursday at noon because the reaction to the Fed must play out and because we still have Jobless Claims (8:30 am), Existing Home Sales (10:00am), and Philly Fed Index announcements (10:00am) to play through. 

Take a look at the chart below showing the Investors Intelligence Advisor Sentiment Index.  It shows the percentage of advisors polled who said they are bullish (red line) and bearish (blue line). 

I won't get into specifics.  But when the two lines converge, advisors are BEARISH and when the lines diverge they are BULLISH.  The extreme readings are CONTRARY readings.  Thus, when we see a high level of bearishness (like we are seeing now), then the spring is coiled and there is fuel available for a bullish rally (advancing prices). 

When studying the charts below, note the upper chart's (S&P 500's) price action compared to the red and blue (bullish and bearish) lines.

Investors Intelligence Advisor Sentiment Chart 1-Year

Investors Intelligence Advisor Sentiment Chart 5-Years

So, with today's relatively bearish sentiment, if the Fed says what the market wants to hear tomorrow, it could make for a STRONG short-term rally.  And that short-term rally then must decide if it wants to turn into a longer term rally.  (But we'll cross that bridge when we get to it.)

Therefore, it's dangerous to be too bearish.  A short covering rally would be very painful to deal with. 

On the other hand, the longer-term signals we are seeing lately are showing market deterioration.  This could continue to take its time to play out.  Remember, the market is almost 100% focused on the Fed.  If the market interprets Bernanke's words to mean that QE will continue (which seems likely), then the market can push higher for several weeks, even if the long-term bullish trend HAS been deteriorating.

So while one spring is coiled to push the market higher, it's super important to be aware of the other coiled spring in the mix -- i.e. all of the signs of long-term deterioration that I discussed last week. 

What we are seeing is the "grand daddy" of internal indicators -- The NYSE Bullish Percent Index -- telling us that more and more stocks are moving below support levels.  This is happening on an intermediate-term basis (weeks to months) and a long-term basis (months to years).  This has been an extremely highly reliable indicator since I've been trading (1995).  But then, I've never seen this kind of relative strength in the U.S. equity market when compared to all other asset classes (foreign developed markets, emerging markets, fixed income, commodities, currencies, etc.). 

You should definitely respect this indicator (NYSE BPI), but it still makes sense to see what the market thinks about the Fed announcement before taking any major steps.

Don't fear MISSING the move.  Either way, there will be plenty of meat on the bone in 48 hours.